[Federal Register Volume 77, Number 100 (Wednesday, May 23, 2012)]
[Rules and Regulations]
[Pages 30595-30764]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-10562]



[[Page 30595]]

Vol. 77

Wednesday,

No. 100

May 23, 2012

Part II





Commodity Futures Trading Commission





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17 CFR Part 1





Securities and Exchange Commission





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17 CFR Part 240





Further Definition of ``Swap Dealer,'' ``Security-Based Swap Dealer,'' 
``Major Swap Participant,'' ``Major Security-Based Swap Participant'' 
and ``Eligible Contract Participant;'' Final Rules

Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules 
and Regulations

[[Page 30596]]


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COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 1

RIN 3038-AD06

SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 240

[Release No. 34-66868; File No. S7-39-10]
RIN 3235-AK65


Further Definition of ``Swap Dealer,'' ``Security-Based Swap 
Dealer,'' ``Major Swap Participant,'' ``Major Security-Based Swap 
Participant'' and ``Eligible Contract Participant''

AGENCY: Commodity Futures Trading Commission; Securities and Exchange 
Commission.

ACTION: Joint final rule; joint interim final rule; interpretations.

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SUMMARY: In accordance with the Dodd-Frank Wall Street Reform and 
Consumer Protection Act of 2010 (``Dodd-Frank Act''), the Commodity 
Futures Trading Commission (``CFTC'') and the Securities and Exchange 
Commission (``SEC'') (collectively, the ``Commissions''), in 
consultation with the Board of Governors of the Federal Reserve System 
(``Board''), are adopting new rules and interpretive guidance under the 
Commodity Exchange Act (``CEA''), and the Securities Exchange Act of 
1934 (``Exchange Act''), to further define the terms ``swap dealer,'' 
``security-based swap dealer,'' ``major swap participant,'' ``major 
security-based swap participant,'' and ``eligible contract 
participant.''

DATES: Effective date. The effective date for this joint final rule and 
joint interim final rule: July 23, 2012, except for CFTC regulations at 
17 CFR 1.3(m)(5) and (6), which are effective December 31, 2012.
    Comment date. The comment period for the interim final rule (CFTC 
regulation at 17 CFR 1.3(ggg)(6)(iii)) will close July 23, 2012.
    Compliance date. Compliance with the element of the CFTC regulation 
at 17 CFR 1.3(m)(8)(iii) requiring that a commodity pool be formed by a 
registered CPO shall be required with respect to a commodity pool 
formed on or after December 31, 2012 for any person seeking to rely on 
such regulation; compliance with such element shall not be required 
with respect to a commodity pool formed prior to December 31, 2012.

FOR FURTHER INFORMATION CONTACT: 
    CFTC: Jeffrey P. Burns, Assistant General Counsel, at 202- 418-
5101, jburns@cftc.gov, Mark Fajfar, Assistant General Counsel, at 202-
418-6636, mfajfar@cftc.gov, Julian E. Hammar, Assistant General 
Counsel, at 202-418-5118, jhammar@cftc.gov, or David E. Aron, Counsel, 
at 202-418-6621, daron@cftc.gov, Office of General Counsel; Gary 
Barnett, Director, at 202-418-5977, gbarnett@cftc.gov, or Frank 
Fisanich, Deputy Director, at 202-418-5949, ffisanich@cftc.gov, 
Division of Swap Dealer and Intermediary Oversight,Commodity Futures 
Trading Commission, Three Lafayette Centre, 1155 21st Street NW., 
Washington, DC 20581;
    SEC: Joshua Kans, Senior Special Counsel, Richard Grant, Special 
Counsel, or Richard Gabbert, Attorney Advisor, at 202-551-5550, 
Division of Trading and Markets, Securities and Exchange Commission, 
100 F Street NE., Washington, DC 20549-7010.

SUPPLEMENTARY INFORMATION:

I. Background

    On July 21, 2010, President Obama signed the Dodd-Frank Act into 
law.\1\ Title VII of the Dodd-Frank Act established a statutory 
framework to reduce risk, increase transparency, and promote market 
integrity within the financial system by, among other things: (i) 
providing for the registration and regulation of swap dealers and major 
swap participants; (ii) imposing clearing and trade execution 
requirements on standardized derivative products; (iii) creating 
recordkeeping and real-time reporting regimes; and (iv) enhancing the 
Commissions' rulemaking and enforcement authorities with respect to all 
registered entities and intermediaries subject to the Commissions' 
oversight.
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    \1\ 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 may be accessed at http://www.cftc.gov/LawRegulation/OTCDERIVATIVES/index.htm.
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    The Dodd-Frank Act particularly provides that the CFTC will 
regulate ``swaps,'' and that the SEC will regulate ``security-based 
swaps.'' The Dodd-Frank Act also adds definitions of the terms ``swap 
dealer,'' ``security-based swap dealer,'' ``major swap participant,'' 
``major security-based swap participant'' and ``eligible contract 
participant'' to the CEA and Exchange Act.\2\ Section 712(d)(1) of the 
Dodd-Frank Act further directs the CFTC and the SEC, in consultation 
with the Board, jointly to further define those terms, among others.\3\
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    \2\ See Dodd-Frank Act sections 721 and 761. Sections 721(b)(2) 
and 761(b)(2) also provide that the CFTC and SEC may by rule further 
define any other term included in an amendment made by Title VII to 
the CEA or the Exchange Act, respectively.
    \3\ In addition, section 712(d)(1) directs the CFTC and SEC, in 
consultation with the Board, jointly to further define the terms 
``swap,'' ``security-based swap,'' and ``security-based swap 
agreement.'' These further definitions are the subject of a separate 
rulemaking by the Commissions. See CFTC and SEC, Notice of Proposed 
Joint Rulemaking, Further Definition of ``Swap,'' ``Security-Based 
Swap,'' and ``Security-Based Swap Agreement''; Mixed Swaps; 
Security-Based Swap Agreement Recordkeeping, 76 FR 29818 (May 23, 
2011) (``Product Definitions Proposal''). Section 712(d)(2)(A), in 
turn, provides that the Commissions shall jointly adopt such other 
rules regarding the definitions set forth in section 712(d)(1) as 
they ``determine are necessary and appropriate, in the public 
interest, and for the protection of investors.''
    In addition, section 721(c) of the Dodd-Frank Act requires the 
CFTC to adopt a rule to further define the terms ``swap dealer,'' 
``major swap participant,'' and ``eligible contract participant'' 
for the purpose of including transactions and entities that have 
been structured to evade Title VII. Also, section 761(b) of the 
Dodd-Frank Act permits the SEC to adopt a rule to further define the 
terms ``security-based swap dealer,'' ``major security-based 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 Title VII.
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    In December 2010, the Commissions proposed rules and 
interpretations to further define the meaning of the terms ``swap 
dealer,'' ``security-based swap dealer,'' ``major swap participant,'' 
``major security-based swap participant,'' and ``eligible contract 
participant.'' \4\ The Commissions received approximately 968 written 
comments in response to the Proposing Release.\5\ In addition, the 
Staffs of the Commissions participated in approximately 114 meetings 
with market participants and other members of the public about the 
Proposing Release,\6\ and the Commissions held a

[[Page 30597]]

Joint Public Roundtable on the proposed dealer and major participant 
definitions.\7\ After considering the comments received, the 
Commissions are adopting final rules and interpretations to further 
define these terms.
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    \4\ See CFTC and SEC, Notice of Proposed Joint Rulemaking: 
Further Definition of ``Swap Dealer,'' ``Security-Based Swap 
Dealer,'' ``Major Swap Participant,'' ``Major Security-Based Swap 
Participant'' and ``Eligible Contract Participant,'' Securities 
Exchange Act Release No. 63452, 75 FR 80174 (Dec. 21, 2010) 
(``Proposing Release'').
    Prior to issuing the Proposing Release, the Commissions issued a 
joint Advance Notice of Proposed Rulemaking (``ANPRM'') requesting 
public comment regarding the definitions of the terms ``swap,'' 
``security-based swap,'' ``security-based swap agreement,'' ``swap 
dealer,'' ``security-based swap dealer,'' ``major swap 
participant,'' ``major security-based swap participant,'' and 
``eligible contract participant.'' See CFTC and SEC, Advance Notice 
of Proposed Joint Rulemaking: Definitions Contained in Title VII of 
Dodd-Frank Wall Street Reform and Consumer Protection Act, 
Securities Exchange Act Release No. 62717, 75 FR 51429 (Aug. 20, 
2010). The Proposing Release and these final rules both reflect 
comments received in response to the ANPRM.
    \5\ Comment letters received in response to the Proposing 
Release may be found on the Commissions' Web sites at http://comments.cftc.gov/PublicComments/CommentList.aspx?id=933 and at 
http://www.sec.gov/comments/s7-39-10/s73910.shtml.
    \6\ Summaries of these staff meetings may be found on the 
Commissions' Web sites at http://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/DF_2_Definitions/index.htm and http://www.sec.gov/comments/s7-39-10/s73910.shtml#meetings.
    \7\ A transcript of the roundtable discussion and public 
comments received with respect to the roundtable may be found on the 
CFTC's Web site at http://www.cftc.gov/PressRoom/Events/opaevent_cftcsecstaff061611.
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II. Definitions of ``Swap Dealer'' and ``Security-Based Swap Dealer''

    The Dodd-Frank Act definitions of the terms ``swap dealer'' and 
``security-based swap dealer'' focus on whether a person engages in 
particular types of activities involving swaps or security-based 
swaps.\8\ Persons that meet either of those definitions are subject to 
statutory requirements related to, among other things, registration, 
margin, capital and business conduct.\9\
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    \8\ See section 721 of the Dodd-Frank Act (adding Section 1a(49) 
of the CEA, 7 U.S.C. 1a(49), to define ``swap dealer'') and section 
761 of the Dodd-Frank Act (adding Section 3(a)(71) of the Exchange 
Act, 15 U.S.C. 78c(a)(71), to define ``security-based swap 
dealer'').
    \9\ The Dodd-Frank Act excludes from the Exchange Act definition 
of ``dealer'' persons who engage in security-based swaps with 
eligible contract participants. See section 3(a)(5) of the Exchange 
Act, 15 U.S.C. 78c(a)(5), as amended by section 761(a)(1) of the 
Dodd-Frank Act.
     The Dodd-Frank Act does not include comparable amendments for 
persons who act as brokers in swaps and security-based swaps. 
Because security-based swaps, as defined in section 3(a)(68) of the 
Exchange Act, are included in the Exchange Act section 3(a)(10) 
definition of ``security,'' persons who act as brokers in connection 
with security-based swaps must, absent an exception or exemption, 
register with the SEC as a broker pursuant to Exchange Act section 
15(a), and comply with the Exchange Act's requirements applicable to 
brokers.
     In mid-2011, the SEC issued temporary exemptions under the 
Exchange Act in connection with the revision of the ``security'' 
definition to encompass security-based swaps. Among other aspects, 
these temporary exemptions extended to certain broker activities 
involving security-based swaps. See ``Order Granting Temporary 
Exemptions under the Securities Exchange Act of 1934 in Connection 
with the Pending Revision of the Definition of ``Security'' to 
Encompass Security-Based Swaps, and Request for Comment,'' 
Securities Exchange Act Release No. 64795 (Jul. 1, 2011), 76 FR 
39927, 39939 (Jul. 7, 2011) (addressing availability of exemption to 
registration requirement for securities brokers).
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    The CEA and Exchange Act definitions in general encompass persons 
that engage in any of the following types of activity:
    (i) Holding oneself out as a dealer in swaps or security-based 
swaps,
    (ii) making a market in swaps or security-based swaps,
    (iii) regularly entering into swaps or security-based swaps with 
counterparties as an ordinary course of business for one's own account, 
or
    (iv) engaging in any activity causing oneself to be commonly known 
in the trade as a dealer or market maker in swaps or security-based 
swaps.\10\

    \10\ See CEA section 1a(49)(A), 7 U.S.C. 1a(49)(A); Exchange Act 
section 3(a)(71)(A), 15 U.S.C. 78c(a)(71)(A).
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These dealer activities are enumerated in the CEA and Exchange Act in 
the disjunctive, in that a person that engages in any one of these 
activities is a swap dealer under the CEA or security-based swap dealer 
under the Exchange Act, even if such person does not engage in one or 
more of the other identified activities.

    At the same time, the statutory dealer definitions provide 
exceptions for a person that enters into swaps or security-based swaps 
for the person's own account, either individually or in a fiduciary 
capacity, but not as a part of a ``regular business.'' \11\ The Dodd-
Frank Act also instructs the Commissions to exempt from designation as 
a dealer a person that ``engages in a de minimis quantity of [swap or 
security-based swap] dealing in connection with transactions with or on 
behalf of its customers.'' \12\ Moreover, the definition of ``swap 
dealer'' (but not the definition of ``security-based swap dealer'') 
provides that an insured depository institution is not to be considered 
a swap dealer ``to the extent it offers to enter into a swap with a 
customer in connection with originating a loan with that customer.'' 
\13\ The statutory definitions further provide that a person may be 
designated as a dealer for one or more types, classes or categories of 
swaps or security-based swaps, or activities without being designated a 
dealer for other types, classes or categories or activities.\14\
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    \11\ See CEA section 1a(49)(C), 7 U.S.C. 1a(49)(C); Exchange Act 
section 3(a)(71)(C), 15 U.S.C. 78c(a)(71)(C).
    \12\ See CEA section 1a(49)(D), 7 U.S.C. 1a(49)(D); Exchange Act 
section 3(a)(71)(D), 15 U.S.C. 78c(a)(71)(D).
    \13\ See CEA section 1a(49)(A), 7 U.S.C. 1a(49)(A).
    \14\ See CEA section 1a(49)(B), 7 U.S.C. 1a(49)(B); Exchange Act 
section 3(a)(71)(B), 15 U.S.C. 78c(a)(71)(B).
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    In the Proposing Release, the Commissions proposed rules to 
identify the activity that would cause a person to be a dealer,\15\ to 
implement the exception for de minimis dealing activity,\16\ to 
implement the exception from the swap dealer definition in connection 
with the origination of loans by insured depository institutions,\17\ 
and to provide for the limited purpose designation of dealers.\18\ The 
release also set forth proposed interpretive guidance related to the 
definitions.
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    \15\ See proposed CFTC Regulation Sec.  1.3(ggg)(1); proposed 
Exchange Act rule 3a71-1(a), (b).
    \16\ See proposed CFTC Regulation Sec.  1.3(ggg)(4); proposed 
Exchange Act rule 3a71-2.
    \17\ See proposed CFTC Regulation Sec.  1.3(ggg)(5).
    \18\ See proposed CFTC Regulation Sec.  1.3(ggg)(3); proposed 
Exchange Act rule 3a71-1(c).
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    After considering the comments received, the Commissions are 
adopting final rules and interpretations to further define the terms 
``swap dealer'' and ``security-based swap dealer.'' In this Adopting 
Release, we particularly address: (i) The general analysis for 
identifying dealing activity involving swaps and security-based swaps; 
(ii) the exclusion from the ``swap dealer'' definition in connection 
with the origination of loans by insured depository institutions; (iii) 
the application of the dealer analysis to inter-affiliate swaps and 
security-based swaps; (iv) the application of the de minimis exception 
from the dealer definitions; and (v) the limited designation of swap 
dealers and security-based swap dealers.

A. General Considerations for the Dealer Analysis

1. Proposed Approach
    The proposed rules to define the activities that would lead a 
person to be a ``swap dealer'' and ``security-based swap dealer'' were 
based closely on the corresponding language of the statutory 
definitions.\19\ The Proposing Release further noted that the Dodd-
Frank Act defined the terms ``swap dealer'' and ``security-based swap 
dealer'' in a functional manner, and stated that those statutory 
definitions should not be interpreted in a constrained, overly 
technical or rigid manner, particularly given the diversity of the swap 
and security-based swap markets. The Proposing Release also identified 
potential distinguishing characteristics of swap dealers and security-
based swap dealers based on the functional role that dealers fulfill in 
the swap and security-based swap markets, such as: dealers tend to 
accommodate demand from other parties; dealers generally are available 
to enter into swaps or security-based swaps to facilitate other 
parties' interest; dealers tend not to request that other parties 
propose the terms of swaps or security-based swaps, but instead tend to 
enter into those instruments on their own standard terms or on terms 
they arrange in response to other parties' interest; and dealers tend 
to be able to arrange customized terms for

[[Page 30598]]

swaps or security-based swaps upon request, or to create new types of 
swaps or security-based swaps at the dealer's own initiative.\20\
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    \19\ See CFTC Regulation Sec.  1.3(ggg); Exchange Act rule 3a71-
1(a), (b).
    \20\ Proposing Release, 75 FR at 80176.
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    The proposal recognized that the principles for identifying dealing 
activity involving swaps can differ from principles for identifying 
dealing activity involving security-based swaps, in part due to 
differences in how those instruments are used.\21\
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    \21\ Id.
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a. ``Swap Dealer'' Activity
    Consistent with the statutory definition, the proposed rule stated 
that the term ``swap dealer'' includes a person that ``regularly enters 
into swaps with counterparties as an ordinary course of business for 
its own account,'' but also that ``the term swap dealer does not 
include a person that enters into swaps for such person's own account, 
either individually or in a fiduciary capacity, but not as a part of a 
regular business.'' The Proposing Release stated that these two 
provisions should be read in combination with each other, and explained 
that the difference between the two provisions is whether or not the 
person enters into swaps as a part of, or as an ordinary course of, a 
``regular business.'' Thus, the Proposing Release equated the phrases 
``ordinary course of business'' and ``regular business.'' The Proposing 
Release also stated that persons who enter into swaps as a part of a 
``regular business'' are those persons whose function is to accommodate 
demand for swaps from other parties and enter into swaps in response to 
interest expressed by other parties. Such persons would be swap 
dealers.\22\ Conversely, the Proposing Release said that persons who do 
not fulfill this function in connection with swaps should not be deemed 
to enter into swaps as part of a ``regular business,'' and thus would 
not likely be swap dealers.\23\
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    \22\ In addition, the Proposing Release explained that (in 
general, and not specifically limited to the provisions relating to 
entering into swaps as part of a ``regular business'') the proposed 
swap dealer definition does not depend on whether a person's 
activity as a swap dealer is the person's sole or predominant 
business (other than through the de minimis exception discussed 
below).
    \23\ See Proposing Release, 75 FR at 80177.
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    In addition, the Proposing Release noted that the nature of swaps 
precludes importing concepts used to identify dealers in other areas. 
The Proposing Release explained that because swaps are typically not 
bought and sold, concepts such as whether a person buys and sells 
swaps, makes a two-sided market in swaps, or trades within a bid/offer 
spread cannot necessarily be used to determine if the person is a swap 
dealer, even if such concepts are useful in determining whether a 
person is a dealer in other financial instruments.\24\
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    \24\ See id. at 80176-77.
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    The Proposing Release further stated that swap dealers can be 
identified through their relationships with counterparties, explaining 
that swap dealers tend to enter into swaps with more counterparties 
than do non-dealers, and in some markets, non-dealers tend to 
constitute a large portion of swap dealers' counterparties. In 
contrast, the Proposing Release said, non-dealers tend to enter into 
swaps with swap dealers more often than with other non-dealers. The 
Proposing Release noted that it is likely that swap dealers are 
involved in most or all significant parts of the swap markets.\25\
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    \25\ See id. at 80177.
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    The Proposing Release concluded that this functional approach would 
identify as swap dealers those persons whose function is to serve as 
the points of connection in the swap markets. Thus, requiring 
registration and compliance with the requirements of the Dodd-Frank Act 
by such persons would thereby reduce risk and enhance operational 
standards and fair dealing in those markets.\26\
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    \26\ See id.
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    The Proposing Release also noted that the swap markets are diverse 
and encompass a wide variety of situations in which parties enter into 
swaps with each other, and invited comment as to what aspects of the 
parties' activities in particular situations should, or should not, be 
considered swap dealing activities. Specifically, the Proposing Release 
invited comment regarding persons who enter into swaps: (i) As 
aggregators; (ii) as part of their participation in physical markets; 
or (iii) in connection with the generation and transmission of 
electricity.\27\
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    \27\ See id. at 80183-84.
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    First, regarding aggregators, the Proposing Release noted that some 
persons, including certain cooperatives, enter into swaps with other 
parties in order to aggregate the swap positions of the other parties 
into a size that would be more amenable to entering into swaps in the 
larger swap market. The Proposing Release explained that, for example, 
certain cooperatives enter into swaps with smaller businesses because 
the smaller business cannot establish a commodity position large enough 
to be traded on a swap or futures market, or large enough to be of 
interest to larger financial institutions. The Proposing Release said 
that while such persons engage in activities that are similar in many 
respects to those of a swap dealer, it may be that the swap dealing 
activities of these aggregators would not exceed the de minimis 
threshold, and therefore they would not be swap dealers. The CFTC 
requested comment as to how the de minimis threshold would apply to 
such persons, and in general on the application of the swap dealer 
definition to this activity. The Proposing Release also noted that the 
CFTC was engaged in a separate rulemaking pursuant to section 
723(c)(3)(B) of the Dodd-Frank Act regarding swaps in agricultural 
commodities, and requested comment on the application of the swap 
dealer definition to dealers, including potentially agricultural 
cooperatives, that limit their dealing activity primarily to swaps in 
agricultural commodities.\28\
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    \28\ After publication of the Proposing Release, the CFTC 
adopted a final rule on agricultural swaps under which swaps in 
agricultural commodities will be permitted to transact subject to 
the same rules as all other swaps. See Agricultural Swaps; Final 
Rule, 76 FR 49291 (Aug. 10, 2011).
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    Second, the Proposing Release noted that the markets in physical 
commodities such as oil, natural gas, chemicals and metals have 
developed highly customized transactions, some of which would be 
encompassed by the statutory definition of the term ``swap,'' and that 
some participants in these markets engage in swap dealing activities 
that are above the proposed de minimis threshold. The CFTC invited 
comment as to any different or additional factors that should be 
considered in applying the swap dealer definition to participants in 
these markets.
    Third, the Proposing Release noted a number of complexities that 
arise when applying the swap dealer definition in connection with the 
generation and transmission of electricity. In particular, the 
Proposing Release noted that additional complexity results because 
electricity is generated, transmitted and used on a continuous, real-
time basis, and because the number and variety of participants in the 
electricity market is very large, and some electricity services are 
provided as a public good rather than for profit. The CFTC invited 
comment as to any different or additional factors that should be 
considered in applying the swap dealer definition to participants in 
the generation and transmission of electricity. Specifically, the CFTC 
invited comment on whether there are special considerations, including 
without limitation special considerations arising from section

[[Page 30599]]

201(f) of the Federal Power Act,\29\ related to not-for-profit power 
systems such as rural electric cooperatives and entities operating as 
political subdivisions of a state and on the applicability of the 
exemptive authority in section 722(f) of the Dodd-Frank Act to address 
those considerations.
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    \29\ 16 U.S.C. 824(f).
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b. ``Security-Based Swap Dealer'' Activity
    The Proposing Release noted the parallels between the definition of 
``security-based swap dealer'' and the definition of ``dealer'' under 
the Exchange Act,\30\ as well as the fact that security-based swaps may 
be used to hedge risks associated with owning certain types of 
securities or to gain economic exposure akin to ownership of certain 
types of securities. As a result, the Proposing Release took the view 
that the same factors that are relevant to determining whether a person 
is a ``dealer'' under the Exchange Act also are generally relevant to 
the analysis of whether a person is a security-based swap dealer. The 
Proposing Release also addressed the relevance of the ``dealer-trader'' 
distinction for identifying dealing activity involving security-based 
swaps,\31\ while recognizing that certain concepts associated with the 
dealer-trader distinction--particularly concepts involving ``turnover 
of inventory'' and ``regular place of business''--appeared potentially 
less applicable to the security-based swap dealer definition. In 
addition, the Proposing Release noted that under the dealer-trader 
distinction, we would expect that entities that use security-based 
swaps to hedge business risks, absent other activities, likely would 
not be dealers.\32\
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    \30\ See Exchange Act sections 3(a)(5)(A), (B), 15 U.S.C. 
78c(a)(5)(A), (B), as amended by Section 761(a)(1) of the Dodd-Frank 
Act.
    \31\ The Proposing Release referred to the fact that the SEC 
previously has noted that the dealer-trader distinction: 
``recognizes that dealers normally have a regular clientele, hold 
themselves out as buying or selling securities at a regular place of 
business, have a regular turnover of inventory (or participate in 
the sale or distribution of new issues, such as by acting as an 
underwriter), and generally provide liquidity services in 
transactions with investors (or, in the case of dealers who are 
market makers, for other professionals).'' Proposing Release, 75 FR 
at 80177 (citing Securities Exchange Act Release No. 47364 (Feb. 13, 
2003) (footnotes omitted)). The Proposing Release further noted that 
other non-exclusive factors that are relevant for distinguishing 
between dealers and non-dealers can include receipt of customer 
property and the furnishing of incidental advice in connection with 
transactions. See id.
    \32\ See Proposing Release, 75 FR at 80177-78.
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c. Additional Principles Common to Both Definitions
i. ``Hold Themselves Out'' and ``Commonly Known in the Trade'' Tests
    The Proposing Release identified the following non-exclusive list 
of factors as potentially indicating that a person meets the ``hold 
themselves out'' and ``commonly known in the trade'' tests of the 
statutory dealer definitions:
     Contacting potential counterparties to solicit interest in 
swaps or security-based swaps;
     Developing new types of swaps or security-based swaps 
(which may include financial products that contain swaps or security-
based swaps) and informing potential counterparties of the availability 
of such swaps or security-based swaps and a willingness to enter into 
such swaps or security-based swaps with the potential counterparties;
     Membership in a swap association in a category reserved 
for dealers;
     Providing marketing materials (such as a Web site) that 
describe the types of swaps or security-based swaps that one is willing 
to enter into with other parties; or
     Generally expressing a willingness to offer or provide a 
range of financial products that would include swaps or security-based 
swaps.\33\
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    \33\ See id. at 80178.
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    The Proposing Release further stated that the test for being 
``commonly known in the trade'' as a swap dealer or security-based swap 
dealer may appropriately reflect, among other factors, the perspective 
of persons with substantial experience with and knowledge of the swap 
and security-based swap markets (regardless of whether a particular 
entity is known as a dealer by persons without that experience or 
knowledge). The Proposing Release also stated that holding oneself out 
as a security-based swap dealer likely would encompass a person who is 
a dealer in another type of security entering into a security-based 
swap with a customer, as well as a person expressing its availability 
to enter into security-based swaps, regardless of the direction of the 
transaction or across a broad spectrum of risks.\34\
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    \34\ See id.
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ii. Market Making
    In addressing the statutory definitions' ``making a market'' test, 
the Proposing Release noted that while continuous two-sided quotations 
and a willingness to buy and sell a security are important indicators 
of market making in the equities market, these indicia may not be 
appropriate in the swap and security-based swap markets. The proposal 
also noted that nothing in the statutory text or legislative history 
suggested the intent to impute a ``continuous'' activity requirement to 
the dealer definitions.\35\
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    \35\ See id.
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iii. No Predominance Test
    The Proposing Release further addressed whether a person should be 
a dealer only if that activity is the person's sole or predominant 
business, and took the view that such an approach was not consistent 
with the statutory definition. The Proposing Release rejected this as 
an unworkable test of dealer status because many parties that commonly 
are acknowledged as dealers also engage in other businesses that 
outweigh their swap or security-based swap dealing business in terms of 
transaction volume or other measures.\36\
---------------------------------------------------------------------------

    \36\ See id. at 80178-79.
---------------------------------------------------------------------------

iv. Application to New Types of Wwaps and New Activities
    The Proposing Release noted that the Commissions intended to apply 
the dealer definitions flexibly when the development of innovative 
business models is accompanied by new types of dealer activity, 
following a facts-and-circumstances approach.\37\
---------------------------------------------------------------------------

    \37\ See id. at 80179.
---------------------------------------------------------------------------

2. Commenters' Views
    Numerous commenters addressed the proposed rules and 
interpretations in connection with the ``swap dealer'' and ``security-
based swap dealer'' definitions. Several commenters addressed 
principles that are common to the two dealer definitions, while a 
number of commenters also addressed interpretations in the Proposing 
Release that were specific to the ``swap dealer'' definition.
a. ``Hold Themselves Out'' and ``Commonly Known in the Trade'' Tests
    Some commenters expressed the view that the persons that hold 
themselves out as or are commonly known as dealers are easy to 
identify.\38\ In addressing the ``hold themselves out'' and ``commonly 
known'' criteria of the dealer definitions, commenters placed 
particular focus on whether only dealers engage in the activities cited 
by the

[[Page 30600]]

Proposing Release, or whether those activities are common both to 
dealers and to other users of swaps and security-based swaps. 
Commenters particularly stated that end users contact potential 
counterparties,\39\ develop new types of swaps or security-based 
swaps,\40\ and propose terms or language for swap or security-based 
swap agreements.\41\ One commenter further stated that identifying 
dealing activity based on whether a person develops new types of swaps 
or proposes swap terms would discourage innovation and the free 
negotiation of swaps.\42\ Some commenters stated that merely responding 
to a request for proposals or quotations should not, in itself, 
constitute dealing.\43\ Commenters also criticized the Proposing 
Release's suggestion that criteria for identifying dealing activity 
include membership in a dealer category of a trade association,\44\ as 
well as providing marketing materials and offering a range of financial 
products.\45\ Commenters also argued for more objective criteria for 
identifying persons ``commonly known'' as dealers.\46\
---------------------------------------------------------------------------

    \38\ See transcript of Joint CFTC-SEC Staff Roundtable 
Discussion on Proposed Dealer and Major Participant Definitions 
Under Dodd-Frank Act, June 16, 2011 (``Roundtable Transcript'') at 
22-23 (remarks of Ron Filler, New York Law School), 50-51 (remarks 
of Ron Oppenheimer, Working Group of Commercial Energy Firms), 215 
(remarks of Bella Sanevich, NISA Investment Advisors LLC).
    \39\ See letters from the Financial Services Roundtable 
(``FSR'') dated February 22, 2011 (``FSR I''), the International 
Swap Dealers Association (``ISDA'') dated February 22, 2011 (``ISDA 
I'') and the Midsize Bank Coalition of America (``Midsize Banks'').
    \40\ See letters from the Committee on Capital Markets 
Regulation (``CCMR'') dated February 22, 2011 (``CCMR I''), FSR I, 
ISDA I and Midsize Banks.
    \41\ See letters from the BG Americas & Global LNG (``BG LNG'') 
dated February 22, 2011 (``BG LNG I''), CCMR I, EDF Trading North 
America, LLC (``EDF Trading'') and The Gavilon Group, LLC 
(``Gavilon'') dated February 21, 2011 (``Gavilon II'').
    \42\ See letter from EDF Trading.
    \43\ See meeting with American Electric Power, Calpine 
Corporation (``Calpine''), Constellation, DC Energy LLC (``DC 
Energy''), Edison International (``Edison Int'l''), Exelon Corp., 
GenOn, Southern Company, Edison Electric Institute (``EEI'') and 
Electric Power Supply Association (``ESPA'') (collectively 
``Electric Companies'') on April 13, 2011.
    \44\ See letter from ISDA I and joint letter from National Corn 
Growers Association (``NCGA'') and Natural Gas Supply Association 
(``NGSA'') (``NCGA/NGSA'') dated February 22, 2011 (``NCGA/NGSA 
I'').
    \45\ See letter from ISDA I.
    \46\ See letters from ISDA I and Peabody Energy Corporation 
(``Peabody'').
---------------------------------------------------------------------------

    Conversely, one commenter said that three particular activities 
cited in the Proposing Release--membership in a swap association 
category reserved for dealers, providing marketing materials and 
expressing a willingness to offer a range of financial products--are 
indicative of holding oneself out as a dealer or being commonly known 
in the trade as a dealer, and should be codified in the final rule.\47\ 
Another commenter suggested other factors, such as having a derivatives 
sales team, that should be treated as indicators of dealer 
activity.\48\ Commenters also expressed the view that this aspect of 
the dealer definition should focus on whether a person solicits 
expressions of interest in swaps from a range of market 
participants,\49\ and that end users of swaps can actively seek out and 
negotiate swaps without necessarily being swap dealers.\50\
---------------------------------------------------------------------------

    \47\ See letter from FSR I.
    \48\ See meeting with Vitol, Inc. (``Vitol'') on February 16, 
2011.
    \49\ See letter from Midsize Banks.
    \50\ See letter from EDF Trading.
---------------------------------------------------------------------------

b. Market Making
    Several commenters generally requested that the Commissions provide 
more guidance as to which activities constitute making a market in 
swaps or security-based swaps.\51\ Commenters also described various 
activities as indicating, or not indicating, market making activity. 
For example, two commenters expressed the view that market making is 
characterized by entering into swaps on one side of the market and then 
establishing offsetting positions on the other side of the market.\52\ 
Other commenters equated market making to providing liquidity by 
regularly quoting bid and offer prices for swaps, and standing ready to 
enter into swaps.\53\ One commenter stated that market making activity 
is indicated by a person consistently presenting itself as willing to 
take either side of a trade.\54\ Two commenters said that market makers 
receive tangible benefits (such as reduced trading fees) in return for 
the obligation to transact when liquidity is required.\55\
---------------------------------------------------------------------------

    \51\ See joint letter from American Benefits Council and the 
Committee on Investment of Employee Benefits Assets (``ABC/CIEBA'') 
and letters from FSR I.
    \52\ See letters from DC Energy and FSR I.
    \53\ See letters from Edison Int'l, NextEra Energy Resources, 
LLC (``NextEra'') dated February 22, 2011 (``NextEra I'') and Vitol, 
and joint letter from American Electric Power, Edison Int'l, Exelon 
Corp., and Southern Company (``Utility Group'').
    \54\ See letter from ISDA I.
    \55\ See joint letter from EEI and EPSA (``EEI/EPSA'') and 
letter from Vitol.
---------------------------------------------------------------------------

    In contrast, one commenter said the proposal correctly did not 
limit market making to consistently quoting a two-sided market, because 
to do so would insert a loophole into the definition.\56\ Some 
commenters expressed the view that mere active participation in a 
market or entering into swaps on both sides of a market does not 
necessarily constitute market making.\57\ Others said that occasionally 
quoting prices on both sides of the market is not market making when 
done to obtain information about the market or to mask one's view of 
the market.\58\ One commenter stated that futures commission merchants 
(``FCMs'') and broker-dealers that facilitate customers' entering into 
swaps are not necessarily market makers.\59\ Other commenters urged the 
Commissions to reject the view that market making requires continuous 
activity.\60\
---------------------------------------------------------------------------

    \56\ See letter from Americans for Financial Reform (``AFR'').
    \57\ See letters from ABC/CIEBA, Managed Funds Association 
(``MFA'') dated February 22, 2011 (``MFA I''), and Vitol.
    \58\ See letters from NextEra Iand Vitol.
    \59\ See letter from Newedge USA LLC (``Newedge''); see also 
Roundtable Transcript at 39 (remarks of Eric Chern, Chicago Trading 
Company).
    \60\ See letters from American Federation of State, County and 
Municipal Employees (``AFSCME''), and FSR I.
---------------------------------------------------------------------------

    A number of commenters addressed the issue of how the dealer 
definitions should treat swaps or security-based swaps entered into on 
a trading platform such as a designated contract market (``DCM''), 
national securities exchange, swap execution facility (``SEF''), or 
security-based SEF (collectively referred to herein as 
``exchanges'').\61\ Several stated that entering into swaps or 
security-based swaps on exchanges should not be considered in 
determining if a person is a dealer.\62\ Some of these commenters 
emphasized the fact that parties would not know the identity of the 
counterparty to the swap executed on an exchange (i.e., such swaps are 
``anonymous''),\63\ while other commenters said that such swaps do not 
constitute ``accommodating demand'' for swaps or ``facilitating 
interest'' in swaps.\64\ Another commenter said that future means of 
executing swaps on exchanges are likely to be diverse, and it is 
premature to draw conclusions

[[Page 30601]]

about how they should be treated in the dealer definitions.\65\
---------------------------------------------------------------------------

    \61\ While some of these commenters specially addressed this 
issue in the context of whether a person is a market maker in swaps, 
others more generally addressed the issue in terms of whether a 
person is a dealer. For clarity, all of those comments are being 
addressed in the market maker context.
    \62\ See letters from EEI/EPSA, International Energy Credit 
Association (``IECA-Credit'') dated February 22, 2011 (``IECA-Credit 
I''), and NextEra I, joint letter from Shell Trading (US) Company 
and Shell Energy North America (US), L.P. (``Shell Trading'') dated 
February 22, 2011 (``Shell Trading I''), and joint letter from 
Allston Trading, LLC, Atlantic Trading USA LLC, Bluefin Trading LLC, 
Chopper Trading LLC, DRW Holdings, LLC, Eagle Seven, LLC, Endeavor 
Trading, LLC, Geneva Trading USA, LLC, GETCO, Hard Eight Futures, 
LLC, HTG Capital Partners, IMC Financial Markets, Infinium Capital 
Management LLC, Kottke Associates, LLC, Liger Investments Limited, 
Marquette Partners, LP, Nico Holdings LLC, Optiver US, Quantlab 
Financial, LLC, RGM Advisors, LLC, Tibra Trading America LLC, 
Traditum Group LLC, WH Trading and XR Trading LLC (``Traders 
Coalition'').
    \63\ See letters from Shell Trading I and Traders Coalition.
    \64\ See letters from EEI/EPSA, IECA-Credit I, and NextEra I. 
For further discussion of this issue, see parts II.A.4 and II.A.5 
below.
    \65\ See letter from Metropolitan Life Insurance Company 
(``MetLife'').
---------------------------------------------------------------------------

    Two commenters asserted that firms that provide liquidity in 
cleared and exchange-executed swaps by actively participating in the 
market provide heterogeneity among liquidity providers and thereby 
disperse risk, and further stated that to regulate such persons as swap 
dealers subject to increased capital requirements would discourage 
their participation in the market and increase risk.\66\
---------------------------------------------------------------------------

    \66\ See letters from Newedge and Traders Coalition; Roundtable 
Transcript at 39 (remarks of Eric Chern, Chicago Trading Company).
---------------------------------------------------------------------------

    One commenter expressed the view that the statutory definition uses 
dealing and market making interchangeably, and suggested that the 
analysis of whether a person acts as a dealer should be subsumed within 
the analysis of whether it acts as a market maker.\67\
---------------------------------------------------------------------------

    \67\ See letter from ISDA I.
---------------------------------------------------------------------------

c. Exception for Activities Not Part of a ``Regular Business''
    Several commenters addressed the exception from the dealer 
definitions for swap or security-based swap activities that are not 
part of a ``regular business.'' Some commenters supported the 
Commissions' proposed interpretation in the context of the ``swap 
dealer'' definition and stated that this interpretation should be 
codified in the text of the final rule.\68\
---------------------------------------------------------------------------

    \68\ See letters from FSR I, MFA I and Midsize Banks.
---------------------------------------------------------------------------

    Many commenters said that the activity of entering into swaps or 
security-based swaps should not be deemed to be a ``regular business,'' 
and thus not indicative of dealing activity, when the person's use of 
swaps or security-based swaps are ancillary to, or in connection with, 
a separate non-swap business that is the person's primary business.\69\ 
Some commenters making this point said that when the person's primary 
business relates to physical commodities, the person's use of swaps 
relating to those commodities does not constitute a ``regular 
business.'' \70\ Other commenters stated that where a person enters 
into swaps to serve its own business needs, as opposed to serving the 
business needs of the counterparty, the person's use of swaps does not 
constitute a ``regular business.'' \71\ Other commenters said that the 
use of swaps to hedge the commercial risks of a business does not 
constitute a ``regular business'' of entering into swaps.\72\ Some 
commenters also suggested that the ``regular business'' exclusion 
should be interpreted to mean ``regular swap dealing business'' or 
``regular security-based swap dealing business'' to prevent the dealer 
definitions from capturing hedgers.\73\
---------------------------------------------------------------------------

    \69\ See Roundtable Transcript at 88 (remarks of Steve Walton, 
Bank of Oklahoma).
    \70\ See letters from Atmos Energy Corporation (``Atmos 
Energy''), Dominion Resources, Inc. (``Dominion Resources''), EDF 
Trading, Edison Int'l, EEI/EPSA, Gavilon II, Hess Corporation and 
its affiliates (``Hess''), Mississippi Public Utility Staff, NextEra 
I, National Milk Producers Federation (``NMPF''), Shell Trading I, 
Utility Group and Working Group of Commercial Energy Firms 
(``WGCEF'') on the swap dealer definition dated February 22, 2011 
(``WGCEF I''), and meeting with Bunge on February 23, 2011.
    \71\ See letters from BT Pension Scheme Management Limited 
(``BTPS''), EDF Trading, EEI/EPSA and Vitol.
    \72\ See letters from American Petroleum Institute (``API'') 
dated February 22, 2011 (``API I''), Calpine, Coalition of Physical 
Energy Companies (``COPE'') dated February 22, 2011 (``COPE I''), 
Dominion Resources, EDF Trading, Edison Int'l and Peabody; see also 
Roundtable Transcript at 45 (remarks of Ed Prosser, Gavilon) and 
letter from Church Alliance. In addition, three commenters said that 
the interpretation of the provisions relating to a ``regular 
business'' in the Proposing Release is correct, because it will 
exclude from the definition of swap dealer those persons using swaps 
to hedge commercial risk. See letters from Air Transport Association 
of America, Inc. (``ATAA''), IECA-Credit I and joint letter from 
Petroleum Marketers Association of America and New England Fuel 
Institute.
    \73\ See letters from Church Alliance and Peabody.
---------------------------------------------------------------------------

    On the other hand, two commenters said that the proposed 
interpretation was correct in the view that the test of whether a 
person has a ``regular business'' of entering into swaps does not 
necessarily depend on whether a person's swap activities are a 
predominant activity, because such an approach would allow a person to 
engage in a significant level of swap dealing activity without 
registering as a swap dealer simply because the person also has 
substantial activities in a non-swap business or businesses.\74\
---------------------------------------------------------------------------

    \74\ See letters from AFR and Better Markets, Inc. (``Better 
Markets'') dated February 22, 2011 (``Better Markets I'').
---------------------------------------------------------------------------

    Other commenters suggested that the types of swap activities that a 
person engages in are relevant to determining whether the person has a 
``regular business'' of entering into swaps. One commenter stated that 
a person has a ``regular business'' of entering into swaps when the 
person has a primary business of accommodating demand or facilitating 
interest in swaps,\75\ while others similarly emphasized that a 
``regular business'' of entering into swaps is characterized by 
financial intermediation activities.\76\ One commenter took the view 
that a person that enters into swaps primarily with financial 
intermediaries does not have a ``regular business'' of entering into 
swaps.\77\
---------------------------------------------------------------------------

    \75\ See letter from IECA-Credit I.
    \76\ See letter from NextEra I and Shell Trading I. Another 
commenter disagreed with this approach, however, saying that a 
person who enters into swaps as an intermediary between smaller 
customers and larger financial institutions is not entering into 
swaps for its ``own account'' and therefore is not a swap dealer, 
but rather would be an FCM or introducing broker. See letter from 
MFX Solutions, Inc. (``MFX'') dated February 22, 2011 (``MFX I'').
    \77\ See letter from Traders Coalition.
---------------------------------------------------------------------------

    Some commenters said that the final rule should clarify the point 
at which a person's episodic or occasional swap activities become a 
``regular business'' of entering into swaps.\78\ Others stated that the 
fact that a person enters into swaps frequently or with a large number 
of counterparties does not necessarily mean that the person has a 
``regular business'' of entering into swaps.\79\
---------------------------------------------------------------------------

    \78\ See letters from BG LNG I and WGCEF I.
    \79\ See letters from NCGA/NGSA I and Vitol. One of these 
commenters asked that the final rule clarify that simply because a 
person engages in swap activity exceeding the thresholds for the de 
minimis exception from the swap dealer definition does not 
necessarily mean that the person is engaged in a ``regular 
business'' of swap dealing. See letter from Vitol.
---------------------------------------------------------------------------

    Commenters proposed specific tests for determining if a person has 
a ``regular business'' of entering into swaps. One commenter said the 
determination should look to whether a person enters into swaps to 
accommodate demand from other parties and to profit from a bid/ask 
spread on swaps (as opposed to swaps that are substitutes for physical 
transactions or positions and used by at least one party to hedge 
commercial risk), and consider specifically the volume, revenues and 
profits of such activities, the person's value at risk (VaR) and 
exposure from such activities, and its resources devoted to such 
activities.\80\ Another commenter said that the determination should be 
based on the nature of the person's business, the person's business 
purpose for using swaps, and the person's method of executing swap 
transactions (e.g., a person whose business primarily relates to 
physical commodities, who uses swaps to hedge commercial risk, and who 
executes swaps on an exchange would be less likely to have a ``regular 
business'' of entering into swaps).\81\
---------------------------------------------------------------------------

    \80\ See letter from NextEra I; see also letter from Hess 
(proposing similar criteria).
    \81\ See letter from Shell Trading I.
---------------------------------------------------------------------------

    One commenter argued that the ``regular business'' exception should 
apply to all four of the dealer tests--not only the test for persons 
that regularly enters into swaps or security-based swaps as an 
``ordinary course of business''--and further argued that the ``regular 
business'' exception should be linked to a ``two-way market'' base

[[Page 30602]]

requirement to avoid commercial hedgers being encompassed by the dealer 
definitions.\82\
---------------------------------------------------------------------------

    \82\ See letter from ISDA dated I.
---------------------------------------------------------------------------

d. Other Dealer Issues
    Commenters also addressed other issues in the Proposing Release, 
including: (i) Whether Congress intended that there be implicit 
preconditions to dealer status; (ii) whether the concepts of 
``accommodating demand'' for swaps or security-based swaps or 
``facilitating interest'' in swaps are useful in identifying dealers; 
and (iii) whether the interpretation of the dealer definitions should 
depend on pre-defined, objective criteria.
i. Preconditions
    Several commenters said that the proposal is overbroad and would 
encompass persons that Congress did not intend to regulate as 
dealers.\83\ Comments in this vein said that the statutory definition 
should be interpreted to require that persons meet certain criteria or 
engage in certain activity, not explicitly stated in the statute, to be 
covered by the swap dealer definition. For instance, some commenters 
said that a dealer is a person who enters into swaps or security-based 
swaps on either side of the market and who profits from fees for doing 
so, or from the spread between the terms of swaps on either side of the 
market.\84\ Other commenters made a similar point, saying that swap 
dealers are those persons that intermediate between swap users on 
either side of the market.\85\
---------------------------------------------------------------------------

    \83\ See, e.g., letters from BG LNG I, EDF Trading, ISDA I, 
NCGA/NGSA dated February 17, 2012 (``NCGA/NGSA II'') and WGCEF I, 
and joint letter from American Farm Bureau Federation, American 
Soybean Association, National Association of Wheat Growers, National 
Cattlemen's Beef Association, National Corn Growers Association, 
National Council of Farmer Cooperatives, National Grain and Feed 
Association, National Milk Producers Federation and National Pork 
Producers Council (``Farmers' Associations'').
    \84\ See letters from COPE I, Edison Int'l, Hess, ISDA I, Shell 
Trading I, Utility Group, Vitol and WGCEF I; see also Roundtable 
Transcript at 43-45 (remarks of Ed Prosser, Gavilon). However, other 
commenters questioned whether profiting from a bid/ask spread is a 
relevant test of dealer status, and emphasized that dealers are 
those persons who take risk by entering into swaps or security-based 
swaps on both sides of the market. See Roundtable Transcript at 21, 
56 (remarks of Richard Ostrander, Morgan Stanley) and 43 (remarks of 
Russ Wasson, National Rural Electric Cooperative Association 
(``NRECA'')). Another commenter pointed out that it could be 
difficult to determine how a person is profiting from entering into 
swaps. See Roundtable Transcript at 42 (remarks of Michael Masters, 
Better Markets).
    \85\ See letters from API I, BG LNG I and NCGA/NGSA II.
---------------------------------------------------------------------------

    The commenters were not all in agreement on this, however. Several 
commenters (including some of those that said swap dealers enter into 
swaps on both sides of the market) also stated that there are a variety 
of situations in which a person's activity of contemporaneously 
entering into swaps on both sides of the market is not indicative of 
dealing activity.\86\ One commenter said that it would not be 
appropriate to require that a person enter into swaps or security-based 
swaps on both sides of the market as a litmus test for dealer status, 
because to do so would create loopholes in the definition.\87\ Two 
commenters also supported rejection of any interpretation that would 
limit the dealer definitions to encompass only those entities that 
solely or predominately act as dealers.\88\
---------------------------------------------------------------------------

    \86\ The examples cited were: entering into swaps on either side 
of a market depending on a firm's commercial purpose for entering 
each particular swap (see letters from the Industrial Energy 
Consumers of America (``IECA-Consumers'') and WGCEF I, and letter 
from the Not-For-Profit Electric End User Coalition (``NFPEEU''), 
consisting of NRECA, American Public Power Association (``APPA'') 
and Large Public Power Council (``LPPC''); see also Roundtable 
Transcript at 44 (remarks of Ed Prosser, Gavilon)); entering into 
swaps on both sides of an illiquid market for purposes of price 
discovery or to elicit bids and offers from other market 
participants (see letters from Hess, Vitol and WGCEF I); and 
entering into swaps on both sides of the market as part of an 
investment strategy (see letter from ABC/CIEBA).
    \87\ See letter from AFR.
    \88\ See letters from AFR and Better Markets I.
---------------------------------------------------------------------------

    In addition, commenters were particularly divided as to whether 
acting as an intermediary always is indicative of swap dealing, as some 
commenters said that a person is not a swap dealer when it simply 
stands between two parties by entering into offsetting swaps with each 
party.\89\
---------------------------------------------------------------------------

    \89\ See letters from BOKF, National Association (``BOK'') dated 
January 13, 2012 (``BOK V''), MFX I, Newedge and Northland Energy 
Trading LLC (``Northland Energy''); see also Roundtable Transcript 
at 48 (remarks of John Nicholas, Newedge). One commenter queried 
whether the final rule should clarify whether a customer 
relationship between the parties to a swap is necessary in order for 
the swap to be relevant in determining whether either of the parties 
is a swap dealer. See letter from Representative Scott Desjarlais 
(``Rep. Desjarlais'').
---------------------------------------------------------------------------

ii. ``Accommodating Demand'' and ``Facilitating Interest''
    A number of commenters addressed the Proposing Release's view that 
a tendency to accommodate demand for swaps and a general availability 
to enter into swaps to facilitate other parties' interest in swaps 
(referred to here as ``accommodating demand'' and ``facilitating 
interest'') are characteristic of swap dealers. Some commenters stated 
that accommodating demand and facilitating interest would not be 
effective factors to identify swap dealers, particularly in bilateral 
negotiations where it is difficult to say which party is accommodating 
demand for swaps.\90\ Other commenters said the activities of 
accommodating demand or facilitating interest are indicative of swap 
dealing only in certain circumstances, such as when they are not 
related to a person's commodity business,\91\ or when done with the 
purpose of serving the needs of the other party to the swap.\92\ Some 
commenters argued that the statement in the Proposing Release that swap 
dealers are likely involved in most or all significant parts of the 
swap markets is incorrect in the market for energy swaps. There, the 
commenters said, persons can find counterparties for swaps without the 
intermediation of a swap dealer, and swaps entered into directly by two 
end users are more frequent.\93\
---------------------------------------------------------------------------

    \90\ See letters from NextEra I and Peabody and meeting with 
Vitol on February 15, 2011.
    \91\ See letter from Shell Trading I.
    \92\ See letters from IECA-Credit I, National Association of 
Insurance Commissioners (``NAIC''), Vitol and WGCEF I. One of these 
commenters also said that entering into a bespoke swap with a 
registered swap dealer, in which the swap dealer lays off risk, 
should not be viewed as accommodating demand or facilitating 
interest. See letter from Vitol.
    \93\ See letter from BG LNG I, NCGA/NGSA I, NFPEEU, NRG Energy, 
Inc. (``NRG Energy'') and WGCEF I and meeting with Vitol on February 
16, 2011.
---------------------------------------------------------------------------

    Other commenters, though, said that the proposal's focus on 
accommodating demand and facilitating interest strikes the right 
balance and that the proposed approach is generally correct.\94\ 
Another commenter did not object to including accommodating demand and 
facilitating risk as factors in the definition, but said that those 
factors should be applied flexibly.\95\
---------------------------------------------------------------------------

    \94\ See letters from AFR and MFX I.
    \95\ See letter from National Grain and Feed Association 
(``NGFA'') dated February 22, 2011 (``NGFA I'').
---------------------------------------------------------------------------

iii. Application of Objective Criteria, and Additional Factors
    Some commenters, specifically addressing the CFTC's proposed 
interpretive approach to the ``swap dealer'' definition, said that the 
final rule should set out objective criteria that market participants 
could use to determine whether or not they are covered by the 
definition and therefore required to register as swap dealers.\96\

[[Page 30603]]

Others focused especially on statements in the Proposing Release to the 
effect that swap dealers are those persons who ``tend to'' engage in 
certain activities, and that persons who engage in certain activities 
are ``likely'' to be swap dealers, as being overly subjective and 
difficult to interpret.\97\
---------------------------------------------------------------------------

    \96\ See letters from BG LNG I, EEI/EPSA, Peabody, Rep. 
Desjarlais and Utility Group. Some commenters said that the CFTC's 
interpretive approach to the swap dealer definition should be 
codified in the text of the final rule. See letters from Alternative 
Investment Management Association Limited (``AIMA'') dated February 
22, 2011 (``AIMA I'') and COPE I.
    \97\ See letters from BG LNG I, Chesapeake Energy Corporation 
(``Chesapeake Energy''), COPE I, ISDA I, Vitol and WGCEF I. Some 
commenters focused on particular aspects of the swap dealer 
definition as requiring further detail, such as, for example, what 
it means to be ``commonly known in the trade'' as a swap dealer (see 
letter from Peabody) and the definition of market making (see 
letters from Midsize Banks and Peabody).
---------------------------------------------------------------------------

    Certain commenters suggested specific objective criteria to use to 
identify swap dealers. One commenter said that swap dealing activity is 
characterized by more frequent use of swaps; having substantial staff 
and technological resources devoted to swaps; a larger portion of 
revenue and profit being derived from swap activity; and owning fewer 
physical assets related to the type of swaps entered into.\98\ Another 
commenter said that to identify swap dealers, the CFTC should compare a 
person's revenue or profits generated by swap activity to its overall 
revenue or profits; compare a person's total business volume to the 
volume, VaR and exposure associated with the swap activity; compare a 
person's total business resources to the resources devoted to swap 
activity; and consider ownership or control of physical assets in the 
specific market or region to which the person's swap activity is 
tied.\99\
---------------------------------------------------------------------------

    \98\ See letter from Hess.
    \99\ See letter from NextEra I.
---------------------------------------------------------------------------

    More generally, some commenters supported codification of more 
concrete tests in connection with the dealer definitions.\100\ However, 
other commenters said that the use of bright line rules to determine 
whether a person is a dealer would be inappropriate given the dynamic 
nature of the swap and security-based swap markets. These commenters 
supported a facts and circumstances approach to the dealer definition 
as a better approach.\101\ One commenter also raised issues about the 
sources of information that may be considered as part of a dealer 
determination.\102\
---------------------------------------------------------------------------

    \100\ See, e.g., letters from EEI/EPSA, FSR I, ISDA I, NextEra I 
and WGCEF I.
    \101\ See letters from Better Markets I, Chris Barnard 
(``Barnard'') and Prof. Michael Greenberger, University of Maryland 
School of Law (``Greenberger'').
    \102\ See letter from ISDA I (stating that sources of 
information considered by the Commissions in determining dealer 
status should be revealed to the entity being evaluated).
---------------------------------------------------------------------------

    e. Application of Exchange Act ``Dealer-Trader'' distinction
    i. Security-Based Swap Dealer Definition
    A number of commenters supported the proposed use of the dealer-
trader distinction under the Exchange Act to interpret the ``security-
based swap dealer'' definition.\103\ Two commenters, however, 
specifically opposed use of the distinction in the context of security-
based swaps, arguing that use of the distinction would create confusion 
or would be inconsistent with the goal of improved transparency.\104\
---------------------------------------------------------------------------

    \103\ See, e.g., letters from Coalition for Derivatives End-
Users (``CDEU''), CCMR I, ISDA I and MetLife.
    \104\ See letters from AFR and AFSCME.
---------------------------------------------------------------------------

    ii. Swap Dealer Definition
    Some commenters said that the CFTC should apply the dealer-trader 
distinction as it has been interpreted with respect to the definition 
of ``dealer'' under the Exchange Act to identify swap dealers.\105\ 
Some commenters said that the applicable interpretations under the 
Exchange Act mean that swaps a person uses for proprietary trading 
(including for speculative purposes) should not be considered in 
determining if the person is a swap dealer because dealers enter into 
transactions in order to profit from spreads or fees regardless of 
their view of the market for the underlying item, whereas traders enter 
into transactions in order to take a view on the direction of the 
market or to obtain exposure to movements in the price of the 
underlying item.\106\ Two commenters said that if the CFTC applied the 
distinction, traders should be subject to potential registration as 
major swap participants, and dealers should be subject to regulation as 
swap dealers.\107\ Commenters acknowledged differences between the 
market for swaps and the market for securities, but said that the 
Exchange Act interpretations are still relevant.\108\
---------------------------------------------------------------------------

    \105\ Some of these commenters said that, since some provisions 
in the statutory swap dealer definition are similar to the 
definition of a ``dealer'' under the Exchange Act, Congress intended 
that the two definitions would be applied in the same way. See 
letters from API I, BG LNG I, CDEU, IECA-Consumers and WGCEF I. 
Others said that the CFTC should apply these interpretations because 
they have been effectively applied for a long time in the context of 
securities. See letters from CCMR I and MFA I.
    \106\ See letters from Gavilon II, and Next Era I, and meetings 
with Electric Companies on April 13, 2011 and WGCEF on April 28, 
2011. Another commenter said the interpretations mean that dealers 
and traders can be distinguished by their activities: dealers hold 
themselves out as buying and selling on a regular basis, derive 
income from providing services in the chain of distribution, and 
profit from price spreads, while traders do not provide services or 
extend credit but, rather, profit from changes in the market value 
of underlying items. See letter from API I.
    \107\ See letters from EDF Trading and IECA-Consumers.
    \108\ See letters from API I, Gavilon I and IECA-Consumers.
---------------------------------------------------------------------------

    On the other hand, some commenters agreed with the CFTC's view not 
to apply Exchange Act interpretations to the definition of the term 
``swap dealer.'' These commenters said that it is appropriate not to 
apply the interpretations under the Exchange Act to identify persons 
that meet the swap dealer definition under the CEA.\109\
---------------------------------------------------------------------------

    \109\ See letters from AFR and AFSCME; see also joint meeting 
with AFR and Better Markets on March 17, 2011 (dealer-trader 
distinction not helpful in identifying swap dealers because the 
transparency and operational robustness of the swap market is much 
lower than in the securities market). One commenter said the 
precedents should be applied only by the SEC to identify security-
based swap dealers. See letter from NAIC.
---------------------------------------------------------------------------

e. Application to Particular Swap Markets
i. Aggregators
    Certain commenters addressed persons who enter into swaps as 
aggregators, with most of those commenters discussing agricultural 
cooperatives. Commenters said that agricultural cooperatives that hedge 
their own risks or the risks of their members regarding agricultural 
commodities should be excluded from the swap dealer definition because 
Congress did not intend to treat agricultural cooperatives as swap 
dealers and because agricultural cooperatives are in effect an 
extension of their members.\110\ Some commenters said that the 
agricultural cooperatives' use of swaps allows their members to hedge 
risks when the members' transactions are too small for (or otherwise 
not qualified for) the futures markets.\111\
---------------------------------------------------------------------------

    \110\ See letters from Dairy Farmers of America (``DFA''), 
Growmark, Land O'Lakes, Inc. (``Land O'Lakes'') dated February 22, 
2011 (``Land O'Lakes II''), National Council of Farmer Cooperatives 
(``NCFC'') dated February 22, 2011 (``NCFC I'') and NMPF. One 
commenter also said that a subsidiary of an agricultural cooperative 
that enters into swaps with its parent cooperative, and the members 
of the parent cooperative, should be excluded from the swap dealer 
definition for the same reason. See meeting with Agrivisor. Another 
commenter said that an agricultural cooperative's swaps with farmers 
and other persons for risk management should be disregarded in 
determining if the cooperative is a swap dealer so long as the swaps 
relate to the marketing function of the cooperative, even if the 
swaps are not with members of the cooperative. See letter from NMPF.
    \111\ See letters from DFA and Growmark.
---------------------------------------------------------------------------

    Some commenters said that an exclusion from the swap dealer 
definition also should be available to private companies that serve as 
aggregators for swaps in agricultural commodities or otherwise offer 
swaps

[[Page 30604]]

for agricultural risk management.\112\ These commenters said that such 
an exclusion would reduce the costs and regulatory burdens imposed on 
such companies and therefore provide a broader choice of swap providers 
to farmers and other agricultural market participants, which they said 
would reduce risks.\113\
---------------------------------------------------------------------------

    \112\ See letters from Farmers' Associations, NGFA I and NMPF.
    \113\ See id.
---------------------------------------------------------------------------

    One commenter discussed a small energy firm that aggregates demand 
for swaps from small energy retailers and consumers. This commenter 
said that such aggregators should be excluded from the swap dealer 
definition because imposing the swap dealer regulations (which would be 
promulgated with large financial firms in mind) on such firms would 
increase costs for the aggregators, discourage the aggregators' 
offering of swaps, and thereby reduce choice and efficiency in the 
market.\114\ Another commenter said that a firm that enters into swaps 
with microfinance lenders and offsetting swaps with commercial banks is 
akin to an introducing broker or FCM, and should be excluded from the 
swap dealer definition on the grounds that it does not enter into swaps 
on its own initiative, but rather to provide access to the swap markets 
to smaller counterparties.\115\
---------------------------------------------------------------------------

    \114\ See letter from Northland Energy. This commenter defined 
an ``aggregator'' as a person who: (i) Enters into swaps 
predominantly in one direction with counterparties that are using 
swaps to establish bona fide hedges; and (ii) offsets risks 
associated with such swaps using regulated futures contracts or 
cleared swaps.
    \115\ See letter from MFX dated June 3, 2011 (``MFX II''). This 
commenter said that the exclusion should be available to a person 
who operates primarily on a not-for-profit basis and limits its swap 
activities to offering swaps to persons in underserved markets and 
offsetting such swaps, and who meets other requirements to limit the 
scope of the exclusion.
---------------------------------------------------------------------------

    Another commenter said that there is no need for any special 
treatment of aggregators in the swap dealer definition. According to 
this commenter, the CFTC's guidance regarding the definition and the de 
minimis exception from the definition address the relevant issues 
properly and completely.\116\
---------------------------------------------------------------------------

    \116\ See letter from Better Markets I.
---------------------------------------------------------------------------

ii. Physical Commodity Swaps
    Commenters that discussed physical commodity swaps primarily 
focused on swaps related to energy commodities such as oil, natural gas 
and electricity. The commenters said that the market for these swaps is 
different from the market for swaps on interest rates and other 
financial commodities because, among other things, the swaps are used 
to mitigate price and delivery risks directly linked to a commercial 
enterprise; less swap activity flows through intermediaries; the 
markets for the underlying physical commodities are separately 
regulated; and the failure of a commodity market participant is not 
likely to impact financial markets as a whole.\117\ Therefore, these 
commenters believe, the application of the swap dealer definition to 
participants in these physical commodity swap markets should be 
different from the application to participants in the financial 
commodity swap markets.\118\ Some commenters said that imposing the 
costs of swap dealer regulation on participants in the markets for 
physical commodity swaps would discourage participation in the market, 
thereby reducing liquidity and increasing market concentration.\119\
---------------------------------------------------------------------------

    \117\ See letters from BG LNG I, Dominion Resources, National 
Energy Marketers Association (``NEM''), NFPEEU, Vitol and WGCEF I 
joint letter from Senator Debbie Stabenow and Representative Frank 
Lucas (many commercial end-users of swaps with inherent physical 
commodity price risk use swaps to hedge such risk and otherwise for 
their own trading objectives and not for the benefit of others) and 
meetings with Bunge on May 18, 2011 and Electric Companies on April 
13, 2011.
    \118\ See id.
    \119\ See letters from Dominion Resources, NEM and NFPEEU.
---------------------------------------------------------------------------

iii. Electricity Swaps
    Commenters on the use of swaps in connection with the generation 
and transmission of electricity addressed a variety of issues. First, 
commenters said that markets related to electricity are different from 
markets for other physical commodities in that electricity must be 
generated and transmitted at the time it is needed (it cannot be stored 
for future use); the overall demand for electricity is inelastic but 
demand at any particular time is subject to external variables, such as 
weather; the generation, transmission and use of electricity is widely 
dispersed and geographically specific; the markets are overseen by 
regulators such as state Public Utility Commissions, regional 
transmission organizations (``RTOs'') and the Federal Energy Regulatory 
Commission (``FERC''); and government mandates require continuous 
supply of electricity and treat electricity as a ``public good.'' \120\ 
Commenters said that because of these differences, the use of swaps 
related to electricity is different from the use of swaps on other 
physical commodities in that electricity swaps: Are more highly 
customized to a particular place and time; are more likely to relate to 
a short time period or be more frequently entered into; typically can 
be tied to a specific generation, transmission or use of electricity; 
are more likely to be entered into directly by end-users rather than 
through dealers; are likely to be entered into by electricity companies 
on both sides of the market; and in many cases were subject to 
regulatory oversight prior to the Dodd-Frank Act.\121\
---------------------------------------------------------------------------

    \120\ See letters from Edison Int'l, the staff of the FERC 
(``FERC Staff''), National Association of Regulatory Utility 
Commissioners (``NARUC''), NEM, NextEra I, NFPEEU and National Rural 
Utilities Cooperative Finance Corporation (``NRU CFC'') dated 
February 14, 2011 (``NRU CFC I''), joint letter from NRECA, APPA, 
LPPC, EEI and EPSA (``Electric Trade Associations'') and meetings 
with Electric Companies on April 13, 2011 and NFPEEU on January 29, 
2011.
    \121\ See letters from Edison Int'l, EEI/EPSA, Electric Trade 
Associations, FERC Staff, NextEra I and NFPEEU and meeting with 
Electric Companies on April 13, 2011.
---------------------------------------------------------------------------

    Commenters made various points regarding how swaps related to 
electricity should be treated for purposes of the swap dealer 
definition. A coalition of not-for-profit power utilities and electric 
cooperatives said that electricity cooperatives should be excluded from 
the swap dealer definition because they are non-profit entities that 
enter into swaps for the benefit of their members, they do not hold 
themselves out as swap dealers, they do not make markets, and their 
swaps are not necessarily reflective of market rates.\122\ Other 
commenters said that swaps related to transactions on tariff schedules 
approved by FERC or the Electric Reliability Council of Texas should be 
disregarded in determining if a person is a swap dealer.\123\ And, some 
commenters said that any special treatment of swaps related to 
electricity should apply not only to companies that generate, transmit 
or distribute electricity, but also to energy marketing companies that 
use swaps to benefit from price changes in the underlying energy 
commodities or to hedge related risks.\124\
---------------------------------------------------------------------------

    \122\ See letter from NFPEEU. This commenter said the exclusion 
from the swap dealer definition should extend to persons acting as 
an operating or purchasing agent for other utilities in connection 
with energy infrastructure products, or otherwise entering into 
energy commodity swaps on behalf of other end users.
    \123\ See letters from EDF Trading, FERC Staff and NARUC.
    \124\ See letters from DC Energy, EDF Trading and EEI/EPSA.
---------------------------------------------------------------------------

    On the other hand, some commenters acknowledged that a person who 
makes a market in swaps related to electricity by standing ready to 
enter into such swaps in order to profit from a bid/ask spread would be 
a swap dealer, even if the person was in the business of generating, 
transmitting or distributing

[[Page 30605]]

electricity and owned physical facilities for that purpose.\125\
---------------------------------------------------------------------------

    \125\ See letter from EEI/EPSA and meeting with Electric 
Companies on April 13, 2011.
---------------------------------------------------------------------------

f. Suggested Exlusions From the Dealer Definitions
    Several commenters took the view that the swap dealer and security-
based swap dealer definitions should categorically exclude, or should 
be interpreted in a way that would be expected to exclude, a variety of 
types of persons or transactions. Commenters particularly suggested 
that the following categories of persons should be excluded from the 
dealer definitions: Agricultural cooperatives and electric cooperatives 
(as addressed above), employee benefit plans as defined in the Employee 
Retirement Income Security Act of 1974 (``ERISA''),\126\ farm credit 
system institutions,\127\ Federal Home Loan Banks,\128\ insured 
depository institutions that limit their swap dealing activity to 
riskless principal transactions,\129\ FCMs and broker-dealers that 
limit their swap dealing activity to riskless principal 
transactions,\130\ financial guaranty insurers and their affiliates 
that do not enter into new swaps,\131\ asset managers,\132\ non-
financial companies offering swaps related to their physical commodity 
business,\133\ any person who enters into swaps or security-based swaps 
only with registered dealers and major participants,\134\ persons that 
do not pose systemic risk,\135\ hedge funds \136\ and entities that 
enter into swaps or security-based swaps solely in a fiduciary 
capacity.\137\
---------------------------------------------------------------------------

    \126\ See letter from ABC/CIEBA.
    \127\ See letter from Farm Credit Council dated February 22, 
2011 (``Farm Credit Council I'').
    \128\ See letters from Credit Union National Association 
(``CUNA'') and Federal Home Loan Banks (``FHLB'') dated February 22, 
2011 (``FHLB I'').
    \129\ See letter from BOK dated January 31, 2011 (``BOK I''); 
but see letter from Vitol at 7 (riskless principal transactions are 
a ``good model for true swap dealing activity'').
    \130\ See letter from Newedge.
    \131\ See letter from Association of Financial Guaranty Insurers 
(``AFGI'').
    \132\ See letter from BlackRock, Inc. (``BlackRock'') dated 
February 22, 2011 (``BlackRock I'').
    \133\ Commenters making this point varied in their phrasing of 
potential exclusions, and particularly suggested exclusions for: 
Agricultural firms offering swaps as risk management tools related 
to physical commodities (see letter from NGFA I); all firms, other 
than financial entities whose primary business is swap dealing (see 
letter from NEM); any person that uses swaps only to reduce price 
volatility, enters into a volume of swaps relating to any physical 
commodity that is less than the volume of its trading in that 
commodity, and is not making a market (see letter from Chesapeake 
Energy); or any person that limit its use of swaps to hedging or 
speculating (see letters from API I).
    \134\ See letter from ISDA I.
    \135\ See letters from NARUC and NCGA/NGSA I.
    \136\ See letter from MFA I.
    \137\ See letters from FSR dated February 22, 2011 and Midsize 
Banks.
---------------------------------------------------------------------------

    Commenters also suggested that the dealer definitions categorically 
exclude, or should be interpreted to exclude, the following types of 
swaps and security-based swaps: Exchange-cleared swaps and security-
based swaps,\138\ options to make or receive delivery of physical 
commodities,\139\ cash forward transactions with embedded swaps and 
book-out transactions,\140\ swaps or security-based swaps that are used 
for hedging or mitigating commercial risk,\141\ swaps entered into to 
profit from future changes in the price of the underlying 
commodity,\142\ swaps or security-based swaps entered into as a 
fiduciary or agent for another person,\143\ swaps or security-based 
swaps entered into for purposes of price discovery,\144\ and, as noted 
above, swaps related to items that are covered by a tariff approved by 
FERC or the Electric Reliability Council of Texas.\145\
---------------------------------------------------------------------------

    \138\ See letters from Commodity Markets Council (``CMC''), EEI/
EPSA, IECA-Credit I, NextEra I, Shell Trading I, Utility Group and 
Vitol.
    \139\ See letters from NextEra I and WGCEF I. The commenters 
acknowledged that such options may or may not be included in the 
definition of ``swap.''
    \140\ See letter from CMC.
    \141\ See, e.g., letters from Edison Int'l and WGCEF I and joint 
letter from Senator Stabenow and Representative Lucas (also saying 
that definition of ``hedging'' should be consistent with respect to 
the dealer and major participant definitions and the end-user 
exception from clearing).
    \142\ See letters from EEI/EPSA, NextEra I, Utility Group and 
WGCEF I.
    \143\ See letters from Midsize Banks, NFPEEU and FSR I.
    \144\ See letters from EEI/EPSA, Vitol and WGCEF I.
    \145\ See letters from EDF Trading, FERC Staff and NARUC.
---------------------------------------------------------------------------

    In contrast, some commenters opposed providing any categorical 
exclusions from the dealer definitions. One commenter stated that the 
definitions' focus on a person's activities--as opposed to whether that 
person falls within a particular category--is a better means of 
determining whether the person is a swap dealer.\146\ Another commenter 
described the requested exclusions as attempts to achieve carve-outs 
that are not provided for in the statute.\147\
---------------------------------------------------------------------------

    \146\ See letter from Better Markets I.
    \147\ See letter from AFSCME. Additional commenters emphasized 
the need for transparency about swaps and swap activities. See 
letters from Jason Cropping and BJ D'Milli.
---------------------------------------------------------------------------

    Lastly, several commenters addressed the extraterritorial 
application of the definitions of the terms ``swap dealer,'' 
``security-based swap dealer,'' ``major swap participant,'' ``major 
security-based swap participant,'' and ``eligible contract 
participant.'' In general, the commenters addressed when and how the 
definitions should be applied to persons based outside the U.S. and how 
the definitions should take account of non-U.S. requirements that may 
be applicable to such persons.\148\ The Commissions intend to 
separately address issues related to the application of these 
definitions to non-U.S. persons in the context of the application of 
Title VII to non-U.S. persons.
---------------------------------------------------------------------------

    \148\ See, e.g., letters from FSR I, Institute of International 
Bankers, ISDA I, Investment Management Association, Japan Financial 
Services Agency, Securities Industry and Financial Markets 
Association (``SIFMA'') dated February 3, 2011 (``SIFMA I''), and 
the World Bank Group, joint letter from the Autorit[eacute] de 
contr[ocirc]le prudential and the Autorit[eacute] des marches 
financiers, joint letter from Bank of America Merrill Lynch, 
Barclays Capital, BNP Paribas S.A. (``BNP Paribas''), Citi, 
Cr[eacute]dit Agricole Corporate and Investment Bank, Credit Suisse 
Securities (USA), Deutsche Bank AG (``Deutsche Bank''), HSBC, Morgan 
Stanley, Nomura Securities International, Inc. (``Nomura 
Securities''), Soci[eacute]t[eacute] G[eacute]n[eacute]rale and UBS 
Securities LLC (``Twelve Firms''), joint letter from the Bank of 
Tokyo-Mitsubishi UFJ, Ltd., Mizuho Corporate Bank, Ltd. and Sumitomo 
Mitsui Banking Corporation, and joint letter from Barclays Bank PLC, 
BNP Paribas, Credit Suisse AG, Deutsche Bank, HSBC, Nomura 
Securities, Rabobank Nederland, Royal Bank of Canada, the Royal Bank 
of Scotland Group pLc, Soci[eacute]t[eacute] G[eacute]n[eacute]rale, 
the Toronto-Dominion Bank and UBS AG.
---------------------------------------------------------------------------

g. Cost-Benefit Issues and Hedging Deterrence
    Several commenters emphasized the cost of being regulated as a 
dealer, and emphasized that an overbroad scope of the dealer 
definitions would impose significant unwarranted costs on entities 
contrary to the goals of the Dodd-Frank Act, and would deter the use of 
swaps and security-based swaps for hedging.\149\ Some commenters also 
noted that impact of the provisions of section 716 of the Dodd-Frank 
Act on entities that are deemed to be swap

[[Page 30606]]

dealers or security-based swap dealers.\150\ Also, one commenter 
suggested that using a qualitative test for the dealer definition might 
increase costs due to regulatory uncertainty.\151\
---------------------------------------------------------------------------

    \149\ See joint letter from Representatives Spencer Bachus and 
Frank Lucas at 2 (``Casting an overly-broad net in defining [dealer 
and major participant] could force some smaller participants to 
leave the marketplace as a result of increased costs, or eliminate 
certain types of contracts used for hedging. If either occurs, 
businesses will be left exposed to market volatility and the 
consequences will ultimately be felt by Americans in the form of 
increased consumer costs.'') and letters from ISDA Iat 7 (``The 
substantial additional burdens and costs of Dealer regulation must 
be reserved for those whose business it is to `make the market,' 
that is, those who consistently both buy and sell. This is in accord 
with Dodd-Frank Act's market regulatory goals, as well as the 
legislation's obvious intent to preserve healthy growth and 
innovation in the U.S. swap markets.'' (footnote omitted)), Peabody 
at 2-3 (``Legal uncertainty over the application to end users of the 
significant regulatory requirements for [swap dealers] could lead 
end users to minimize their use of swaps in order to avoid the risk 
of being deemed to be [a swap dealer].''), and Church Alliance 
(stating that the risk of incurring the costs of dealer regulation 
would harm employee benefit plans by reducing their use of swaps and 
security-based swaps for hedging and risk mitigation).
    \150\ See letters from American Bankers Association (``ABA'') 
dated November 3, 2011 (``ABA I''), BOK I, and ISDA I. Section 716 
of the Dodd-Frank Act prohibits any ``swaps entity''--a term that 
encompasses swap dealers and security-based swap dealers--from 
receiving Federal assistance with respect to any swap, security-
based swap, or other activity of the swaps entity.
    \151\ See letter from API I (stating that costs of regulatory 
uncertainty stem from the use of qualitative factors for identifying 
dealing, and from regulatory efforts to reach beyond ``true'' swap 
dealers); see also letter from Dominion Resources (the opportunity 
costs associated with regulatory uncertainty should be considered).
---------------------------------------------------------------------------

    One commenter specifically suggested that in considering the final 
rules, the Commissions should consider empirical data regarding the 
costs and benefits flowing from the rules and issue a second analysis 
of the costs and benefits of the rules for public comment,\152\ while 
other commenters said that the consideration of cost and benefits 
should include the cumulative cost of interrelated regulatory burdens 
arising from all the rules proposed under the Dodd-Frank Act.\153\ 
Other commenters said the Commissions should consider alternatives that 
would impose fewer costs.\154\
---------------------------------------------------------------------------

    \152\ See letter from WGCEF I.
    \153\ See letters from ABA I, NFPEEU and WGCEF dated December 
20, 2011, enclosing a report prepared by NERA Economic Consulting 
(``NERA'') (``WGCEF VIII''); see also letter from NERA dated March 
13, 2012.
    \154\ See letters from NextEra I (referring to alternative de 
minimis tests) and NFPEEU.
---------------------------------------------------------------------------

    Another commenter said that the cost-benefit analyses in the 
Proposing Release may have understated the benefits of the proposed 
rules, because focusing on individual aspects of all the rules proposed 
under the Dodd-Frank Act prevents consideration of the full range of 
benefits that arise from the rules as a whole, in terms of providing 
greater financial stability, reducing systemic risk and avoiding the 
expense of assistance to financial institutions in the future.\155\ 
This commenter said the consideration of benefits of the proposed rules 
should include the mitigated risk of a financial crisis.\156\
---------------------------------------------------------------------------

    \155\ See letter from Better Markets dated June 3, 2011 
(``Better Markets II'').
    \156\ Better Markets cited estimates that the worldwide cost of 
the 2008 financial crisis in terms of lost output was between $60 
trillion and $200 trillion, depending primarily on the long term 
persistence of the effects. See letter from Better Markets II.
---------------------------------------------------------------------------

3. Final Rules and Interpretation--General Principles
    Consistent with the Proposing Release, the final rules that define 
the terms ``swap dealer'' and ``security-based swap dealer'' closely 
follow the statutory definitions' four tests and exclusion for 
activities that are not part of a ``regular business.'' \157\ In 
addition, this Adopting Release sets forth interpretive guidance 
regarding various elements of the final rules.
---------------------------------------------------------------------------

    \157\ See CFTC Regulation Sec.  1.3(ggg)(1), (2); Exchange Act 
rule 3a71-1(a), (b).
---------------------------------------------------------------------------

    Because the definitions of the terms ``swap dealer'' in the CEA and 
``security-based swap dealer'' in the Exchange Act are substantially 
similar, the rules further defining those terms and the accompanying 
interpretations in this Adopting Release reflect common underlying 
principles. At the same time, the interpretations regarding the 
application of the definitions differ in certain respects given the 
differences in the uses of and markets for swaps and security-based 
swaps.\158\ For example, because security-based swaps may be used to 
hedge or gain economic exposure to underlying individual securities 
(while recognizing distinctions between security-based swaps and other 
types of securities, as discussed below), there is a basis to build 
upon the same principles that presently are used to identify dealers 
for other types of securities. These same principles, though 
instructive, may be inapplicable to swaps in certain circumstances or 
may be applied differently in the context of dealing activities 
involving commodity, interest rate, or other types of swaps.
---------------------------------------------------------------------------

    \158\ Section 712(a)(7)(A) of the Dodd-Frank Act provides that 
in adopting rules and orders implementing Title VII, the Commissions 
shall treat functionally or economically similar products or 
entities in a similar manner. Section 712(a)(7)(B), though, provides 
that the Commissions need not act in an identical manner.
---------------------------------------------------------------------------

    For these reasons, we separately are addressing the interpretation 
of the ``swap dealer'' and ``security-based swap dealer'' definitions.
    Also, as discussed below, the Commissions are directing their 
respective staffs to report separately regarding the rules being 
adopted in connection with the definition and related interpretations. 
These staff reports will help the Commissions evaluate the ``swap 
dealer'' and ``security-based swap dealer'' definitions in all 
respects, including whether new or revised tests or approaches would be 
appropriate for identifying swap dealers and security-based swap 
dealers.\159\
---------------------------------------------------------------------------

    \159\ See part V, infra.
---------------------------------------------------------------------------

4. Final Rules and Interpretation--Definition of ``Swap Dealer''
    The Dodd-Frank Act contains a comprehensive definition of the term 
``swap dealer,'' based upon types of activities. As noted above, we are 
adopting a final rule under the CEA that, like the proposed rule, 
defines the term ``swap dealer'' using terms from the four statutory 
tests and the exclusion for swap activities that are not part of ``a 
regular business.'' \160\ The final rule includes modifications from 
the proposed rule that are described below, including provisions 
stating that swaps entered into for hedging physical positions as 
defined in the rule, swaps between majority-owned affiliates, swaps 
entered into by a cooperative with its members, and certain swaps 
entered into by registered floor traders, are excluded from the swap 
dealer determination.\161\ The Commissions, in consideration of 
comments received, are also making certain modifications to the 
interpretive guidance set out in the Proposing Release with respect to 
various elements of the statutory definition of the term ``swap 
dealer,'' as described below.
---------------------------------------------------------------------------

    \160\ See CFTC Regulation Sec.  1.3(ggg)(1), (2).
    \161\ See CFTC Regulation Sec.  1.3(ggg)(6)(ii), (iii).
---------------------------------------------------------------------------

    The determination of whether a person is covered by the statutory 
definition of the term ``swap dealer'' requires application of various 
provisions of the rule further defining that term, as well as the 
interpretive guidance in this Adopting Release, depending on the 
person's particular circumstances. We intend that the determination 
with respect to a particular person would proceed as follows.
    The person would begin by applying the statutory definition, and 
the provisions of the rule which implement the four statutory tests and 
the exclusion for swap activities that are not part of ``a regular 
business,'' \162\ in order to determine if the person is engaged in 
swap dealing activity. In that analysis, the person would apply the 
interpretive guidance described in this part II.A.4, which provides for 
consideration of the relevant facts and circumstances. As part of this 
consideration, the person would apply elements of the dealer-trader 
distinction, as appropriate, including as described in part II.A.4.a, 
below.
---------------------------------------------------------------------------

    \162\ See CFTC Regulation Sec.  1.3(ggg)(1), (2).
---------------------------------------------------------------------------

    The rule provides that certain swaps are not considered in the 
determination of whether a person is a swap dealer.\163\ In particular, 
swaps entered into by an insured depository institution with a customer 
in connection with originating a loan with that customer, \164\ swaps

[[Page 30607]]

between majority-owned affiliates, \165\ swaps entered into by a 
cooperative with its members,\166\ swaps entered into for hedging 
physical positions as defined in the rule,\167\ and certain swaps 
entered into by registered floor traders \168\ are excluded from the 
swap dealer determination.
---------------------------------------------------------------------------

    \163\ See CFTC Regulation Sec.  1.3(ggg)(5), (6).
    \164\ See CFTC Regulation Sec.  1.3(ggg)(5); see also part II.B, 
infra.
    \165\ See CFTC Regulation Sec.  1.3(ggg)(6)(i); see also part 
II.C, infra.
    \166\ See CFTC Regulation Sec.  1.3(ggg)(6)(ii); see also part 
II.C, infra.
    \167\ See CFTC Regulation Sec.  1.3(ggg)(6)(iii); see also part 
II.B.4.e, infra.
    \168\ See CFTC Regulation Sec.  1.3(ggg)(6)(iv); see also part 
II.B.4.f, infra.
---------------------------------------------------------------------------

    If, after completing this review (taking into account the 
applicable interpretive guidance and excluding any swaps as noted 
above), the person determines that it is engaged in swap dealing 
activity, the next step is to determine if the person is engaged in 
more than a de minimis quantity of swap dealing.\169\ If so, the person 
is a swap dealer. When the person registers, it may apply to limit its 
designation as a swap dealer to specified categories of swaps or 
specified activities of the person in connection with swaps.\170\
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    \169\ See CFTC Regulation Sec.  1.3(ggg)(4); see also part II.D, 
infra.
    \170\ See CFTC Regulation Sec.  1.3(ggg)(3); see also part II.E, 
infra.
---------------------------------------------------------------------------

    In this part II.A.4., we provide interpretive guidance on the 
application of the ``swap dealer'' definition, modified from the 
Proposing Release as appropriate based on comments received. This 
guidance separately addresses the following: application of the dealer-
trader framework; the ``holding out'' and ``commonly known'' criteria; 
market making; the not part of ``a regular business'' exception; the 
exclusion of swaps entered into for hedging physical positions as 
defined in the rule; and the overall interpretive approach to the 
definition.\171\
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    \171\ The Commissions note that interpretations of the 
applicability of the dealer-trader distinction to the ``swap 
dealer'' definition under the CEA do not affect existing, or future, 
interpretations of the dealer-trader distinction under the Exchange 
Act.
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a. Use of the Dealer-Trader Distinction
    We believe that the dealer-trader distinction \172\--which already 
forms a basis for identifying which persons fall within the 
longstanding Exchange Act definition of ``dealer''--in general provides 
an appropriate framework for interpreting the statutory definition of 
the term ``swap dealer.'' \173\ While there are differences in the 
structure of those two statutory definitions,\174\ we believe that 
their parallels--particularly their exclusions for activities that are 
``not part of a regular business''--warrant analogous interpretive 
approaches for distinguishing dealers from non-dealers.\175\ Thus, the 
dealer-trader distinction forms the basis for a framework that 
appropriately distinguishes between persons who should be regulated as 
swap dealers and those who should not. We also believe that the 
distinction affords an appropriate degree of flexibility to the 
analysis, and that it would not be appropriate to seek to codify the 
distinction in rule text.
---------------------------------------------------------------------------

    \172\ See note 31, supra. The principles embedded within the 
``dealer-trader distinction'' are also applicable to distinguishing 
dealers from non-dealers such as hedgers or investors. See note 250, 
infra.
    \173\ The Commissions note that interpretations of the 
applicability of the dealer-trader distinction to the ``swap 
dealer'' definition under the CEA do not affect existing, or future, 
interpretations of the dealer-trader distinction under the Exchange 
Act.
    \174\ For example, while the ``dealer'' definition encompasses 
certain persons in the business of ``buying and selling'' 
securities, the ``swap dealer'' definition does not address either 
``buying'' or ``selling.'' We also note that the ``dealer'' 
definition requires the conjunctive ``buying and selling''--which 
connotes a degree of offsetting two-sided activity. In contrast, the 
swap dealer definition (particularly the ``regularly enters into'' 
swaps language of the definition's third prong) lacks that 
conjunctive terminology.
    \175\ In the Proposing Release, the CFTC did not propose to use 
principles from the dealer-trader distinction to interpret the 
definition of the term ``swap dealer,'' instead proposing an 
interpretive approach that focused on, among other things, a 
person's functional role in the swap markets and its relationships 
with swap counterparties. See Proposing Release, 75 FR at 80177. 
There was, however, some overlap in practice between the factors 
identified in the Proposing Release relating to a swap dealer's 
functional role and relationships and the principles of the dealer-
trader distinction that were proposed to be applied to identify 
security-based swap dealers. Moreover, the changes to the 
interpretive approach to the swap dealer definition that we are 
adopting here and discussed in this part II.A.4 are in many respects 
similar to the principles of the dealer-trader distinction. We also 
acknowledge the commenters who asked for additional guidance 
regarding the application of the definitions. See, e.g., letters 
from Gavilon II, Peabody and the Utility Group, and meeting with 
CDEU on April 7, 2011.
    Thus, while the incorporation of the dealer-trader distinction 
in the interpretation of the term ``swap dealer'' constitutes a 
change from the Proposing Release, this is simply reflective of the 
other changes to the CFTC's interpretive approach that we are 
adopting for the final rule and the overlap between the factors 
relating to a swap dealer's functional role and counterparty 
relationships and the principles of the dealer-trader distinction.
---------------------------------------------------------------------------

    The Commissions recognize that the dealer-trader distinction needs 
to be adapted to apply to swap activities in light of the special 
characteristics of swaps and the differences between the ``dealer'' 
definition, on the one hand, and the ``swap dealer'' definition, on the 
other. Relevant differences between the swap market and the markets for 
securities (other than security-based swaps) include:
     Level of activity--Swap markets are marked by less 
activity than markets involving certain types of securities (while 
recognizing that some debt and equity securities are not actively 
traded). This suggests that in the swap context, concepts of 
``regularity'' should account for a participant's level of activity in 
the market relative to the total size of the market.
     No separate issuer--Each counterparty to a swap in essence 
is the ``issuer'' of that instrument; in contrast, dealers in cash 
market securities generally transact in securities issued by another 
party. This distinction suggests that the concept of maintaining an 
``inventory'' of securities is inapposite in the context of swaps. 
Moreover, this distinction--along with the fact that the ``swap 
dealer'' definition lacks the conjunctive ``buying and selling'' 
language of the ``dealer'' definition--suggests that concepts of two-
sided markets at times would be less relevant for identifying swap 
dealers than they would be for identifying dealers.\176\
---------------------------------------------------------------------------

    \176\ The analysis also should account for the fact that a party 
to a swap can use other derivatives or cash market instruments to 
hedge the risks associated with the swap position, meaning that two-
way trading is not necessary to maintain a flat risk book.
---------------------------------------------------------------------------

     Predominance of over-the-counter and non-standardized 
instruments--Swaps an thus far are not significantly traded on 
exchanges or other trading systems, in contrast to some cash market 
securities (while recognizing that many cash market securities also are 
not significantly traded on those systems).\177\ These attributes--
along with the lack of ``buying and selling'' language in the swap 
dealer definition, as noted above--suggest that concepts of what it 
means to make a market need to be construed flexibly in the contexts of 
the swap markets.
---------------------------------------------------------------------------

    \177\ Even though we expect trading of swaps on exchanges 
following the implementation of Title VII, we expect there to remain 
a significant amount of over-the-counter activity involving swaps.
---------------------------------------------------------------------------

     Mutuality of obligations and significance to ``customer'' 
relationship--In contrast to a secondary market transaction involving 
equity or debt securities, in which the completion of a purchase or 
sale transaction can be expected to terminate the mutual obligations of 
the parties to the transaction, the parties to a swap often will have 
an ongoing obligation to exchange cash flows over the life of the 
agreement. In light of this attribute, some market participants have 
expressed the view that they have ``counterparties'' rather than 
``customers'' in the context of their swap activities.
    In applying the dealer-trader distinction, it also is necessary to 
apply

[[Page 30608]]

the statutory provisions that will govern swap dealers in an effective 
and logical way. Those statutory provisions added by the Dodd-Frank Act 
advance financial responsibility (e.g., the ability to satisfy 
obligations, and the maintenance of counterparties' funds and assets) 
associated with swap dealers' activities,\178\ other counterparty 
protections,\179\ and the promotion of market efficiency and 
transparency.\180\ As a whole, the relevant statutory provisions 
suggest that we should interpret the ``swap dealer'' definition to 
identify those persons for which regulation is warranted either: (i) 
Due to the nature of their interactions with counterparties; or (ii) to 
promote market stability and transparency, in light of the role those 
persons occupy within the swap and security-based swap markets.
---------------------------------------------------------------------------

    \178\ E.g., capital and margin requirements (CEA section 4s(e)), 
and requirements for segregation of collateral (CEA sections 4d(f), 
4s(l)).
    \179\ E.g., requirements with respect to business conduct when 
transacting with special entities (CEA sections 4s(h)(2), 4s(h)(4), 
4s(h)(5)); disclosure requirements (CEA section 4s(h)(3)(B)); 
requirements for fair and balanced communications (CEA section 
4s(h)(3)(D)); other requirements related to the public interest and 
investor protection (CEA section 4s(h)(3)(D)); and conflict of 
interest provisions (CEA section 4s(j)(5)).
    \180\ E.g., reporting and recordkeeping requirements (CEA 
section 4s(f)); daily trading records requirements (CEA section 
4s(g)); regulatory standards related to the confirmation, 
processing, netting, documentation and valuation of security-based 
swaps (CEA section 4s(i)); position limit monitoring requirements 
(CEA section 4s(j)(1)); risk management procedure requirements (CEA 
section 4s(j)(2)); and requirements related to the disclosure of 
information to regulators (CEA section 4s(j)(3)).
---------------------------------------------------------------------------

    There are several aspects of our interpretive approach to the swap 
dealer definition that are particularly similar to the dealer-trader 
distinction as it will be applied to determine if a person is a 
security-based swap dealer. In particular, the following activities, 
which are indicative of dealing activity in the application of the 
dealer-trader distinction,\181\ similarly are indicative that a person 
is acting as a swap dealer: \182\ (i) Providing liquidity by 
accommodating demand for or facilitating interest in the instrument 
(swaps, in this case), holding oneself out as willing to enter into 
swaps (independent of whether another party has already expressed 
interest), or being known in the industry as being available to 
accommodate demand for swaps; (ii) advising a counterparty as to how to 
use swaps to meet the counterparty's hedging goals, or structuring 
swaps on behalf of a counterparty; (iii) having a regular clientele and 
actively advertising or soliciting clients in connection with swaps; 
\183\ (iv) acting in a market maker capacity on an organized exchange 
or trading system for swaps; \184\ and (v) helping to set the prices 
offered in the market (such as by acting as a market maker) rather than 
taking those prices, although the fact that a person regularly takes 
the market price for its swaps does not foreclose the possibility that 
the person may be a swap dealer.
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    \181\ See generally part II.A.5, infra.
    \182\ To clarify, the activities listed in the text are 
indicative of acting as a swap dealer. Engaging in one or more of 
these activities is not a prerequisite to a person being covered by 
the swap dealer definition.
    \183\ As with the interpretation of the dealer-trader 
distinction with respect to securities, a nomenclature distinction 
between ``counterparties'' and ``customers'' is not significant for 
purposes of applying the dealer-trader distinction to swap 
activities. Contractual provisions related to nomenclature, such as 
a provision stating that no ``customer'' relationship is present, 
would not be significant if the reality of the situation is 
different. See note 271, infra, and accompanying text.
    \184\ As with the dealer-trader distinction as it has been 
interpreted under the Exchange Act with respect to securities (and 
as noted below in the discussion of the ``makes a market in swaps'' 
prong of the swap dealer definition), the presence of an organized 
exchange or trading system is not a prerequisite to being a market 
maker for purposes of the swap dealer definition, nor is acting as a 
market maker a prerequisite to being a swap dealer.
---------------------------------------------------------------------------

    The Commissions further note that the following elements of the 
interpretive approach to the swap dealer definition are also generally 
consistent with the dealer-trader distinction as it will be applied to 
determine if a person is a security-based swap dealer: (i) A 
willingness to enter into swaps on either side of the market is not a 
prerequisite to swap dealer status; (ii) the swap dealer analysis does 
not turn on whether a person's swap dealing activity constitutes that 
person's sole or predominant business; (iii) a customer relationship is 
not a prerequisite to swap dealer status; and (iv) in general, entering 
into a swap for the purpose of hedging, absent other activity, is 
unlikely to be indicative of dealing. Last, under the interpretive 
approach to the definition of both the terms ``swap dealer'' and 
``security-based swap dealer,'' whether a person is acting as a dealer 
will turn upon the relevant facts and circumstances, as informed by the 
interpretive guidance set forth in this Adopting Release.
    At the same time, the Commissions recognize that the dealer-trader 
distinction is not static, but rather has evolved over time through 
interpretive materials. The Commissions expect the dealer-trader 
distinction to evolve over time with respect to swaps independently of 
its evolution over time with respect to securities or security-based 
swaps. Prior interpretations and future developments in the law 
regarding securities or security-based swaps may inform the 
interpretation of the swap dealer definition, but will not be 
dispositive in identifying dealers in the swap markets.\185\
---------------------------------------------------------------------------

    \185\ In interpreting the term ``swap dealer,'' we intend to 
consider, but do not formally adopt, the body of court decisions, 
SEC releases, and SEC staff no-action letters that have interpreted 
the dealer-trader distinction.
---------------------------------------------------------------------------

b. Indicia of Holding Oneself Out as a Dealer in Swaps or Being 
Commonly Known in the Trade as a Dealer in Swaps
    The final rule further defining the term ``swap dealer'' includes 
the provisions in the proposed rule which incorporate the statutory 
requirements that the term includes a person that is holding itself out 
as a dealer in swaps or is engaging in any activity causing it to be 
commonly known in the trade as a dealer or market maker in swaps.\186\
---------------------------------------------------------------------------

    \186\ See CFTC Regulation Sec.  1.3(ggg)(1)(i) and (iv).
---------------------------------------------------------------------------

    We continue to believe that the Proposing Release appropriately 
identifies a number of factors as indicia of ``hold[ing] itself out as 
a dealer in swaps'' and ``engag[ing] in any activity causing [itself] 
to be commonly known in the trade as a dealer or market maker in 
swaps.'' \187\ In our view, those factors thus are relevant to 
determining if a person is a swap dealer. For example, regarding the 
proposed factor of ``membership in a swap association in a category 
reserved for dealers,'' we note that the bylaws of the International 
Swaps and Derivatives Association (``ISDA'') provide that any business 
organization that:

    \187\ These factors are as follows: Contacting potential 
counterparties to solicit interest; developing new types of swaps or 
security-based swaps and informing potential counterparties of their 
availability and of the person's willingness to enter into the swap 
or security-based swap; membership in a swap association in a 
category reserved for dealers; providing marketing materials 
describing the type of swaps or security-based swaps the party is 
willing to enter into; and generally expressing a willingness to 
offer or provide a range of products or services that include swaps 
or security-based swaps. See Proposing Release, 75 FR at 80178.

    Directly or through an affiliate, as part of its business 
(whether for its own account or as agent), deals in derivatives 
shall be eligible for election to membership in the Association as a 
Primary Member, provided that no person or entity shall be eligible 
for membership as a Primary Member if such person or entity 
participates in derivatives transactions solely for the purpose of 
risk hedging or asset or liability management.\188\
---------------------------------------------------------------------------

    \188\ See By-laws of ISDA at 3, available at: https://www.isdadocs.org/membership. The Commissions note that the Primary 
Members of ISDA are not limited to only financial firms.

    We believe that in circumstances such as this, where a category of 
association

[[Page 30609]]

membership requires that a person deal in derivatives and not limit its 
participation in derivative transactions to solely risk hedging, 
membership in the category is an indicator of swap dealer status.\189\
---------------------------------------------------------------------------

    \189\ However, while such membership is an indicator of swap 
dealer status, a person holding such membership could nonetheless be 
excluded by other provisions of the definition of the term ``swap 
dealer.'' For example, an insured depository institution that limits 
its activity to offering swaps in connection with the origination of 
loans, as discussed below in part II.B, would not be covered by the 
definition simply because it holds such membership.
---------------------------------------------------------------------------

    We take note, however, of the comments that these activities may be 
insufficient to establish that a person is a swap dealer. In 
particular, we generally agree with commenters that many commercial end 
users of swaps do, from time to time, actively seek out and negotiate 
swaps. Yet, based on the applicable facts and circumstances, these end 
users do not necessarily fall within the definition of a swap dealer 
solely because they actively seek out and negotiate swaps from time to 
time.
    The activities described in the Proposing Release as indicia of 
holding oneself out as a swap dealer or engaging in any activity 
causing oneself to be commonly known as a swap dealer should not be 
considered in a vacuum, but should instead be considered in the context 
of all the activities of the swap participant. While the activities 
listed in the Proposing Release are indicators that a person is holding 
itself out or is commonly known as a swap dealer, these are factors to 
be considered in the analysis. They are not per se conclusive, and 
could be countered by other factors indicating that the person is not a 
swap dealer.\190\ Because of the flexibility--including the 
consideration of applicable facts and circumstances--needed for such an 
analysis, we do not believe that it is appropriate to codify this 
guidance in rule text, as suggested by some commenters.
---------------------------------------------------------------------------

    \190\ The statutory definition of the term ``swap dealer'' 
contains four separate clauses, or ``prongs,'' joined by the 
disjunctive ``or,'' the ordinary meaning of which is that the prongs 
are stated as alternative types of swap dealer. Accordingly, where 
an assessment of all the activities of a swap participant 
demonstrates that the person is not holding itself out as a swap 
dealer or engaging in any activity that causes it to be commonly 
known as a swap dealer, that person may, nonetheless, be a swap 
dealer based on the market making or regular business prongs of the 
swap dealer definition, discussed below. The Commissions note, 
however, that as discussed below in part II.A.4.g, the CFTC's 
overall interpretive guidance, including guidance regarding the 
dealer-trader framework, applies to identify swap dealers under all 
four prongs of the statutory ``swap dealer'' definition.
---------------------------------------------------------------------------

c. Market Making
    The final rule defining ``swap dealer'' includes the provision from 
the proposed rule which incorporates the statutory requirement that 
this term include a person that ``makes a market in swaps.'' \191\
---------------------------------------------------------------------------

    \191\ See CFTC Regulation Sec.  1.3(ggg)(1)(ii). Because the 
statutory swap dealer definition contains four disjunctive prongs, 
the CFTC does not agree with a commenter (see letter from ISDA I) 
who asserted that status as a market maker in swaps is a 
prerequisite to a person being a swap dealer.
---------------------------------------------------------------------------

    We have considered the comments suggesting various descriptions of 
activities that should and should not be deemed to be market making in 
swaps for purposes of this rule. In consideration of these comments, we 
clarify that making a market in swaps is appropriately described as 
routinely standing ready to enter into swaps at the request or demand 
of a counterparty. In this regard, ``routinely'' means that the person 
must do so more frequently than occasionally, but there is no 
requirement that the person do so continuously.\192\
---------------------------------------------------------------------------

    \192\ A person that occasionally, or less than routinely, enters 
into a swap at the request of a counterparty is not a maker of a 
market in swaps, and therefore is not a swap dealer on that basis. 
However, we reiterate, as stated in the Proposing Release, that 
since many types of swaps are not entered into on a continuous 
basis, it is not necessary that a person enter into swaps at the 
request or demand of counterparties on a continuous basis in order 
for the person to be a market maker in swaps and, therefore, a swap 
dealer.
---------------------------------------------------------------------------

    It is appropriate, in response to comments asking for further 
guidance regarding what activities constitute making a market in swaps, 
to describe some of the activities indicative of whether a person is 
routinely standing ready to enter into swaps at the request or demand 
of a counterparty. Such activities include routinely: (i) Quoting bid 
or offer prices, rates or other financial terms for swaps on an 
exchange; (ii) responding to requests made directly, or indirectly 
through an interdealer broker, by potential counterparties for bid or 
offer prices, rates or other similar terms for bilaterally negotiated 
swaps; (iii) placing limit orders for swaps; or (iv) receiving 
compensation for acting in a market maker capacity on an organized 
exchange or trading system for swaps.\193\ These examples are not 
exhaustive, and other activities also may be indicative of making a 
market in swaps if the person engaging in them routinely stands ready 
to enter into swaps as principal at the request or demand of a 
counterparty.
---------------------------------------------------------------------------

    \193\ In addition, section 619 of the Dodd-Frank Act (the 
``Volcker Rule'') generally prohibits banking entities from engaging 
in proprietary trading, but contains an exception for certain market 
making-related activities. The Commissions have proposed an approach 
to the Volcker Rule under which a person could seek to avoid the 
Volcker Rule in connection with swap activities by asserting the 
availability of that market making exception. See SEC, Board, Office 
of the Comptroller of the Currency (``OCC''), and Federal Deposit 
Insurance Corporation (``FDIC''), Prohibitions and Restrictions on 
Proprietary Trading and Certain Interests in, and Relationships 
With, Hedge Funds and Private Equity Funds; Proposed Rule, 76 FR 
68846 (Nov. 7, 2011); CFTC, Prohibitions and Restrictions on 
Proprietary Trading and Certain Interests in, and Relationships 
With, Hedge Funds and Private Equity Funds; Proposed Rule, 77 FR 
8332 (Feb. 14, 2012). Under this approach, such a person would 
likely also be required to register as a swap dealer (unless the 
person is excluded from the swap dealer definition, such as by the 
exclusion of certain swaps entered into in connection with the 
origination of a loan). The SEC has proposed to adopt the same 
approach with respect to the interplay of the Volcker Rule and the 
definition of the term ``security-based swap dealer.'' See note 272, 
infra.
---------------------------------------------------------------------------

    In determining whether a person's routine presence in the market 
constitutes market making under these four factors, the dealer-trader 
interpretative framework may be usefully applied.\194\ Under the 
dealer-trader distinction, seeking to profit by providing liquidity to 
the market is an indication of dealer activity.\195\ Thus, in applying 
these four factors, it is useful to consider whether the person is 
seeking, through presence in the market, compensation for providing 
liquidity, compensation through spreads or fees, or other compensation 
not attributable to changes in the value of the swaps it enters 
into.\196\ If not, such activity would not be indicative of market 
making.
---------------------------------------------------------------------------

    \194\ We recognize that routine presence in the swap market is 
not necessarily indicative of making a market in swaps. For example, 
persons may be routinely present in the market in order to engage in 
swaps for purposes of hedging, to advance their investment 
objectives, or to engage in proprietary trading.
    \195\ See note 265, infra, and accompanying text.
    \196\ In this case, the spread from which a person profits may 
be between two or more swaps, or it may be between a swap and 
another position or financial instrument. In contrast, entering into 
swaps in order to obtain compensation attributable to changes in the 
value of the swaps is indicative of using swaps for a hedging, 
investment or trading purpose.
---------------------------------------------------------------------------

    Some commenters suggested that, in order to be a market maker in 
swaps, a person must make a two-way market in swaps.\197\ Nonetheless, 
it is possible for a person making a one-way market in swaps to be a 
maker of a market in swaps and, therefore, within the swap dealer 
definition. This may be true, for example, where a person routinely

[[Page 30610]]

stands ready to enter into swaps on a particular side of the market--
say, routinely bidding for floating exposures on a swap trading 
platform--while entering into transactions on the other side of the 
market in other instruments (such as futures contracts). The relevant 
indicator of market maker status is the willingness of the person to 
routinely stand ready to enter into swaps at the request or demand of a 
counterparty (as opposed to entering into swaps to accommodate one's 
own demand or desire to participate in a particular market), be it on 
one or both sides of the market, and then to enter into offsetting 
positions, either in the swap market or in other markets.
---------------------------------------------------------------------------

    \197\ See letters cited in notes 52 to 58, supra. Although swaps 
are notional contracts requiring the performance of agreed upon 
terms by each party, it is possible to describe swap users in 
practical terms as being on either ``side'' of a market. For 
example, for many swaps the party paying a fixed amount is on one 
``side'' of the market and the party paying a floating amount is on 
the other ``side.''
---------------------------------------------------------------------------

    The Commissions disagree with the commenters who said that swaps 
executed on an exchange should not be considered in determining if a 
person is a market maker in swaps and thus a swap dealer.\198\ First, 
the statutory definition of the term ``swap dealer'' makes no 
distinction between swaps executed on an exchange and swaps that are 
not, suggesting that the same protections should apply regardless of 
the method of executing the swap. Second, from the perspective of an 
end user seeking to execute a swap on an exchange, the important 
consideration under our analysis is whether a market maker is ready to 
enter into swaps, not whether the market maker is aware of the 
counterparty's identity. A market maker in swaps routinely stands ready 
to enter into swaps at the request or demand of a counterparty, 
regardless of whether the counterparty and the market maker meet on a 
disclosed basis through bilateral negotiations or anonymously through 
an exchange.\199\ Similarly, the issue of whether a person is a 
registered FCM or broker-dealer is not necessarily relevant to whether 
the person is a maker of a market in swaps, if the person is routinely 
standing ready to enter into swaps at the request or demand of a 
counterparty. Third, we believe it would be inappropriate to disregard 
swaps executed on exchanges in order, as some commenters 
suggested,\200\ to encourage market participants to use, or to provide 
liquidity to, exchanges. Finally, variety of exchanges, markets, and 
other facilities for the execution of swaps are likely to evolve in 
response to the requirements of the Dodd-Frank Act, and there is no 
basis for any bright-line rule excluding swaps executed on an exchange, 
given the impossibility of obtaining information about how market 
participants will interact and execute swaps in the future, after the 
requirements under the Dodd-Frank Act are fully in effect. For all 
these reasons, we have determined that it is inappropriate to restrict 
the ``making a market in swaps'' prong of the swap dealer definition 
(i.e., routinely standing ready to enter into swaps at the request or 
demand of a counterparty) to swaps that are not executed on an 
exchange.\201\
---------------------------------------------------------------------------

    \198\ See, e.g., letters cited in note 62, supra.
    \199\ As discussed above, in many cases routine presence in the 
swap market, without more, would not constitute market making 
activity. Nevertheless, the CFTC will, in connection with 
promulgation of final rules relating to capital requirements for 
swap dealers and major swap participants, consider institution of 
reduced capital requirements for entities or individuals that fall 
within the swap dealer definition and that execute swaps only on 
exchanges, using only proprietary funds. Similarly, the CFTC also 
will consider the applicability to such entities or individuals of 
the other requirements imposed on swap dealers (e.g., internal 
business conduct standards, external business conduct standards with 
counterparties), and may adjust those swap dealer requirements as 
appropriate.
    \200\ See, e.g., letters cited in note 66, supra. Since the 
structures of the markets on which swaps will be executed are still 
in development, and market obligations have not been established, 
there is little support for comments asserting that market makers 
should be defined as only those persons who receive benefits from 
the market (such as reduced trading fees) in return for the 
obligation to transact when the market requires liquidity.
    \201\ By contrast, it may be appropriate, over time, to tailor 
the specific requirements imposed on swap dealers depending on the 
facility on which the swap dealer executes swaps. For example, the 
application of certain business conduct requirements may vary 
depending on how the swap is executed, and it may be appropriate, as 
the swap markets evolve, to consider adjusting certain of those 
requirements for swaps that are executed on an exchange or through 
particular modes of execution.
---------------------------------------------------------------------------

d. Exception for Activities Not Part of ``a Regular Business''
    The final rule includes the provisions in the proposed rule that 
incorporate the provisions of the statutory definition regarding 
activities that are not part of ``a regular business'' of entering into 
swaps. One provision states that the term ``swap dealer'' includes a 
person that ``regularly enters into swaps with counterparties as an 
ordinary course of business for its own account''; the other provision 
states that the term ``swap dealer'' does not include a person that 
``enters into swaps for such person's own account, either individually 
or in a fiduciary capacity, but not as a part of a regular business.'' 
\202\
---------------------------------------------------------------------------

    \202\ Final CFTC Regulation Sec.  1.3(ggg)(2) is modified from 
the proposal to include the word ``a'' before the words ``regular 
business,'' to conform the text of the rule to the text of the 
statute. See CEA section 1a(49)(C), 7 U.S.C. 1a(49)(C).
    As stated in the Proposing Release, we interpret the reference 
in the definition of the term ``swap dealer'' to a person entering 
into swaps ``with counterparties * * * for its own account'' to 
refer to a person who enters into a swap as a principal, and not as 
an agent. A person who enters into swaps as an agent for customers 
(i.e., for the customers' accounts) would be required to register as 
either an FCM, introducing broker, commodity pool operator or 
commodity trading advisor, depending on the nature of the person's 
activity.
---------------------------------------------------------------------------

    The Commissions continue to believe, as stated in the Proposing 
Release, that the phrases ``ordinary course of business'' and ``a 
regular business'' are, for purposes of the definition of ``swap 
dealer'' essentially synonymous. In this context, we interpret these 
phrases to focus on activities of a person that are usual and normal in 
the person's course of business and identifiable as a swap dealing 
business. It is not necessarily relevant whether the person conducts 
its swap-related activities in a dedicated subsidiary, division, 
department or trading desk, or whether such activities are a person's 
``primary'' business or an ``ancillary'' business, so long as the 
person's swap dealing business is identifiable.\203\
---------------------------------------------------------------------------

    \203\ We recognize, as noted by one commenter (see letter from 
ISDA I), that the ``regular business'' exclusion is not limited 
solely to the ``ordinary course of business'' test of the swap 
dealer definition. Our interpretations of the other three tests are, 
and should be read to be, consistent with the exclusion of 
activities that are not part of a regular business.
---------------------------------------------------------------------------

    We have taken into consideration comments seeking additional 
guidance regarding the types and levels of activities that constitute 
having ``a regular business'' of entering into swaps.\204\ In this 
regard, any one of the following activities would generally constitute 
both entering into swaps ``as an ordinary course of business'' and ``as 
a part of a regular business'': \205\ (i) Entering into swaps with the 
purpose of satisfying the business or risk management needs of the 
counterparty (as opposed to entering into swaps to accommodate one's 
own demand or desire to participate in a particular market); (ii) 
maintaining a separate profit and loss statement reflecting the results 
of swap activity or treating swap activity as a separate profit center; 
or (iii) having staff and resources allocated to dealer-type activities 
with counterparties, including activities relating to credit analysis, 
customer onboarding, document negotiation, confirmation generation, 
requests for novations and amendments, exposure monitoring and 
collateral calls, covenant monitoring, and reconciliation.\206\
---------------------------------------------------------------------------

    \204\ See, e.g., letters from BG LNG I, COPE I, IECA-Credit I, 
Shell Trading I, WGCEF I and Vitol (stating that the proposed 
approach was overly subjective and requesting guidance as to the 
specific activities that are covered by the statutory definition).
    \205\ These activities are inconsistent with entering into a 
swap to hedge a physical position as defined in Sec.  
1.3(ggg)(6)(iii). As discussed below, such hedging is not dealing 
activity.
    \206\ The three indicators of being engaged in ``a regular 
business'' of entering into swaps described here are set forth in 
the alternative. Any one of these indicators may be sufficient, 
based on a facts and circumstances analysis, to reach a conclusion 
that an entity is engaged in ``a regular business'' of entering into 
swaps.

---------------------------------------------------------------------------

[[Page 30611]]

    The Commissions see merit in the comments saying that ``a regular 
business'' of entering into swaps can be characterized by entering into 
swaps to satisfy the business or risk management needs of the other 
party to the swap, and so incorporate this element into our 
interpretation of the rule.\207\ Also, an objective indicator of a 
person being engaged in ``a regular business'' of entering into swaps 
is when the person accounts for the results of its swap activities 
separately, by maintaining a separate profit and loss statement for 
those activities or treating them as a separate profit center. Our 
interpretation incorporates this indicator of activity that is ``a 
regular business'' of entering into swaps.
---------------------------------------------------------------------------

    \207\ This element of the interpretation reflects our agreement 
with those commenters who said that ``a regular business'' of 
entering into swaps is characterized by having a business of 
accommodating demand or facilitating interest in swaps (see letter 
from IECA-Credit I), and those commenters who said that ``a regular 
business'' does not encompass the use of swaps to serve a person's 
own business needs, as opposed to serving the business needs of the 
counterparty (see letters cited in note 71, supra).
---------------------------------------------------------------------------

    Other comments suggesting specific criteria to identify ``a regular 
business'' also were helpful. We agree with commenters \208\ that ``a 
regular business'' of entering into swaps can be characterized by 
having staff and resources allocated to the types of activities in 
which swap dealers must engage with their counterparties, such as those 
noted above (e.g., credit analysis, confirmation generation, collateral 
calls, and covenant monitoring). However, we understand that some end 
users of swaps engage in some of these activities and, in certain 
circumstances, may have staff and resources available for these 
activities. Therefore, this element of the definition should be applied 
in a reasonable manner, taking all appropriate circumstances into 
account. This element does not depend on whether a specific amount or 
percentage of expenses or employee time are related to these swap 
activities. Instead, it is appropriate to objectively examine a 
person's use of staff and resources related to swap activities. Using 
staff and resources to a significant extent in conducting credit 
analysis, opening and monitoring accounts and the other activities 
noted above, is an indication that the person is engaged in ``a regular 
business'' of entering into swaps.
---------------------------------------------------------------------------

    \208\ See letters cited in note 80, supra.
---------------------------------------------------------------------------

    Regarding the commenters' assertion that the activity of entering 
into swaps in connection with a person's physical commodity business 
cannot constitute ``a regular business'' of the person, we believe that 
while in most cases this is not dealing activity,\209\ a per se 
exclusion of this type is not appropriate because it is possible that 
in some circumstances a person might enter into swaps that are 
connected to a physical commodity business but also serve market 
functions characteristic of the functions served by swap dealers. Also, 
again, the statutory definition does not contain any such exclusion, 
but rather includes any person who ``regularly enters into swaps with 
counterparties as an ordinary course of business for its own account,'' 
without regard to the person's particular type of business.
---------------------------------------------------------------------------

    \209\ See CFTC Regulation Sec.  1.3(ggg)(6)(iii) (swaps entered 
into for hedging physical positions as defined in the rule are not 
considered in the determination of whether a person is a swap 
dealer).
---------------------------------------------------------------------------

    Consistent with the statutory definition, we interpret ``a regular 
business'' of entering into swaps in a manner that applies equally to 
all market participants that engage in the activities set forth in the 
statutory definition. This will ensure that all participants in the 
swap markets are regulated in a fair and consistent manner, regardless 
of whether their underlying business is primarily physical or financial 
in nature.\210\
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    \210\ Regulation of firms engaged in an underlying physical 
business is also consistent with regulatory practices outside the 
U.S. For example, non-financial entities register with the Financial 
Services Authority in the U.K. as ``Oil Market Participants'' and 
``Energy Market Participants.'' See Financial Services Authority 
Handbook EMPS and OMPS, available at http://fsahandbook.info/FSA/html/handbook.
---------------------------------------------------------------------------

    Finally, as noted above, the manner in which persons negotiate, 
execute and use swaps is likely to evolve in response to the 
requirements of the Dodd-Frank Act and the other forces that will shape 
the swap markets going forward. For this reason, it would be 
inappropriate to craft per se exclusions from the swap dealer 
definition at a time when the only available information about the use 
of swaps relates to the period prior to implementation of the Dodd-
Frank Act.\211\
---------------------------------------------------------------------------

    \211\ For the same reasons, we do not believe it would be 
appropriate, in determining whether a person has a ``regular 
business'' of entering into swaps, to consider whether a person 
engages in activities normally associated with financial 
institutions, as some commenters suggested. See letters cited in 
note 76, supra.
---------------------------------------------------------------------------

e. Interim Final Rule Excluding Swaps Entered Into for Hedging Physical 
Positions
    We note that some commenters said that swaps used to hedge or 
mitigate commercial risks should not be considered in determining 
whether a person is a swap dealer.\212\ We understand that swaps are 
used to hedge risks in numerous and varied ways, and we expect that the 
number of persons covered by the definition will be very small in 
comparison to the thousands of persons that use swaps for hedging.
---------------------------------------------------------------------------

    \212\ See, e.g., letters cited in note 72, supra.
---------------------------------------------------------------------------

    In terms of the statutory definition of the term ``swap dealer,'' 
the CFTC notes as an initial matter that there is no specific provision 
addressing hedging activity. Thus, the statutory definition leaves the 
treatment of hedging swaps to the CFTC's discretion; it neither 
precludes consideration of a swap's hedging purpose, nor does it 
require an absolute exclusion of all swaps used for hedging.\213\
---------------------------------------------------------------------------

    \213\ In this regard, the statutory definition of the term 
``swap dealer'' stands in contrast to the statutory definition of 
the term ``major swap participant'' which, as discussed further 
below, explicitly provides that positions in swaps held for hedging 
or mitigating commercial risk are to be excluded in certain parts of 
that definition. See CEA section 1a(33)(A)(i)(1), 7 U.S.C. 
1a(33)(A)(i)(1). The absence of any explicit requirement in the 
``swap dealer'' definition to exclude swaps held for hedging or 
mitigating commercial risk does not support the view that Congress 
intended to categorically exclude all swaps that may serve as hedges 
in determining whether a person is covered by the definition.
    Similarly, the absence of any limitation in the statutory 
definition of the term ``swap dealer'' to financial entities, when 
such limitation is included elsewhere in Title VII, indicates that 
no such limitation applies to the swap dealer definition. CEA 
section 2(h)(7), 7 U.S.C. 2(h)(7), specifically limits the 
application of the clearing mandate, in certain circumstances, to 
only ``financial entities.'' That section also provides a detailed 
definition of the term ``financial entity.'' See CEA section 
2(h)(7)(C), 7 U.S.C. 2(h)(7)(C). That such a limitation is included 
in this section, but not in the swap dealer definition, does not 
support the view that the statutory definition of the term ``swap 
dealer'' should encompass only financial entities.
---------------------------------------------------------------------------

    In general, entering into a swap for the purpose of hedging is 
inconsistent with swap dealing.\214\ The practical

[[Page 30612]]

difficulty lies in determining when a person has entered into a swap 
for the purpose of hedging, as opposed to other purposes for entering 
into swaps, such as accommodating demand for swaps or as part of making 
a market in swaps, and in distinguishing a swap with a hedging purpose 
from a swap with a hedging consequence. In view of these uncertainties, 
the CFTC believes it is appropriate to adopt an interim final rule that 
draws upon the principles of bona fide hedging that the CFTC has long 
applied to identify when a financial instrument is used for hedging 
purposes, and excludes from the swap dealer analysis swaps entered into 
for the purpose of hedging physical positions that meet the 
requirements of the rule.
---------------------------------------------------------------------------

    \214\ For example, under the dealer-trader distinction, the 
Commissions would expect persons that use security-based swaps to 
hedge their business risks, absent other activity, likely would not 
be dealers. See part II.A.5.b, infra. Under the CFTC's interpretive 
guidance, making a market in swaps is appropriately described as 
routinely standing ready to enter into swaps at the request or 
demand of a counterparty, and the indicia of swap dealing as a 
``regular business'' include entering into swaps to satisfy the 
business or risk management needs of the counterparty. Entering into 
swaps for the purpose of hedging one's own risks generally would not 
be indicative of this form of swap activity. See also, e.g., joint 
letter from Senator Stabenow and Representative Lucas (the final 
rule should distinguish using swaps for hedging from swap dealing).
---------------------------------------------------------------------------

    Specifically, the CFTC is adopting as an interim final rule CFTC 
Regulation Sec.  1.3(ggg)(6)(iii), which provides that the 
determination of whether a person is a swap dealer will not consider a 
swap that the person enters into, if:
    (i) The person enters into the swap for the purpose of offsetting 
or mitigating the person's price risks that arise from the potential 
change in the value of one or several (a) assets that the person owns, 
produces, manufactures, processes, or merchandises or anticipates 
owning, producing, manufacturing, processing, or merchandising; (b) 
liabilities that the person owns or anticipates incurring; or (c) 
services that the person provides, purchases, or anticipates providing 
or purchasing;
    (ii) the swap represents a substitute for transactions made or to 
be made or positions taken or to be taken by the person at a later time 
in a physical marketing channel;
    (iii) the swap is economically appropriate to the reduction of the 
person's risks in the conduct and management of a commercial 
enterprise;
    (iv) the swap is entered into in accordance with sound commercial 
practices; and
    (v) the person does not enter into the swap in connection with 
activity structured to evade designation as a swap dealer.\215\
---------------------------------------------------------------------------

    \215\ See CFTC Regulation Sec.  1.3(ggg)(6)(iii). All five 
requirements set forth in the regulation must be met with respect to 
the swap, in order for the swap to be excluded from the swap dealer 
determination by the regulation.
---------------------------------------------------------------------------

    Thus, although the CFTC is not incorporating the bona fide hedging 
provisions of the CFTC's position limits rule here, the exclusion from 
the swap dealer analysis draws upon language in the CFTC's definition 
of bona fide hedging.\216\ For example, the exclusion expressly 
includes swaps hedging price risks arising from the potential change in 
value of existing or anticipated assets, liabilities, or services, if 
the hedger has an exposure to physical price risk. And, as in the bona 
fide hedging rule, the exclusion utilizes the word ``several'' to 
reflect that there is no requirement that swaps hedge risk on a one-to-
one transactional basis in order to be excluded, but rather they may 
hedge on a portfolio basis.\217\ For these reasons, swaps that qualify 
as enumerated hedging transactions and positions are examples of the 
types of physical commodity swaps that are excluded from the swap 
dealer analysis if the rule's requirements are met.\218\
---------------------------------------------------------------------------

    \216\ See CFTC Regulation Sec.  151.5(a)(1). The definition of 
bona fide hedging in CFTC Regulation Sec.  1.3(z), which applies for 
excluded commodities, is not relevant here, because it does not 
contain the requirement that the swap represents a substitute for a 
transaction made or to be made or a position taken or to be taken in 
a physical marketing channel, as required by CFTC Regulation Sec.  
1.3(ggg)(6)(iii)(B). We believe that this requirement is an 
important aspect of how principles from the bona fide hedging 
definition are useful in identifying swaps that are entered into for 
the purpose of hedging as opposed to other purposes.
    \217\ See CFTC, Position Limits for Futures and Swaps; Final 
Rule, 76 FR 71626, 71649 (Nov. 18, 2011).
    \218\ The swaps that qualify as enumerated hedging transactions 
and positions are those listed in CFTC Regulation Sec.  151.5(a)(2) 
and appendix B to part 151. These examples are illustrative of the 
types of ``assets,'' ``liabilities,'' and ``services'' contemplated 
in CFTC Regulation Sec.  1.3(ggg)(6)(iii), because the price risk 
arising from changes in their value could be offset or mitigated 
with a swap that represents a substitute for transactions made or to 
be made or positions taken or to be taken by the person at a later 
time in a physical marketing channel. To be clear, notwithstanding 
that a swap does not fit precisely within such examples, it may 
still satisfy CFTC Regulation Sec.  1.3(ggg)(6)(iii).
     Regarding commenters' queries about dynamic hedging, which one 
commenter described as the ability to modify the hedging structure 
related to physical assets or positions when relevant pricing 
relationships applicable to that asset change (see joint letter from 
WGCEF and CMC), we note that qualification as bona fide hedging has 
never been understood to require that hedges, once entered into, 
must remain static. We expect that entites would move to update 
their hedges periodically when pricing relationships or other market 
factors applicable to the hedge change.
---------------------------------------------------------------------------

    This provision in the final rule is consistent with our overall 
interpretive approach to the definition of the term ``swap dealer.'' 
The interpretations of the statutory dealer definitions by both 
Commissions focus on a person's activities in relation to its 
counterparties and other market participants.\219\ As noted above, for 
example, one indicator that a person enters into swaps as part of ``a 
regular business'' is that the person does so to satisfy the business 
or risk management needs of the counterparty. This aspect of the swap 
dealer analysis turns on the accommodation of a counterparty's needs or 
demands. If a person enters into swaps for the purpose of hedging a 
physical position as defined in CFTC Regulation Sec.  1.3(ggg)(6)(iii), 
by contrast, then the swap can be identified as not having been entered 
into for the purpose of accommodating the counterparty's needs or 
demands.\220\ Also, a person's activity of seeking out swap 
counterparties in order to hedge a physical position as defined in the 
rule generally would not warrant regulations to promote market 
stability and transparency or to serve the other purposes of dealer 
regulation.\221\
---------------------------------------------------------------------------

    \219\ See parts II.A.4.e and II.A.5.a, infra. For example, the 
conclusion that a person's relationship with its counterparties can 
lead to associated obligations is consistent with the ``shingle 
theory,'' which implies a duty of fair dealing when a person hangs 
out its shingle to do business. See note 260, infra.
    \220\ In this way, the exclusion from the swap dealer analysis 
of swaps hedging physical positions as defined in CFTC Regulation 
Sec.  1.3(ggg)(6)(iii) is similar to the exclusions, discussed 
below, of swaps between affiliates and swaps between a cooperative 
and its members. See CFTC Regulation Sec.  1.3(ggg)(6)(i)(ii); see 
also part II.C, infra. However, to the extent a person engages in 
dealing activities involving swaps, the presence of offsetting 
positions that hedge those dealing activities would not excuse the 
requirement that the person register as a swap dealer.
    \221\ Thus, the CFTC's interpretation of the swap dealer 
definition in this regard draws upon principles in the dealer-trader 
distinction. See part II.A.4.a. Additional authority for CFTC 
Regulation Sec.  1.3(ggg)(6)(iii) is provided by subparagraph (B) of 
the swap dealer definition. This subparagraph provides that a person 
``may be designated as a swap dealer for a single type or single 
class or category of swap or activities and considered not to be a 
swap dealer for other types, classes, or categories of swaps or 
activities.'' CEA Section 1a(49)(B), 7 U.S.C. 1a(49)(B). It thereby 
authorizes a review of a person's various activities with respect to 
swaps, and a determination that some of the person's activities are 
covered by a designation as a swap dealer, while other of the 
person's activities are not. Thus, a person who enters into some 
swaps for hedging physical positions as defined in CFTC Regulation 
Sec.  1.3(ggg)(6)(iii), and also enters into other swaps in 
connection with activities covered by the swap dealer definition, 
could be designated as a swap dealer only for the latter activities.
---------------------------------------------------------------------------

    At the same time, however, there may be circumstances where a 
person's activity of entering into swaps is encompassed by the 
statutory definition of the term ``swap dealer,'' notwithstanding that 
the swaps have the effect of hedging or mitigating the person's 
commercial risk.\222\ Although these swaps could, in theory, be 
excluded from the swap dealer analysis, we believe that a broader, per 
se exclusion for all swaps that hedge or mitigate commercial risk is

[[Page 30613]]

inappropriate for the swap dealer definition.
---------------------------------------------------------------------------

    \222\ For example, ``pay floating/receive fixed'' swaps entered 
into by a swap dealer with long exposure to the floating side of a 
market would have the effect of hedging the dealer's exposure.
---------------------------------------------------------------------------

    First, the hedging exclusion that we are adopting is in the nature 
of a safe harbor; i.e., it describes activity that will not be 
considered swap dealing activity. As such, the CFTC believes that it is 
appropriate that the interim final rule not be cast broadly.\223\ This 
does not mean that other types of hedging activity that do not meet the 
requirements of the interim final rule are necessarily swap dealing 
activity. Rather, such hedging activity is to be considered in light of 
all other relevant facts and circumstances to determine whether the 
person is engaging in activity (e.g., accommodating demand for swaps, 
making a market for swaps, etc.) that makes the person a swap dealer.
---------------------------------------------------------------------------

    \223\ While we recognize that a rule delineating the swap 
activities that do not constitute swap dealing would simplify and 
make more certain, at least in some contexts, the application of the 
swap dealer definition, there are also reasons for caution in 
incorporating a categorical exclusion for hedging.
---------------------------------------------------------------------------

    Second, the usefulness of an exclusion of all swaps that hedge or 
mitigate commercial risk for certain aspects of the major swap 
participant definition \224\ is not a reason to use the same exclusion 
in the swap dealer definition, since the swap dealer definition serves 
a different function. The definition of the term ``major swap 
participant,'' which applies only to persons who are not swap 
dealers,\225\ is premised on the prior identification, by the swap 
dealer definition, of persons who accommodate demand for swaps, make a 
market in swaps, or otherwise engage in swap dealing activity. The 
major swap participant definition performs the subsequent function of 
identifying persons that are not swap dealers, but hold swap positions 
that create an especially high level of risk that could significantly 
impact the U.S. financial system.\226\ Only for this subsequent 
function is it appropriate to apply the broader exclusion of swaps held 
for the purpose of hedging or mitigating commercial risk.\227\
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    \224\ See part IV.C, infra.
    \225\ See CEA Sec.  1a(33)(A)(i), 7 U.S.C. 1a(33)(A)(i).
    \226\ See CEA Sec.  1a(33)(B), 7 U.S.C. 1a(33)(B).
    \227\ We do not believe that the differences between the 
exclusion in the major participant definitions for swaps held for 
the purpose of hedging or mitigating commercial risk and the 
exclusion in the swap dealer definition for certain swaps entered 
into for the purpose of hedging risks related to physical positions 
mean that the Commissions, or the CFTC in particular, have 
implemented two different definitions of hedging. In fact, neither 
of these exclusions define the term ``hedging.'' Rather, the 
differences between the two exclusions reflect differences in the 
parameters that must be satisfied in order to ensure that hedging 
swaps are appropriately excluded from the two different definitions.
---------------------------------------------------------------------------

    The CFTC believes that since the over-the-counter swap markets have 
operated largely without regulatory oversight and encompass swaps used 
for a wide variety of commercial purposes, no method has yet been 
developed to reliably distinguish, through a per se rule, between: (i) 
Swaps that are entered into for the purpose of hedging or mitigating 
commercial risk; and (ii) swaps that are entered into for the purpose 
of accommodating the counterparty's needs or demands or otherwise 
constitute swap dealing activity, but which also have a hedging 
consequence.\228\ In contrast, the CFTC notes that it has set forth and 
modified standards for bona fide hedging transactions and granted 
exemptions in compliance with such standards for decades.\229\ These 
historically-developed standards form the basis of the interim final 
rule excluding from the swap dealer analysis certain swaps that hedge 
the risks associated with a physical position.
---------------------------------------------------------------------------

    \228\ As noted in the preceding paragraph, it is not necessary 
to make this distinction for purposes of the major swap participant 
definition.
    \229\ See, e.g., 42 FR 42751 (Aug. 8, 1977). Although the latest 
formulation of the definition of bona fide hedging--CFTC Regulation 
Sec.  151.5(a)--was recently adopted, see CFTC, Position Limits for 
Futures and Swaps; Final Rule and Interim Final Rule, 76 FR 71626 
(Nov. 18, 2011), the bona fide hedging test has been in use for 
decades.
---------------------------------------------------------------------------

    The exclusion in CFTC Regulation Sec.  1.3(ggg)(6)(iii) depends not 
on the effect or consequences of the swap, but on whether the purpose 
for which a person enters into a swap is to hedge a physical position 
as defined in the rule. If so, then the swap is excluded from the 
dealer analysis because using swaps for that purpose is inconsistent 
with, and is not, dealing activity.\230\ On the other hand, if, at the 
time the swap is entered into, the person's purpose for entering into 
the swap is not as defined in CFTC regulation Sec.  1.3(ggg)(6)(iii), 
or if it is unclear whether the swap is for such purpose, then the fact 
that the swap hedges the person's exposure in some regard does not 
preclude consideration of that swap in the dealer analysis.\231\ In 
this latter case, all relevant facts and circumstances regarding the 
swap and the person's activity with respect to the swap would be 
relevant in the determination of whether the person is a swap 
dealer.\232\
---------------------------------------------------------------------------

    \230\ To be clear, the swaps a person enters into for hedging 
physical positions as defined in CFTC Regulation Sec.  
1.3(ggg)(6)(iii) are not indicative of dealing activity under any of 
the prongs of the swap dealer definition.
    \231\ In this regard, CFTC Regulation Sec.  1.3(ggg)(6)(iii) is 
different from certain of the CFTC's rules regarding bona fide 
hedging, where a person's purpose in entering into a swap may not be 
relevant.
    \232\ We believe that, in practice, the difficulty of 
distinguishing, in applying the swap dealer definition, swaps 
entered into for the purpose of hedging from other types of swaps 
will be resolvable when the facts and circumstances of a person's 
swap activities are taken into consideration in light of our 
interpretive guidance.
---------------------------------------------------------------------------

    We believe that, based on the CFTC's experience in applying bona 
fide hedging principles with respect to swaps hedging risks related to 
physical positions, the exclusion in CFTC Regulation Sec.  
1.3(ggg)(6)(iii) at this time is the best means of providing certainty 
to market participants regarding which swaps may be disregarded in the 
dealer analysis. However, commenters presented a range of views as to 
the exclusions from the dealer analysis that may be appropriate in this 
regard.\233\ Accordingly, the CFTC is implementing this exclusion on an 
interim rule basis and is seeking comments on all aspects of the 
interim rule, including any adjustments that may be appropriate in the 
rule or accompanying interpretive guidance.
---------------------------------------------------------------------------

    \233\ See, e.g., letters cited in note 141, supra.
---------------------------------------------------------------------------

    The CFTC also seeks comments on whether a different approach to 
swaps entered into for the purpose of hedging risk is appropriate to 
implement the statutory definition of the term ``swap dealer.''
    For example, the CFTC invites commenters to address whether any 
exclusion of hedging swaps from the swap dealer analysis is 
appropriate, and if so, how swaps that are entered into for purposes of 
hedging may be identified and distinguished from other swaps. 
Commenters are encouraged to address whether it is relevant to 
distinguish swaps entered into for purposes of hedging from swaps that 
have a consequential result of hedging, and if so, how such swaps may 
be distinguished. Also, commenters may address whether the exclusion 
should be limited to swaps hedging risks related to physical positions 
or extended to encompass swaps hedging financial risks or other types 
of risks.
    Commenters should address whether the exclusion in CFTC Regulation 
Sec.  1.3(ggg)(6)(iii) should be consistent with the exclusion in CFTC 
Regulation Sec.  1.3(kkk). If so, why, and if not, why not? If the two 
exclusions should be consistent, does consistency require that that 
exclusions be identical, or would there be variations in application of 
the two exclusions? Are there market participants whose swap positions 
would be classified as held for the purpose of hedging or mitigating 
commercial risk under CFTC Regulation

[[Page 30614]]

Sec.  1.3(kkk) but would not qualify for the exclusion under CFTC 
Regulation Sec.  1.3(ggg)(6)(iii)? If so, specifically identify the 
types of market participants and swaps. If the CFTC were to apply in 
the swap dealer definition the exclusion in CFTC Regulation Sec.  
1.3(kkk) in lieu of the exclusion in CFTC Regulation Sec.  
1.3(ggg)(6)(iii), would there be negative market impacts? If so, what 
are they? Would there be positive market impacts? If so, what are they? 
In particular, what type(s) of swaps that ``hedge or mitigate 
commercial risk,'' but that are not excluded under the interim rule, 
may constitute dealing activity in light of the rules and interpretive 
guidance regarding the swap dealer definition set forth in this 
Adopting Release?
    Comments regarding the costs and benefits related to the interim 
final rule and any alternative approaches, including in particular the 
quantification of such costs and benefits, are also invited.
    Commenters are encouraged, to the extent feasible, to be 
comprehensive and detailed in providing their approach and rationale. 
The comment period for the interim final rule will close July 23, 2012.
f. Swaps Entered Into by Persons Registered as Floor Traders
    Commenters discussed whether the swap dealer definition encompasses 
the activity of entering into swaps on or subject to the rules of a DCM 
or SEF, and submitted for clearing to a derivatives clearing 
organization (``DCO''), particularly when firms engage in that activity 
using only proprietary funds.\234\ Because Title VII of the Dodd-Frank 
Act amended the definition of floor trader specifically to encompass 
activities involving swaps,\235\ the CFTC believes that it would lead 
to potentially duplicative regulation if floor traders engaging in 
swaps in their capacity as floor traders were also required to register 
as swap dealers. Accordingly, the CFTC believes that it is appropriate 
not to consider such swaps when determining whether a person acting as 
a floor trader, as defined under CEA section 1a(23),\236\ and 
registered with the CFTC under CFTC Regulation Sec.  3.11, is a swap 
dealer if the floor trader meets certain conditions. Specifically, the 
final rule provides that, in determining whether a person is a swap 
dealer, each swap that the person enters into in its capacity as a 
floor trader as defined by CEA section 1a(23) or on a SEF shall not be 
considered for the purpose of determining whether the person is a swap 
dealer, provided that the person:
---------------------------------------------------------------------------

    \234\ See letter from Trading Coalition. One commenter 
specifically discussed floor traders and floor brokers and the 
regulatory regime that should apply to them following implementation 
of the Dodd Frank Act. See letter from Christopher K. Hehmeyer.
    We note that other commenters suggested that all swaps cleared 
on an exchange should be excluded from the dealer definitions. See 
letters cited in note 138, supra. However, the discussion here is 
limited to persons who are registered as floor traders and meet 
other conditions. Also, the final rule provision discussed here does 
not exclude floor traders from the definition of the term ``swap 
dealer;'' rather, it provides that if the stated conditions are met, 
certain swaps entered into by floor traders are excluded from the 
swap dealer analysis.
    \235\ See section 721(a)(11) of the Dodd-Frank Act (amending the 
definition of the term ``floor trader'' in CEA section 1a(23)). The 
Exchange Act does not have an equivalent regulatory category to 
floor trader under the CEA, and thus Congress did not make a similar 
amendment to the Exchange Act.
    \236\ The definition of the term ``floor trader'' includes a 
person entering into swaps on a ``contract market.'' See CEA section 
1a(23). This exclusion also encompasses swaps that a registered 
floor trader enters into on or subject to the rules of a SEF, in 
addition to on or subject to the rules of a DCM, so long as the swap 
meets the conditions stated in the exclusion.
---------------------------------------------------------------------------

    (i) Is registered with the CFTC as a floor trader pursuant to CFTC 
Regulation Sec.  3.11;
    (ii) enters into swaps solely with proprietary funds for that 
trader's own account on or subject to the rules of a DCM or SEF, and 
submits each such swap for clearing to a DCO;
    (iii) is not an affiliated person of a registered swap dealer;
    (iv) does not directly, or through an affiliated person, negotiate 
the terms of swap agreements, other than price and quantity or to 
participate in a request for quote process subject to the rules of a 
DCM or SEF;
    (v) does not directly or through an affiliated person offer or 
provide swap clearing services to third parties;
    (vi) does not directly or through an affiliated person enter into 
swaps that would qualify as hedging physical positions pursuant to CFTC 
Regulation Sec.  1.3(ggg)(6)(iii) or hedging or mitigating commercial 
risk pursuant to CFTC Regulation Sec.  1.3(kkk), with the exception of 
swaps that are executed opposite a counterparty for which the 
transaction would qualify as a bona fide hedging transaction;
    (vii) does not participate in any market making program offered by 
a DCM or SEF; and
    (viii) complies with the record keeping and risk management 
requirements of CFTC Regulation Sec. Sec.  23.201, 23.202, 23.203, and 
23.600 with respect to each such swap as if it were a swap dealer.\237\
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    \237\ See CFTC Regulation Sec.  1.3(ggg)(6)(iv).
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    This rule permits floor traders who might otherwise be required to 
register as a swap dealer to be registered solely as floor traders with 
the CFTC. Given the limitations on the scope of the rule, the 
requirements for floor traders using the relief to comply with 
recordkeeping and risk management rules applicable to swap dealers as a 
condition of the relief, and the fact that swaps subject to the rule 
are traded on a DCM or SEF and cleared through a DCO, the CFTC believes 
it is not necessary to have floor traders subject to this rule register 
as both floor traders and swap dealers as a result of swaps activities 
covered by the rule.\238\
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    \238\ The Commissions note the rule applies only to CFTC-
registered floor traders engaging in swaps on DCMs or SEFs and 
cleared through DCOs. As noted above, the SEC does not have a 
regulatory category under the Exchange Act equivalent to floor 
trader under the CEA and none of these provisions apply in the 
context of security-based swap dealers or any entity regulated under 
the Exchange Act. Any person engaging in security-based swap 
transactions, whether or not these activities are similar to those 
engaged in by floor traders, will need to independently consider 
whether they need to register as security-based swap dealers as a 
result of their activities.
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g. Additional Interpretive Issues Relating to the ``Swap Dealer'' 
Definition
    As noted above, the Commissions, in consideration of comments 
received, are making certain modifications to the interpretive guidance 
concerning the definition of the term ``swap dealer'' set out in the 
Proposing Release. However, the Commissions are retaining certain 
elements of their proposed interpretation of the term ``swap dealer,'' 
as discussed below.
    First, with respect to the comments asserting that the proposed 
interpretive approach is overly broad,\239\ we note that the statute 
provides that the term ``swap dealer'' means ``any person'' who engages 
in the activities described in any of the four prongs of the 
definition, subject to the exceptions and qualifications set out in the 
statute. In view of this statutory text, these comments effectively 
assert that the statute should be interpreted to include preconditions 
to swap dealer status that are not set forth in the statute. For 
example, the assertion that the swap dealer definition must be limited 
to persons who enter into swaps on both sides of the market would 
impose a requirement that does not exist in the statute. Similarly, the 
comments to the effect that swap dealers are only those persons who 
seek to profit by intermediating between swap market participants adds 
a requirement not set forth in the statute.
---------------------------------------------------------------------------

    \239\ See letters cited at notes 83 to 84, supra.
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    We believe, though, that the activities that cause a person to be 
covered by the

[[Page 30615]]

swap dealer definition should be addressed in the context of the four 
prongs of the statutory definition. That is, the relevant question is 
whether a person engages in any of the types of activities enumerated 
in the statute, and not whether the person meets any additional, 
supposedly implicit preconditions to swap dealer status.
    Second, the Commissions continue to believe, as stated in the 
Proposing Release, that accommodating demand and facilitating interest 
are appropriately used as factors in identifying swap dealers. As noted 
by commenters, however, the mere fact that a person entering into a 
particular swap has the effect of ``accommodating demand'' or 
``facilitating interest'' in swaps does not conclusively establish that 
the person is a swap dealer. Instead, the person's overall activities 
in the swap market (or particular sector of the swap market if the 
person is active in a variety of sectors) should be compared against 
these factors. If, in the context of its overall swap activities, a 
person fulfills a function of accommodating demand or facilitating 
interest in swaps for other parties, then these factors would be 
significant in the analysis and the person is likely to be a swap 
dealer.\240\
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    \240\ The language of the four statutory tests for swap dealer 
status (which refer to a person who holds itself out as a dealer, is 
commonly known as a dealer, makes a market in swaps or regularly 
enters into swaps with counterparties) contemplate that a dealer is 
a person who, through its swap activities, functions to create legal 
relationships that transfer risk between independent persons. See 
CEA section 1a(49)(A), 7 U.S.C. 1a(49)(A).
    See also Proposing Release, 75 FR at 80177 (describing swap 
dealers as those persons whose function is to serve as the points of 
connection in the swap markets); letter from COPE I at 4 (``Simply 
stated, dealers are in the regular business of being a point of 
connection to the market for others that need access to the market 
to hedge risk.''): Roundtable Transcript at 21 (remarks of Richard 
Ostrander, Morgan Stanley; ``a dealer is someone who is out there 
willing to enter into trades'').
---------------------------------------------------------------------------

    Third, as discussed above, we have adopted some of the objective 
criteria suggested by commenters with respect to the indicia of holding 
oneself out as a dealer or being commonly known as a dealer, market 
making, and the ``regular business'' prongs of the swap dealer 
definition.\241\ For instance, allocating staff and technological 
resources to swap activity, deriving revenue and profit from swap 
activity, or responding to customer-initiated orders for swaps can all 
be indicative of having ``a regular business'' of entering into swaps 
and, therefore, indicative of being a swap dealer. In addition, 
activities such as providing advice about swaps or offering oneself as 
a point of connection to other parties needing access to the swap 
market are indicative of a person holding itself out as a swap dealer, 
if the person also enters into swaps in conjunction with such 
activities.
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    \241\ See part II.B.2.d.iii, supra.
---------------------------------------------------------------------------

    The guidance we have provided about these indicia is responsive to 
concerns expressed by commenters about the application of the swap 
dealer definition to energy markets. As described above, some 
commenters stated that in energy markets, unlike in some other markets, 
end-users often enter into swaps directly with each other, on both 
sides of the market, without the involvement of a separate category of 
businesses serving as intermediaries.\242\ As a result, according to 
these commenters, energy swap market participants often engage in some 
of the activities that are indicative of swap dealer status. Some of 
these commenters contended that our activity-based interpretation of 
the swap dealer definition could therefore result in the inappropriate 
inclusion of energy market participants in the coverage of the 
definition of the term ``swap dealer.'' \243\
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    \242\ See parts II.A.2.f.ii and iii, supra.
    \243\ See letters cited in note 117, supra. Comments expressing 
concern that the definition of the term ``swap dealer'' could 
include physical commodities businesses also were presented to 
Congress during consideration of legislation leading to passage of 
the Dodd-Frank Act. See Proposed Legislation by the U.S. Department 
of the Treasury Regarding the Regulation of Over-The-Counter 
Derivatives Markets: Hearing Before the H. Comm. On Agriculture, 
111th Cong. 103 (2009) (submitted report on behalf of the Working 
Group of Commercial Energy Firms). However, as noted above, there is 
no exclusion in the statutory definition for such businesses.
---------------------------------------------------------------------------

    We believe that the language of the statutory ``swap dealer'' 
definition supports our activity-based interpretation and does not 
support categorical exclusions of particular types of persons from the 
``swap dealer'' definition based on the general nature of their 
businesses. Further evidence that such a categorical exclusion is 
unwarranted is provided by the fact that a number of energy market 
participants--BP Plc., Cargill, Incorporated, Centrica Energy Limited, 
ConocoPhillips, EDF Trading Limited, GASELYS, Hess Energy Trading 
Company, LLC, Hydro-Quebec, Koch Supply & Trading, LP, RWE Supply & 
Trading GmbH, Shell Energy North America (US), L.P., STASCO, Totsa 
Total Oil Trading S.A., and Vattenfall Energy Trading Netherlands 
N.V.--have voluntarily joined ISDA as primary dealers.\244\ As 
previously noted, any business organization that ``deals in derivatives 
shall be eligible for election to membership in the Association as a 
primary member, provided that no person or entity shall be eligible for 
membership as a Primary Member if such person or entity participates in 
derivatives transactions solely for the purpose of risk hedging or 
asset or liability management.'' \245\ Hence, a categorical exclusion 
from the ``swap dealer'' definition based on any particular type of 
business or general market activity also would be inconsistent with 
current industry structure and practice.
---------------------------------------------------------------------------

    \244\ The list of ISDA Primary Members is available at http://www.isda.org/membership/isdamemberslist.pdf.
    \245\ See note 188, supra.
---------------------------------------------------------------------------

    At the same time, however, the fact that a person engages in some 
swap activities that are indicative of swap dealer status does not, by 
itself, mean that the person is covered by the definition of the term 
``swap dealer.'' The ``not as part of a regular business'' exception 
and our guidance about its meaning address the issue of swap market 
participants that engage to some extent in the activities 
characteristic of swap dealers. The guidance we have provided here 
therefore provides the appropriate approach to addressing these issues 
in energy markets as elsewhere.
    Although several commenters attempted to articulate bright-line 
tests that would differentiate swap dealers from other swap market 
participants, the suggested bright-line tests generally could not be 
applied across the board to all types of swap market activity. For 
example, some commenters suggested that swap dealers can be identified 
as those who profit from entering into swaps on both sides of the 
market (and under the interpretive approach set forth in this Adopting 
Release, such activity may be an indicator of swap dealing).\246\ But 
other commenters said that, in certain circumstances, entering into 
swaps on both sides of the market is not necessarily indicative of swap 
dealing.\247\
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    \246\ See letters cited in note 84, supra.
    \247\ See letters cited in note 86, supra. As noted above in the 
discussion of market making, a swap dealer may in some circumstances 
enter into swaps on only one side of the market.
---------------------------------------------------------------------------

    The ways in which participants throughout the market use swaps are 
simply too diverse for swap dealer status to be resolved with a single, 
one-factor test. This is reflected in the statutory definition of the 
term ``swap dealer'' itself. Focused as it is on types of activities, 
with four prongs set forth in the alternative to cover different types 
of swap dealing activity, the statutory swap dealer definition is not 
susceptible to the bright-line test that

[[Page 30616]]

some commenters seek. For these reasons, we continue to believe that it 
is appropriate to apply the multi-factor interpretive approach set 
forth in this Adopting Release.
    In closing, we emphasize that the purpose of in this part IV.A.4 is 
to provide guidance as to how the rules further defining the term 
``swap dealer'' will be applied in particular, complex situations where 
a person's status as a swap dealer may be uncertain. Even though 
bright-line tests and categorical exclusions are inappropriate, we 
recognize that the large majority of market participants use swaps for 
normal course hedging, financial, investment or trading purposes and 
are not swap dealers.
5. Final Rules and Interpretation--Definition of ``Security-Based Swap 
Dealer''
a. General Reliance on the Dealer-Trader Distinction
    As discussed above, we are adopting a rule under the Exchange Act 
that defines ``security-based swap dealer'' in terms of the four 
statutory tests and the exclusion for security-based swap activities 
that are not as part of a ``regular business.'' \248\ Also, we believe 
that the dealer-trader distinction \249\--which already forms a basis 
for identifying which persons fall within the longstanding Exchange Act 
definition of ``dealer''--in general provides an appropriate framework 
for interpreting the meaning of ``security-based swap dealer.'' \250\ 
While there are differences in the structure of those two statutory 
definitions,\251\ we believe that their parallels--particularly both 
definitions' exclusions for activities that are ``not part of a regular 
business''--warrant analogous interpretive approaches for 
distinguishing dealers from non-dealers.
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    \248\ See Exchange Act rule 3a71-1(a), (b).
    \249\ See note 31, supra.
    \250\ The principles embedded within the ``dealer-trader 
distinction'' are not solely useful for distinguishing persons who 
constitute dealers from active ``traders,'' but also are applicable 
to distinguishing dealers from non-dealers such as hedgers or 
investors. The ``dealer-trader'' nomenclature has been used for 
decades. See Loss, Securities Regulation 722 (1st ed. 1951) (``One 
aspect of the `business' concept is the matter of drawing the line 
between a `dealer' and a trader--an ordinary investor who buys and 
sells for his own account with some frequency.'').
    \251\ For example, while the ``dealer'' definition encompasses 
certain persons in the business of ``buying and selling'' 
securities, the ``security-based swap dealer'' definition does not 
address either ``buying'' or ``selling.'' As we noted in the 
Proposing Release, we do not believe that the lack of those terms in 
the ``security-based swap dealer'' definition leads to material 
interpretive distinctions, as the Dodd-Frank Act amended the 
Exchange Act definitions of ``buy'' and ``purchase,'' and the 
Exchange Act definitions of ``sale'' and ``sell,'' to encompass 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. 
See Proposing Release, 75 FR at 80178 n.26 (citing Dodd-Frank Act 
sections 761(a)(3), (4), which amend Exchange Act sections 3(a)(13), 
(14)).
    At the same time, we note that the ``dealer'' definition 
requires the conjunctive ``buying and selling''--which connotes a 
degree of offsetting two-sided activity. In contrast, the 
``security-based swap dealer'' definition (particularly the 
``regularly enters into security-based swaps'' language of the 
definition's third test) lacks that conjunctive terminology.
---------------------------------------------------------------------------

    As discussed above,\252\ the Commissions note that interpretations 
of the applicability of the dealer-trader distinction to the ``swap 
dealer'' definition under the CEA do not affect existing, or future, 
interpretations of the dealer-trader distinction under the Exchange 
Act--both with regard to the ``security-based swap dealer'' definition, 
and with regard to the ``dealer'' definition.
---------------------------------------------------------------------------

    \252\ See note 171, supra.
---------------------------------------------------------------------------

    In interpreting the security-based swap dealer definition in terms 
of the dealer-trader distinction, the Commissions have been mindful 
that some commenters expressed the view that we instead should rely on 
other interpretive factors that were identified in the Proposing 
Release (e.g., accommodating demand). We believe, nonetheless, that the 
dealer-trader distinction forms the basis for a framework that 
appropriately distinguishes between persons who should be regulated as 
security-based swap dealers and those who should not. We also believe 
that the distinction affords an appropriate degree of flexibility to 
the analysis, and that it would not be appropriate to seek to codify 
the distinction.
    At the same time, the Commissions recognize that the dealer-trader 
distinction needs to be adapted to apply to security-based swap 
activities in light of the special characteristics of security-based 
swaps and the differences between the ``dealer'' and ``security-based 
swap dealer'' definitions. Relevant differences include:
     Level of activity--Security-based swap markets are marked 
by less activity than markets involving certain other types of 
securities (while recognizing that some debt and equity securities are 
not actively traded). This suggests that in the security-based swap 
context concepts of ``regularity'' should account for the level of 
activity in the market.
     No separate issuer--Each counterparty to a security-based 
swap in essence is the ``issuer'' of that instrument; in contrast, 
dealers in cash market securities generally transact in securities 
issued by another party. This distinction suggests that the concept of 
turnover of ``inventory'' of securities, which has been identified as a 
factor in connection with the dealer-trader distinction, is inapposite 
in the context of security-based swaps. Moreover, this distinction--
along with the fact that the ``security-based swap dealer'' definition 
lacks the conjunctive ``buying and selling'' language of the ``dealer'' 
definition \253\--suggests that concepts of two-sided markets at times 
would be less relevant for identifying ``security-based swap dealers'' 
than they would be for identifying ``dealers.'' \254\
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    \253\ See note 251, supra.
    \254\ The analysis also should account for the fact that a party 
to a security-based swap can use other derivatives or cash market 
instruments to hedge the risks associated with the security-based 
swap position, meaning that two-way trading is not necessary to 
maintain a flat risk book.
---------------------------------------------------------------------------

     Predominance of over-the-counter and non-standardized 
instruments--Security-based swaps thus far are not significantly traded 
on exchanges or other trading systems, in contrast to some cash market 
securities (while recognizing that many cash market securities also are 
not significantly traded on those systems).\255\ These attributes--
along with the lack of ``buying and selling'' language in the security-
based swap dealer definition, as noted above--suggest that concepts of 
what it means to make a market need to be construed flexibly in the 
context of the security-based swap market.\256\
---------------------------------------------------------------------------

    \255\ Even though we expect trading of security-based swaps on 
security-based swap execution facilities or exchanges following the 
implementation of Title VII, we expect there to remain a significant 
amount of over-the-counter activity involving security-based swaps.
    \256\ For example, the definition of ``market maker'' in 
Exchange Act section 3(a)(38)--which is applicable for purposes of 
the Exchange Act ``unless the context otherwise requires'' (see 
Exchange Act section 3(a))--defines the term ``market maker'' to 
mean ``any specialist permitted to act as a dealer, any dealer 
acting in the capacity of block positioner, and any dealer who, with 
respect to a security, holds himself out (by entering quotations in 
an inter-dealer communications system or otherwise) as being willing 
to buy and sell such security for his own account on a regular or 
continuous basis.'' That definition is useful in the context of 
systems in which standardized securities are regularly or 
continuously bought and sold, but would not be apposite in the 
context of non-standardized securities or securities that are not 
regularly or continuously transacted.
---------------------------------------------------------------------------

     Mutuality of obligations and significance to ``customer'' 
relationship--In contrast to a secondary market transaction involving 
equity or debt securities, in which the completion of a purchase or 
sale transaction can be expected to terminate the mutual obligations of 
the parties to the

[[Page 30617]]

transaction, the parties to a security-based swap often will have an 
ongoing obligation to exchange cash flows over the life of the 
agreement. In light of this attribute, some market participants have 
expressed the view that they have ``counterparties'' rather than 
``customers'' in the context of their swap activities.
    It also is necessary to use the dealer-trader distinction to 
interpret the security-based swap dealer definition so that the 
statutory provisions that will govern security-based swap dealers are 
applied in an effective and logical way. Those statutory provisions 
added by the Dodd-Frank Act advance financial responsibility (e.g., the 
ability to satisfy obligations, and the maintenance of counterparties' 
funds and assets) associated with security-based swap dealers' 
activities,\257\ other counterparty protections,\258\ and the promotion 
of market efficiency and transparency.\259\ As a whole, the relevant 
statutory provisions suggest that we should apply the dealer-trader 
distinction to interpret the security-based swap dealer definition in a 
way that identifies those persons for which regulation is warranted 
either: (i) Due to the nature of their interactions with 
counterparties; \260\ or (ii) to promote market stability and 
transparency, in light of the role those persons occupy within the 
security-based swap markets.\261\
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    \257\ E.g., capital and margin requirements (Exchange Act 
section 15F(e)), and requirements for segregation of collateral 
(Exchange Act section 3E).
    \258\ E.g., requirements with respect to business conduct when 
transacting with special entities (Exchange Act sections 15F(h)(2), 
(h)(4), (h)(5)); disclosure requirements (Exchange Act section 
15F(h)(3)(B)); requirements for fair and balanced communications 
(Exchange Act section 15F(h)(3)(C)); other requirements related to 
the public interest and investor protection (Exchange Act section 
15F(h)(3)(D)); and conflict of interest provisions (Exchange Act 
section 15F(j)(5)).
    \259\ E.g., reporting and recordkeeping requirements (Exchange 
Act section 15F(f)); daily trading records requirements (Exchange 
Act section 15F(g)); regulatory standards related to the 
confirmation, processing, netting, documentation and valuation of 
security-based swaps (Exchange Act section 15F(i)); position limit 
monitoring requirements (Exchange Act section 15F(j)(1)); risk 
management procedure requirements (Exchange Act section 15F(j)(2)); 
and requirements related to the disclosure of information to 
regulators (Exchange Act section 15F(j)(3)).
    \260\ The conclusion that a person's relationship with its 
counterparties can lead to associated obligations is consistent with 
the ``shingle theory,'' which implies a duty of fair dealing when a 
person hangs out its shingle to do business. See Securities and 
Exchange Commission, Report of the Special Study of Securities 
Market Part I at 238 (1963) (``An obligation of fair dealing, based 
upon the general antifraud provisions of the Federal securities 
laws, rests upon the theory that even a dealer at arm's length 
impliedly represents when he hangs out his shingle that he will deal 
fairly with the public.''; footnote omitted); Weiss, Registration 
and Regulation of Brokers and Dealers 171 (1965) (``the solicitation 
and acceptance by a broker-dealer of orders from customers and the 
confirmation of transactions do constitute a representation by the 
broker-dealer that he will deal fairly with his customers and that 
such transactions will be handled promptly in the usual manner, in 
accordance with trade custom'').
    \261\ The importance of regulating dealers due to the centrality 
of their market role was illustrated by the Government Securities 
Act of 1986. When Congress provided for the regulation of government 
securities dealers, Congress specifically cited the lack of 
regulation as contributing to the failures of several unregulated 
government securities dealers. See S. Rep. No. 99-426 (1986), as 
reprinted in 1986 U.S.C.C.A.N. 5395, 5400-04. The resulting statute 
provided for a definition of ``government securities dealer'' that 
in relevant part is parallel to the definitions of ``dealer'' and 
``security-based swap dealer,'' particularly with regard to sharing 
an exclusion for activities that are not part of a ``regular 
business.'' See Exchange Act section 3(a)(44).
---------------------------------------------------------------------------

b. Principles for Applying the Dealer-Trader Distinction to Security-
Based Swap Activity
    In light of the statutory security-based swap dealer definition, 
statutory provisions applicable to security-based swap dealers and 
market characteristics addressed above, the Commissions believe that 
the factors set forth below are relevant for identifying security-based 
swap dealers and for distinguishing those dealers from other market 
participants. This guidance seeks to address commenter requests that we 
further clarify the scope of the security-based swap dealer definition, 
and the Commissions believe that these factors provide appropriate 
guidance without being inflexible or allowing the opportunity for 
evasion that may accompany a bright-line test. At the same time, the 
determination of whether a person is acting as a security-based swap 
dealer ultimately depends on the relevant facts and circumstances. In 
light of the overall context in which a person's activity occurs, the 
absence of one or more of these factors does not necessitate the 
conclusion that a person is not a security-based swap dealer.\262\
---------------------------------------------------------------------------

    \262\ Similarly, depending on the relevant facts and 
circumstances, the presence of certain of the illustrative 
activities described here does not necessitate the conclusion that 
the entity is a dealer.
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     Providing liquidity to market professionals or other 
persons in connection with security-based swaps. A market participant 
might manifest this indication of dealer activity by accommodating 
demand or facilitating interest expressed by other market 
participants,\263\ holding itself out as willing to enter into 
security-based swaps, being known in the industry as being available to 
accommodate demand for security-based swaps, or maintaining a sales 
force in connection with security-based swap activities.\264\
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    \263\ This is to be distinguished from an entity entering into 
security-based swaps for other business purposes, such as to gain 
economic exposure to a particular market.
    \264\ A sales force, however, is not a prerequisite to a person 
being a security-based swap dealer. For example, a person that 
enters into security-based swaps in a dealing capacity can fall 
within the dealer definition even if it uses an affiliated entity to 
market and/or negotiate those security-based swaps (e.g., the person 
is a booking entity). Depending on the applicable facts and 
circumstances, the affiliate that performs the marketing and/or 
negotiation functions may fall within the Exchange Act's definition 
of ``broker'' (which was not revised by Title VII). See Exchange Act 
section 3(a)(4)(A).
---------------------------------------------------------------------------

     Seeking to profit by providing liquidity in connection 
with security-based swaps. A market participant may manifest this 
indication of security-based swap dealer activity--which is consistent 
with the definition's ``regular business'' requirement--by seeking 
compensation in connection with providing liquidity involving security-
based swaps (e.g., by seeking a spread, fees or other compensation not 
attributable to changes in the value of the security-based swap).\265\ 
The Commissions do not believe that this necessarily requires that a 
person be available to take either side of the market at any time, or 
that a person continuously engage in this type of activity, to be a 
security-based swap dealer. Although one commenter expressed the view 
that the security-based swap dealer definition requires that a person 
be consistently available to take either side of the market,\266\ in 
our view such an approach would be underinclusive.\267\
---------------------------------------------------------------------------

    \265\ Indicia of this objective may include, but would not be 
limited to, maintaining separate profit/loss statements in 
connection with this type of activity, and/or devoting staff and 
resources to this type of activity.
    In this regard, we believe that the issue of whether a person 
tends to take the prices offered in the market, rather than helping 
to set those prices (such as by providing quotes, placing limit 
orders, or otherwise accommodating demand), can be relevant as a 
factor for distinguishing security-based swap dealers from non-
dealers. At the same time, we are mindful that a dealer may also 
accept the market price as part of its dealer activity (such as when 
a person enters into a security-based swap to offset the risk it 
assumes in connection with its security-based swap dealing 
activity); as a result, the fact that a person regularly takes the 
market price as part of its security-based swap transactions does 
not foreclose the possibility that the person may be a security-
based swap dealer.
    \266\ See letter from ISDA I.
    \267\ It is possible for a dealer to be compensated for 
providing liquidity by entering into sequential offsetting 
positions, or by hedging the security-based swap position by using a 
different type of security-based swap, a swap or some other 
financial instrument. Accordingly, a rule of decision that permitted 
a person to avoid dealer regulation by providing liquidity in 
connection with security-based swaps, and laying off the associated 
risk using a different type of security-based swap, a swap or a 
different instrument entirely, would be susceptible to abuse. 
Moreover, as noted above, the definition of ``security-based swap 
dealer'' does not contain the ``buying and selling'' language found 
in the general Exchange Act definition of ``dealer.'' Thus, while 
being regularly willing to enter into either side of the security-
based swap market would suggest that a person is engaged in dealing 
activity, the absence of such activity should not necessarily lead 
to an inference that a person is not acting as a dealer.
     We also note that some commenters have stated that two-way 
quoting by itself should not necessarily be enough to make a person 
a dealer, and some of those commenters specifically stated that a 
person may use two-sided quotes as part of the price discovery 
process or to elicit trading interest. See, e.g., letter from MFA I. 
Here too, it is important to consider whether the activity also has 
a dealing business purpose, such as seeking to profit by providing 
liquidity. Moreover, all participants in the security-based swap 
market, whether or not security-based swap dealers, should be 
mindful of the potential application of the antifraud and anti-
manipulation provisions of the federal securities laws to such 
activities. Section 10(b) of the Exchange Act and Exchange Act rule 
10b-5 particularly prescribe the use of any manipulative or 
fraudulent device in connection with the purchase or sale of any 
security, which includes manipulative trading. See Terrance 
Yoshikawa, Securities Exchange Act Release No. 53731 (Apr. 26, 
2006), 87 SEC Docket 2924, 2930-31 & n.19 (citing Ernst & Ernst v. 
Hochfelder, 425 U.S. 185, 199 (1976)). The SEC has characterized 
manipulation as ``the creation of deceptive value or market activity 
for a security, accomplished by an intentional interference with the 
free forces of supply and demand.'' See Swartwood, Hesse, Inc., 50 
S.E.C. 1301, 1307 (1992) (citing Hochfelder, 425 U.S. at 199; 
Schreiber v. Burlington Northern, Inc., 472 U.S. 1 (1985); Feldbaum 
v. Avon Products, Inc., 741 F.2d 234 (8th Cir. 1984)).

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[[Page 30618]]

     Providing advice in connection with security-based swaps 
or structuring security-based swaps. Advising a counterparty as to how 
to use security-based swaps to meet the counterparty's hedging goals, 
or structuring security-based swaps on behalf of a counterparty, also 
would indicate security-based swap dealing activity. It particularly is 
important that persons engaged in those activities are appropriately 
regulated so that their counterparties will receive the protections 
afforded by certain of the statutory business conduct rules (e.g., 
special entity requirements and communication requirements) \268\ 
applicable to security-based swap dealers.\269\ The Commissions 
recognize commenter concerns that end-users may also develop new types 
of security-based swaps,\270\ but also recognize that the activities of 
end-users related to the structuring of security-based swaps for 
purposes of hedging commercial risk are appreciably different than 
being in the business of structuring security-based swaps on behalf of 
a counterparty.
---------------------------------------------------------------------------

    \268\ The SEC has proposed rules to implement Title VII 
provisions relating to external business conduct standards for 
security-based swap dealers (as well as major security-based swap 
participants). See Exchange Act Release No. 64766 (June 29, 2011), 
76 FR 42396 (July 18, 2011).
    \269\ This factor would also reasonably take into account 
whether a preexisting relationship involving other types of 
securities or other financial instruments is present. For example, 
to the extent a person has an existing broker or dealer relationship 
with a counterparty in connection with other types of securities, 
and also enters into a security-based swap with that counterparty, a 
reasonable inference would be that the person entered into the 
security-based swap in a dealer capacity. Any other approach would 
invite abuse, as persons could seek to leverage existing 
relationships of trust while avoiding regulation as a security-based 
swap dealer.
    \270\ See letter from FSR I.
---------------------------------------------------------------------------

     Presence of regular clientele and actively soliciting 
clients. These dealer-trader factors would reasonably appear to be 
applicable in the security-based swap context, just as they are 
applicable in the context of other types of securities, as indicia of a 
business model that seeks to profit by providing liquidity. The 
Commissions are mindful that some industry participants have 
highlighted a distinction between ``counterparties'' and ``customers'' 
in connection with swaps, and have suggested that they have no 
``customers'' in the swap context. We do not believe such points of 
nomenclature are significant for purposes of identifying security-based 
swap dealers, however.\271\
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    \271\ For purposes of the dealer-trader analysis, as it applies 
in the context of security-based swaps or any other security, we 
would not expect contractual provisions stating that the 
counterparty is not relying on the person's advice to have any 
significance.
---------------------------------------------------------------------------

     Use of inter-dealer brokers. As with activities involving 
other types of securities, the Commissions would expect that a person's 
use of an inter-dealer broker in connection with security-based swap 
activities to be an indication of the person's status as a dealer.
     Acting as a market maker on an organized security-based 
swap exchange or trading system. Acting in a market maker capacity on 
an organized exchange or trading system for security-based swaps would 
indicate that the person is acting as a dealer.\272\ While the 
Commissions recognize that some commenters have expressed the view that 
persons who solely enter into security-based swaps on an organized 
security-based swap exchange or trading system should not be regulated 
as security-based swap dealers,\273\ in our view such an approach would 
be contrary to the express language of the definition. This is not to 
say, of course, that the presence of an organized exchange or trading 
system is a prerequisite to being a market maker for purposes of the 
security-based swap dealer definition.\274\ Moreover, acting as a 
market maker is not a prerequisite to being a security-based swap 
dealer.\275\ On the other hand, being a member of an organized exchange 
or trading system for purposes of trading security-based swaps does not 
necessarily by itself make a person a security-based swap dealer.\276\
---------------------------------------------------------------------------

    \272\ Under the proposal of the SEC, the Board, the OCC and the 
FDIC to implement the provisions of section 619 of the Dodd-Frank 
Act (also known as the ``Volcker Rule''), a person who claims the 
benefit of the market maker exception to that section's prohibitions 
and restrictions on proprietary trading in connection with security-
based swap activities would be required to register with the SEC as 
a security-based swap dealer, unless the person is exempt from 
registration or is engaged in a dealing business outside the U.S., 
and is subject to substantive regulation in the jurisdiction where 
the business is located. See Securities Exchange Act Release No. 
65545, 76 FR 68846, 68947 (Nov. 7, 2011) (proposed implementing rule 
Sec.  ------.4(b)(2)(iv)(C)).
    \273\ See, e.g., letter from Traders Coalition.
    \274\ Given the current nature of the security-based swap 
market, including the present level of activity and the present lack 
of significant trading of security-based swaps on exchanges or 
organized trading systems, we believe that it would negate the 
legislative intent to interpret the definition's use of market 
making concepts to require the same use of quotation media that are 
incorporated into the interpretation of market making concepts in 
the context of securities that are actively traded on an organized 
exchange or trading system. At the same time, we recognize that 
routine activity in the security-based swap market is not 
necessarily indicative of making a market in security-based swaps. 
For example, persons may routinely be active in the market for 
purposes of hedging, to advance their investment objectives, or to 
engage in proprietary trading.
    \275\ The definition of ``security-based swap dealer'' contains 
four alternative tests, only two of which use market making 
terminology. Moreover, the third test of the security-based swap 
dealer definition--which addresses persons who regularly enter into 
security-based swaps as an ordinary course of business for their own 
account--appears particularly inapt as a proxy for market making 
activity. Transacting with customers is not an element of this 
alternative test. A person thus may be a security-based swap dealer 
even if it transacts exclusively with other market professionals. 
Cf. OCC, ``Risk Management of Financial Derivatives'' 3-4 (1997) 
(stating that OCC has classified banks as ``Tier I'' dealers if they 
act as market makers by ``providing quotes to other dealers and 
brokers, and other market professionals''). Compare letter from ISDA 
I (taking the view that the dealer definition should be interpreted 
in the context of market-making concepts).

    \276\ The analysis of the status of members of such exchanges 
and trading systems in part may be influenced by the final Exchange 
Act rules that govern such systems, as well as the internal rules of 
such systems.
---------------------------------------------------------------------------

As with the current application of the dealer-trader distinction to the 
Exchange Act ``dealer'' definition, the question of whether a person is 
acting as a security-based swap dealer ultimately will turn upon the 
relevant facts and circumstances, as informed by these criteria.
c. Additional Interpretive Issues
    Activity by hedgers. As noted above, a number of commenters raised 
concerns that an overbroad ``security-based swap dealer'' definition 
would inappropriately encompass persons

[[Page 30619]]

using security-based swaps for hedging purposes.\277\ As we stated in 
the Proposing Release, however, under the dealer-trader distinction the 
Commissions would expect persons that use security-based swaps to hedge 
their business risks, absent other activity, likely would not be 
dealers.\278\ We maintain that view. In other words, to the extent that 
a person engages in security-based swap activity to hedge commercial 
risk, or otherwise to hedge risks unrelated to activities that 
constitute dealing under the dealer-trader distinction (particularly 
activities that have the business purpose of seeking to profit by 
providing liquidity in connection with security-based swaps), the 
Commissions would not expect those hedging transactions to lead a 
person to be a security-based swap dealer.\279\ Of course, to the 
extent a person engages in dealing activities involving security-based 
swaps, the presence of offsetting positions that hedge those dealing 
activities would not excuse the requirement that the person register as 
a security-based swap dealer.\280\
---------------------------------------------------------------------------

    \277\ See, e.g., letter from Church Alliance.
    \278\ See Proposing Release, 75 FR at 80178 n.27. The Proposing 
Release also noted that if a person's other activities satisfy the 
definition of security-based swap dealer, the person must comply 
with the applicable requirements with regard to all of its security-
based swap activities, absent an order to the contrary. We further 
noted in the Proposing Release that we would expect end-users to use 
security-based swaps for hedging purposes less commonly than they 
use swaps for hedging purposes.
    \279\ In addition, consistent with the exclusion from the dealer 
analysis of activities involving majority-owned affiliates, see part 
II.C, infra, to the extent that a person engages in activities to 
hedge positions subject to the inter-affiliate exclusion, absent 
other activity, the Commission would not expect those hedging 
transactions to lead a person to be a security-based swap dealer. 
Conversely, security-based swap activities connected with the 
indicia of dealing discussed above (e.g., seeking to profit by 
providing liquidity in connection with security-based swaps) 
themselves would suggest security-based swap dealing activity.
    \280\ For example, if a person were to use other instruments to 
hedge the risks associated with its security-based swap dealing 
activity, that hedging would not undermine the obligation of the 
person to register as a security-based swap dealer, notwithstanding 
the fact that it could be asserted that the dealing positions happen 
to hedge those other positions.
---------------------------------------------------------------------------

    No predominance test. As discussed in the Proposing Release, the 
Commissions do not believe that the security-based swap dealer analysis 
should appropriately turn upon whether a person's dealing activity 
constitutes that person's sole or predominant business. The separate de 
minimis exemption, however, may have the effect of excusing from dealer 
regulation those persons whose security-based swap dealing activities 
are relatively modest.
    Presence or absence of a customer relationship. Although commenters 
have expressed the view that a person that engages in security-based 
swap activities on an organized market should not be deemed to be a 
dealer unless it engages in those activities with customers,\281\ we do 
not agree. It is true that having a customer relationship can 
illustrate a business model of seeking to profit by providing 
liquidity, and thus provide one basis for concluding that a person is 
acting as a security-based swap dealer. Nonetheless, the presence of 
market making terminology within the definition is inconsistent with 
the view that a security-based swap dealer must have ``customers.'' 
Also, Title VII requirements applicable to security-based swap dealers 
address interests apart from customer protection.\282\ Accordingly, to 
the extent that a person regularly enters into security-based swaps 
with a view toward profiting by providing liquidity--rather than by 
taking directional positions--that person may be a security-based swap 
dealer regardless of whether it views itself as maintaining a 
``customer'' relationship with its counterparties.\283\
---------------------------------------------------------------------------

    \281\ See letters from ISDA I and Traders Coalition.
    \282\ Particularly in light of the view expressed by some market 
participants that they only have ``counterparties'' in the swap 
markets, and not ``customers,'' any interpretation of the 
``security-based swap dealer'' definition that is predicated on the 
existence of a customer relationship may lead to an overly narrow 
construction of the definition.
    \283\ For example, a person's activity involving entering into 
security-based swaps on a SEF may cause it to be a security-based 
swap dealer even in the absence of a customer relationship with any 
of its counterparties.
---------------------------------------------------------------------------

    Criteria associated with ``holding self out'' as a dealer or being 
``commonly known in the trade'' as a security-based swap dealer. The 
Proposing Release articulated a number of activities that could satisfy 
the definition's tests for a person ``holding itself out'' as a dealer 
or being ``commonly known in the trade'' as a dealer.\284\ Several 
commenters criticized those proposed criteria, largely on the grounds 
that those criteria would inappropriately encompass end-users who seek 
to use security-based swaps for hedging purposes, or otherwise would be 
overbroad or irrelevant.\285\ The Commissions recognize the 
significance of the concerns those commenters raised, and agree that 
these activities need to be considered within the context of whether a 
person engages in those activities with the purpose of facilitating 
dealing activity. While we do not believe that any of those activities 
by themselves would necessarily indicate that a person is acting as a 
security-based swap dealer, under certain circumstances they may serve 
as an indicia of a business purpose of seeking to profit by providing 
liquidity in connection with security-based swaps.\286\
---------------------------------------------------------------------------

    \284\ As noted above, these were: contacting potential 
counterparties to solicit interest; developing new types of swaps or 
security-based swaps and informing potential counterparties of their 
availability and of the person's willingness to enter into the swap 
or security-based swap; membership in a swap association in a 
category reserved for dealers; providing marketing materials 
describing the type of swaps or security-based swaps the party is 
willing to enter into; and generally expressing a willingness to 
offer or provide a range of products or services that include swaps 
or security-based swaps. See Proposing Release, 75 FR at 80178.
    \285\ See part II.A.2.a, supra.
    \286\ While the Proposing Release identified ``membership in a 
swap association in a category reserved for dealers'' as a factor in 
connection with the ``holding out'' and ``commonly known'' tests, we 
recognize that, depending on the applicable facts and circumstances, 
such membership may not be sufficient to cause a person to be a 
security-based swap dealer if the person does nothing else to cause 
it to be considered a dealer.
---------------------------------------------------------------------------

6. Requests for Exclusions From the Dealer Definitions
    Certain commenters have sought to exclude entire categories of 
persons from the dealer definitions, notwithstanding that some persons 
in those categories may engage in the activities set forth in the 
statutory definition (as further defined by the Commissions).\287\ The 
final rules nonetheless do not incorporate categorical exclusions of 
persons from the dealer definitions because the statutory definitions 
provide that ``any person'' who engages in the activities enumerated in 
the definitions is covered by the dealer definitions, unless the 
person's activities fall within one of the statutory exceptions.\288\ 
In this regard, it is significant that the exceptions in the dealer 
definitions depend on whether a person engages in certain types of swap 
or security-based swap activity, not on other characteristics of the 
person. That is, the exceptions apply for swaps between an insured 
depository institution and its customers in connection with originating 
loans,\289\ swaps or security-based swaps entered into not as a part of 
a regular business,\290\ and swap or security-based swap dealing that 
is below a de minimis

[[Page 30620]]

level.\291\ The Dodd-Frank Act does not exclude any category of persons 
from the coverage of the dealer definitions; rather, it excludes 
certain activities from the dealer analysis.
---------------------------------------------------------------------------

    \287\ See part II.A.2.f, supra.
    \288\ See CEA section 1a(49), 7 U.S.C. 1a(49); Exchange Act 
section 3(a)(71), 15 U.S.C. 78c(a)(71).
    \289\ See CEA section 1a(49)(A), 7 U.S.C. 1a(49)(A).
    \290\ See CEA section 1a(49)(C), 7 U.S.C. 1a(49)(C); Exchange 
Act section 3(a)(71)(C), 15 U.S.C. 78c(a)(71)(C).
    \291\ See CEA section 1a(49)(D), 7 U.S.C. 1a(49)(D); Exchange 
Act section 3(a)(71)(D), 15 U.S.C. 78c(a)(71)(D).
---------------------------------------------------------------------------

    Given that the statutory dealer definitions focus on a person's 
activity, the Commissions believe that it is appropriate to determine 
whether a person meets any of the tests set forth in those statutory 
definitions, and thus is acting as a swap dealer or security-based swap 
dealer, on a case-by-case basis reflecting the applicable facts and 
circumstances.\292\ If a person's swap or security-based swap 
activities are of a nature to be covered by the statutory definitions, 
and those activities are not otherwise excluded, then the person is 
covered by the definitions. The contrary is equally true--a person who 
is not engaged in activities covered by the statutory definitions, or 
whose activities are excluded from the definition, is not covered by 
the definitions.\293\ The per se exclusions requested by the commenters 
have no foundation in the statutory text, and have the potential to 
lead to arbitrary line drawing that may result in disparate regulatory 
treatment and inappropriate competitive advantages.\294\
---------------------------------------------------------------------------

    \292\ The Commissions believe that a facts and circumstances 
approach is particularly appropriate here, where the broad terms of 
the statutory dealer definitions indicate that the Commissions 
should apply their expertise and discretion to interpret the 
statutory text.
    \293\ For example, a manufacturer, producer, processor, or 
merchant that enters into swaps to hedge its currency or interest 
rate risk, absent any facts and circumstances establishing dealing 
activity, is not a swap dealer.
    \294\ In response to the commenters concerns, the Commissions 
have adopted certain tailored exclusions of certain types of swaps 
and security-based swaps in the final rule.
---------------------------------------------------------------------------

    The final rules particularly do not include any exclusions for 
aggregators of swaps or other persons that use swaps in connection with 
the physical commodity markets, including swaps in connection with the 
generation, transmission and distribution of electricity. It is likely, 
though, that a significant portion of the financial instruments used 
for risk management by such persons are forward contracts in 
nonfinancial commodities that are excluded from the definition of the 
term ``swap.'' \295\ Such forward contracts are not relevant in 
determining whether a person is a swap dealer.
---------------------------------------------------------------------------

    \295\ A coalition of not-for-profit power utilities and electric 
cooperatives has advised that it plans to submit a request for an 
exemption for transactions between entities described in section 
201(f) of the Federal Power Act, as contemplated by section 722(f) 
of the Dodd-Frank Act. See letter from NFPEEU. Separately, some 
regional transmission organizations and independent systems 
operators have expressed interest in submitting an exemption 
application to the CFTC as well. See generally section 722(e) of the 
Dodd-Frank Act. Such exemptions, if granted after notice and comment 
pursuant to CEA section 4(c), 7 U.S.C. 6(c), could further address 
commenters' concerns in this regard.
---------------------------------------------------------------------------

B. ``Swap Dealer'' Exclusion for Swaps in Connection With Originating a 
Loan

1. Proposed Approach
    The statutory definition of the term ``swap dealer'' excludes an 
insured depository institution (``IDI'') ``to the extent it offers to 
enter into a swap with a customer in connection with originating a loan 
with that customer.'' \296\ This exclusion does not appear in the 
definition of the term ``security-based swap dealer.''
---------------------------------------------------------------------------

    \296\ See CEA section 1a(49)(A), 7 U.S.C. 1a(49)(A).
---------------------------------------------------------------------------

    Proposed CFTC Regulation Sec.  1.3(ggg)(5) would implement this 
statutory exclusion by providing that an IDI's swaps with a customer in 
connection with originating a loan to that customer are disregarded in 
determining if the IDI is a swap dealer. In order to prevent evasion, 
the proposed rule further provided that the statutory exclusion does 
not apply where the purpose of the swap is not linked to the financial 
terms of the loan; the IDI enters into a ``sham'' loan; or the 
purported ``loan'' is actually a synthetic loan such as a loan credit 
default swap or loan total return swap.
1. Commenters' Views
    Nearly all the commenters on this issue were IDIs seeking a broad 
interpretation of the exclusion. The commenters addressed four primary 
issues: (i) The type of swaps that should be covered by the exclusion; 
(ii) the time period during which parties would be required to enter 
into the swap in order for the swap to be considered to be ``in 
connection with originating a loan;'' (iii) which transactions should 
be deemed to be ``loans'' for purposes of the exclusion; and (iv) which 
entities should be included within the definition of IDI.
    First, regarding the type of swap that should be covered by the 
exclusion, as proposed, Sec.  1.3(ggg)(5) would require that the rate, 
asset, liability or other notional item underlying the swap be, or be 
directly related to, a financial term of the loan (such as the loan's 
principal amount, duration, rate of interest or currency). Some 
commenters agreed with the principle of limiting the exclusion to swaps 
that are connected to the financial terms of the loan, stating that the 
exclusion should cover any swap between a borrower and the lending IDI, 
so long as the swap's notional amount is no greater than the loan 
amount, the swap's duration is no longer than the loan's duration, and 
the swap's index and payment dates match the index and payment dates of 
the loan.\297\ Another commenter, agreeing with the proposed approach, 
said that there is no basis to extend the loan origination exclusion to 
swaps related to the borrower's business risks, as opposed to the 
financial terms of the loan.\298\
---------------------------------------------------------------------------

    \297\ See letters from Branch Banking & Trust Company (``BB&T'') 
dated February 3, 2011 (``BB&T I''), B&F Capital Markets, Inc. 
(``B&F Capital'') dated February 18, 2011 (``B&F Capital I''), 
Capital One Financial Corporation (``Capital One'') and Capstar Bank 
(``Capstar''); see also joint letter from Atlantic Capital Bank, 
Cobiz Bank, Cole Taylor Bank, Commerce Bank, N.A., East West Bank, 
First Business Bank, First National Bank of Pennsylvania, Heartland 
Financial USA, Inc., Old National Bancorp, Peoples Bancorp of North 
Carolina, Inc., Susquehanna Bank, The PrivateBank and Trust Co, The 
Savannah Bank, N.A., The Washington Trust Company, Trustmark 
National Bank, UMB Financial Corporation, Valley National Bank, 
Webster Bank NA, WesBanco Bank (``Regional Banks'') (general support 
for limitation to swaps connected to financial terms of the loan).
    \298\ See letter from Better Markets I.
---------------------------------------------------------------------------

    Other commenters, though, said that this limitation to swaps 
connected to the financial terms of the loan was inappropriate or 
inconsistent with the Dodd-Frank Act, and that any swap required by the 
loan agreement or required by the IDI as a matter of prudent lending 
should be covered by the exclusion.\299\ Some of the commenters arguing 
for the broader exclusion emphasized that the exclusion should be 
available for any swap with the lending IDI which reduces the 
borrower's risks, such as a commodity swap the borrower uses for 
hedging, because reduction of commodity price risks faced by the 
borrower also reduces the risk that the loan will not be repaid to the 
IDI.\300\ Commenters said that if the exclusion does not apply to swaps 
hedging the borrower's commodity price risks, then only IDIs that are 
able to create a separately capitalized affiliate will be able to offer 
commodity swaps (because section 716 of the Dodd-Frank Act limits the 
ability of IDIs to offer commodity swaps), thereby reducing the 
availability of commodity swaps to

[[Page 30621]]

borrowers that are smaller companies.\301\
---------------------------------------------------------------------------

    \299\ See letters from BOK dated February 18, 2011 (``BOK II''), 
FSR I, ISDA I, Midsize Banks, OCC Staff at 6 (noting that ``[l]oan 
underwriting criteria for community and mid-size banks * * * may 
require, as a condition of the loan, that the borrower be hedged 
against the commodity price risks incidental to its business'') and 
White & Case LLP (``White & Case'') and joint letter from Senator 
Stabenow and Representative Lucas.
    \300\ See letters from BOK II, FSR I, OCC Staff and White & 
Case.
    \301\ See letters from ABA I and BOK I. Other commenters 
addressed the relationship between the swap dealer definition and 
section 619 of the Dodd-Frank Act (the ``Volcker Rule''). See joint 
letter from Capital One, Fifth Third Bancorp and Regions Financial 
Corporation.
---------------------------------------------------------------------------

    Second, regarding timing, the proposed rule requested comment on 
whether this exclusion should apply only to swaps that are entered into 
contemporaneously with the IDI's origination of the loan (and if so, 
how ``contemporaneously'' should be defined for this purpose), or 
whether this exclusion also should apply to swaps entered into during 
part or all of the duration of the loan. In response, commenters said 
that the exclusion should apply to swaps entered into in anticipation 
of a loan or at any time during the loan term.\302\ Commenters said 
that application of the exclusion throughout the duration of the loan 
would give IDIs and borrowers flexibility as to when to fix interest 
rates in fixed/floating swaps relating to loans and would allow 
borrowers to make other hedging decisions over a longer time 
period.\303\ Commenters also said that loans such as construction 
loans, equipment loans and committed loan facilities may allow for 
draws of loan principal over an extended period of time, and that swaps 
entered into by the borrower and lending IDI through the course of such 
a loan should be covered by the exclusion.\304\
---------------------------------------------------------------------------

    \302\ See letters from BB&T I, B&F Capital I, BOK II, Capital 
One, Capstar, FSR I, Midsize Banks, Manufacturers and Traders Trust 
Company (``M&T'') dated June 3, 2011 (``M&T I'') and September 28, 
2011 (``M&T II''), Peoples Bank Co. (``Peoples Bank''), Regional 
Banks and White & Case.
    \303\ See letters from B&F Capital I, BOK II, Capital One, 
Capstar and M&T I and M&T II.
    \304\ See letters from FSR dated October 17, 2011 (``FSR VI''), 
M&T II and Wells Fargo Bank, N.A. (``Wells Fargo'') dated August 16, 
2011 (``Wells Fargo II'').
---------------------------------------------------------------------------

    Third, as to which transactions should be deemed ``loans'' for 
purposes of the exclusion, the proposal said that the exclusion should 
be available in connection with all transactions by which an IDI is a 
source of funds to a borrower, including, for example, loan 
syndications, participations and refinancings. Commenters agreed that 
the exclusion should be available for IDIs that are in a loan 
syndicate, purchasers of a loan, assignees of a loan or participants in 
a loan.\305\ On loan syndications and participations in particular, one 
commenter said that the exclusion should be available even if the 
notional amount of the swap is more than the amount of the loan tranche 
assigned to the IDI, so long as the swap notional amount is not more 
than the entire amount of the loan.\306\ Another commenter said that 
the exclusion should not be available if the IDI's participation in the 
loan drops below a minimum level (such as 20 percent) because such use 
of the exclusion by minimally-participating IDIs would invite 
abuse.\307\
---------------------------------------------------------------------------

    \305\ See letters from BB&T I, Midsize Banks, Regional Banks and 
White & Case; see also letter from Loan Market Association 
(providing background information on loan participations).
    \306\ See letter from Regional Banks.
    \307\ See letter from Better Markets I.
---------------------------------------------------------------------------

    Some commenters said that other types of transactions also should 
be treated as ``loans'' for purposes of the exclusion. The transactions 
cited by commenters in this regard include leases, letters of credit, 
financings documented as sales of financial assets, bank qualified tax 
exempt loans and bonds that are credit enhanced by an IDI.\308\ Other 
commenters said the exclusion should apply where entities related to an 
IDI provide financing, such as loans or financial asset purchases by 
bank-sponsored commercial paper conduits where the IDI provides 
committed liquidity,\309\ and transactions where a special purpose 
entity formed by an IDI is the source of financing and enters into the 
swap.\310\ Some commenters said the exclusion should encompass all 
transactions where an IDI facilitates a financing,\311\ or all 
extensions of credit by an IDI,\312\ or all transactions where an IDI 
provides risk mitigation to a borrower.\313\
---------------------------------------------------------------------------

    \308\ See letters from BB&T I, Capital One, FSR I, M&T I, 
Midsize Banks and Regional Banks.
    \309\ See letter from FSR I.
    \310\ See letter from Midsize Banks.
    \311\ See letters from Pacific Coast Bankers' Bancshares 
(``PCBB'') and Regional Banks.
    \312\ See letters from FSR I and Midsize Banks.
    \313\ See letter from PCBB.
---------------------------------------------------------------------------

    Fourth, with respect to the types of financial institutions that 
are eligible for the loan origination exclusion, three commenters said 
that IDIs, for purposes of this exclusion, encompass more than banks or 
savings associations with federally-insured deposits. The Farm Credit 
Council said the exclusion should be extended to Farm Credit System 
institutions because one of these institutions enters into interest 
rate swaps with borrowing customers identical in function to those 
offered by commercial banks and savings associations in connection with 
loans, and the institutions are subject to similar regulatory 
requirements and covered by a similar insurance regime.\314\ Another 
commenter said that the exclusion should be extended to other regulated 
financial institutions, such as insurers, so as not to create an 
unlevel playing field.\315\ And the Federal Home Loan Banks said that 
the exclusion should be available to them because they are subject to 
similar regulatory oversight and capital standards and engage in a 
similar function of extending credit as do commercial banks and savings 
associations.\316\ In addition, some commenters said the exclusion 
should be broadly construed as a general matter, to encourage 
competition in the swap market between smaller and larger banks and to 
increase borrowers' choice among potential swap providers.\317\
---------------------------------------------------------------------------

    \314\ Consequently, the Farm Credit Council argued, disallowing 
these institutions from using the exclusion would give commercial 
banks and savings associations a competitive advantage in 
agricultural lending. See letters from Farm Credit Council I and 
dated February 17, 2012 (``Farm Credit Council II''). Another 
commenter argued that, to the contrary, making Farm Credit System 
institutions eligible for the exclusion would confer an 
inappropriate competitive advantage on those institutions. See 
letter from ABA dated February 14, 2012 (``ABA II''). This commenter 
said that Farm Credit System institutions have certain advantages 
over other IDIs, and the commenter asserted that Farm Credit System 
institutions were left out of the statutory language of the 
exclusion in order that they would not receive additional 
competitive advantages. See id.
    \315\ See letter from NAIC.
    \316\ See letter from FHLB I. The Credit Union National 
Association said that the Federal Home Loan Banks should not be 
covered by the swap dealer definition because they do not enter into 
swaps for their own account as part of a regular business. See 
letter from CUNA.
    \317\ See letters from BB&T I, B&F Capital dated June 1, 2011 
(``B&F Capital II''), Capital One, Capstar, M&T I and Peoples Bank.
---------------------------------------------------------------------------

    Two commenters asked for clarification of the following technical 
points in the proposed rule: (i) Whether a swap would be covered by the 
exclusion even if it does not hedge all the risks under the loan, (ii) 
whether a swap that is within the exclusion could continue to be 
treated as covered by the exclusion by an IDI if the IDI transfers the 
loan, and (iii) whether an IDI should count swaps covered by the 
exclusion in determining if its dealing activity is above the de 
minimis thresholds.\318\ Another commenter asked whether an IDI with 
swaps that are covered by the exclusion could be a swap dealer based on 
other dealing activity.\319\ And others asked whether the exclusion 
would cover swaps used by an IDI to hedge its risks arising from a loan 
(i.e., a swap which the IDI enters into with a party other than the 
loan borrower).\320\
---------------------------------------------------------------------------

    \318\ See letters from FSR VI and Midsize Banks.
    \319\ See letter from Better Markets I.
    \320\ See letters from B&F Capital I, FSR I, ISDA I, M&T I and 
Midsize Banks.
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3. Final Rule
    The CFTC believes that the extent of this exclusion should be 
determined by

[[Page 30622]]

the language of the statutory definition, which relates to an IDI that 
``offers to enter into a swap with a customer in connection with 
originating a loan with that customer.'' The expansive interpretation 
of the exclusion advanced by some commenters, however, would read the 
statute to exclude almost any swap that an IDI enters into with a loan 
customer. That is not the exclusion that was enacted. Instead, we 
interpret the statutory phrase ``enter into a swap with a customer in 
connection with originating a loan with that customer'' to mean that 
the swap is directly connected to the IDI's process of originating the 
loan to the customer.
    Because of the statute's direct reference to ``originating'' the 
loan, it would be inappropriate to construe the exclusion as applying 
to all swaps entered into between an IDI and a borrower at any time 
during the duration of the loan. If this were the intended scope of the 
statutory exclusion, there would be no reason for the text to focus on 
swaps in connection with ``originating'' a loan. The CFTC recognizes 
the concern expressed by commenters that: (i) there be flexibility 
regarding when the IDI and borrower enter into a swap relating to a 
loan, and (ii) the expectation when an IDI originates a loan with a 
customer is often that the customer will enter into a swap with the IDI 
when there is a subsequent advance, or a draw, of principal on the 
loan. We do not believe, however, that the statutory term 
``origination'' can reasonably be stretched to cover the entire term of 
every loan that an IDI makes to its customers. At some point, the 
temporal distance renders the link to loan origination too attenuated, 
and the risk of evasion too great, to support the exclusion. In order 
to balance these competing and conflicting considerations, the final 
rule applies the exclusion to any swap that otherwise meets the terms 
of the exclusion and is entered into no more than 90 days before or 180 
days after the date of execution of the loan agreement, or no more than 
90 days before or 180 days after the date of any transfer of principal 
to the borrower from the IDI (e.g., a draw of principal) pursuant to 
the loan, so long as the aggregate notional amount of the swaps in 
connection with the financial terms of the loan at any time is no more 
than the aggregate amount of the borrowings under the loan at that 
time.\321\
---------------------------------------------------------------------------

    \321\ We note that because the exclusion is available within the 
specified time period around the execution of the loan agreement and 
any draw of principal under the loan, any amendment, restructuring, 
extension or other modification of the loan will, in itself, neither 
preclude application of the exclusion nor expand application of the 
exclusion.
---------------------------------------------------------------------------

    Since a loan involves the repayment of funds to the IDI on 
particular terms, a swap that relates to those terms of repayment 
should be covered by the exclusion. In addition, we recognize that, as 
stated by commenters, requirements in an IDI's loan underwriting 
criteria relating to the borrower's financial stability are an 
important part of ensuring that loans are repaid.\322\ Therefore, the 
final rule modifies the proposed rule to provide that the exclusion 
applies to swaps between an IDI and a loan borrower that are connected 
to the financial terms of the loan, such as, for example, the loan's 
duration, interest rate, currency or principal amount, or that are 
required under the IDI's loan underwriting criteria to be in place as a 
condition of the loan in order to hedge commodity price risks 
incidental to the borrower's business.\323\ The first category of swaps 
generally serve to transform the financial terms of a loan for purposes 
of adjusting the borrower's exposure to certain risks directly related 
to the loan itself, such as risks arising from changes in interest 
rates or currency exchange rates. The second category of swaps mitigate 
risks faced by both the borrower and the lender, by reducing risks that 
the loan will not be repaid. Thus, both types of swaps are directly 
related to repayment of the loan. Although some commenters said that 
this exclusion should also apply to other types of swaps, we believe it 
would be inappropriate to construe this exclusion as encompassing all 
swaps that are connected to a borrower's other business activities, 
even if the loan agreement requires that the borrower enter into such 
swaps or otherwise refers to them.\324\ In contrast to a swap that 
transforms the financial terms of a loan or is required by the IDI's 
loan underwriting criteria to reduce the borrower's commodity price 
risks, other types of swaps serve a more general risk management 
purposes by reducing other risks related to the borrower or the loan. 
If the purpose of the exclusion were to cover the broad range of swaps 
cited by some commenters (such as all swaps reducing a borrower's 
business risks), then the terms of the statute limiting the exclusion 
to swaps that are ``in connection with originating a loan with that 
customer'' would be superfluous.\325\ To give effect to the statutory 
text, the exclusion is limited to a swap that is connected to the 
financial terms of the loan or is required by the IDI's loan 
underwriting criteria to to be in place as a condition of the loan in 
order to hedge commodity price risks incidental to the borrower's 
business.
---------------------------------------------------------------------------

    \322\ See letter from OCC Staff.
    \323\ The final rule provides that the second category of swaps 
must hedge a price risk related to a commodity other than an 
excluded commodity because if the price risk relates to an excluded 
commodity (such as an interest rate) the swap must be connected to 
the financial terms of the loan in order to be covered by the 
exclusion.
    \324\ On the other hand, there is no requirement that the loan 
agreement reference a swap in order for the swap to be excluded, if 
the swap otherwise qualifies for the exclusion.
    \325\ Also, we believe that the broader range of swaps serving 
general risk management purposes are more likely to involve concerns 
regarding market transparency and appropriate business conduct 
practices addressed by swap dealer regulation than are the narrower 
range of swaps that are encompassed by the exclusion.
---------------------------------------------------------------------------

    Regarding the types of transactions that will be treated as a 
``loan'' for purposes of the exclusion, courts have defined the term 
``loan'' in other statutory contexts based on the settled meaning of 
the term under common law. This definition encompasses any contract by 
which one party transfers a defined quantity of money and the other 
party agrees to repay the sum transferred at a later date.\326\ Rather 
than examine at this time the many particularized examples of financing 
transactions cited by some commenters, the term ``loan'' for purposes 
of this exclusion should be interpreted in accordance with this settled 
legal meaning.\327\
---------------------------------------------------------------------------

    \326\ See, e.g., In Re Renshaw, 222 F.3d 82, 88 (2d Cir. 2000) 
(``Because Congress did not define the term ``loan'' for [11 U.S.C.] 
Sec.  523(a)(8), we must interpret it according to its settled 
meaning under common law. The classic definition of a loan [is] * * 
* as follows: To constitute a loan there must be (i) a contract, 
whereby (ii) one party transfers a defined quantity of money, goods, 
or services, to another, and (iii) the other party agrees to pay for 
the sum or items transferred at a later date.'') (citing In re Grand 
Union Co., 219 F. 353, 356 (2d Cir. 1914)).
    \327\ The final rule adopts provisions from the proposed rule 
that, in order to prevent evasion, the statutory exclusion does not 
apply where the IDI originates a ``sham'' loan; or the purported 
``loan'' is actually a synthetic loan such as a loan credit default 
swap or loan total return swap. See CFTC Regulation Sec.  
1.3(ggg)(5)(iii).
---------------------------------------------------------------------------

    As stated in the proposed rule, this exclusion is available to all 
IDIs that are a source of a transfer of money to a borrower pursuant to 
a loan. The final rule adopts provisions from the proposed rule that 
the exclusion is available to an IDI that is a source of money by being 
part of a loan syndicate, being an assignee of a loan, obtaining a 
participation in a loan, or purchasing a loan.\328\ However, the 
proposed rule did

[[Page 30623]]

not state explicitly how the notional amount of a swap subject to the 
exclusion must relate to the amount of money provided by an IDI that is 
in a loan syndicate or is an assignee of, participant in or purchaser 
of a loan. In this regard, some commenters said that a borrower and the 
IDIs in a lending syndicate need flexibility to allocate responsibility 
for the swap(s) related to the loan as they may agree.\329\ We believe 
that, to allow for this flexibility, the exclusion may apply to a swap 
(which is otherwise covered by the exclusion) even if the notional 
amount of the swap is different from the amount of the loan tranche 
assigned to the IDI. However, we also agree with a commenter that the 
IDI should have a substantial participation in the loan.\330\ The 
requirement of substantial participation would prevent an IDI from 
applying the exclusion where the IDI makes minimal lending commitments 
in multiple loan syndicates where it offers swaps, causing its swap 
activity to be far out of proportion to its loan activity.\331\
---------------------------------------------------------------------------

    \328\ See CFTC Regulation Sec.  1.3(ggg)(5)(ii). As is also 
stated in the Proposing Release, if an IDI were to transfer its 
participation in a loan to a non-IDI, then the non-IDI would not be 
able to claim this exclusion, regardless of the terms of the loan or 
the manner of the transfer. Similarly, a non-IDI that is part of a 
loan syndicate with IDIs would not be able to claim the exclusion.
    \329\ See, e.g., letter from Regional Banks.
    \330\ See letter from Better Markets I. This commenter suggested 
a minimal threshold of at least 20 percent of the loan. However, we 
believe that a 10 percent commitment constitutes a substantial 
participation in the loan which supports offering of a swap up to 
the loan's full amount.
    \331\ For example, an IDI could act as a 0.1 percent participant 
in one hundred different loans in order to serve as the sole swap 
counterparty to the borrowers for hedging the borrowers' interest 
rate risk on the loans. Thus, by lending or committing to lend $100 
million, the IDI could apply the exclusion to swaps with an 
aggregate notional amount of $100 billion.
---------------------------------------------------------------------------

    Therefore, the final rule includes a provision that the exclusion 
may apply regardless of whether the notional amount of the swap is the 
same as the amount of the loan, but only if the IDI is the sole source 
of funds under the loan or is committed to be, under the applicable 
loan agreements, the source of at least 10 percent of the maximum 
principal amount under the loan.\332\ If the IDI does not meet this 10 
percent threshold, the final rule provides that the exclusion may apply 
only if the aggregate notional amount of all the IDI's swaps with the 
customer related to the financial terms of the loan is no more than the 
amount lent by the IDI to the customer.\333\ We also note that, in all 
cases, application of the exclusion requires that the aggregate 
notional amount of all swaps entered into by the borrower with any 
person in connection with the financial terms of the loan at any time 
is not more than the aggregate principal amount outstanding under the 
loan at that time.\334\
---------------------------------------------------------------------------

    \332\ See CFTC Regulation Sec.  1.3(ggg)(5)(i)(D)(1) and (2).
    \333\ See CFTC Regulation Sec.  1.3(ggg)(5)(i)(D)(3).
    \334\ See CFTC Regulation Sec.  1.3(ggg)(5)(i)(E). Paragraphs 
(D)(3) and (E) of this regulation refer to all swaps ``in connection 
with the financial terms of the loan'' in order to clarify that only 
such swaps are relevant in this regard. For example, if the IDI were 
to enter into a swap with the customer that is not in connection 
with the loan's financial terms, the swap would not be relevant 
because the exclusion would not apply to the swap.
---------------------------------------------------------------------------

    We also reiterate the interpretation in the Proposing Release that 
the word ``offer'' in this exclusion includes scenarios where the IDI 
requires the customer to enter into a swap, or where the customer asks 
the IDI to enter into a swap, specifically in connection with a loan 
made by that IDI.
    We also continue to emphasize, as stated in the Proposing Release, 
that the statutory language of the exclusion limits its availability to 
only IDIs as defined in the statute. Regarding some commenters' 
statements about the competitive effect of this interpretation of the 
term ``insured depository institution,'' we believe that the scope of 
application of the swap dealer definition to various entities should be 
treated in the de minimis exception, which is available to all persons.
    In order to provide clarification in response to certain technical 
questions raised by commenters, we note that whether a swap hedges all 
of the risk, or only some of the risk, of a loan is not relevant to 
application of the exclusion. Nor is it relevant to the exclusion if 
the IDI later transfers or terminates the loan in connection with which 
the swap was entered into, so long as the swap otherwise qualifies for 
the exclusion and the loan was originated in good faith and was not a 
sham.\335\ Further, swaps that are covered by the exclusion should not 
be considered in determining if an IDI exceeds the de minimis level of 
swap dealing activity, because the statute provides that swaps covered 
by the exclusion should not be considered in determining if an IDI is a 
swap dealer, and the de minimis exception provides that it considers 
the ``quantity of [a person's] swap dealing.'' \336\ The application of 
the exclusion to swaps entered into by an IDI in connection with the 
origination of loans, however, does not mean that the IDI could not be 
a swap dealer because of other of the IDI's activities that constitute 
swap dealing. Regarding swaps used by an IDI to hedge or lay off its 
risks arising from a loan, we do not believe it is appropriate to treat 
such swaps as covered by the exclusion, because the statute explicitly 
limits the exclusion to swaps ``with a customer,'' which such hedging 
swaps are not. However, a swap that an IDI enters into for the purpose 
of hedging or laying off the risk of a swap that is covered by the IDI 
exclusion will not be considered in the de minimis determination, or 
otherwise in evaluating whether the IDI is covered by the swap dealer 
definition.\337\
---------------------------------------------------------------------------

    \335\ On the other hand, if the IDI were to transfer the swap 
(but not the loan) to another IDI, and the IDI that is the 
transferee of the swap is not a source of money to the borrower 
under the loan, then the transferee IDI would not be able to apply 
the exclusion to the swap.
    \336\ See CEA sections 1a(49)(A) and 1a(49)(D), 7 U.S.C. 
1a(49)(A) and 1a(49)(D).
    \337\ An IDI that is seeking out swap counterparties to enter 
into swaps in order to hedge or lay off the risk of a swap that is 
subject to the IDI exclusion would generally not be accommodating 
demand for swaps or facilitating interest in swaps.
---------------------------------------------------------------------------

    Last, we believe it is appropriate to require that an IDI claiming 
the exclusion report its swaps that are covered by the exclusion to a 
swap data repository (``SDR''). This requirement is consistent with the 
prevailing practice that IDIs handle the documentation of loans made to 
borrowers, and will provide for consistent reporting of swaps that are 
covered by the exclusion, thereby allowing the CFTC and other 
regulators to monitor the use of the exclusion.
    In sum, the final rule balances the need for flexibility in 
response to existing lending practices, consistent with the constraints 
imposed by the statutory text as enacted, against the risk of 
establishing a gap in the regulatory framework enacted in Title 
VII.\338\ It provides that the exclusion may be claimed by a person 
that meets the following conditions: (i) The person is an IDI; (ii) the 
IDI enters into a swap with the borrower that does not extend beyond 
the termination of the loan; (iii) the swap is connected to the 
financial terms of the loan or is required by the IDI's loan 
underwriting criteria to to be in place as a condition of the loan in 
order to hedge commodity price risks incidental to the borrower's 
business; (iv) the loan is within the common law meaning of ``loan'' 
and it is not a sham or a synthetic loan; (v) the IDI is the source of 
money to the borrower in connection with the loan either directly, or 
(so long as the IDI is the source of at least 10 percent of the entire 
amount of the loan) through syndication, participation, assignment, 
purchase, refinancing or otherwise; (vi) the IDI

[[Page 30624]]

enters into the swap with the borrower within 90 days before or 180 
days after the date the execution of the loan agreement, or within 90 
days before or 180 days after any transfer of principal to the borrower 
from the IDI pursuant to the loan; (vii) the aggregate notional amount 
of all swaps entered into by the borrower with all persons in 
connection with the financial terms of the loan at any time is not more 
than the aggregate amount of the borrowings under the loan at that 
time; and (viii) the IDI agrees to report the swap to an SDR.
---------------------------------------------------------------------------

    \338\ The final rule text in CFTC Regulation Sec.  
1.3(ggg)(5)(i) has been revised to conform the text of the rule to 
the statutory provision which refers to ``an insured depository 
institution [that] * * * enter[s] into a swap with a customer in 
connection with originating a loan with that customer.'' See CEA 
Sec.  1a(49)(A), 7 U.S.C. 1a(49)(A)
---------------------------------------------------------------------------

    An IDI that enters into swaps that do not meet these conditions, 
and thus do not qualify for the statutory exclusion, is not necessarily 
required to register as a swap dealer. Rather, the IDI would apply the 
statutory definition and the provisions of the rule (taking into 
account the applicable interpretive guidance set forth in this Adopting 
Release), solely with respect to its swaps that are not subject to the 
IDI exclusion, in order to determine whether it is engaged in swap 
dealing activity that exceeds the de minimis threshold.

C. Application of Dealer Definitions to Legal Persons and to Inter-
Affiliate Swaps and Security-Based Swaps

1. Proposed Approach and Commenters' Views
    In the Proposing Release, the Commissions preliminarily concluded 
that designation as a dealer would apply on an entity-level basis 
(rather than to a trading desk or other business unit that is not 
organized as a separate legal person), and that an affiliated group of 
legal persons could include more than one dealer.\339\ The Proposing 
Release also stated that the dealer analysis should consider the 
economic reality of swaps and security-based swaps between affiliates, 
and preliminarily noted that swaps or security-based swaps ``between 
persons under common control may not involve the interaction with 
unaffiliated persons that we believe is a hallmark of the elements of 
the definitions that refer to holding oneself out as a dealer or being 
commonly known as a dealer.'' \340\
---------------------------------------------------------------------------

    \339\ See Proposing Release, 75 FR at 80183.
    \340\ Id. The Proposing Release further noted that sections 
721(c) and 761(b)(3) give the Commissions anti-evasion authority, to 
the extent that an entity were to seek to use transactions between 
persons under common control to avoid one of the dealer definitions. 
See id. (erroneously referring to section 721(c) as section 
721(b)(3).
---------------------------------------------------------------------------

    Commenters supported the view that swaps and security-based swaps 
among affiliates should be excluded from the dealer analysis.\341\ A 
number of commenters took the view that the dealer definitions should 
not apply when there is common control between counterparties, or when 
common control is combined with the consolidation of financial 
statements.\342\ Some commenters suggested that this interpretation 
regarding the scope of the dealer definitions should incorporate 
concepts of affiliation that are found in other statutory and 
regulatory provisions.\343\ Several commenters also opposed the 
suggestion (raised as part of the Proposing Release's request for 
comments) that this interpretation be limited to transactions among 
wholly owned subsidiaries.\344\
---------------------------------------------------------------------------

    \341\ See, e.g., letters from API I, COPE I, ISDA I, Midsize 
Banks, ONEOK, Inc. (``ONEOK'') and Peabody.
     Several commenters explained the widespread use of central 
hedging desks to allocate risk within affiliate groups or to gather 
risk from within a group and lay that risk off on the market. See, 
e.g., letters from EEI/EPSA, Kraft Foods Inc. (``Kraft''), MetLife 
and Prudential Financial, Inc. (``Prudential'') dated February 17, 
2011 (``Prudential I'').
     Some commenters particularly stated that the use of a single 
entity to face the market on behalf of an affiliate group had 
several risk-reducing and efficiency-enhancing benefits, and that 
those benefits would be lost if the dealer definitions were to lead 
corporate groups to avoid using central trading desks and instead 
require each affiliate to face the market as an independent end-
user. See letters from FSR I, Philip Morris International Inc. 
(``Philip Morris''), Shell Trading dated June 3, 2011 (``Shell 
Trading II'') and Utility Group, and joint letter from ABA 
Securities Association, American Council of Life Insurers 
(``ACLI''), FSR, Futures Industry Association (``FIA''), Institute 
of International Bankers, ISDA and SIFMA (``Financial 
Associations'').
     Some commenters also stated that legislative history suggested 
that Congress did not intend that the dealer definition capture 
transactions involving the use of an affiliate to hedge commercial 
risk. See letters from CDEU and Prudential I.
    \342\ See letters from CDEU (common control), Financial 
Associations (common control and consolidation), MetLife 
(consolidation), ONEOK (common control, evaluated based on whether 
the trading interests of the entities are aligned) and Prudential I 
(citing CFTC letter interpretation regarding common control).
    \343\ See, e.g., letters from EDF Trading (proposing definition 
from regulations promulgated by the Federal Energy Regulatory 
Commission) and Peabody (proposing definition of ``affiliate'' used 
in federal securities laws) and joint letter from the Bank of Tokyo-
Mitsubishi UFJ, Ltd., Mizuho Corporate Bank, Ltd. and Sumitomo 
Mitsui Banking Corp. (suggesting use of control definition in Bank 
Holding Company Act).
    \344\ See, e.g., letters from Kraft and ONEOK.
---------------------------------------------------------------------------

2. Final Interpretation and Rule
a. Application to Legal Persons
    Consistent with the Proposing Release, the Commissions interpret 
``person'' as used in the swap dealer and security-based swap dealer 
definitions to refer to a particular legal person. Accordingly, the 
dealer definitions will apply to the particular legal person performing 
the dealing activity, even if that person's dealing activity is limited 
to a trading desk or discrete business unit,\345\ unless the person is 
able to take advantage of a limited designation as a dealer.\346\
---------------------------------------------------------------------------

    \345\ Within an affiliated group of companies, however, only 
those legal persons that engage in dealing activities will be 
designated as dealers; that designation will not be imputed to other 
non-dealer affiliates or to the group as a whole. A single affiliate 
group may, however, have multiple swap or security-based swap 
dealers.
    \346\ Limited designation as a dealer is addressed in more 
detail below in part II.E.
---------------------------------------------------------------------------

b. Application to Inter-Affiliate Swaps and Security-Based Swaps
    The final rules codify exclusions from the dealer definitions for a 
person's swap or security-based swap activities with certain 
affiliates.\347\ These rules are consistent with the Proposing 
Release's recognition of the need to consider the economic reality of 
any swaps or security-based swaps that a person enters into with 
affiliates. Market participants may enter into such inter-affiliate 
swaps or security-based swaps for a variety of purposes, such as to 
allocate risk within a corporate group or to transfer risks within a 
corporate group to a central hedging or treasury entity.
---------------------------------------------------------------------------

    \347\ See CFTC Regulation Sec.  1.3(ggg)(6)(i); Exchange Act 
rule 3a71-1(d). A person's market-facing swap or security-based swap 
activity may still cause that person to be a dealer, even if that 
market-facing activity is linked to the inter-affiliate activity, to 
the extent that the market-facing activity satisfies the dealer 
definition. However, a person's market-facing swap activity for 
hedging purposes as defined in CFTC Regulation Sec.  
1.3(ggg)(6)(iii) would not cause that person to be a dealer.
---------------------------------------------------------------------------

    Under the final rules, the dealer analysis will not apply to swaps 
and security-based swaps between majority-owned affiliates.\348\ When 
the economic interests of those affiliates are aligned adequately--as 
would be found in the case of majority-ownership--such swaps and 
security-based swaps serve to allocate or transfer risks within an 
affiliated group, rather than to move those risks out of the group to 
an unaffiliated third party. For this reason, and as contemplated by 
the Proposing Release,\349\ we do not believe that such

[[Page 30625]]

swaps and security-based swaps involve the interaction with 
unaffiliated persons to which dealer regulation is intended to apply.
---------------------------------------------------------------------------

    \348\ See CFTC Regulation Sec.  1.3(ggg)(6)(i); Exchange Act 
rule 3a71-1(d)(1). For the purposes of these rules, the 
counterparties are majority-owned affiliates if one party directly 
or indirectly holds a majority ownership interest in the other, or 
if a third party directly or indirectly holds a majority interest in 
both, based on holding a majority of the equity securities of an 
entity, or the right to receive upon dissolution or the contribution 
of a majority of the capital of a partnership. See CFTC Regulation 
Sec.  1.3(ggg)(6)(i); Exchange Act rule 3a71-1(d)(2).
    \349\ See Proposing Release, 75 FR at 80183 (noting that swaps 
or security-based swaps between affiliates ``may not involve the 
interaction with unaffiliated persons that we believe is a hallmark 
of the elements of the definitions that refer to holding oneself out 
as a dealer or being commonly known as a dealer'').
---------------------------------------------------------------------------

    The standard in the final rules differs from the standard suggested 
by the Proposing Release, which alluded to affiliates as legal persons 
under ``common control.'' This change is based on our further 
consideration of the issue, including consideration of comments that an 
inter-affiliate exclusion should be available when common control is 
combined with the consolidation of financial statements. Although we 
are not including a requirement that financial statements be 
consolidated--as we do not believe that the scope of this exclusion 
should be exposed to the risk of future changes in accounting 
standards--in our view a majority ownership standard is generally 
consistent with consolidation under GAAP.\350\ Absent majority 
ownership, we cannot be confident that there would be an alignment of 
economic interests that is sufficient to eliminate the concerns that 
underpin dealer regulation.
---------------------------------------------------------------------------

    \350\ See FASB ASC Section 810-10-25, Consolidation--Overall--
Recognition (stating that consolidation is appropriate if a 
reporting entity has a controlling financial interest in another 
entity and a specific scope exception does not apply).
---------------------------------------------------------------------------

    In taking this approach, we have also considered alternatives 
suggested by commenters. For example, while one commenter suggested 
that we adopt a definition of ``affiliate'' as used in the securities 
laws,\351\ we believe that such an approach would be too broad for the 
purpose of this exclusion from dealing activity, given that common 
control by itself does not ensure that two entities' economic interests 
are sufficiently aligned.\352\
---------------------------------------------------------------------------

    \351\ See letter from Peabody. The commenter did not specify 
which definition of ``affiliate'' in the securities laws it was 
proposing. For example, Rule 405 of the Securities Act of 1933 
defines affiliate in terms of common control, see 17 CFR 230.405, 
and Section 20(a) of the Exchange Act takes a similar approach. The 
Investment Company Act of 1940 (``ICA'') defines affiliate to 
include entities with a common ownership interest as low as 5 
percent, ICA section 2(a)(3). Two other commenters proposed using a 
common control standard, perhaps also in reference to the Rule 405 
definition of ``affiliate.''
    \352\ The definitions of ``affiliate'' and ``control'' found in 
Rule 405 and other securities law provisions are appropriate in the 
context of the prophylactic and remedial provisions in which they 
are found. Rule 405, for example, uses the terms ``affiliate'' and 
``control'' to identify those persons that have the power to effect 
registration of an issuer's securities, and the broad definitions 
ensure that the persons with that power actually fulfill their 
obligation to do so. By comparison, the exclusion of inter-affiliate 
swaps and security-based swaps from the dealer analysis should be 
more tightly focused to address situations in which counterparties 
have similar economic interests.
     Another commenter noted the definition of ``affiliate'' found 
in certain Federal Energy Regulation Commission regulations--which 
define ``affiliate'' in terms of a ten percent or five percent 
common ownership interest. See letter from EDF Trading. Those 
relatively low ownership thresholds, however, are intended to 
address different concerns regarding collusion and cross-
subsidization, and do not appear appropriate for an interpretation 
that has the potential to reduce the counterparty and market 
protections provided by Title VII. See 18 CFR sections 35.36(a)(9), 
35.39, 366.2(b), 366.3.
---------------------------------------------------------------------------

c. Application to Cooperatives
    Similar considerations apply, in certain situations, to cooperative 
entities that enter into swaps with their members in order to allocate 
risk between the members and the cooperative. Commenters identified two 
general types of such cooperatives--``cooperative associations of 
producers'' as defined in section 1a(14) of the CEA \353\ and 
cooperative financial entities such as Farm Credit System institutions 
and Federal Home Loan Banks.\354\ As is the case for affiliated groups 
of corporate entities, we believe that when one of these cooperatives 
enters into a swap with one of its members,\355\ the swap serves to 
allocate or transfer risks within an affiliated group, rather than to 
move those risks from the group to an unaffiliated third party, so long 
as the cooperative adheres to certain risk management practices.
---------------------------------------------------------------------------

    \353\ 7 U.S.C. 1a(14). A cooperative association of producers is 
at least 75 percent owned or controlled, directly or indirectly, by 
producers of agricultural products and must comply with the Capper-
Volstead Act (referred to in the CEA as the Act of February 18, 
1922, 7 U.S.C. 291 and 292). See letters from Land O'Lakes II, NCFC 
I and NMPF.
    \354\ See letters from Farm Credit Council I and FHLB I. The NRU 
CFC qualifies as a cooperative financial entity, but we understand 
that it does not enter into a significant amount of swaps with its 
members; rather, it enters into swaps with unaffiliated third 
parties. See letter from NRU CFC I and meeting with NRU CFC on 
January 13, 2011.
    \355\ The term ``cooperative association of producers'' also 
includes any organization acting for a group of such associations 
and owned or controlled by such associations. See CEA section 
1a(14), 7 U.S.C. 1a(14). For a cooperative association of producers 
that is acting for and owned or controlled by such associations, we 
believe that this conclusion applies to any swap between such 
cooperative association of producers and any cooperative association 
of producers that is a member of it, and any producer that is a 
member of any such cooperative association of producers that is 
itself a member of the first cooperative association of producers. 
See CFTC Regulation Sec.  1.3(ggg)(6)(ii)(C).
     However, we do not believe that this conclusion applies to any 
security-based swap that a cooperative association of producers may 
enter into, nor does it apply to any swap related to a non-physical 
commodity (such as a rate swap). For this reason, the exclusion for 
cooperative associations of producers is limited to swaps that are 
primarily based on a commodity that is not an excluded commodity. 
See CFTC Regulation Sec.  1.3(ggg)(6)(ii)(A)(3). The term ``excluded 
commodity'' is defined in CEA section 1a(19), 7 U.S.C. 1a(19).
---------------------------------------------------------------------------

    Accordingly, the final rules specifically provide that the dealer 
analysis excludes swaps between a cooperative and its members, so long 
as the swaps in question are reported to the relevant SDR by the 
cooperative and are subject to policies and procedures of the 
cooperative which ensure that it monitors and manages the risk of such 
swaps.\356\ The final rules define the term ``cooperative'' to include 
cooperative associations of producers and any entity chartered under 
Federal law as a cooperative and predominantly engaged in activities 
that are financial in nature.\357\ The cooperatives covered by this 
relief are subject to provisions of Federal law providing for their 
cooperative purpose. Cooperative associations of producers have been 
recognized since the passage of the Capper-Volstead Act as being 
permitted to engage in certain cooperative activities without violating 
antitrust laws.\358\ Cooperative financial institutions such as the 
Farm Credit System institutions and Federal Home Loan Banks are 
chartered under Federal laws that limit their membership and require 
that they serve certain public purposes.\359\
---------------------------------------------------------------------------

    \356\ See CFTC Regulation Sec.  1.3(ggg)(6)(ii). To be clear, 
these cooperatives are not excluded from the dealer definitions. See 
part II.A.6, supra. Rather, swaps between a cooperative and its 
members (and swaps that a cooperative enters into to hedge or lay 
off the risk of such swaps) are excluded from the dealer analysis. 
If a cooperative were to engage in other swap activities that are 
covered by, and not otherwise excluded from, the statutory 
definition of the term ``swap dealer,'' then it would be required to 
register as a swap dealer.
    \357\ See CFTC Regulation Sec.  1.3(ggg)(6)(ii)(B).
    \358\ See Capper-Volstead Act section 1, 7 U.S.C. 291.
    \359\ See Farm Credit Act of 1971, 12 U.S.C. 2001 et seq. and 
Federal Home Loan Bank Act, 12 U.S.C. 1421 et seq.
---------------------------------------------------------------------------

    We are aware that other persons commented that their swap 
activities should be excluded from the dealer analysis because they use 
swaps in connection with a cooperative or non-profit purpose, or 
because they aggregate demand for swaps arising from numerous small 
entities.\360\ However, the key distinction drawn in granting this 
relief is that cooperatives covered by the exclusion enter into swaps 
with their members in order to allocate risk between the members and

[[Page 30626]]

the cooperative. By contrast, the other entities noted above enter into 
swaps with unaffiliated parties in order to transfer risks between 
unaffiliated parties.\361\ As noted above, the Commissions believe that 
the contemplated scope of the statutory definitions does not include 
instances where a person's swap activities transfer risk within an 
affiliated group, but does extend to activities that create legal 
relationships that transfer risk between unaffiliated parties. Thus, it 
is appropriate that the dealer analysis exclude swaps between a 
cooperative and its members, but such analysis should include swaps 
between a cooperative or other aggregator and unaffiliated persons.
---------------------------------------------------------------------------

    \360\ See letter from NFPEEU (not-for-profit power utilities, 
electric cooperatives and related persons); letters from Farmers' 
Associations, NGFA I and NMPF (referring to private companies that 
serve as aggregators for swaps in agricultural commodities or 
otherwise offer swaps for agricultural risk management); and letter 
from Northland Energy (small energy firm that aggregates demand for 
swaps from small energy retailers and consumers).
    \361\ See, e.g., letter from NFPEEU (not-for-profit power 
utilities and electric cooperatives generally enter into swaps 
between themselves, with large industrial consumers, and a wide 
range of other counterparties). Indeed, the Dodd-Frank Act permits 
the CFTC to exempt agreements, contracts or transactions between 
entities described in section 201(f) of the Federal Power Act, such 
as certain not-for-profit power utilities and electric cooperatives. 
See section 722(f) of the Dodd-Frank Act. As noted above, a 
coalition of not-for-profit power utilities and electric 
cooperatives has advised that it plans to submit a request for the 
exemption contemplated by section 722(f) of the Dodd-Frank Act. See 
note 295 supra.
---------------------------------------------------------------------------

D. De Minimis Exception

1. Proposed Approach
    The Dodd-Frank Act's definitions of ``swap dealer'' and ``security-
based swap dealer'' require that the Commissions exempt from dealer 
designation any entity ``that engages in a de minimis quantity'' of 
dealing ``in connection with transactions with or on behalf of 
customers.'' The statutory definitions further require the Commissions 
to ``promulgate regulations to establish factors with respect to the 
making of any determination to exempt.'' \362\
---------------------------------------------------------------------------

    \362\ CEA section 1a(49)(D), 7 U.S.C. 1a(49)(D); Exchange Act 
section 3(a)(71)(D), 15 U.S.C. 78c(a)(71)(D).
---------------------------------------------------------------------------

    In the Proposing Release, we preliminarily concluded that the de 
minimis exception ``should be interpreted to address amounts of dealing 
activity that are sufficiently small that they do not warrant 
registration to address concerns implicated by the regulations 
governing swap dealers and security-based swap dealers. In other words, 
the exception should apply only when an entity's dealing activity is so 
minimal that applying dealer regulations to the entity would not be 
warranted.'' \363\ In taking this view, we rejected the suggestion that 
the de minimis exception should compare a person's swap or security-
based swap dealing activities to the person's non-dealing 
activities.\364\
---------------------------------------------------------------------------

    \363\ Proposing Release, 75 FR at 80179 (footnote omitted).
    \364\ See id. at 80179-80.
---------------------------------------------------------------------------

    At the same time, we recognized that this proposed approach did not 
appear to ``readily translate into objective criteria.'' We further 
recognized that a range of alternative approaches may be reasonable, 
and we solicited comment as to what factors should be used to implement 
the exception.\365\
---------------------------------------------------------------------------

    \365\ See id. at 80180.
---------------------------------------------------------------------------

    The proposed de minimis exception was comprised of three factors, 
all of which a person would have had to satisfy to avail itself of the 
exception.\366\ The first proposed factor would have limited the 
aggregate effective amount, measured on a gross basis, of the swaps or 
security-based swaps that a person entered into over the prior 12 
months in connection with its dealing activities to $100 million \367\ 
(or $25 million with regard to counterparties that are ``special 
entities'').\368\
---------------------------------------------------------------------------

    \366\ Under the proposal, the factors would consider a person's 
swap or security-based swap dealing activity as a whole, rather than 
separately considering different types of swaps or security-based 
swaps. See Proposing Release, 75 FR at 80181.
    \367\ See proposed Exchange Act rule 3a71-2(a). The proposed 
standard reflected our understanding that in general the notional 
size of a small swap or security-based swap is $5 million or less, 
and that the proposed threshold would reflect 20 instruments of that 
size. The standard also sought to reflect the customer protection 
issues implicated by swaps and security-based swaps. See Proposing 
Release, 75 FR at 80180.
    The proposed notional threshold would not consider the market 
risk offsets associated with combining long and short positions. In 
addition, the proposed notional threshold would not account for the 
amount of collateral held or posted by the entity, or other risk 
mitigating factors. See id.
    \368\ See proposed Exchange Act rule 3a71-2(a). As set forth by 
the statutory business conduct rules applicable to security-based 
swap dealers (as set forth in Exchange Act section 15F(h)(2)(C)), 
``special entity'' refers to: Federal agencies; States, State 
agencies and political subdivisions (including cities, counties and 
municipalities); ``employee benefit plans'' as defined under the 
Employee Retirement Income Security Act of 1974 (``ERISA''); 
``governmental plans'' as defined under ERISA; and endowments. Title 
VII imposes additional business conduct requirements on security-
based swap dealers in connection with special entities. See CEA 
sections 4s(h)(2), 4s(h)(4), 4s(h)(5); Exchange Act section 
15F(h)(2), (4), (5).
---------------------------------------------------------------------------

    The second proposed factor would have limited a person's swap or 
security-based swap dealing activity to no more than 15 counterparties 
over the prior 12 months (while counting counterparties that are 
members of an affiliated group as one counterparty for these purposes). 
The final proposed factor would have limited a person's dealing 
activity to no more than 20 swaps or security-based swaps over the 
prior 12 months (without counting certain amendments as new swaps or 
security-based swaps).
2. Commenters' Views
a. Basis for the Exception
    Some commenters sought to link the de minimis exception to systemic 
risk criteria by taking the position that a person should have to 
register as a dealer only if its dealing activities pose systemic 
significance.\369\ One commenter specifically objected to the position 
in the Proposing Release that the de minimis exception should take into 
account customer protection principles.\370\ On the other hand, one 
commenter supported the rejection of a risk-based de minimis test.\371\
---------------------------------------------------------------------------

    \369\ See, e.g., letters from CDEU, MFX II, NCGA/NGSA II and 
SIFMA--Regional Dealers Derivatives Committee (``SIFMA--Regional 
Dealers'').
    \370\ See letter from WGCEF I (arguing that basing the exception 
on customer protection principles would be contrary to the statutory 
framework, given that only ECPs are eligible to participate in off-
exchange swap transactions).
    \371\ See letter from Better Markets I.
---------------------------------------------------------------------------

    Some commenters argued that the de minimis test should account for 
proportionality criteria that would excuse entities whose dealing 
activity is relatively minor compared to their other activities.\372\
---------------------------------------------------------------------------

    \372\ See, e.g., letters from FHLB I, IECA-Credit I, NCGA/NGSA 
I, NRG Energy, Peabody and WGCEF I. One commenter said the 
proportionality criteria should also consider an entity's activities 
with respect to the physical commodity underlying its swaps. See 
letter from NCGA/NGSA I. But see letter from Better Markets I 
(supporting rejection of a proportionality test). Some commenters 
suggested more than one alternative approach.
---------------------------------------------------------------------------

b. Significance of ``Customer'' Language
    One commenter took the position that the language within the de 
minimis exception that specifically referred to ``transactions with or 
on behalf of customers'' meant that the exception should be available 
only for persons who limit their swaps or security-based swaps to those 
that are entered into with or on behalf of customers.\373\ Other 
commenters posited the opposite view that the ``customer'' language 
should be read to mean that a person's dealing activities with 
counterparties other than customers may be disregarded for purposes of 
the exception (i.e., non-customer transactions would not count against 
the de minimis thresholds).\374\ Some commenters argued that

[[Page 30627]]

transactions entered into in a fiduciary capacity should be disregarded 
for purposes of the exception.\375\ One commenter questioned the 
proposal's use of the term ``counterparty'' in lieu of the statutory 
term ``customer.'' \376\
---------------------------------------------------------------------------

    \373\ See letter from Better Markets I. Another commenter said 
that the ``customer'' language serves to emphasize that the de 
minimis exception is available to entities that provide swaps to 
customers. See letter from NGFA I.
    \374\ See letters from ISDA I, Vitol and WGCEF I. Another 
commenter said that the use of the term ``customer'' indicates that 
all transactions with physical commodity customers should be 
disregarded in determining if a person is a dealer. See letter from 
EDF Trading.
    \375\ See, e.g., letter from FSR I.
    \376\ See letter from Vitol (suggesting that the proposed 
language meant that dealing activity involved ``customers'' but not 
``counterparties'').
---------------------------------------------------------------------------

c. Proposed Tests and Thresholds
    Commenters criticized the proposed de minimis thresholds in a 
variety of ways. These included arguments that the proposed thresholds 
were inappropriately low,\377\ would harm end-users by reducing the 
number of entities willing to enter into low-value swaps and security-
based swaps,\378\ would be unjustified on a cost-benefit basis,\379\ 
and were disproportionately low compared to the activities of 
recognized dealers.\380\ Other commenters said the de minimis 
thresholds should be set at a level to allow entities to engage in a 
meaningful amount of customer-facing swaps or security-based swaps 
without being required to register as dealers.\381\
---------------------------------------------------------------------------

    \377\ See, e.g., letters from API I, CDEU, DFA, EDF Trading, 
Farm Credit Council I, Growmark, Land O'Lakes dated January 13, 2011 
(``Land O'Lakes I''), Midsize Banks, NCFC I, NCGA/NGSA II, New York 
City Bar Association--Committee on Futures and Derivatives 
Regulation (``NYCBA Committee''), Northland Energy, NRG Energy, 
Regional Banks and SIFMA--Regional Dealers. Some commenters also 
said that the thresholds, particularly those for swaps, should vary 
according to the riskiness of the swap or type of commodity 
underlying the swap. See letters from BG LNG I, Farm Credit Council 
I, Gavilon II, ISDA I, NFPEEU, Vitol and WGCEF I.
    \378\ See, e.g., letters from API I, BG LNG IFarm Credit Council 
I, Midsize Banks, NCFC I, NGFA I, Regional Banks and SIFMA--Regional 
Dealers and meetings with Electric Companies on April 13, 2011, the 
Asset Management Group of SIFMA (``SIFMA--AMG'') on February 4, 2011 
and WGCEF on April 28, 2011.
    \379\ See, e.g., letters from CDEU and Vitol. Another commenter 
noted that application of a cost-benefit analysis of the de minimis 
threshold could be challenging. See Roundtable Transcript at 193-94 
(remarks of Camille Rudge, The PrivateBank and Trust Company).
    \380\ See letter from CDEU (citing statistics indicating that 
the average respondent to an ISDA survey had an annual ``event 
volume'' of over 297,000 OTC derivatives trade processing actions); 
see also letter from Regional Banks.
    \381\ See meetings with Electric Companies on April 13, 2011, 
Gavilon on May 11, 2011 and WGCEF on April 28, 2011.
---------------------------------------------------------------------------

    A number of commenters particularly criticized the proposed 
notional threshold, with some commenters suggesting that the threshold 
should be based on a percentage of the total swap market \382\ or some 
other fixed value,\383\ or arguing in favor of an exposure-based 
threshold in lieu of a notional threshold.\384\ Other commenters said 
that the aggregate notional amount of swaps is not a meaningful measure 
of an entity's dealing activity.\385\ A few commenters supported the 
proposed notional threshold.\386\
---------------------------------------------------------------------------

    \382\ See letter from COPE I (suggesting 0.001% of the total 
U.S. swap market, amounting to approximately $3 billion); see also 
letters from API dated June 3, 2011 (``API II''), EDF Trading, 
Edison Int'l, EEI/EPSA, IECA-Credit I, NCGA/NGSA II, NextEra, 
NFPEEU, Utility Group and WGCEF I (suggesting 0.001% of the total 
U.S. swap market).
    \383\ See, e.g., meeting with Land O'Lakes on January 6, 2011 
(suggesting the threshold be increased by 2 to 5 times--i.e., to 
$200 million to $500 million); letters from Growmark, FHLB I and MFX 
II (each supporting $1 billion notional standard); Regional Banks 
(supporting $2 billion notional standard); letter from NCFC dated 
October 31, 2011 (``NCFC III'') (supporting alternative notional 
standards of $1 billion or $3 billion depending on certain 
assumptions); letter from FSR VI and joint letter from Capital One, 
Fifth Third Bancorp and Regions Financial Corporation (suggesting 
notional standard of at least $2 billion); letter from WGCEF dated 
June 3, 2011 regarding the swap dealer definition (``WGCEF V'') 
(suggesting notional standard of $3.5 billion); and letter from IPR-
GDF Suez Energy North America (suggesting notional standard of $10 
billion). Some commenters suggested more than one possible 
threshold.
    \384\ See, e.g., letters from Farm Credit Council I, FSR VI and 
Midsize Banks. Other commenters said the threshold should account 
for the effect of netting. See letters from API II, Chesapeake 
Energy, Land O'Lakes I and MFX II. On the other hand, one commenter 
specifically supported the use of the gross notional amount. See 
letter from Greenberger.
    \385\ See letters from Farm Credit Council I, ISDA I, Land 
O'Lakes I, Midsize Banks, NCFC I, SIFMA--Regional Dealers and Vitol.
    \386\ See letters from AFR, Better Markets I, Greenberger and 
NMPF. One of these commenters said that data on credit default swaps 
analyzed by the SEC's Division of Risk, Strategy, and Financial 
Innovation indicates that the $100 million proposed notional 
thresholds are too high. See letters from Better Markets to CFTC and 
SEC dated April 6, 2012 (``Better Markets III'').
---------------------------------------------------------------------------

    Some commenters argued against basing the de minimis exception on 
the number of a person's swaps or security-based swaps or the number of 
a person's counterparties,\387\ or supported increasing those 
thresholds above the proposed standard.\388\ Commenters also suggested 
a variety of other alternatives to the proposed tests.\389\
---------------------------------------------------------------------------

    \387\ See, e.g., letters from API II, Atmos Energy, Chesapeake 
Energy, COPE I, EEI/EPSA, Gavilon II, IECA-Credit I, Land O'Lakes I, 
NCGA/NGSA II, NEM, NextEra I, NMPF, NRG Energy, Peabody and Utility 
Group.
    \388\ See, e.g., letters from ISDA I (suggesting 25 transactions 
over 12 months); FHLB I (suggesting 25 counterparties and 50 
transactions over 12 months) FSR I and Midsize Banks (each 
suggesting 75 counterparties and 200 transactions over 12 months); 
Regional Banks (suggesting 100 counterparties and 300 transactions 
over 12 months); Growmark and MFX II (suggesting thresholds should 
be increased by a factor of 10) and meeting with Land O'Lakes on 
January 6, 2011 (suggesting thresholds should be increased by a 
factor of between 2 and 5).
    One commenter said the number of transaction and number of 
counterparty standards should be disjunctive--i.e., a dealer's 
activity would be de minimis if it were below either standard. See 
letter from Northland Energy. Other commenters raised questions 
about how counterparties or transactions should be counted for 
purposes of the standard. See letters from CDEU (novations should 
not be counted as new transactions) and J.P. Morgan (members of an 
affiliated group should be counted as one counterparty), joint 
letter from BB&T, East West Bank, Fifth Third Bank, The PrivateBank 
and Trust Company, Regions Bank, Sun Trust Bank, U.S. Bank National 
Association and Wells Fargo Bank, N.A. (``Midmarket Banks'') 
(questioning how to count multiple borrower counterparties to a loan 
and swap) and meeting with Land O'Lakes on January 6, 2011 (members 
of a cooperative should be counted as one counterparty).
    Last, some commenters said that the number of transaction or 
number of counterparty standards should be deleted because they are 
not useful as tests of de minimis status. See letters from Gavilon 
II (eliminate both standards) and SIFMA--Regional Dealers (eliminate 
number of counterparties standard).
    \389\ See letters from IECA-Credit I (suggesting that exception 
exclude persons whose positions either are below a notional 
threshold or are below a combined proportionality and revenue 
threshold), SIFMA--Regional Dealers (supporting annual threshold of 
500 customer-facing or riskless principal swaps, consistent with the 
de minimis exception from the Exchange Act ``broker'' definition in 
connection with bank brokerage activity, as well as SEC rules in 
connection with the Exchange Act definition of ``dealer''), FHLB I 
(supporting non-quantitative test accounting for relatively small 
swap-related exposure compared to primary customer activity, 
collateral that also provides credit support for other business done 
with the customer, an existing relationship with customer and 
inability of customer to obtain swaps from entities that primarily 
are dealers), Gavilon II (alluding to use of non-quantitative 
tests), MFX II (suggesting establishment of a separate qualitative 
process by which a dealer may establish why registration is not 
warranted) and DC Energy (thresholds should be set at a level 
appropriate to support the capital levels to be required for swap 
dealers).
---------------------------------------------------------------------------

d. Additional Issues
    Some commenters emphasized the need to provide protections in 
connection with ``special entities.'' \390\ Certain commenters sought 
to identify problems related to the application of the proposed 
thresholds in connection with particular types of businesses or 
markets,\391\ or to aggregators or

[[Page 30628]]

cooperatives.\392\ Other commenters suggested that the exception should 
focus dealer regulation toward ``financial'' entities.\393\ One 
commenter emphasized the need for the exception to be available when 
the end-user is a credit union, bank or thrift.\394\
---------------------------------------------------------------------------

    \390\ See letters from Better Markets I (arguing that the de 
minimis exception should not be available in connection with 
transactions with special entities), AFR (similar), Greenberger 
(supporting reduction of the notional threshold for transactions 
with special entities to $5 million) and AFSCME. Some commenters 
said the standard for swaps and security-based swaps with special 
entities should be a notional value equal to 0.0001% of the total 
U.S. swap market. See letters from COPE I, EDF Trading, EEI/EPSA, 
IECA-Credit I, NFPEEU and Utility Group. One commenter said the 
threshold for special entities should be eliminated because it is 
not useful in determining de minimis status. See letter from Gavilon 
II.
    \391\ See letters from BG LNG I (small energy companies), COPE I 
and Northland Energy (each discussing commodity markets, suggesting 
that notional thresholds be based on the unit of a commodity), NCFC 
I (commodity prices), NGFA I (grain elevators) and WGCEF I (energy 
prices).
    \392\ See, e.g., letters from Growmark and Land O'Lakes I.
    \393\ See letters from NEM, NextEra I, and NGFA I.
    \394\ See letter from CUNA.
---------------------------------------------------------------------------

    Commenters sought clarification that the de minimis criteria would 
not apply to transactions for hedging or proprietary trading 
purposes,\395\ or to inter-affiliate transactions.\396\
---------------------------------------------------------------------------

    \395\ See, e.g., letters from API I, EDF Trading, Gavilon II and 
SIFMA--Regional Dealers.
    \396\ See, e.g., letter from Atmos Energy Holdings, Inc (``Atmos 
Holdings'').
---------------------------------------------------------------------------

    Commenters also raised issues related to the exception's treatment 
of the proposed use of a rolling annual period for calculations,\397\ 
the proposed use of ``effective notional amounts,'' \398\ the 
possibility of adjusting the thresholds over time,\399\ how the de 
minimis tests would apply in the context of affiliated positions,\400\ 
and how the exception would account for swaps or security-based swaps 
entered into before the definition's effective date.\401\
---------------------------------------------------------------------------

    \397\ See letters from NCGA/NGSA I (supporting measurement of 
rolling period average over 12 months), NextEra I (supporting 
evaluation as of the last day of each calendar quarter rather than 
over the immediate preceding 12 months) and Northland Energy 
(requesting clarification that if a monetary notional amount is 
used, the evaluation periods should be fixed rather than rolling).
    \398\ See letters from ISDA I (stating that the use of 
``effective notional amount'' in the test introduces ambiguity and 
uncertainty) and WGCEF I (notional amounts should be measured on a 
``delta-equivalent'' basis).
    \399\ See letters from Farm Credit Council I (supporting 
automatic periodic increases to reflect changes in market size, the 
size of typical contracts and inflation), Greenberger (supporting 
reevaluation of the de minimis criteria on an ongoing basis), and BG 
LNG I, EEI/EPSA, NCFC I and WGCEF I (each supporting inflation or 
market size adjustments).
    \400\ See meeting with Edison Int'l (requesting clarification 
that an entity that is prohibited from coordinating its financial 
derivatives activities should determine whether it qualifies for the 
de minimis exception without considering financial derivatives 
entered into by its affiliated entities).
    \401\ See letter from Covington & Burling (urging clarification 
that lookback period will not commence until all the relevant 
regulations become effective).
---------------------------------------------------------------------------

    Some commenters suggested that the de minimis thresholds be set 
higher initially to provide for efficient use of regulatory 
resources.\402\ One commenter requested clarification that the 
exception would apply prospectively without regard to dealing 
activities taken prior to the effectiveness of Title VII.\403\ One 
commenter requested that a person that falls above the de minimis tests 
be able to take advantage of application and re-evaluation periods akin 
to those associated with the major participant definitions.\404\
---------------------------------------------------------------------------

    \402\ See letters from BGLNG I and WGCEF V. See also Roundtable 
Transcript at 50-51 (remarks of Ron Oppenheimer, WGCEF), 57 (remarks 
of Richard Ostrander, Morgan Stanley) and 208-09 (remarks of Bella 
Sanevich, NISA Investment Advisors).
    \403\ See letter from FSR I.
    \404\ See letter from WGCEF I; see also Northland Energy 
(supporting grace period for registration if the de minimis 
threshold is exceeded).
---------------------------------------------------------------------------

    Two commenters expressed support for the proposed self-executing 
approach of the exception.\405\ Some commenters requested clarification 
that the de minimis exception is independent of the loan origination 
exclusion in the CEA ``swap dealer'' definition.\406\
---------------------------------------------------------------------------

    \405\ See letters from ISDA I and Northland Energy.
    \406\ See letters from FSR VI and Midsize Banks.
---------------------------------------------------------------------------

    A number of commenters also addressed the application of dealer 
regulation to non-U.S. entities. While those comments did not 
specifically address the de minimis exception, the exception may be 
relevant to addressing these cross-border issues.\407\
---------------------------------------------------------------------------

    \407\ Some commenters particularly took the view that the 
application of the dealer definitions to non-U.S. persons should 
solely address those persons' U.S. dealing activities. See letters 
from FSR I, ISDA I and Soci[eacute]t[eacute] G[eacute]n[eacute]rale. 
Some commenters also specifically identified concerns of 
international comity in this context. See letters cited in note 148, 
supra.
     The Commissions intend to address the application of dealer 
regulation to non-U.S. persons as part of separate releases that 
generally will address the application of Title VII to non-U.S. 
persons.
---------------------------------------------------------------------------

    One commenter separately addressed the credit default swap data 
analysis made available by CFTC and SEC staffs.\408\ The commenter 
expressed the view that this data supported the adoption of a de 
minimis threshold of $100 million or less, particularly focusing on the 
number of entities that may be excluded under particular 
thresholds.\409\
---------------------------------------------------------------------------

    \408\ See letter from Better Markets III.
    \409\ See id.
---------------------------------------------------------------------------

3. Final Rules--General Principles for Implementing the De Minimis 
Exception
a. Balancing Regulatory Goals and Burdens
    The Commissions recognize that implementing the de minimis 
exception requires a careful balancing that considers the regulatory 
interests that could be undermined by an unduly broad exception as well 
as those regulatory interests that may be promoted by an appropriately 
limited exception.
    On the one hand, a de minimis exception, by its nature, will 
eliminate key counterparty protections provided by Title VII for 
particular users of swaps and security-based swaps.\410\ The broader 
the exception, the greater the loss of protection.\411\ Moreover, in 
determining the scope of the exception, it is important to consider not 
only the current state of the swap and security-based swap markets, but 
also to account for how those markets may evolve in the future. This is 
particularly important because the full implementation of Title VII--
including enhancements to pricing transparency and the increased access 
to central clearing--reasonably may be expected to facilitate new 
entrants into the swap and security-based swap markets. To the extent 
that such entrants engage in dealing activity below the de minimis 
threshold--either for the long term or until their activity surpasses 
the threshold--the relative amount of unregistered activity within the 
market may be expected to increase. Accordingly, a higher de minimis 
threshold may not only result in a certain percentage of unregistered 
activity being transacted initially, consistent with the current 
market, but also may result in an even greater proportion of 
unregistered activity being transacted in the future.
---------------------------------------------------------------------------

    \410\ A number of commenters expressed particular concerns as to 
the threats that an overbroad exception would pose to special 
entities. See letters from AFR (noting that Congress incorporated 
special protections for special entities in reaction to news reports 
about special entities losing millions of dollars ``after signing up 
for derivatives deals they did not understand,'' and urging the 
elimination of any de minimis exception for transactions with 
special entities); Better Markets I (stating that history has shown 
that special entities are vulnerable to abuse, and that they need 
capital, collateral and business conduct protections as much as or 
more than any other category of market participants); and AFSCME 
(expressing skepticism as to the view that dealer status would 
preclude firms from entering into transactions with special 
entities). Some of those commenters also generally supported the 
proposed $100 million de minimis threshold. See letters from AFR and 
Better Markets I; see also letter from Greenberger (stating that the 
dynamic nature of the derivatives sector of the financial markets 
should counsel caution, and that the de minimis threshold should be 
reevaluated on an ongoing basis).
    \411\ Notwithstanding the reduction in protection, however, in 
the case of swaps and security-based swaps the general antifraud 
provisions of the CEA and the securities laws, respectively, 
including rules to be adopted by the SEC pertaining specifically to 
security-based swaps, will continue to apply to all transactions in 
security-based swaps. See, e.g., CEA section 4b(2), 7 U.S.C. 6b(2).
---------------------------------------------------------------------------

    On the other hand, the Commissions also recognize that Congress 
included a statutorily mandated de minimis exception for certain swap 
and security-based swap dealing activity, and that an appropriately 
calibrated de minimis exception has the potential to advance other 
interests. For example, the de minimis exception may further the 
interest of regulatory efficiency when

[[Page 30629]]

the amount of a person's dealing activity is, in the context of the 
relevant market, limited to an amount that does not warrant 
registration to address the concerns implicated by government 
regulation of swap dealers and security-based swap dealers. To advance 
this interest, it is necessary to consider the benefits to the 
marketplace associated with the regulation of dealers against the total 
burdens and potential impacts on competition, capital formation and 
efficiency associated with that regulation.\412\
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    \412\ While we are mindful that the Commissions have yet to 
adopt all the final substantive rules applicable to swap dealers and 
security-based swap dealers, we nonetheless believe that we have 
sufficient understanding of those potential requirements to 
reasonably balance the relevant factors to identify the initial 
level of dealing activity that should be considered to be de 
minimis. Moreover, finalizing the dealer definitions will help 
provide for the orderly and informed finalization of those other 
substantive rules governing swap dealers and security-based swap 
dealers.
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    In addition, the exception can provide an objective test for 
persons who engage in some swap or security-based swap activities that, 
in their view, potentially raise the risk that they would be deemed to 
be dealers.\413\ The exception also may permit persons that are not 
registered as dealers to accommodate existing clients that have a need 
for swaps or security-based swaps in conjunction with other financial 
services or commercial activities, thus avoiding the need for such 
clients to establish separate relationships with registered dealers, 
which may have attendant costs. The exception further may promote 
competition in dealing activity within the swap or security-based swap 
markets, by helping to allow non-registered persons to commence 
providing dealing services while avoiding the costs associated with 
full-fledged dealers. More competition within the market for swaps and 
security-based swaps may not only decrease the costs for participants 
in the market, but also may help to decrease systemic risk by lessening 
the current apparent concentration of dealing activity among a few 
major market participants.\414\
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    \413\ ``Congress incorporated a de minimis exception to the Swap 
Dealer definition to ensure that smaller institutions that are 
responsibly managing their commercial risk are not inadvertently 
pulled into additional regulation.'' See 156 Cong. Rec. S6192 (daily 
ed. July 22, 2010) (letter from Senators Dodd and Lincoln to 
Representatives Frank and Peterson).
    \414\ See 478 through 487 and accompanying text, infra.
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    The statutory requirements that apply to swap dealers and security-
based swap dealers include requirements aimed at the protection of 
customers and counterparties,\415\ as discussed above, as well as 
requirements aimed at helping to promote effective operation and 
transparency of the swap and security-based swap markets.\416\ The 
overall economic benefits provided by these requirements in large part 
will depend on the proportion of swaps and security-based swaps that 
are transacted subject to these requirements. In other words, the 
greater the dealing activity of a registered dealer, the more 
significant the resulting increase in market efficiency,\417\ and the 
greater the reduction in risks faced by the entity's customers and 
counterparties.\418\ These benefits can be expected to accrue over the 
long term and be distributed over the market and its participants as a 
whole. This is not to say, however, that it would be insignificant for 
any particular counterparty if its swaps or security-based swaps were 
to fall outside of the ambit of dealer regulation. For example, a 
customer or counterparty that is not protected by the business conduct 
rules applicable to dealers might be more likely to suffer losses 
associated with entering into an inappropriate or misunderstood swap or 
security-based swap than if the instrument was transacted pursuant to 
the business conduct rules applicable to registered dealers.
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    \415\ As discussed above, in part, these customer and 
counterparty protections derive from the financial responsibility 
requirements applicable to dealers, particularly: capital and margin 
requirements (CEA section 4s(e); Exchange Act section 15F(e)), and 
requirements for segregation of collateral (CEA sections 4d(f), 
4s(l); Exchange Act section 3E).
    These customer and counterparty protections also derive from 
certain other requirements applicable to dealers, particularly: 
requirements with respect to business conduct when transacting with 
special entities (CEA sections 4s(h)(2), 4s(h)(4), 4s(h)(5); 
Exchange Act sections 15F(h)(2), (h)(4), (h)(5)); disclosure 
requirements (CEA section 4s(h)(3)(B); Exchange Act section 
15F(h)(3)(B)); requirements for fair and balanced communications 
(CEA section 4s(h)(3)(D); Exchange Act section 15F(h)(3)(C)); other 
requirements related to the public interest and investor protection 
(CEA section 4s(h)(3)(D); Exchange Act section 15F(h)(3)(D)); and 
conflict of interest provisions (CEA section 4s(j)(5); Exchange Act 
section 15F(j)(5)).
    \416\ Relevant provisions are: reporting and recordkeeping 
requirements (CEA section 4s(f); Exchange Act section 15F(f)); daily 
trading records requirements (CEA section 4s(g); Exchange Act 
section 15F(g)); regulatory standards related to the confirmation, 
processing, netting, documentation and valuation of security-based 
swaps (CEA section 4s(i); Exchange Act section 15F(i)); position 
limit monitoring requirements (CEA section 4s(j)(1); Exchange Act 
section 15F(j)(1)); risk management procedure requirements (CEA 
section 4s(j)(2); Exchange Act section 15F(j)(2)); and requirements 
related to the disclosure of information to regulators (CEA section 
4s(j)(3); Exchange Act section 15F(j)(3)).
    \417\ For example, the more swaps or security-based swaps a 
dealer enters into, the more significant will be the efficiency 
benefits associated with confirmation, processing, netting 
documentation and valuation requirements applicable to dealers.
    \418\ For example, the more swaps or security-based swaps a 
dealer enters into, the more significant the number of 
counterparties that will be protected by the disclosure and other 
business conduct obligations imposed on dealers.
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    In contrast to the benefits associated with dealer regulation, many 
of the burdens of dealer regulation will accrue in the short term and 
will fall directly on registered dealers.\419\ Some of those burdens 
may be expected to be independent of the amount of an entity's dealing 
activity (i.e., entities that engage in minimal dealing activity would 
still be expected to face certain burdens associated with the 
registration process and the development of compliance and other 
systems if they are required to register as dealers), while other 
burdens (e.g., the impact of margin and capital rules applicable to 
dealers) may be more directly linked to the amount of that entity's 
dealing activity.
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    \419\ Certain commenters also have expressed concerns that the 
prospect of regulation may deter certain entities from engaging in 
limited swap or security-based swap dealing activities, see, e.g., 
letters from SIFMA--Regional Dealers and Midsize Banks, which could 
reduce the availability of those instruments.
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    As discussed below, the Commissions have sought to balance the 
various interests associated with a de minimis exception, as well as 
the benefits and burdens associated with such an exception, in 
developing the factors to implement the de minimis exceptions to the 
``swap dealer'' and ``security-based swap dealer'' definitions.
    However, in moving forward with implementing this balancing 
approach, we recognize that the information that currently is available 
regarding certain portions of the swap market is limited. Following the 
full implementation of Title VII, more information will be available to 
permit us to assess the effectiveness of this balancing for particular 
markets and to revise the exception as appropriate.
    In that context--and in light of the tools currently available to 
us--we have been influenced, in particular, by comments taking the view 
that the de minimis factors should take into account the size and 
unique attributes of the market for swaps and security-based 
swaps.\420\ We believe that factors that exclude entities whose dealing 
activity is sufficiently modest in light of the total size, 
concentration and other attributes of the applicable markets can be 
useful in avoiding the imposition of

[[Page 30630]]

regulatory burdens on those entities for which dealer regulation would 
not be expected to contribute significantly to advancing the customer 
protection, market efficiency and transparency objectives of dealer 
regulation. The Commissions note, however, that they are not of the 
general view that the costs of extending regulation to any particular 
entity must be outweighed by the quantifiable or other benefits to be 
achieved with respect to that particular entity. The Commissions, 
rather, analyze the overall benefits and costs of regulation, keeping 
in mind, as noted above, that the benefits may be distributed, accrue 
over the long-term, and be difficult to quantify or to measure as 
easily as certain costs.\421\
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    \420\ See, e.g., letters from CDEU (comparing proposed 
thresholds with statistics regarding the activities of recognized 
dealers) and EEI/EPSA (recommending that thresholds be set at an 
amount equal to 0.001 percent of the aggregate size of the U.S. 
swaps market, and 0.0001 percent for swaps in which the counterparty 
is a special entity).
    \421\ For example, it does not appear possible to demonstrate 
empirically--let alone quantify--the increase or decrease in the 
possibility that a financial crisis would occur at a particular 
future time and with a particular intensity in the absence of 
financial regulation or as a result of varying levels or types of 
financial regulation. It also is difficult to demonstrate 
empirically that the customer protections associated with dealer 
regulation would increase or decrease the likelihood that any 
particular market participant would suffer injury (or the degree to 
which the participant would suffer injury) associated with entering 
into an inappropriate swap or security-based swap. At the same time, 
certain costs may also not be readily susceptible to quantification 
or measurement, for example, the costs that might be associated with 
diminished presence, if any, of new entrants. The inability to 
quantify these benefits and costs does not mean that the benefits 
and costs of dealer regulation are any less substantial.
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b. Specific Factors Implementing the De Minimis Exception
i. Notional Test
    Consistent with the proposal, the final rules implementing the de 
minimis exception take into account the notional amount of an entity's 
swap or security-based swap positions over the prior 12 months arising 
from its dealing activity.\422\ While the Commissions recognize that 
notional amounts do not directly measure the exposure or risk 
associated with a swap or security-based swap position, such measures 
do reflect the relative amount of an entity's dealing activity.\423\ 
Moreover, although some commenters have posited measures of risk or 
exposure as alternatives to notional measures, such risk or exposure 
measures could, to the extent they allow for netting or collateral 
offsets, potentially allow an unregistered entity to engage in large 
amounts of swap or security-based swap dealing activity while remaining 
within the de minimis exception so long as that entity nets or 
collateralizes its swap or security-based swap positions. Such an 
outcome could undermine the customer protection and market operation 
benefits associated with dealer regulation. As with the proposed rules, 
the notional factor in the final rules is based on the notional 
positions of an entity over a 12 month period, rather than capping the 
current notional amount of a position at any time, to better reflect 
the amount of an entity's current activity.
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    \422\ See CFTC Regulation Sec.  1.3(ggg)(4); Exchange Act rule 
3a71-2(a)(1). Over the first year following the effective date of 
the final rules implementing the statutory definition of ``swap'' 
and ``security-based swap'' as set forth in CEA section 1a(47) and 
Exchange Act section 3(a)(68), respectively, this notional test will 
be based on the person's dealing activity following that effective 
date. See id. Accordingly, the analysis of whether a person may take 
advantage of the de minimis exception will not encompass the 
person's dealing activity prior to that effective date, given the 
need for the person to know whether an instrument is a swap or 
security-based swap for purposes of the analysis.
    \423\ ``Changes in notional volumes are generally reasonable 
reflections of business activity, and therefore can provide insight 
into potential revenue and operational issues. However, the notional 
amount of derivatives contracts does not provide a useful measure of 
either market or credit risks.'' OCC Quarterly Report at 8.
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    The final rules, like the proposed rules, include lower notional 
thresholds for dealing activities in which the counterparty is a 
``special entity.'' \424\ This is consistent with the fact that Title 
VII's requirements applicable to swap dealers and security-based swap 
dealers provide heightened protection to those types of entities.\425\ 
It is important that the de minimis exception not undermine those 
statutory protections.\426\ Also, consistent with the Proposing 
Release, these notional standards will be based on ``effective 
notional'' amounts when the stated notional amount is leveraged or 
enhanced by the structure of the swap or security-based swap.\427\
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    \424\ For these purposes, ``special entity'' means: (i) A 
Federal agency; (ii) a state, state agency, city, county, 
municipality, or other political subdivision of a state; (iii) any 
employee benefit plan, as defined in section 3 of the Employee 
Retirement Income Security Act of 1974 (``ERISA''); (iv) any 
governmental plan, as defined in section 3 of ERISA; or (v) any 
endowment, including an endowment that is an organization described 
in section 501(c)(3) of the Internal Revenue Code of 1986. See CEA 
section 4s(h)(2)(C) and CFTC Regulation Sec.  23.401(c); Exchange 
Act section 15F(h)(2)(C).
    \425\ See CEA sections 4s(h)(2), (4), (5); see also CFTC, 
Business Conduct Standards for Swap Dealers and Major Swap 
Participants with Counterparties; Final Rule, 77 FR 9733 (Feb. 17, 
2012); Exchange Act sections 15F(h)(2), (4), (5) (providing 
additional requirements for dealers that advise special entities or 
that enter into swaps or security-based swaps with special 
entities).
    \426\ The importance of the statutory protections for special 
entities has been highlighted by the SEC's recent action in 
connection with the inappropriate sale of notes linked to the 
performance of synthetic collateralized debt obligations to a number 
of school districts. According to a complaint filed in federal 
district court, these securities were unsuitable for the investment 
needs of the school districts, were sold to school districts that 
lacked the requisite sophistication and experience to independently 
evaluate the risks of the investment, and exposed the school 
districts to a heightened risk of catastrophic loss ultimately led 
to a complete loss of their investments. ``SEC Charges Stifel, 
Nicolaus and Former Executive with Fraud in Sale of Investments to 
Wisconsin School Districts,'' SEC Litigation Release No. 22064 (Aug. 
10, 2011) (http://www.sec.gov/litigation/litreleases/2011/lr22064.htm).
    \427\ For example, if an exchange of payments associated with a 
$1 million notional equity swap was based on three times the return 
associated with the underlying equity, the effective notional amount 
of the equity swap would be $3 million.
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ii. Other Tests From the Proposing Release
    The proposed rules limited the number of swaps or security-based 
swaps that an entity could enter into in a dealing capacity, and the 
number of an entity's counterparties in a dealing capacity. The final 
rules do not include those measures. In part, this reflects commenter 
concerns that a standard based on the number of swaps or security-based 
swaps or counterparties can produce arbitrary results by giving 
disproportionate weight to a series of smaller transactions or 
counterparties.\428\
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    \428\ See, e.g., letter from COPE I.
---------------------------------------------------------------------------

c. Significance of Statutory ``Customer'' Language
    Consistent with the Proposing Release, the final rules implementing 
the de minimis exception do not require the presence of any type of 
defined ``customer'' relationship.
    In adopting these rules the Commissions have considered alternative 
approaches suggested by commenters, including one commenter's 
suggestion that the de minimis exception should be available only in 
connection with swaps or security-based swaps entered into as part of a 
``customer'' relationship.\429\ In considering that alternative view, 
however, we believe that it is significant that the statutory exception 
lacks terminology such as ``existing'' or ``preexisting'' that limits 
the availability of the exception or otherwise to distinguishes a 
``customer'' relationship from other types of counterparty 
relationship. Also, while that alternative view could still permit an 
unregistered person to provide limited dealer services as an 
accommodation to an existing customer or counterparty, an 
interpretation that predicates the exception on the presence of a 
particular type of ``customer'' relationship would not advance other 
potential benefits associated with a de minimis exception, including 
the

[[Page 30631]]

benefit of providing certainty in connection with the swap or security-
based swap activities of end-users.\430\ Accordingly, we do not believe 
that the ``customer'' reference standing alone provides a sufficient 
basis to conclude that the exception should only be available if there 
is an existing relationship of some type, and the final rules neither 
require that a dealer accommodate the demand of an existing customer 
nor require the presence of a preexisting relationship for the 
exception to apply.
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    \429\ See letter from Better Markets I.
    \430\ As discussed above, see note 413, supra, there is 
legislative history that suggests that an intended purpose of the 
exception would be to ensure that the dealer definition does not 
encompass ``smaller institutions that are responsibly managing their 
commercial risk.''
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    We also are not persuaded by the different commenter suggestion 
that the statutory de minimis exception's ``customer'' language means 
that an unregistered dealer should be permitted to engage in unlimited 
dealing activity so long as its counterparties are not customers.\431\ 
Such an unlimited exception would appear to be contrary to the express 
language of the statutory exception. In addition, such an approach 
would lead to the perverse result of discouraging entities from 
entering into swaps or security-based swaps to facilitate risk 
management activities of customers (while encouraging other dealing 
activities), which appears contrary to Title VII's general approach of 
seeking to limit undue impacts on the swap and security-based swap 
activities of commercial end-users.
---------------------------------------------------------------------------

    \431\ See, e.g., letter from ISDA I.
---------------------------------------------------------------------------

d. Focus on ``Dealing'' Activity
    Some commenters suggested that we clarify that the limitations 
associated with the de minimis exception apply only in connection with 
a person's dealing activities, and not to the person's hedging or 
proprietary trading activities.\432\ The Commissions agree that the de 
minimis exception is intended to permit an unregistered person to 
engage in a limited amount of dealing activity without regard to the 
person's non-dealing activity. Thus, to the extent that a particular 
swap or security-based swap position is not connected to dealing 
activity under the applicable interpretation of the statutory dealer 
definition, it will not count against the de minimis thresholds. 
Conversely, if a swap or security-based swap position is connected to 
the person's dealing activity, the position will count against those 
thresholds.\433\
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    \432\ See, e.g., letters from SIFMA--Regional Dealers and EDF 
Trading.
    \433\ For purposes of the de minimis exception to the security-
based swap dealer definition, we note that one indicator of dealing 
activity under the dealer-trader distinction is that a person profit 
by providing liquidity in connection with security-based swaps. 
Accordingly, for purposes of the de minimis exception to the 
security-based swap dealer definition, a security-based swap 
position that hedges or otherwise offsets a position that was 
entered into as part of dealing activity would itself comprise part 
of the person's dealing activity, and hence count against the de 
minimis thresholds.
     For purposes of the de minimis exception to the swap dealer 
definition, we take the view that the relevant question in 
determining whether swaps count as dealing activity against the de 
minimis thresholds is whether the swaps fall within the swap dealer 
definition under the statute and the final rules, as further 
interpreted by this Adopting Release. If hedging or proprietary 
trading activities did not fall within the definition, including 
because of the application of CFTC Regulation Sec.  1.3(ggg)(6), 
they would not count against the de minimis thresholds.
---------------------------------------------------------------------------

    Commenters also requested clarification that the de minimis 
thresholds do not apply to a person's inter-affiliate swaps and 
security-based swaps, nor apply to swaps covered by the exclusion for 
swaps entered into by insured depository institutions in connection 
with the origination of loans to customers.\434\ Consistent with the 
discussion above,\435\ such swaps or security-based swaps do not 
constitute dealing activity and should not be counted against the de 
minimis thresholds. Similarly, swaps between a cooperative and its 
members, as provided in CFTC Regulation Sec.  1.3(ggg)(6)(ii), and 
swaps entered into for the hedging purpose defined in CFTC Regulation 
Sec.  1.3(ggg)(6)(iii) should not be counted against the de minimis 
threshold.\436\
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    \434\ See, e.g., letters from Atmos Holdings and FSR I.
    \435\ See parts II.B and II.C, supra.
    \436\ Swaps and security-based swaps that hedge, mitigate, or 
offset the types of swaps and security-based swaps discussed in the 
foregoing paragraph, which do not constitute dealing activity, 
similarly should not be counted against the de minimis thresholds.
---------------------------------------------------------------------------

    In light of the increased notional thresholds of the final rules, 
and the resulting opportunity for a person to evasively engage in large 
amounts of dealing activity if it can multiply those thresholds, the 
final rules provide that the notional thresholds to the de minimis 
exception encompass swap and security-based swap dealing positions 
entered into by an affiliate controlling, controlled by or under common 
control with the person at issue.\437\ This is necessary to prevent 
persons from avoiding dealer regulation by dividing up dealing activity 
in excess of the notional thresholds among multiple affiliates.\438\
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    \437\ See CFTC Regulation Sec.  1.3(ggg)(4)(i); Exchange Act 
rule 3a71-2(a)(1). For these purposes, we interpret control to mean 
the possession, direct or indirect, of the power to direct or cause 
the direction of the management and policies of a person, whether 
through the ownership of voting securities, by contract or 
otherwise. This is consistent with the definition of ``control'' and 
``affiliate'' in connection with Exchange Act rules regarding 
registration statements. See Exchange Act rule 12b-2.
     The final rules use a control standard in connection with the 
de minimis notional thresholds as a means reasonably designed to 
prevent evasion of the limitations of that exception. This contrasts 
with the majority-ownership standard used by the inter-affiliate 
exclusions from the dealer and major participant definitions. See 
parts II.C.2 and IV.G.2, infra. That majority-ownership standard, 
which in application will not be expected to be satisfied in all 
circumstances in which a control standard is satisfied, is 
reasonably designed to reflect the economic alignment that 
appropriately underpins those exclusions.
    \438\ In other words, for example, if a parent entity controls 
two subsidiaries which both engage in activities that would cause 
the subsidiaries to be covered by the dealer definitions, then each 
subsidiary must aggregate the swaps or security-based swaps that 
result from both subsidiaries' dealing activities in determining if 
either subsidiary qualifies for the de minimis exception.
    The SEC expects to address the application of this principle to 
the security-based swap activities of non-U.S. persons in a separate 
release.
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e. Alternative Approaches We Are Not Following
    Certain commenters have suggested alternative approaches to 
implementing the de minimis exception. While the Commissions have 
considered those suggested alternatives, we do not believe that they 
provide the optimal framework for implementing the exception.
    For example, some commenters took the position that the de minimis 
exception should focus dealer regulation on those entities whose 
dealing activities pose systemic risk, and excuse other dealers from 
having to register.\439\ Such an approach, however, would fail to 
account for regulatory interests apart from the control of systemic 
risk that are addressed by dealer regulation, including statutory 
provisions that protect customers and counterparties in other ways, and 
that promote effective market operations and transparency.\440\
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    \439\ See, e.g., letters from CDEU and SIFMA--Regional Dealers.
    \440\ We also disagree with the suggestion that it would be 
inconsistent with the Title VII framework to consider customer 
protection issues in setting the de minimis factors. See letter from 
WGCEF I. While the restrictions on the availability of swaps and 
security-based swaps to non-ECPs help to mitigate certain customer 
protection concerns, Title VII includes specific safeguards designed 
to protect dealers' customers and counterparties regardless of 
whether those are ECPs. It would not be consistent with Title VII to 
ignore those interests.
---------------------------------------------------------------------------

    Some commenters also have suggested that the de minimis exception 
should subsume a proportionality

[[Page 30632]]

standard, whereby an entity may be excluded from dealer regulation if 
its dealing activity comprises only a relatively small portion of its 
overall activities (or its overall swap or security-based swap 
activities), or if its dealing activity is ``tangential'' to its 
principal business.\441\ We are not incorporating that type of approach 
into the de minimis factors, however, because that approach would not 
appear to provide a logical way to balance the benefits and burdens of 
dealer regulation. A proportionality approach could permit a large 
entity to engage in a significant amount of dealing activity without 
being subject to dealer regulation, thus undermining the benefits of 
dealer regulation. Moreover, a proportionality approach could lead to 
arbitrary results by excusing a large entity from dealer regulation 
while requiring the registration of a smaller entity that engages in 
less total dealing activity (if that smaller amount of dealing activity 
comprises a greater portion of the smaller entity's total 
activity).\442\
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    \441\ See letter from FHLB I.
    \442\ As discussed below, if an entity is a dealer, the 
regulations applicable to dealers in general will govern all of the 
entity's swap or security-based swap activities and positions. 
Depending on the applicable facts and circumstances, however, the 
entity may be able to avail itself of a limited purpose designation 
as a dealer. See part II.E, infra.
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    Some commenters also supported the use of non-quantitative 
standards in connection with the de minimis exception.\443\ Although we 
recognize that such an approach may help us weigh the facts and 
circumstances associated with a particular person's dealing activity, 
we believe that it is more appropriate to base the exception on an 
objective quantitative standard, to allow the exception to be self-
executing, and to promote predictability among market participants and 
the efficient use of regulatory resources. Unlike the overall 
definitions of ``swap dealer'' and ``security-based swap dealers,'' 
which consider the entirety of a person's activities with respect to 
swaps, the de minimis exception is only relevant to persons who have 
determined that they are engaged in swap or security-based swap 
dealing, and are looking to determine whether the quantity of their 
dealing activity is de minimis. For this more particular and focused 
determination, an objective quantitative standard is more appropriate.
---------------------------------------------------------------------------

    \443\ See letters from FHLB I, Gavilon II, and MFX II.
---------------------------------------------------------------------------

    Commenters also made various suggestions as to the types of factors 
and accompanying thresholds that should be used in connection with the 
de minimis exception. Those suggestions are addressed more specifically 
below in the specific context of the swap dealer and security-based 
swap dealer de minimis exceptions.
4. Final Rules--De Minimis Exception to Swap Dealer Definition
a. Overview of the Final Rule
    After considering commenters' views, the final rule implementing 
the de minimis exception caps an entity's dealing activity involving 
swaps at $3 billion over the prior 12 months.\444\ This amount is based 
on input from commenters and is supported by several rationales, 
including the estimated size of the domestic swap market, among others.
---------------------------------------------------------------------------

    \444\ CFTC Regulation Sec.  1.3(ggg)(4). As noted above, for the 
first year following the effective date of the rules implementing 
the definition of ``swap'' the analysis would only address activity 
following that effective date. For clarity, the final rule also has 
been revised from the proposal to provide that persons taking 
advantage of the exception ``shall be deemed not to be'' swap 
dealers (the proposed rule used the phrasing ``shall not be deemed 
to be'' swap dealers) The final rule also reflects certain 
structural changes consistent with the substantive changes from the 
proposed rule. In addition, as discussed above, see part II.D.3.d, 
supra, the final rule has been revised to provide that the notional 
thresholds to the de minimis exception encompass swap dealing 
positions entered into by an affiliate controlling, controlled by or 
under common control with the person at issue.
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    As noted above, commenters who suggested a fixed notional standard 
proposed that the standard be set at a level between $200 million and 
$3.5 billion in notional amount of swaps entered into over a period of 
twelve months.\445\ In considering these comments, we are mindful of 
the variety of uses of swaps in various markets and therefore it is 
understandable that various commenters would reach different 
conclusions regarding the appropriate standard. At the same time, we 
see value in setting a single standard for all swaps so that there is a 
``level playing field'' for all market participants and so that the 
standard can be implemented easily without the need to categorize 
swaps. Considering the written input of the commenters as well as the 
discussions of the de minimis standard at the Commissions' joint 
roundtable and numerous meetings with market participants, and the 
benefits of the regulation of swap dealers (i.e., protection of 
customers and counterparties, and promotion of the effective operation 
and transparency of the swap markets), we believe a notional standard 
at a level of $3 billion appropriately balances the relevant regulatory 
goals.
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    \445\ One commenter suggested a threshold of $3 billion. See 
letter from COPE I (suggesting 0.001% of the total U.S. swap market, 
amounting to approximately $3 billion). Other commenters also 
supported a threshold of 0.001% of the total U.S. swap market. See 
letters cited in note 382, supra.
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    As noted above, several commenters suggested that the standard be 
set at an amount equal to 0.001 percent of the overall domestic market 
for swaps. The Commissions note, however, that comprehensive 
information regarding the total size of the domestic swap market is 
incomplete, with more information available with respect to certain 
asset classes than others. The CFTC evaluated data regarding one 
particular type of swap--credit default swaps (``CDS'') based on 
indices of debt securities known as ``index CDS''--that was provided by 
the SEC.\446\ As noted in the CFTC analysis of this data, however, the 
information is not filtered to reflect activity that would constitute 
swap dealing under the Dodd-Frank Act, so it is not possible to use the 
data to draw conclusions regarding any specific entity's status as a 
swap dealer.\447\ The data reflects only activity relating to index 
CDS, which constitute a very narrow part of the overall swap market, 
and, as noted in the CFTC analysis, similar data regarding other types 
of swaps is not available.\448\ Subject to these limitations, the data 
may help evaluate the impact of alternative approaches to implementing 
the de minimis exception.
---------------------------------------------------------------------------

    \446\ The CFTC analysis was made available to the public. See 
memorandum to the public comment file from the CFTC Office of the 
Chief Economist.
    \447\ See id.
    \448\ See id.
---------------------------------------------------------------------------

    One often-cited measure of the market, the Quarterly Report on Bank 
Trading and Derivatives Activities issued by the OCC (``OCC Quarterly 
Report'') is both limited, in that it includes only data related to the 
activities of U.S. bank holding companies, commercial banks and trust 
companies, and over-inclusive, in that it includes activities related 
to instruments that are not or may not be included in the final 
definition of ``swap'' (including futures, forwards, certain foreign 
exchange instruments, and certain options) and it includes both swaps 
and security-based swaps. Nonetheless, the Commissions believe that the 
available (imperfect) data suggests that a $3 billion notional standard 
is generally consistent with the commenters' suggestion of basing the 
standard on a percentage of the overall domestic market for swaps.
    The total notional value of $333.1 trillion in ``derivatives'' 
stated in the most recent OCC Quarterly Report includes approximately 
$221.1 trillion

[[Page 30633]]

in ``swaps'' and ``credit derivatives.'' \449\ Since some instruments 
that are security-based swaps are included in this total,\450\ the 
total notional value of swap positions at U.S. bank holding companies, 
commercial banks and trust companies at the end of the second quarter 
of 2011 of may be estimated to be somewhat less than $221.1 trillion.
---------------------------------------------------------------------------

    \449\ See Office of the Comptroller of the Currency, ``Quarterly 
Report on Bank Trading and Derivatives Activities, Second Quarter 
2011'' at tables 1 and 2 (http://www.occ.gov/topics/capital-markets/financial-markets/trading/derivatives/dq211.pdf). These totals 
reflect the sum of the amounts reported for the top 25 bank holding 
companies reported in table 1 and for all but the top 25 commercial 
banks and trust companies reported in table 2.
    However, this adjustment is only approximate, because the 
definitions of ``swap'' and ``credit derivative'' used in the OCC 
Quarterly Report are likely to be significantly different from the 
final definition of ``swap'' and ``security-based swap'' for 
purposes of the Dodd-Frank Act. For the same reason, it is uncertain 
how many of the notional value of $54.5 trillion in options reported 
in the OCC Quarterly Report are swaps or security-based swaps.
    Also, data from the CDS trade information warehouse maintained 
by the Depository Trust & Clearing Corporation (``DTCC'') indicates 
that total global notional CDS positions on indices amount to 
approximately $10.47 trillion. See http://dtcc.com/products/derivserv/data_table_i.php?tbid=3 (data for the week ending 
October 7, 2011, obtained on October 17, 2011).
    \450\ See part II.D.5, infra, for a discussion of the size of 
the security-based swap market.
---------------------------------------------------------------------------

    This total notional value is by nature under-inclusive, because it 
reflects only swap positions at U.S. bank holding companies, commercial 
banks and trust companies and not the swap positions of other market 
participants. However, there are also reasons that the information from 
the OCC Quarterly Report may overstate the notional value of swaps that 
would be relevant to estimating the size of the domestic swap market 
for purposes of the de minimis standard. While we believe the data is 
not sufficiently precise at this time to serve as the sole basis for 
the notional standard, a standard of $3 billion seems that it is likely 
generally consistent with 0.001 percent of the domestic swap market 
that would be relevant to a potential dealer's de minimis swap activity 
figure. First, the large majority of derivatives in the OCC Quarterly 
Report (approximately $229 trillion in notional value for commercial 
banks and trust companies) are derivatives between ``dealers'' (as 
defined for the purposes of the report.) \451\ Thus, it is likely that 
a large part of the derivatives in the OCC Quarterly Report reflect 
transactions between financial institutions that will be swap dealers. 
It is also notable that approximately $204.6 trillion in notional value 
of the derivatives (i.e., not only swaps) reported by U.S. commercial 
banks were interest rate contracts, many of which are swaps entered 
into by IDIs with customers in connection with the origination of loans 
which will be excluded from the determination of whether the IDIs are 
swap dealers.\452\ Finally, the OCC Quarterly Report measures swap 
positions held at a certain point in time, rather than the level of 
swap activity over a certain time period, again indicating that the 
figures are broader than those that would be subject to the de minimis 
figure. Accordingly, it appears that notional amount of the overall 
domestic market for swaps that actually would be relevant to 
determining the notional standard, and thus the appropriate basis for 
the 0.001 percent calculation, may be significantly lower than $331 
trillion.
---------------------------------------------------------------------------

    \451\ See OCC Quarterly Report at Graph 1.
    \452\ See OCC Quarterly Report at Graph 3.
---------------------------------------------------------------------------

    Because there is merit in the 0.001 percent ratio suggested by 
several commenters, we believe an appropriate balance of the goal of 
promoting the benefits of regulation (while recognizing the 
unquantifiable nature of those benefits) against the competing goal of 
avoiding the imposition of burdens on those entities for which 
regulation as a dealer would not be associated with achieving those 
benefits in a significant way, would be reached by setting the notional 
standard for swaps at a level that is near (taking into account the 
uncertainties noted above) 0.001 percent of a reasonable estimate of 
the overall domestic market for all swaps between all counterparties. 
We believe a $3 billion notional value standard is appropriate taking 
all these considerations into account.
b. Dealing Activity Involving Special Entities
    For swaps in which the counterparty is a special entity, the final 
rules set a notional standard consistent with the proposal of $25 
million over the prior 12 months.\453\ The Commissions believe that 
this notional standard is appropriate in light of the special 
protections that Title VII affords to special entities. In adopting 
this threshold, we recognize the serious concerns raised by commenters 
stating that the de minimis exception should not permit any dealing 
activities (by persons who are not registered as swap dealers) 
involving special entities, in light of losses that special entities 
have incurred in the financial markets.\454\ However, the final rule 
does not fully exclude such dealing activity from the exception, in 
light of the potential benefits that may arise from a de minimis 
exception. In this way, the threshold would not completely foreclose 
the availability of swaps to special entities from unregistered 
dealers, but the threshold would limit the financial and other risks 
associated with those positions for a special entity, which would in 
turn limit the possibility of inappropriately undermining the special 
protections that Title VII provides to special entities.
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    \453\ CFTC Regulation Sec.  1.3(ggg)(4)(i).
    \454\ See letters from AFR and Better Markets I.
---------------------------------------------------------------------------

c. Phase-in Procedure
    The Commissions believe that a phase-in period for the de minimis 
threshold would facilitate the orderly implementation of Title VII by 
permitting market participants and the Commissions to familiarize 
themselves with the application of the swap dealer definition and swap 
dealer requirements and to consider the information that will be 
available about the swap market, including real-time public reporting 
of swap data and information reported to swap data repositories. In 
addition, a phase-in period would afford the Commissions additional 
time to study the swap markets as they evolve in the new regulatory 
framework and allow potential swap dealers that engage in smaller 
amounts of activity (relative to the current size of the market) 
additional time to adjust their business practices, while at the same 
time preserving a focus on the regulation of the largest and most 
significant swap dealers. The Commissions also recognize that the data 
informing their current view of the de minimis threshold is based on 
the markets as they exist today, and that the markets will evolve over 
the coming years in light of the new regulatory framework and other 
developments.
    We have also considered that there may be some uncertainty 
regarding the exact level of swap dealing activity, measured in terms 
of a gross notional amount of swaps, that should be regarded as de 
minimis. While some quantitative data regarding the usage of swaps is 
available, there are many aspects of the swap markets for which 
definitive data is not available. We have also considered comments 
suggesting that the de minimis thresholds should be set higher 
initially to provide for efficient use of regulatory resources,\455\ or 
that implementation of the dealer requirements should be phased.\456\ 
For

[[Page 30634]]

all these reasons, the Commissions believe it is appropriate that the 
final rules provide for a phase-in period following the effective date 
during which higher de minimis thresholds would apply.
---------------------------------------------------------------------------

    \455\ See letters cited in footnote 402, supra.
    \456\ See, e.g., Roundtable Transcript at 35 (remarks of Ron 
Filler, New York Law School) and letters from FSR dated May 12, 2011 
(``FSR III'') and WGCEF V.
---------------------------------------------------------------------------

    In particular, during this phase-in period, a person's swap dealing 
activity over the prior 12 months is capped at a gross notional value 
of $8 billion.\457\ With respect to swaps with special entities, the 
Commissions believe it is appropriate that the $25 million gross 
notional value threshold apply during the phase-in period.\458\ In 
light of the available data--and the limitations of that data in 
predicting how the full implementation of Title VII will affect dealing 
activity in the swap markets--the Commissions believe that the 
appropriate threshold for the phase-in period is an annual gross 
notional level of swap dealing activity of $8 billion or less. In 
particular, the $8 billion level should still lead to the regulation of 
persons responsible for the vast majority of dealing activity within 
the swap markets.
---------------------------------------------------------------------------

    \457\ See CFTC Regulation Sec.  1.3(ggg)(4)(i).
    \458\ This limitation regarding swaps with special entities 
during the phase-in period is consistent with the Dodd-Frank Act's 
goal of helping special entities be in a position to benefit from 
the counterparty protections associated with the regulation of 
registered swap dealers under Title VII.
---------------------------------------------------------------------------

    Accordingly, the Commissions believe that while a $3 billion 
notional threshold reflects an appropriate long-term standard based on 
the available data,\459\ it also is appropriate to allow a degree of 
latitude in applying the threshold over time in the event that 
subsequent developments in the markets or the evaluation of new data 
from swap data reporting facilities suggest that the thresholds should 
be adjusted. In particular, the implementation of swap data reporting 
under the Dodd-Frank Act may result in new data that would be useful in 
confirming the Commissions' determination to establish the $3 billion 
threshold which applies after the phase-in period.
---------------------------------------------------------------------------

    \459\ See, e.g., part II.D.4.a, supra.
---------------------------------------------------------------------------

    For these reasons, review of the de minimis exception will comprise 
an important part of the reports that the CFTC is directing its staff 
to conduct with regard to the swap dealer definition during the phase-
in period. Among other topics, the report should consider market data 
addressing swap dealing activity over a period of approximately two 
years, and any resulting changes in swap dealing activity, by dealers 
above and below the $8 billion phase-in threshold, and above and below 
the $3 billion level applicable after the phase-in period. The report 
is required to be completed by the CFTC staff no later than 30 months 
following the date that a swap data repository first receives swap data 
under the CFTC's regulations, and the report will be published for 
public comment.\460\ The CFTC will take this report, in conjunction 
with any public comment on it, into account in weighing further action 
on the de minimis exception at the end of the phase-in period.
---------------------------------------------------------------------------

    \460\ See CFTC Regulation Sec.  1.3(ggg)(4)(ii)(C).
---------------------------------------------------------------------------

    The final rules provide that nine months after publication of its 
staff report, the CFTC may, in its discretion, either promulgate an 
order that the phase-in period will end as of the date set forth by the 
CFTC in that order, or issue for public comment a notice of proposed 
rulemaking to modify the de minimis threshold, in which case the CFTC 
would also issue an order establishing the date that the phase-in 
period will end.\461\ The period of nine months provided in the rule is 
intended to provide the CFTC an opportunity to consider its staff 
report, public comments on the staff report and any other relevant 
information.
---------------------------------------------------------------------------

    \461\ See CFTC Regulation Sec.  1.3(ggg)(4)(ii)(C).
---------------------------------------------------------------------------

    The CFTC recognizes that the determination of the appropriate de 
minimis threshold is a significant issue requiring thorough 
consideration of a variety of regulatory and market factors. At the 
same time, the CFTC recognizes the need for predictability in how the 
de minimis exception will apply. Therefore, the final rules include a 
finality provision, stating that the phase-in period will end no later 
than five years after the date that a swap data repository first 
receives swap data under the CFTC's regulations.\462\
---------------------------------------------------------------------------

    \462\ See CFTC Regulation Sec.  1.3(ggg)(4)(ii)(D).
---------------------------------------------------------------------------

    Persons who are able to avail themselves of the higher de minimis 
threshold that applies during the phase-in period will not be required 
to do so. In particular, a person that is engaged in dealing activity 
involving swaps in excess of the $3 billion threshold may choose to 
commence the process for registering as a swap dealer during the phase-
in period.\463\
---------------------------------------------------------------------------

    \463\ See CFTC Regulation Sec.  1.3(ggg)(4)(vi).
---------------------------------------------------------------------------

d. CFTC Staff Report
    As noted above, the CFTC is directing its staff to report to the 
CFTC as to whether changes are warranted to the rules implementing the 
swap dealer definition, including the rule implementing the de minimis 
exception. We are mindful that following the full implementation of 
Title VII--which itself is contingent on the implementation of the 
dealer definition--more data will be available to the CFTC via swap 
data repositories. We expect that this additional data will assist the 
CFTC in testing the assumptions and addressing the effects of the final 
rule we are adopting to implement the de minimis exception. For 
example, this data should help the CFTC assess, among other things, the 
nature and amount of unregulated dealing activity that occurs under the 
$3 billion threshold. The CFTC will make this report available for 
public comment so that it may benefit from additional input and 
analysis regarding the swap dealer definition.
    By making use of post-implementation data, the staff report 
(together with public comment on the report) will help the CFTC better 
evaluate the exception in light of potential market changes resulting 
from the full implementation of Title VII--including market changes 
resulting from the de minimis exception itself--as part of determining 
whether revised de minimis thresholds would be appropriate. The report 
and public comment thereon will also be taken into consideration by the 
CFTC in determining what action, if any, to take with respect to the 
phase-in period associated with the de minimis exception.
    The final rules provide, moreover, that the CFTC may change the 
requirements of the de minimis exception by rule or regulation.\464\ 
Through this mechanism, the CFTC may revisit the rule implementing the 
exception and potentially change that rule, for example, if data 
regarding the post-implementation swap market suggests that different 
de minimis thresholds would be appropriate.\465\ In determining whether 
to revisit the thresholds, the CFTC intends to pay particular attention 
to whether the de minimis exception results in a swap dealer definition 
that encompasses too many entities whose activities are not

[[Page 30635]]

significant enough to warrant full regulation under Title VII, or, 
alternatively, whether the de minimis exception leads an undue amount 
of dealing activity to fall outside of the ambit of the Title VII 
regulatory framework, or leads to inappropriate reductions in 
counterparty protections (including protections for special entities). 
The CFTC also intends to pay particular attention to whether 
alternative approaches would more effectively promote the regulatory 
goals that may be associated with a de minimis exception.
---------------------------------------------------------------------------

    \464\ CFTC Regulation Sec.  1.3(ggg)(4)(v). CEA section 
1a(49)(D) (like Exchange Act section 3(a)(71)(D)) particularly 
states that the ``Commission''--meaning the CFTC--may exempt de 
minimis dealers and promulgate related regulations. We do not 
interpret the joint rulemaking provisions of section 712(d) of the 
Dodd-Frank Act to require joint rulemaking here, because such an 
interpretation would read the term ``Commission'' out of CEA section 
1a(49)(D) (and Exchange Act section 3(a)(71)(D)), which themselves 
were added by the Dodd-Frank Act.
    \465\ See letter from Greenberger (stating that the dynamic 
nature of the derivatives sector of the financial markets should 
counsel caution, and that the de minimis threshold should be 
reevaluated on an ongoing basis).
---------------------------------------------------------------------------

5. Final Rules--De Minimis Exception to ``Security-Based Swap Dealer'' 
Definition
a. Overview of the Final Rule
    The final rule implementing the de minimis exception to the 
``security-based swap dealer'' definition has been revised from the 
proposal in a number of ways. As discussed above, the final rule does 
not incorporate proposed limits on the number of security-based swaps 
that a person may enter into in a dealing capacity, or on the number of 
security-based swap counterparties a person may have when acting in a 
dealing capacity.\466\ Moreover, the provisions of the exception that 
cap an unregistered person's annual notional dealing activity with 
counterparties other than ``special entities'' have been increased from 
the proposed $100 million threshold.\467\ Instead, the final rule caps 
such dealing activity involving security-based swaps that are credit 
default swaps--which largely would consist of single-name credit 
default swaps--at $3 billion in notional amount over the prior 12 
months.\468\ For other types of security-based swaps (e.g., single-name 
or narrow-based equity swaps or total return swaps), the exception caps 
an unregistered person's dealing activity at $150 million in notional 
amount over the prior 12 months.\469\ Also, as addressed below, the 
final rule provides for phase-in levels in excess of those $3 billion 
and $150 million thresholds for a certain period of time.
---------------------------------------------------------------------------

    \466\ See part II.D.3.b, supra.
    \467\ For clarity, the final rule also has been revised from the 
proposal to provide that persons taking advantage of the exception 
``shall be deemed not to be'' dealers (the proposed rule used the 
phrasing ``shall not be deemed to be'' dealers), and to provide that 
such persons ``shall not be subject to Section 15F of the Exchange 
Act and the rules, regulations and interpretations issued 
thereunder.'' See Exchange Act rule 3a71-2(a). The final rule also 
reflects certain structural changes consistent with the substantive 
changes from the proposed rule.
     In addition, as discussed above, see part II.D.3.d, supra, the 
final rule has been revised to provide that the notional thresholds 
to the de minimis exception encompass swap and security-based swap 
dealing positions entered into by an affiliate controlling, 
controlled by or under common control with the person at issue.
    \468\ Exchange Act rule 3a71-2(a)(1)(i). The final rule, like 
the proposal, requires the analysis of de minimis levels to be based 
on effective notional amounts to the extent that the stated notional 
amount is leveraged or enhanced by the structure of the security-
based swap (such as, for example, if the exchange of payments 
associated with an equity swap was based on a multiple of the return 
associated with the underlying equity). See Exchange Act rule 3a71-
2(a)(3).
    It is important to recognize that while these types of de 
minimis principles are relevant to the ``security-based swap 
dealer'' definition, they are not applicable to the general 
definitions of ``broker'' and ``dealer'' under the Exchange Act, or 
the broker-dealer registration requirements of Exchange Act section 
15(a). Unlike the ``security-based swap dealer'' definition, those 
other definitions, with the exception of the bank-broker definition 
in section 3(a)(4)(B)(xi) of the Exchange Act, lack de minimis 
exceptions.
    \469\ Exchange Act rule 3a71-2(a)(1)(ii).
---------------------------------------------------------------------------

    In addition, consistent with the proposal, the final rule caps an 
unregistered person's security-based swap dealing activity involving 
counterparties that are ``special entities'' at $25 million in notional 
amount over the prior 12 months.\470\ The final rule further provides 
that the SEC may establish alternative methods of determining the scope 
of the de minimis exception by rule or regulation.\471\
---------------------------------------------------------------------------

    \470\ Exchange Act rule 3a71-2(a)(1)(iii).
    \471\ Exchange Act rule 3a71-2(d); see part II.D.5.f, infra.
---------------------------------------------------------------------------

b. Interests Associated With a De Minimis Exception
    In developing this final rule, we have sought to balance the 
interests advanced by the de minimis exception against the protections 
that would be weakened were the exception applied in an overbroad 
manner. In making this evaluation, we have taken into account data 
regarding the security-based swap market and especially data regarding 
the activity--including activity that may be suggestive of dealing 
behavior--of participants in the single-name credit default swap 
market.\472\
---------------------------------------------------------------------------

    \472\ Certain data has been addressed by an analysis regarding 
the market for single-name credit default swaps performed by the 
SEC's Division of Risk, Strategy, and Financial Innovation. See 
``Information regarding activities and positions of participants in 
the single-name credit default swap market'' (Mar. 15, 2012) 
(available at http://www.sec.gov/comments/s7-39-10/s73910-154.pdf) 
(``CDS Data Analysis''). We believe that the data underlying this 
analysis provides reasonably comprehensive information regarding the 
credit default swap activities and positions of U.S. market 
participants, but note that the data does not encompass those credit 
default swaps that both: (i) do not involve U.S. counterparties; and 
(ii) are based on non-U.S. reference entities. Our reliance on this 
data, which we believe to be the best available, should not be 
interpreted to indicate our views as to the nature or extent of the 
application of Title VII to non-U.S. persons; instead, the SEC 
anticipates that issues regarding the extraterritorial application 
of Title VII will be addressed in a separate release.
    As discussed below, see notes 476 and 485, infra, we also have 
considered more limited publicly available data regarding equity 
swaps.
    The CDS Data Analysis also included an appendix of data 
regarding index credit default swaps. We do not consider that data 
for purposes of the analysis described in this section because the 
statutory definition of ``security-based swap'' in relevant part 
encompasses swaps based on single securities or on narrow-based 
security indices. See Exchange Act sec. 3(a)(68)(A); see also 
Exchange Act Release No. 64372, 76 FR 29818 (May 23, 2011) (proposed 
rules further defining ``security-based swap'' and certain other 
terms).
---------------------------------------------------------------------------

    As discussed above, a de minimis exception eliminates key Title VII 
protections for some market participants by regulating less dealer 
activity. Conversely, an appropriately applied de minimis exception may 
provide an objective test when there is doubt as to whether particular 
activities may cause a person to be deemed to be a dealer; \473\ allow 
non-dealers to accommodate the incidental security-based swap needs of 
existing clients; and help to facilitate competition by allowing the 
entry of new dealers into the market. In addition, as discussed above, 
a de minimis exception may promote regulatory efficiency by providing a 
framework to help focus dealer regulation upon those entities for which 
such regulation is warranted, rather than upon entities that engage in 
relatively limited amounts of dealing activity.\474\
---------------------------------------------------------------------------

    \473\ We believe that the application of the dealer-trader 
distinction and the guidance we have provided that distinguishes 
hedging activities from dealing activities in the security-based 
swap market will also help dealers meet their obligations.
    \474\ See part II.D.3.a, supra.
---------------------------------------------------------------------------

i. Providing for Regulatory Coverage of the Vast Majority of Dealing 
Activity
    In seeking to develop a de minimis exception that preserves key 
counterparty and market protections while promoting regulatory 
efficiency, we have considered the comparative amount of security-based 
swap dealing activity that could fall outside the ambit of dealer 
regulation as a result of the exception. In doing so we have considered 
not only the security-based swap market as it currently exists, but 
also how the market reasonably may be expected to change after the full 
implementation of Title VII.
    In performing this comparative exercise we are, in part, drawing 
inferences from the CDS Data Analysis, a dataset released by the SEC 
staff that characterizes nearly all transactions in single-name credit 
default swaps during the 2011 calendar year.\475\ Though the final 
rules apply to all security-based swaps, not just single-name credit

[[Page 30636]]

default swaps, the SEC believes that these data are sufficiently 
representative of the market to help inform the analysis because an 
estimated 95 percent of all security-based swap transactions appear 
likely to be single-name credit default swaps.\476\ The SEC also 
recognizes that although the de minimis exception is applicable to 
persons only with respect to their dealing activity, the CDS Data 
Analysis contains transactions reflecting both dealing activity and 
non-dealing activity, including transactions by persons who may engage 
in no dealing activity whatsoever.\477\
---------------------------------------------------------------------------

    \475\ See note 472, supra.
    \476\ While recognizing that the Commissions have yet to adopt 
final rules defining a ``security-based swap,'' we believe that 
single-name credit default swaps will constitute roughly 95 percent 
of the market, as measured on a notional basis, for instruments that 
will fall within that definition, with certain equity swaps (in 
other words, total return swaps based on single equities or narrow-
based indices of equities) constituting the primary example of 
security-based swaps that are not credit default swaps.
    In particular, according to data published by BIS, the global 
notional amount outstanding in equity forwards and swaps as of June 
2011 was $2.03 trillion, and the notional amount outstanding in 
credit default swaps was approximately $32.4 trillion. See 
Statistical Annex, BIS Quarterly Review (December 2011), at A10 
(available at http://www.bis.org/publ/qtrpdf/r_qs1112.pdf). 
Although the BIS data reflects the global OTC derivatives market, 
and not just U.S. market, we have no reason to believe that these 
ratios differ significantly in the U.S. market. In fact, OCC data 
regarding U.S. entities generally confirms these ratios, in that as 
of June 30, 2011, U.S. commercial banks and trust companies held 
$15.23 trillion in notional outstanding credit derivative positions 
and $677 billion in equity derivative positions, meaning that credit 
derivatives accounted for approximately 95 percent of the total 
credit and equity derivative positions held by these entities. See 
OCC Quarterly Report at tables 1 and 10. Cf. letter from Greenberger 
(referencing OCC data as relevant to determining size of swap 
market).
    \477\ A person that is engaged in security-based swap dealing 
activity, for example, may also engage in proprietary trading 
involving security-based swaps that would be reflected in the 
transaction data. Even accounting for such possibilities, however, 
the SEC believes that the data nonetheless support the broad 
conclusion described below that dealing activity within the 
security-based swap market is highly concentrated.
---------------------------------------------------------------------------

    As described more fully in the CDS Data Analysis, to ascertain 
which entities might be transacting as dealers, and which may not be, 
various criteria were employed as indicia of possible dealing activity. 
In each case, the results suggest the great extent to which there is 
currently a high degree of concentration of potential dealing activity 
in the single-name credit default swap market. For example, using the 
criterion that dealers are likely to transact with many counterparties 
who themselves are not dealers, analysis of 2011 transaction data show 
that only 28 out of 1,084 market participants have three or more 
counterparties that themselves are not recognized as dealers by 
ISDA.\478\ As the data show, 15 of these 28 potential dealers exceeded 
a threshold of $100 billion notional transacted in single-name credit 
swaps during 2011, which accounts for over 98 percent of the 28 
entities' total activity.\479\ At a lower threshold of $10 billion 
notional, 21 of the 28 potential dealers are included (representing 
99.7 percent of the activity of potential dealers), and at an even 
lower threshold of $3 billion notional, 25 potential dealers are 
included (representing 99.9 percent).\480\
---------------------------------------------------------------------------

    \478\ See CDS Data Analysis at table 3c. The SEC recognizes that 
the analysis of this transaction data is imperfect as a tool for 
identifying dealing activity, given that the presence or absence of 
dealing activity ultimately turns upon the relevant facts and 
circumstances of an entity's security-based swap transactions, as 
informed by the dealer-trader distinction. Criteria based on the 
number of an entity's counterparties that are not recognized as 
dealers nonetheless appear to be useful for identifying apparent 
dealing activity in the absence of full analysis of the relevant 
facts and circumstances, given that engaging in security-based swap 
transactions with non-dealers would be consistent with the conduct 
of seeking to profit by providing liquidity to others, as 
anticipated by the dealer-trader distinction. In emphasizing this 
criterion for identifying dealing activity, we are not seeking to 
predict with precision how many entities ultimately may register as 
security-based swap dealers. The ultimate number of dealers that may 
register can also be expected to reflect growth in the market, new 
dealing entrants, and in some cases the registration of multiple 
dealing entities within an affiliated group.
    \479\ See CDS Data Analysis at table 3c. In particular, those 15 
entities engaged in a total of $11.01 trillion in notional single-
name credit default swap transactions over 2011, which reflects 98.5 
percent of the total $11.18 trillion in notional transactions over 
2011 for the 28 total identified possible dealers.
    \480\ See id. The 21 possible dealers with a 2011 notional in 
excess of $10 billion account for a total of $11.15 trillion in 
notional single-name credit default swap transactions in 2011, or 
over 99.7 percent of the total. The 25 possible dealers in excess of 
$3 billion account for almost $11.18 in notional transactions in 
2011, or over 99.9 percent of the total.
---------------------------------------------------------------------------

    Other criteria for identifying possible dealing activity based on 
the number of an entity's non-dealer counterparties similarly suggest a 
high degree of concentration of dealing activity within the current 
security-based swap market.\481\ Criteria that consider the number of 
an entity's total single-name security-based swap counterparties,\482\ 
criteria that consider alternative factors for identifying dealing 
activity,\483\ and certain combined criteria \484\ further

[[Page 30637]]

suggest a high concentration of dealing activity within the security-
based swap market.
---------------------------------------------------------------------------

    \481\ For example, two other criteria consider the number of an 
entity's non-dealer counterparties (in those cases identifying as 
dealers those persons that have seven or more, or five or more, 
counterparties not recognized as dealers by ISDA) also indicate that 
potential dealers with notional amounts in excess of $100 billion in 
2011 account for over 98 percent of the notional transactions of all 
entities meeting the applicable criteria in 2011. Potential dealers 
with notional transactions above $10 billion in 2011 (let alone 
those with notional transactions above $3 billion) reflect all or 
virtually the entire notional amount of all dealers identified by 
those criteria. See id. at tables 3a and 3b.
    \482\ The CDS Data Analysis also sought to identify dealing 
activity based on the total number of an entity's counterparties. 
See id. at tables 2a through 2c. Those criteria similarly suggest a 
high degree of concentration of dealing activity within the single-
name credit default swap market:
    i. A criterion that identifies potential dealing activity based 
on an entity having twenty or more counterparties in single-name 
security-based swaps identified 16 possible dealers. Fourteen of 
those entities had notional transactions in excess of $100 billion 
in 2011, reflecting over 99 percent of the total associated with all 
16. The remaining two identified entities had notional transactions 
in excess of $10 billion in 2011. See id. at table 2a.
    ii. A criterion that identifies potential dealing activity based 
on an entity having 15 or more counterparties in single-name 
security-based swaps identified 33 possible dealers. Fifteen of 
those entities had notional transactions in excess of $100 billion 
in 2011, reflecting over 97 percent of the total associated with all 
33. A total of 27 of those entities had notional transactions in 
excess of $10 billion in 2011, and a total of 32 of those entities 
had notional transactions in excess of $3 billion in 2011, both 
reflecting over 99 percent of the total. See id. at table 2b.
    iii. A criterion that identifies potential dealing activity 
based on an entity having 10 or more counterparties in single-name 
security-based swaps identified 154 possible dealers. Fifteen of 
those exceeded $100 billion in notional transactions in 2011, 
reflecting over 90 percent of the total; 49 of those exceeded $10 
billion in notional transactions in 2011, reflecting over 97 percent 
of the total; and 93 exceeded $3 billion in notional transactions in 
2011, reflecting over 99 percent of the total. See id. at table 2c.
    In considering the data we are weighing these criteria less 
heavily than we are weighing the criteria based on the number of 
counterparties who are not identified by ISDA as dealers. This is 
because it is reasonable to foresee a non-dealer making use of 
multiple dealers to get the best possible price or to make use of 
special expertise possessed by certain dealers, meaning that the 
criteria discussed in this footnote are more likely to identify 
entities not engaged in dealing activity.
    \483\ Other criteria in the CDS Data Analysis sought to identify 
dealing activity based on whether an entity maintains a relatively 
flat book. Those criteria also indicated that entities with notional 
transactions in excess of $100 billion in 2011 represented over 97 
percent of the total for all entities identified by those criteria, 
while entities with notional transactions in excess of $10 billion 
in 2011 represented over 99 of the total for all entities identified 
by those criteria. See id. at tables 4 and 5. We are weighing those 
criteria less heavily than we are weighing the counterparty-based 
criteria discussed above because an entity that engages in 
directional trades could also appear to have a flat book if its 
portfolio contained transactions representing various directional 
bets, but of similar aggregate notional sizes on both sides of the 
market. See id. at 3.
     The analysis also included one criterion that considers 
potential dealing activity based on a low propensity to post margin. 
See id. at table 6. While we do not believe that this analysis 
deserves the same degree of weight as the others, given concerns 
about the completeness of the data (see id. at 4), we note that this 
criterion nonetheless also indicates a high concentration of dealing 
activity in the market. See id. at table 6 (indicating that of the 
473 entities identified by this criterion, the 14 entities with 
notional transactions in excess of $100 billion in 2011 account for 
roughly 94 percent of the total notional transaction activity 
associated with all 473 entities over 2011).
    \484\ Finally, the CDS Data Analysis also included criteria that 
identified potential dealing activity based on an entity meeting two 
or three of the other criteria considered. See id. at tables 7 and 
8. These criteria again indicate a high degree of concentration of 
dealing activity in the market. The analysis that addressed whether 
an entity met two of the other criteria identified 92 possible 
dealers, with the 15 entities having notional transactions in excess 
of $100 billion in 2011 representing over 96 percent of the total 
activity of those 92 entities in 2011. See id. at table 7. The 
analysis that addressed whether an entity met three of the other 
criteria identified 41 possible dealers, with the 15 entities having 
notional transactions in excess of $100 billion in 2011, 
representing over 98 percent of the total activity of those 41 
entities in 2011. See id. at table 8.
---------------------------------------------------------------------------

    While less data are available in connection with other types of 
instruments constituting security-based swaps, such as equity swaps, 
the available data similarly suggest a high concentration of positions 
in those instruments among potential dealers.\485\
---------------------------------------------------------------------------

    \485\ For example, OCC data shows that, of the five largest bank 
or trust companies, four have notional equity derivative positions 
of above $1 billion, and that those four entities account for $630 
billion in notional positions out of $677 billion for all U.S. 
commercial banks or trust companies, which constitutes approximately 
93 percent of the total. See OCC Quarterly Report at table 10. 
Similarly, a review of the equity swaps positions of the 50 largest 
U.S. bank holding companies shows that nine bank holding companies 
have notional equity swap positions exceeding $1 billion, and 
account for 99.5 percent of the total positions held by such 
companies, and 29 have no positions in equity swaps. (Data was 
compiled from each bank holding company's FR 9-YC, available at 
http://www.ffiec.gov/nicpubweb/nicweb/Top50Form.aspx). Cf. letter 
from WGCEF V (referencing swap position data from bank holding 
companies' Forms FR Y-9C as relevant to determining size of the swap 
market).
---------------------------------------------------------------------------

    Though inspection of the data does not seem to suggest a single 
precise de minimis threshold, the above analysis of potential dealing 
activity is useful in that it reveals a range of possible thresholds 
from $100 billion to $3 billion that would cover anywhere from 98 
percent through 99.9 percent of the total activity of all potential 
dealers in 2011. However, these thresholds--and their implied market 
coverage ratios--only reflect levels of activity that exist in today's 
highly concentrated market. In order to further narrow the range of 
possible thresholds, and to select an appropriate level for the de 
minimis exception, the analysis must consider the potential state of 
the market as it might reasonably exist after the implementation of 
Title VII.
ii. Avoiding Gaps Resulting From the Regulatory Changes in Conjunction 
With the Exception
    Although the overall portion of security-based swap activity that 
would appear to be subject to dealer regulation based on current 
measures of dealing concentration in the market constitutes an 
important factor to consider in balancing the regulatory burdens and 
benefits associated with a de minimis exception, analysis of the 
current market should not serve as the sole mechanism for setting the 
exception.
    In particular, sole reliance on an approach that focuses on current 
measures of market concentration would not adequately account for 
likely changes to the market associated with the implementation of 
regulation. In part, these changes may be a direct result of the full 
implementation of Title VII--including enhancements to transparency and 
increases in central clearing--as those changes reasonably may be 
expected to reduce the concentration of dealing activity within the 
market over time.\486\ Also, to the extent implementation of Title VII 
permits new dealers to enter the market, the availability of a de 
minimis exception would mean those new dealing entrants would fall 
outside the ambit of dealer regulation, either for the long term or 
until their dealing activity surpasses the applicable notional 
threshold.\487\ Accordingly, de minimis thresholds that are based 
solely on the current state of the market, including the current 
concentration of dealing activity within the market, may reasonably be 
expected to fail to account for the amount of dealing activity that in 
the future could fall outside of the ambit of dealer regulation due to 
the exception.\488\
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    \486\ Cf. Bessembinder and Maxwell, ``Transparency and the 
Corporate Bond Market,'' Journal of Economic Perspectives, Spring 
2008, at 217, 226 (noting that after reporting of U.S. OTC bond 
transactions through the Trade Reporting and Compliance Engine 
(``TRACE'') became mandatory, the portion of trades completed by the 
12 largest dealers fell from 56 percent to 44 percent).
    \487\ We understand that large dealers have competitive 
advantages under the current market, in light of the desire of 
counterparties to engage in security-based swap transactions with 
large, well capitalized and highly rated dealers. See, e.g., Craig 
Pirrong, Rocket Science, Default Risk and The Organization of 
Derivatives Markets, Working Paper, University of Houston (2006) 
(available at http://www.cba.uh.edu/spirrong/Derivorg1.pdf). The 
lower business costs associated with being unregulated may prove to 
partially offset that advantage. At the same time, we reasonably may 
expect that informed counterparties will take into account the lower 
protections--and higher risks--associated with transactions with 
unregulated dealers in determining whether to use regulated or 
unregulated dealers as counterparties.
    \488\ We note that there also are benefits to increased 
competition and a decrease in concentration of dealer activity, as 
contemplated by Title VII, including potentially lower costs for 
market participants and a decrease in systemic risk.
---------------------------------------------------------------------------

    For example, as discussed above, when possible dealers in single-
name credit default swaps are identified by an entity having three or 
more counterparties that are not recognized by ISDA as being dealers, 
entities with notional transactions in excess of $100 billion over a 12 
month period represent over 98 percent of the total activity of all 
such possible dealers over that period, leaving two percent of possible 
dealing activity below that level.\489\ However, a de minimis threshold 
of $100 billion would allow new entrants to commence engaging in 
unregulated dealing in competition with persons who are regulated as 
dealers pursuant to Title VII, which, depending on the number and size 
of such entrants, could significantly decrease the portion of dealing 
activity in the market done by registered dealers (at least until the 
point that new entrants cross the de minimis threshold, if they do at 
all). For example, if 15 new entrants \490\ were to engage in security-
based swap dealing activity up to a $100 billion threshold, the result 
could be that nearly 15 percent of dealing activity within the single-
name credit default swap market would be left outside of the ambit of 
dealer regulation.\491\
---------------------------------------------------------------------------

    \489\ See CDS Data Analysis at table 3c; see also note 479, 
supra. As noted above, these amounts may not only reflect dealing 
activity by an entity. Thus, even putting aside the possibility of 
new unregulated entrants into the market, the portion of dealing 
activity in the market that is represented by entities whose 
trailing notional dealing activity exceeds $100 billion may in fact 
be less than 98 percent.
    \490\ The illustrative use of new entrants for purposes of this 
discussion is intended to reflect the potential that new entrants to 
the market could take advantage of a de minimis threshold in a way 
that leads to a higher level of unregulated dealing activity within 
the market. In using this illustration we are not seeking to 
explicitly predict how many new entrants may come into the market in 
response to any particular de minimis threshold, nor are we seeking 
to predict how many new entrants may seek to stay under the de 
minimis thresholds and how many instead would seek to use the 
exception as a step on the way to eventually registering as a 
security-based swap dealer. Rather, we simply are illustrating why 
it is important to account for market changes in connection with 
setting the de minimis threshold.
    The OTC Derivatives Supervisors Group--a group chaired by the 
Federal Reserve Bank of New York and consisting of the CFTC and SEC 
as well as other international supervisors and major over-the-
counter derivatives market participants--currently recognizes 15 
major OTC derivatives dealers. Accordingly, as an illustrative 
example, we have assumed that this number of significant security-
based swap dealers would approximately double--i.e., include 15 new 
dealers--in the wake of the various regulatory changes contemplated 
by the Dodd-Frank Act, many of which may result in increased access 
and competition in the security-based swap market (e.g., enhanced 
priced transparency and increased access to central clearing). 
However, we emphasize that this number has been selected as an 
illustrative example, and have accordingly provided similar examples 
assuming ten and five new entrants.
    \491\ Fifteen new entities that each engage in $100 billion in 
dealing activity would reflect $1.5 trillion in additional dealing 
activity outside the ambit of dealer regulation, which could lead to 
roughly 14.9 percent of total dealing activity being outside the 
ambit of dealing regulation (with that $1.5 trillion being added to 
the existing $168 billion reflected by entities that fall below the 
$100 billion threshold, and that sum divided by $11.18 trillion, 
under the assumption that the new entrants displace business from 
the fifteen entities above the de minimis threshold). To further 
illustrate, under the same assumptions and analysis, the implied 
unregulated market share would be roughly 10.4 percent for ten new 
entities and 6.0 percent for five new entities.
    In certain regards these illustrations, on the one hand, may 
overestimate the effect of new entrants because of the assumption 
that such entrants engage in dealing activities up to, but not 
surpassing, the de minimis threshold. While it is not impossible 
that some entities may seek to use the de minimis exception to 
conduct business as an unregulated niche dealer, it also is 
plausible that entities generally may seek to use the exception to 
commence engaging in dealing activity, with the goal of ultimately 
becoming registered dealers that are not constrained by the de 
minimis threshold.
    On the other hand, these illustrations in certain respects may 
underestimate the amount of dealing activity that can fall outside 
of the regulatory ambit. For example, the amounts of security-based 
swap activity of persons identified in the analysis as dealers may 
not exclusively constitute dealing activity, meaning that persons 
whose notional transactions over a 12-month period exceed a 
particular threshold in fact may not be engaged in that amount of 
dealing activity, and hence may still be able to take advantage of 
the de minimis exception. Also, these illustrations do not seek to 
reflect increased activity by existing dealers that already fall 
below the assumed threshold.

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[[Page 30638]]

    Similarly, a de minimis threshold of $25 billion may also lead to a 
material reduction in the portion of the market covered by registered 
dealers. For example, using the same assumptions as above, 15 new 
entrants up to a $25 billion threshold could leave over four percent of 
dealing activity in the market outside of the ambit of dealing 
regulation.\492\ When other metrics are used to identify possible 
dealing activity, the possibility of a significant regulatory gap 
remains.\493\
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    \492\ Fifteen new entities each engaged in $25 billion in 
dealing activity would reflect $375 billion in additional dealing 
activity outside the ambit of dealer regulation, which could lead to 
4.1 percent of total dealing activity being outside the ambit of 
dealing regulation (with that $375 billion being added to the 
existing $80.2 billion reflected by entities that fall below the $25 
billion threshold, and that sum divided by $11.18 trillion, under 
the assumption that the new entrants displace business from the 
seventeen entities above the de minimis threshold). To further 
illustrate, under the same assumptions and analysis, the implied 
unregulated market share would be 3.0 percent for 10 new entities 
and 1.8 percent for 5 new entities. Obviously, these illustrations 
are subject to the same limitations as are discussed above in the 
context of the $100 million threshold illustration.
    \493\ For example, similar results are obtained when possible 
dealing activity is identified based on whether an entity passes at 
least three of the other metrics discussed above. See CDS Data 
Analysis at table 8. Using the same types of assumptions as are 
discussed above, with fifteen new entities, a de minimis threshold 
of $100 billion could lead to 15.0 percent of dealing activity 
falling outside the ambit of dealer regulation, while a de minimis 
threshold of $25 billion could lead to 4.2 percent of dealing 
activity falling outside of regulation.
---------------------------------------------------------------------------

    Overall, it is reasonable to conclude that the higher the de 
minimis threshold, the greater the likelihood that the exception, 
combined with other changes resulting from the implementation of Title 
VII that may encourage new entrants, will lead to a proportionately 
larger amount of unregulated (except with respect to antifraud and 
anti-manipulation prohibitions) dealing activity.\494\ We believe that 
it is reasonable to interpret the statutory language of the de minimis 
exception in a way that prevents a proportionately large amount of 
dealing activity within the security-based swap market from falling 
outside the ambit of dealer regulation. Accordingly, choosing to set a 
lower de minimis threshold from among the range of potential thresholds 
would limit the amount of potential future dealing activity that could 
be transacted without being subject to dealer rules and 
regulations.\495\
---------------------------------------------------------------------------

    \494\ As noted above, encouraging new entrants also has benefits 
flowing from increased competition and a decrease in concentration 
of dealer activity. See note 488, supra.
    \495\ For example, 15 new dealer entrants engaged in up to $3 
billion in dealing activity would account for up to $45 billion in 
dealing activity. This result would mean approximately 0.4 percent 
of total potential future dealing activity could be transacted by 
unregistered dealers, as opposed to the potential for approximately 
15 percent of potential future dealing activity to be transacted by 
unregistered dealers if the de minimis were set to $100 billion. See 
CDS Data Analysis at table 3c. As with the illustrative examples 
above, these calculations assume that the new entrants displace 
business from the entities above the de minimis threshold.
---------------------------------------------------------------------------

iii. Promoting Statutory Counterparty Protections
    Sole reliance on an approach based on overall market coverage in 
balancing regulatory burdens and benefits would also threaten to unduly 
discount important counterparty protection interests, as discussed 
above and highlighted in the proposal.\496\ For example, in light of 
data indicating that $5 million constitutes a common notional size for 
a single-name credit default swap position,\497\ a de minimis notional 
threshold of $25 billion annually would permit an unregistered dealer 
to engage in as many as 5000 trades of that size. The counterparties to 
these unregistered dealers would not receive the benefit of the 
protections that Title VII affords to the counterparties of registered 
dealers. These include, among others, the segregation protections 
afforded to persons who post margin to dealers in connection with over-
the-counter security-based swap transactions.\498\ Accordingly, this 
consideration also suggests that choosing a de minimis threshold closer 
to the lower end of the range of potential thresholds would better 
preserve the counterparty protections contemplated by Title VII.
---------------------------------------------------------------------------

    \496\ See part II.D.3.a, supra; see also Proposing Release at 
80180 (highlighting ``customer protection issues raised by swaps and 
security-based swaps--including risks that counterparties may not 
fully appreciate when entering into swaps and security-based 
swaps'').
    \497\ See Federal Reserve Bank of New York staff report, ``An 
Analysis of CDS Transactions: Implications for Public Reporting'' 
(2011) at 8 (stating that for dollar-denominated single name CDS on 
corporate or sovereign reference entities, $5 million represented 
the most common notional size) (available at http://www.newyorkfed.org/research/staff_reports/sr517.pdf); see also 
Proposing Release at 80180 (noting ``that in general the notional 
seize of a small swap or security-based swap is $5 million or 
less'').
    We note, by comparison, that Congress has determined that a de 
minimis amount of securities broker activity by banks entails 500 
trades annually. See Exchange Act section 3(a)(4)(B)(xi) (excluding 
from the ``broker'' definition a bank that annually effects no more 
than 500 securities transactions, other than transactions subject to 
certain other exceptions, so long as the transaction is not effected 
by a bank employee that also is a broker-dealer employee).
    We further note that, while the number of counterparties or 
transactions potentially implicated by unregistered dealing activity 
is an important consideration in establishing an initial de minimis 
level, it does not alter our view, described above, that a single de 
minimis standard based on notional value--rather than the proposal's 
framework of three distinct standards based on notional value, 
number of counterparties, and number of transactions--is an 
appropriate choice in light of concerns expressed by commenters that 
a standard based on the number of transactions or counterparties can 
produce arbitrary results. See part II.D.3.b.ii, supra.
    \498\ Exchange Act section 3E, which was added by section 763(d) 
of the Dodd-Frank Act, provides a series of requirements in 
connection with the segregation of assets held as collateral in 
security-based swap transactions. These include requirements that 
security-based swap dealers and major security-based swap 
participants provide their counterparties with notice that they have 
the right to require segregation, and that such segregation must be 
at an independent third-party custodian.
---------------------------------------------------------------------------

c. Balancing Reflected in the Final Rules--Credit Default Swaps That 
Constitute Security-Based Swaps
    The final thresholds that implement the de minimis exception (and 
corresponding phase-in levels) address security-based swaps that are 
credit default swaps separately from other types of security-based 
swaps, in light of differences in the respective markets.
i. General Threshold for Credit Default Swaps That Constitute Security-
Based Swaps
    We conclude that $3 billion over the prior 12 months constitutes an 
appropriate notional threshold for applying the de minimis exception in 
connection with dealing activity involving credit default swaps that 
constitute security-based swaps.

[[Page 30639]]

    In reaching this conclusion, we recognize the significance of 
comments that supported the proposed $100 million threshold,\499\ and 
that urged caution in raising that proposed threshold,\500\ as well as 
commenters who supported increases to the threshold.\501\ We further 
recognize the importance of applying the de minimis exception in a way 
that promotes regulatory efficiency. We also recognize the range of 
potential thresholds suggested by the data currently available. Based 
on the competing factors described above, we believe that $3 billion 
reflects a reasonable notional threshold--though not necessarily the 
only such threshold.
---------------------------------------------------------------------------

    \499\ See letters from Better Markets I and AFR.
    \500\ See letter from Greenberger.
    \501\ See, e.g., letter from COPE I.
---------------------------------------------------------------------------

    In our view, the currently available data regarding the single-name 
credit default swap market indicates that a notional threshold of $3 
billion would be expected to result in the regulation, as dealers, of 
persons responsible for the vast majority of dealing activity within 
that market, both as of today and, as described above, in the future as 
the benefits of the other Title VII rules are implemented and new 
dealer entrants come to market.\502\
---------------------------------------------------------------------------

    \502\ Of the 28 market participants that have three or more 
security-based swap counterparties that themselves are not 
recognized by dealers by ISDA, 25 had notional single-name credit 
default swap positions in excess of $3 billion in 2011. The 
remaining three entities in total accounted for only $3.59 billion 
in notional transactions in 2011, reflecting less than 0.1 percent 
of the $11.18 trillion total for those 28 market participants. See 
CDS Data Analysis at table 3c.
    The other criteria set forth in the analysis for identifying 
possible dealing activity in general similarly indicate that 
entities with notional transactions in excess of $3 billion in 2011 
account for more than 99 percent of the total notional transactions 
of all identified entities in 2011. See id. at tables 2a-c, 3a-b, 4, 
5, 7 and 8. While the criterion based on the posting of initial 
margin only indicates 98 percent coverage for all of the 473 
identified entities, see id. at table 6, as discussed above we 
believe it is appropriate to provide less weight to that criterion, 
which is based on voluntary reporting.
    As noted above, see note 478, supra, we recognize that the 
underlying market data encompasses all of the security-based swap 
activity of persons identified as dealers, not only their dealing 
activity. Because the thresholds that implement the de minimis 
exception address only a person's dealing activity, this raises the 
possibility that the analysis overstates the extent to which a $3 
billion threshold would encompass persons responsible for dealing 
activity within the single-name security-based swap market. Even 
with that possibility, however, we believe that the data indicates 
such a high concentration of dealing activity within the market that 
it is reasonable to conclude that a $3 billion threshold likely 
would encompass persons responsible for the vast majority of dealing 
activity within the market.
---------------------------------------------------------------------------

    In providing for a $3 billion notional threshold, we also recognize 
the threshold would permit an unregistered dealer annually to engage in 
up to 600 security-based swaps (as opposed to 20 transactions under the 
proposed threshold, assuming a $5 million average notional size). In 
this regard, we note that Congress, in another statutory de minimis 
exception within the Exchange Act, determined that 500 securities 
transactions annually constituted a de minimis amount of transactions 
for banks under the ``broker'' definition.\503\ We further believe that 
a $3 billion threshold appropriately addresses commenter concerns 
regarding the de minimis exception being unduly narrow.\504\
---------------------------------------------------------------------------

    \503\ See Exchange Act section 3(a)(4)(B)(xi); see also letter 
from SIFMA--Regional Dealers (supporting a threshold of 500 trades 
consistent with the statutory de minimis exception in connection 
with bank brokerage activity).
    \504\ For example, $3 billion is equal to the threshold 
suggested by many commenters in the context of the swap market, 
which is much larger than the security-based swap market. See letter 
from COPE (supporting a 0.001 percent notional threshold based on 
the overall swaps market, which would amount to $3 billion). Indeed, 
this $3 billion threshold appears to reflect roughly 0.024 percent 
of the overall market for single-name credit default swaps, a 
percentage that is much greater than the 0.001 percent multiplier 
that a number of commenters (see, e.g., letters cited in note 382, 
supra) suggested in the swap market context. See CDS Data Analysis 
at table 1 (indicating that participants in the single-name credit 
default swap market engage in a total of $12.6 trillion in single-
name credit default swap transactions in 2011).
---------------------------------------------------------------------------

    In adopting this $3 billion threshold, we have carefully considered 
one commenter's view that the CDS Data Analysis suggests that the 
proposed $100 million threshold in fact is too high, and that any 
increase in that proposed $100 million threshold would be arbitrary and 
capricious.\505\ In reaching these conclusions, the commenter focused 
on the number of entities that potentially are engaged in dealing 
activity but that could be excluded based on particular de minimis 
thresholds. For example, the commenter indicated that pursuant to one 
of the CDS Data Analysis's combined metrics for identifying dealing 
activity, a de minimis threshold of $3 billion could lead to the 
exclusion of up to 58 percent of all persons engaged in possible 
dealing activity. The commenter further suggested that some entities 
engaged in dealing activity may reduce their activities to take 
advantage of the de minimis exception and hence reduce liquidity, and 
argued that there would be no basis for the exception to be based on a 
market participant's percentage of total security-based swap 
activity.\506\
---------------------------------------------------------------------------

    \505\ See letter from Better Markets III.
    \506\ The letter also raised issues regarding the ``customer'' 
language of the exception and argued that the de minimis exception 
should not represent a risk-based test. We address those issues 
elsewhere. See parts II.D.3.c (regarding ``customer'' language) and 
II.D.3.e (regarding rejection of risk-based and proportionality 
tests), infra.
    In addition, the letter expressed the view that a percentage-
based formula would be difficult to implement, by requiring market 
participants to repeatedly calculate the ratio of their activity to 
total market activity. We concur. The $3 billion threshold we are 
adopting reflects a fixed dollar amount, and does not share the 
complications that would arise from an approach based on a 
particular percentage of the market.
---------------------------------------------------------------------------

    It is important to recognize that while the commenter focused on 
the number of entities that might be excluded pursuant to the 
exception, and suggested that higher notional dollar amount thresholds 
could lead to the exclusion of a larger number of entities, the 
statutory provision for the de minimis exception does not require the 
exemption of a ``de minimis number'' of dealers. The statute instead 
requires the exemption of persons engaged in a ``de minimis quantity'' 
of dealing activity.\507\ The statutory language therefore indicates 
that the focus of the rule implementing the exception should be the 
amount of an entity's dealing activity, not how many entities 
ultimately may be able to take advantage of the exception.
---------------------------------------------------------------------------

    \507\ See Exchange Act section 3(a)(71)(D).
---------------------------------------------------------------------------

    Also, although the commenter implied that there would be no basis 
for the rule implementing the exception to take into account a market 
participant's security-based swap dealing activity compared to total 
dealing activity in the market, for the reasons discussed in this 
section we believe that such an approach can appropriately provide for 
the regulatory coverage of the vast majority of dealing activity in a 
way that promotes regulatory efficiency, without leading to unwarranted 
regulatory gaps. In contrast, in our view the commenter did not 
persuasively articulate a strong rationale for adopting the alternative 
approach proposed in the letter, which would appear to lead to the 
registration of a number of dealers that proportionately engage in a 
very small amount of dealing activity.\508\
---------------------------------------------------------------------------

    \508\ The commenter correctly pointed out that the regulatory 
requirements applicable to registered dealers encompass counterparty 
protection requirements, and that the de minimis exception should 
not defeat those requirements. We recognize that the implementation 
of the exception should take those counterparty protections into 
account, and we have sought to do so. We do not believe, however, 
that those important counterparty protection goals require a de 
minimis approach that focuses on the number of entities that would 
be excluded, in lieu of the statutory focus on whether a particular 
entity engages in a de minimis quantity of dealing activity.
---------------------------------------------------------------------------

    In support of its approach, the commenter emphasized data regarding 
persons who meet certain combined criteria outlined in the CDS Data

[[Page 30640]]

Analysis. As discussed above, we believe that criteria based on the 
number of an entity's counterparties that are not recognized as dealers 
deserve special weight due to the potential consistency of those 
criteria with the dealer-trader distinction.\509\ Identifying dealer 
activity using those criteria does not support the view that a $3 
billion threshold would lead to the exclusion of a large number of 
entities engaged in dealing activity.\510\
---------------------------------------------------------------------------

    \509\ See notes 478, 482, and 483, supra.
    \510\ For example, the CDS Data Analysis identifies:
     Three possible dealers with notional transactions below 
$3 billion in 2011--out of a total of 28 possible dealers--when 
possible dealing activity is based on having three or more 
counterparties that themselves are not identified as dealers;
     One possible dealer with notional transactions below $3 
billion in 2011- out of a total of 20 possible dealers--when 
possible dealing activity is based on having five or more 
counterparties that themselves are not identified as dealers; and
     Zero possible dealers with notional transactions below 
$3 billion in 2011--out of a total of 16 possible dealers--when 
possible dealing activity is based on having seven or more 
counterparties that themselves are not identified as dealers.
    See CDS Data analysis at tables 3c, 3b and 3a.
    In addition, as described above, an approach focused on the 
quantity of activity is supported by relatively consistent results 
depending on which criterion from the CDS Data Analysis is applied--
i.e., each criterion shows a high amount of concentration and a 
commensurately low quantity of activity below the $3 billion 
threshold. By contrast, applying different criteria results in very 
different numbers of entities excluded under any specified 
threshold, suggesting that an approach focused on the number of 
entities may be highly dependent on how the possible dealing 
activity of those entities is defined.
---------------------------------------------------------------------------

    Finally, we also are not persuaded by the commenter's suggestion 
that a number of entities engaged in dealing activity would reduce 
those activities to take advantage of a $3 billion de minimis 
threshold, and hence reduce liquidity in the market by five percent. To 
reach that figure, the commenter needed to exclude the vast majority of 
dealing activity in the market.\511\ While we recognize that it is 
possible that current market participants may adjust their dealing 
activity in light of the de minimis threshold, and that this 
potentially could reduce the liquidity provided by certain entities, we 
also recognize that the de minimis exception has the potential to 
promote liquidity by facilitating new entrants into the market.
---------------------------------------------------------------------------

    \511\ In particular, in arguing that this incentive would reduce 
liquidity by five percent, the commenter excluded all business done 
by entities within the top two brackets (i.e., above $100 billion 
notional), on the grounds that those entities ``are assumed to 
transact mostly with larger entities.'' Based on the criteria on 
which the commenter relied, those 15 entities are responsible for 
over 96 percent of the activity of all possible dealers. See CDS 
Data Analysis at tables 7 and 8. Absent that exclusion, the 
estimated reduction of liquidity would amount to a small fraction of 
a percent.
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ii. Phase-in Period in Connection With Dealing Activity Involving 
Credit Default Swaps That Constitute Security-Based Swaps
    The final rules further provide that persons with notional dealing 
activity of $8 billion or less over the prior 12 months involving 
credit default swaps that constitute security-based swaps would be able 
to avail themselves of a phase-in period.\512\ Those persons would not 
be subject to the generally applicable compliance date that occurs no 
later than 60 days following publication of these final rules in the 
Federal Register.\513\
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    \512\ Exchange Act rule 3a71-2(a)(2).
    \513\ Even with the general 60 day compliance period, however, 
market participants will not necessarily be security-based swap 
dealers at the end of 60 days. In particular, for the first year 
following the effective date of the final rules implementing the 
definition of ``security-based swap'' pursuant to the Exchange Act 
section 3(a)(68), the de minimis analysis would only address 
security-based swap dealing activity following that effective date. 
See Exchange Act rule 3a71-2(a)(1). Among other things, this means 
that until the rules defining ``security-based swap'' are effective, 
no market participants would be deemed to be security-based swap 
dealers.
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    The use of a phase-in period--in connection with a person's status 
as a security-based swap dealer and in connection with the other 
regulatory requirements that are appurtenant to dealer status--is 
intended to facilitate the orderly implementation of Title VII. In 
addition, the phase-in period will afford the SEC additional time to 
study the security-based swap market as it evolves in the new 
regulatory framework and will allow potential dealers that engage in 
smaller amounts of activity (relative to the current size of the 
market) additional time to adjust their business practices, while at 
the same time preserving the focus of the regulation on the largest and 
most significant dealers. The SEC also recognizes that the data 
informing its current view of the de minimis threshold is based on the 
market as it exists today, and that the market will evolve over the 
coming years in light of the new regulatory framework and other 
developments.
    Accordingly, while the SEC believes that a $3 billion notional 
threshold reflects an appropriate long-term standard based on the 
currently available data,\514\ it also is appropriate to provide for a 
phase-in period for those entities with $8 billion or less in dealing 
activity, because subsequent developments in the market or the 
evaluation of new data from the security-based swap reporting 
facilities contemplated by the Dodd-Frank Act may suggest that the 
threshold should be increased or decreased. In particular, the 
implementation of security-based swap data reporting under the Dodd-
Frank Act will result in significant new data and afford an opportunity 
to review the Commission's determination to establish a $3 billion 
threshold.
---------------------------------------------------------------------------

    \514\ See note 502, supra.
---------------------------------------------------------------------------

    For these reasons, an important part of the report that the SEC is 
directing its staff conduct with regard to the definitions of 
``security-based swap dealer'' and ``major security-based swap 
participant'' (described in detail below) will be a consideration of 
the operation of the de minimis exception following the full 
implementation of Section 15F under Title VII.\515\ The SEC will take 
into account this report, along with public comment on the report, in 
determining whether to propose any changes to the rule implementing the 
de minimis exception, including any increases or decreases to the $3 
billion threshold. The report will be linked to the availability of 
data regarding the activity of regulated security-based swap market 
participants in that it must be completed no later than three years 
\516\ following a ``data collection initiation date'' that is the later 
of: the last compliance date for the registration and regulatory 
requirements for security-based swap dealers and major security-based 
swap participants under Section 15F of the Exchange Act; or the first 
date on which compliance with the trade-by-trade reporting rules for 
credit-related and equity-related security-based swaps to a registered 
security-based swap data repository is required.\517\
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    \515\ See Exchange Act rule 3a71-2A(a)(1); see also part V, 
infra.
    \516\ See Exchange Act rule 3a71-2A(b).
    \517\ The SEC will announce the data collection initiation date 
on its Web site and publish it in the Federal Register. See Exchange 
Act rule 3a71-1(a)(2)(iii).
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    In light of the available data--and the limitations of that data in 
predicting how the full implementation of Title VII will affect dealing 
activity in the security-based swap market--the SEC believes that $8 
billion constitutes an appropriate level for the availability of the 
phase-in period. The available data indicate that such a level 
generally comports with the balance of interests that informed the 
determination of the appropriate long-term threshold of $3 billion 
described above. In particular, the $8 billion level should still lead 
to the regulation of persons responsible for the vast majority of 
dealing activity

[[Page 30641]]

within the market.\518\ In addition, we do not believe that providing a 
phase-in period for persons with notional dealing activity over the 
prior 12 months of less than $8 billion would lead to a risk of an 
undue portion of the market falling outside of the ambit of dealer 
regulation, even after considering the potential entry of unregulated 
new dealers into the market.\519\
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    \518\ Of the 28 market participants that have three or more 
security-based swap counterparties that themselves are not 
recognized by dealers by ISDA, 23 had notional single-name credit 
default swap transactions in excess of $8 billion in 2011. The 
remaining five entities in total accounted for only $12.3 billion in 
notional transactions in 2011, reflecting roughly 0.1 percent of the 
$11.18 total for the 28 market participants. See CDS Data Analysis 
at table 3c. Only two of the 28 entities identified as possible 
dealers by that criterion had annual notional transactions between 
$3 billion and $8 billion in 2011.
    Most of the other criteria set forth in the analysis for 
identifying possible dealing activity in general similarly indicate 
that entities with notional transactions in excess of $8 billion in 
2011 account for more than 99 percent of the total notional 
transactions of all identified entities that year. See id. at tables 
2a-b, 3a-b, 4 and 5. While the criterion based on an entity having 
10 or more counterparties only indicates 98 percent coverage for all 
of the 154 identified entities at an $8 billion transaction level, 
see id. at table 2c, as noted above this criterion may identify 
persons who in reality are not engaged in dealing activity. See note 
482, supra. Also, while the criterion based on the posting of 
initial margin only indicates 97 percent coverage for all of the 473 
identified entities at an $8 billion transaction level, see id. at 
table 6, as discussed above that criterion is based on voluntary 
reporting.
    \519\ For example, 15 new dealer entrants up to $8 billion in 
annual notional dealing activity would account for $120 billion in 
dealing activity. This would amount to roughly 1.2 percent of the 
total notional single-name security-based swap activity over 12 
months of entities identified as possible dealers by virtue of 
having three or more counterparties that are not recognized by 
dealers by ISDA. See CDS Data Analysis at table 2c.
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    The final rule provides that the phase-in period will continue 
until the ``phase-in termination date'' that the SEC will publish on 
its Web site and in the Federal Register.\520\ In particular, the rule 
provides that nine months following publication of that report, and 
after giving due consideration of the report and associated public 
comment, the SEC may either: (1) Terminate the phase-in period and by 
order establish and publish the phase-in termination date; or (2) 
determine that it is necessary or appropriate in the public interest to 
propose an alternative de minimis threshold, in which case the SEC, by 
order published in the Federal Register, will provide notice of that 
determination and establish the phase-in termination date.\521\ If the 
SEC does not establish the phase-in termination date in either of those 
ways, the phase-in termination date shall automatically occur in any 
event on what would be a date certain, which will be five years 
following the data collection initiation date.\522\
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    \520\ Exchange Act rule 3a71-2(a)(2)(i).
    \521\ Exchange Act rule 3a71-2(a)(2)(iii)(A).
    \522\ Exchange Act rule 3a71-2(a)(2)(iii)(B).
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    These provisions should allow sufficient time for the staff to 
complete its report, for the SEC to receive and review public comment 
on the report, and for the SEC to draw conclusions regarding 
establishing the phase-in termination date or proposing potential 
changes to the rule implementing the de minimis exception, in a way 
that also promotes the orderly and predictable termination of the 
phase-in period.\523\
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    \523\ This approach balances the fact that the SEC believes that 
its $3 billion and $150 million de minimis thresholds are 
appropriate in light of the currently available data and the 
market's need for a degree of certainty as to the length of this 
phase-in period, on the one hand, against the possibility that the 
staff report and the accompanying public comment may demonstrate 
that revision to these thresholds is necessary, on the other hand.
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    This phase-in period will not be available in connection with the 
$25 million threshold for dealing activity involving special entities, 
discussed below. In addition, the final rule provides that this phase-
in period will not be available in connection with security-based swap 
dealing activities involving natural persons, other than natural 
persons who qualify as ECPs by virtue of CEA section 1a(18)(A)(xi)(II), 
which addresses natural persons who have $5 million or more invested on 
a discretionary basis and who enter into a security-based swap to 
manage the risk associated with their assets and liabilities.\524\ 
These limitations to the availability of the phase-in period are 
consistent with the Dodd-Frank Act's goal of helping special entities 
be in a position to benefit from the counterparty protections 
associated with the regulation of registered security-based swap 
dealers under Title VII, as well as the SEC's mandate to protect 
participants in the securities markets.
---------------------------------------------------------------------------

    \524\ See Exchange Act rule 3a71-2(a)(2)(i). In other words, the 
phase-in period will still be available in connection with dealing 
activities with natural persons who are ECPs because they have 
entered into a security-based swap for hedging purposes. While we 
recognize the importance of Title VII protections to natural persons 
who engage in security-based swap activity, we also recognize the 
benefit of facilitating such persons' use of security-based swaps as 
hedges. Accordingly, persons who engage in dealing activity with 
natural persons who are ECPs under other provisions of the ECP 
definition will be subject to the applicable de minimis threshold 
for all of their dealing activity, without the availability of the 
phase-in period.
    Persons who engage in dealing activity with natural persons who 
are not ECPs will fall within the Exchange Act definition of 
``dealer,'' which has no de minimis exception. See Exchange Act 
section 3(a)(5)(A) (generally excluding dealers in security-based 
swaps from the Exchange Act definition of ``dealer,'' unless the 
counterparty is not an ECP).
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    Persons who are able to avail themselves of the phase-in period, of 
course, will not be required to do so. Any person that chooses to 
register with the SEC as a security-based swap dealer shall be deemed 
to be a security-based swap dealer subject to all applicable regulatory 
requirements for such registrants, regardless of whether the person 
engages in security-based swap dealing activity in an amount that is 
below the applicable de minimis threshold or phase-in level.\525\
---------------------------------------------------------------------------

    \525\ See Exchange Act rule 3a71-2(e).
---------------------------------------------------------------------------

d. Balancing Reflected in the Final Rules--Other Types of Security-
Based Swaps
    The final rule provides that the de minimis exception for dealing 
activity involving security-based swaps other than credit default swaps 
will be based on a threshold of $150 million notional over the prior 12 
months.\526\ In addition, a phase-in period will be available in 
connection with persons whose dealing activity involving those 
instruments is $400 million or less in notional amount over the prior 
12 months.
---------------------------------------------------------------------------

    \526\ Exchange Act rule 3a71-2(a)(1)(ii). The proposal requested 
comment on whether different segments of the security-based swap 
market should be treated differently. See Proposing Release at 80101 
(``Commenters further are requested to address * * * whether the [de 
minimis] exemption's factors should vary depending on the type of 
swap or security-based swap at issue.'').
---------------------------------------------------------------------------

    These amounts reflect roughly one-twentieth of the corresponding 
amounts associated with the exception for credit default swaps that 
constitute security-based swaps. As discussed above, while less data is 
available regarding other types of security-based swaps than is 
available regarding single-name credit default swaps, the available 
data is consistent in indicating that those other types of security-
based swaps on a notional basis currently comprise roughly one-
twentieth of the total amount of instruments that will be expected to 
constitute security-based swaps.\527\ In light of this significantly 
smaller market, we believe that a $3 billion notional threshold would 
threaten to cause an overly large portion of dealing activity within 
the market to fall outside the ambit of dealer regulation.
---------------------------------------------------------------------------

    \527\ See note 476, supra.
---------------------------------------------------------------------------

    In this regard, we note that it is likely that there are fewer 
barriers to entry in connection with acting as a dealer in security-
based swaps such as equity swaps and total return swaps on debt than 
there are in connection with acting as a dealer in single-name credit 
default

[[Page 30642]]

swaps.\528\ We also note that because equity swaps and total return 
swaps on debt can serve as close economic proxies for equity and debt 
securities, an overly broad de minimis threshold in connection with 
such instruments could threaten to undermine the Exchange Act framework 
for regulating persons who act as dealers in equity and debt.
---------------------------------------------------------------------------

    \528\ For example, persons registered with the SEC as broker-
dealers in connection with other types of securities would appear to 
be well positioned to act as dealers in connection with equity 
swaps, as such broker-dealers already would be expected to have 
systems in place to enter into equity positions to hedge their 
equity swap dealing positions.
---------------------------------------------------------------------------

    At the same time--notwithstanding the smaller scope of this market 
and the lesser availability of data regarding dealing activity within 
the market--we do not believe that it is necessary to make the de 
minimis exception unavailable in connection with dealing activity 
involving security-based swaps that are not credit default swaps. In 
this regard we particularly note that the limited available data 
regarding equity swaps suggests a high degree of concentration in 
dealing activity involving those instruments,\529\ which indicates that 
an appropriately sized de minimis threshold can be expected to promote 
regulatory efficiency.
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    \529\ As noted above, four commercial banks and trust companies 
accounted for 93 percent of all equity positions held by such 
companies as of June 30, 2011, and nine bank holding companies 
accounted for over 99 percent of all equity positions held by the 
fifty largest such companies as of December 2011. See note 485, 
supra.
---------------------------------------------------------------------------

    Balancing those factors, we conclude that a $150 million annual 
notional threshold is appropriate to implement the de minimis exception 
in connection with security-based swaps that are not credit default 
swaps, consistent with our understanding of the comparative size of 
that market as applied to the threshold applicable to credit default 
swap dealing activity. For reasons similar to those described above, we 
conclude that there should be a phase-in period available to persons 
whose annual notional dealing activity in connection with security-
based swaps that are not credit default swaps is no more than $400 
million in annual 12-month notional amount. This phase-in period is 
subject to the same limitations regarding transactions involving 
special entities and natural persons as apply to the phase-in period 
for credit default swaps. It also will be subject to the same 
provisions regarding the termination of the phase-in period as apply in 
connection with credit default swaps.\530\ The comparative lack of data 
involving these markets--in contrast to the market for single-name 
credit default swaps--particularly highlights how the use of a phase-in 
period that is linked to the availability of post-implementation data 
is appropriate.\531\
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    \530\ See Exchange Act rule 3a71-2(a)(2); see also notes 520 
through 522, supra, and accompanying text.
    \531\ The SEC expects that the staff report should be especially 
helpful for providing data regarding dealing activity in connection 
with those other types of security-based swaps to consider the 
impact of the termination of the phase-in period, as well as 
potential changes to the de minimis exception in connection with 
these instruments.
---------------------------------------------------------------------------

    As above, a person who is eligible to take advantage of the phase-
in period in connection with these types of security-based swaps may 
nonetheless register as a security-based swap dealer.
e. Dealing Activity Involving Special Entities
    Consistent with the proposal, the final rules in general will cap 
an entity's dealing activity involving security-based swaps at no more 
than $25 million notional amount over the prior 12 months when the 
counterparty to the security-based swap is a special entity.\532\ There 
will be no phase-in period in connection with transactions involving 
special entities. In adopting this threshold, we recognize the serious 
concerns raised by commenters that stated that the de minimis exception 
should not permit any dealing activities involving special entities in 
light of losses that special entities have incurred in the financial 
markets,\533\ as well as the special protection that Title VII affords 
special entities.\534\
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    \532\ Exchange Act rule 3a71-2(a)(1)(iii).
    \533\ See letters from AFR and Better Markets I.
    \534\ In this regard we note that Title VII authorizes the SEC 
to impose special business conduct requirements when a security-
based swap dealer is counterparty to a special entity. See Exchange 
Act section 15F(h)(5). In proposing rules to implement these 
requirements, the SEC requested comment regarding the scope of the 
``special entity'' definition, including, for example, regarding 
whether the SEC should interpret ``special entity'' to exclude a 
collective investment vehicle in which one or more special entities 
have invested. See Exchange Act Release No. 64766 (June 29, 2011), 
76 FR 42396, 42422 (July 18, 2011). For purposes of interpreting 
this special entity threshold to the de minimis exception--
particularly with regard to when a special entity would be a 
counterparty to a person that is engaged in dealing activity--the 
SEC believes that it will be appropriate to be guided by final 
interpretations regarding when a dealer will be a counterparty to a 
special entity for purposes of those business conduct requirements.
---------------------------------------------------------------------------

    At this time, the final rule does not fully exclude such dealing 
activity from the exception, in light of the potential benefits that 
may arise from a de minimis exception. In this way, the threshold would 
not completely foreclose the availability of security-based swaps to 
special entities from unregistered dealers--as $25 million would 
annually accommodate up to five single-name credit default swaps of a 
$5 million notional size--but the threshold would limit the financial 
and other risks associated with those positions for a special entity, 
which would in turn limit the possibility of inappropriately 
undermining the special protections that Title VII provides to special 
entities.
    In reaching this conclusion we recognize that special entities do 
participate in the single-name credit default swap market, given that 
an analysis of market data indicates that in 2011 special entities were 
parties to over $40 billion in single-name credit default swap 
transactions.\535\ At the same time, the impact of this $25 million 
threshold--particularly concerns that the threshold may foreclose the 
ability of special entities to access dealers in the market--appears to 
be mitigated by the fact that the counterparties to those special 
entities tend to engage in notional transactions in single-name credit 
default swap well in excess of the general de minimis standards.\536\ 
In light of the underlying counterparty protection issues, we see no 
basis to distinguish between types of security-based swaps in setting 
this special entity threshold.
---------------------------------------------------------------------------

    \535\ See CDS Data Analysis at table 9.
    \536\ See id. at n.8 (noting that the average notional activity 
of those 16 counterparties was $680 billion, with the lowest being 
approximately $9 billion).
---------------------------------------------------------------------------

    For similar reasons, in the future as we consider whether to amend 
the de minimis exception we expect to pay particular attention to 
whether the threshold for transactions involving special entities 
should further be lowered.
f. Future Revisions to the Rule
    As noted above and described in detail below in part V, the SEC is 
directing its staff to report on whether changes are warranted to the 
rules and interpretations implementing the security-based swap dealer 
definition, including the rule implementing the de minimis 
exception.\537\ The SEC will take the report and associated public 
comment into account in determining whether to propose any changes to 
the rule implementing the exception.\538\ Consistent with that 
possibility, the final rule provides that the SEC may change the 
requirements of the de minimis exception by rule or regulation.\539\ 
Through this mechanism,

[[Page 30643]]

the SEC may revisit the rule implementing the exception and potentially 
change that rule, for example, if data regarding the security-based 
swap market following the implementation of Section 15F under Title VII 
suggests that different de minimis thresholds would be 
appropriate.\540\ In determining whether to revisit the thresholds, the 
SEC intends to pay particular attention to whether the de minimis 
exception results in a dealer definition that encompasses too many 
entities whose activities are not significant enough to warrant full 
regulation under Title VII, or, alternatively, whether the de minimis 
exception leads an undue amount of dealing activity to fall outside of 
the ambit of the Title VII regulatory framework, or leads to 
inappropriate reductions in counterparty protections (including 
protections for special entities). The SEC also intends to pay 
particular attention to whether alternative approaches would more 
effectively promote the regulatory goals that may be associated with a 
de minimis exception.
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    \537\ See Exchange Act rule 3a71-2A(a)(1).
    \538\ See notes 520 through 522, supra, and accompanying text.
    \539\ Exchange Act rule 3a71-2(d). Exchange Act section 
3(a)(71)(D) particularly states that the ``Commission''--meaning the 
SEC--may exempt de minimis dealers and promulgate related 
regulations. We do not interpret the joint rulemaking provisions of 
section 712(d) of the Dodd-Frank Act to require joint rulemaking 
here, because such an interpretation would read the term 
``Commission'' out of Exchange Act section 3(a)(71)(D), which itself 
was added by the Dodd-Frank Act.
    \540\ See letter from Greenberger (stating that the dynamic 
nature of the derivatives sector of the financial markets should 
counsel caution, and that the de minimis threshold should be 
reevaluated on an ongoing basis).
---------------------------------------------------------------------------

6. Registration Period for Entities That Exceed the De Minimis Factors
    The de minimis exception raises implementation issues akin to those 
associated with the major participant definition, in that both 
provisions use tests that have retrospective elements to determine 
whether an entity must register and be subject to future regulation. As 
a result, some commenters have suggested that entities that surpass the 
de minimis thresholds should be able to take advantage of a grace 
period to undertake the process of registering as swap dealers or 
security-based swap dealers.\541\ Otherwise, absent such a ``roll-in'' 
period, entities whose dealing activities surpass the relevant de 
minimis factors would immediately be in violation of dealer 
registration requirements. In light of these concerns, and the interest 
of avoiding undue market disruptions, the Commissions believe that it 
is appropriate to provide entities that exceed applicable the de 
minimis factors a period of time to register as dealers.
---------------------------------------------------------------------------

    \541\ See letters from Northland Energy and WGCEF I.
---------------------------------------------------------------------------

    Accordingly, the final rules have been revised from the proposal to 
provide for a timing standard that is similar to what we are using in 
connection with the major participant definition.\542\ That is, if an 
entity that has relied on the de minimis exception no longer is able to 
rely on the exception because its dealing activity exceeds a relevant 
threshold, the entity would have two months, following the end of the 
month in which it no longer is able to take advantage of the exception, 
to submit a completed application to register as a swap dealer or 
security-based swap dealer.\543\
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    \542\ Compare CFTC Regulation Sec.  1.3(hhh)(3); Exchange Act 
rule 3a67-8(a) (providing that persons who meet the criteria to be 
major participants will have two months to submit a completed 
registration application).
    \543\ See CFTC Regulation Sec.  1.3(ggg)(4)(ii); Exchange Act 
rule 3a71-2(b). As discussed below with regard to the implementation 
period for the major participant definitions, persons will have 
additional time to comply with the applicable requirements following 
the submission of a completed application. See part IV.L.3, infra.
---------------------------------------------------------------------------

    Also, akin to the major participant definitions,\544\ a person 
registered as a swap dealer or security-based swap dealer may apply to 
withdraw that registration, while continuing to engage in a limited 
amount of dealing activity in reliance on the de minimis exception, if 
that person has been registered as a dealer for at least 12 
months.\545\ This should help ensure that persons do not rapidly move 
in and out of dealer status based on short-term fluctuations in their 
swap or security-based swap activities.
---------------------------------------------------------------------------

    \544\ Compare CFTC Regulation Sec.  1.3(hhh)(5); Exchange Act 
rule 3a67-8(c) (providing that a major participant may be deemed to 
no longer be a major participant if its swap or security-based swap 
positions are below the relevant thresholds for four quarters).
    \545\ See CFTC Regulation Sec.  1.3(ggg)(4)(ii); Exchange Act 
rule 3a71-2(c). Consistent with this approach, moreover, the final 
rule has been revised from the proposal to clarify that the de 
minimis exception in general is not available to a registered swap 
dealer or security-based swap dealer. See CFTC Regulation Sec.  
1.3(hhh)(1)(i); Exchange Act rule 3a71-2(a)(1) (revised language 
clarifying availability of exception to a person that is not a swap 
dealer or security-based swap dealer).
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    The final rules implementing the de minimis exception do not 
provide any reevaluation period for entities that engage in a level of 
dealing activity above the de minimis thresholds, in contrast to the 
major participant definitions.\546\ We do not believe that there is an 
appropriate basis for such a provision, particularly given that dealer 
regulation addresses customer protection and market operation and 
transparency concerns apart from risk concerns.
---------------------------------------------------------------------------

    \546\ Compare CFTC Regulation Sec.  1.3(hhh)(4); Exchange Act 
rule 3a67-8(b) (providing for a reevaluation period in connection 
with the major participant definitions when a person does not exceed 
any applicable threshold by more than 20 percent in a calendar 
quarter).
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E. Limited Purpose Designation as a Dealer

1. Proposed Approach
    The definitions of the terms ``swap dealer'' and ``security-based 
swap dealer'' provide that the Commissions may designate a person as a 
dealer for one type, class or category of swap or security-based swap, 
or specified swap or security-based swap activities, without the person 
being considered a dealer for other types, classes, categories or 
activities.\547\
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    \547\ CEA section 1a(49)(B); Exchange Act section 3(a)(71)(B).
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    In the Proposing Release, we noted that these provisions represent 
permissive grants of authority that do not require the Commissions to 
provide limited designations.\548\ We further stated that a person that 
is covered by the definitions of the terms ``swap dealer'' or 
``security-based swap dealer'' would be considered a dealer for all 
types, classes or categories of the person's swaps or security-based 
swaps, or activities involving swaps or security-based swaps, in light 
of the difficulty of seeking to separate a person's dealing activities 
from their non-dealing activities involving swaps or security-based 
swaps, unless such person sought and received designation as a dealer 
for only specified categories of swaps or security-based swaps, or 
specified activities.\549\ We explained that this would provide persons 
the opportunity to seek a limited designation based on applicable facts 
and circumstances, and that we anticipated that a dealer could seek a 
limited designation at the time of its initial registration or 
later.\550\
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    \548\ See Proposing Release, 75 FR at 80182.
    \549\ See id.; see also proposed CFTC Regulation Sec.  
1.3(ggg)(3); proposed Exchange Act rule 3a71-1(c).
    \550\ See Proposing Release, 75 FR at 80182.
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    In the Proposing Release, the CFTC further noted that non-financial 
entities such as physical commodity firms potentially may conduct 
dealing activity through a division rather than through a separately 
incorporated subsidiary, and that such an entity's swap dealing 
activity would not be a core component of its overall business. The 
CFTC added that if this type of entity registered as a dealer, certain 
swap dealer requirements would apply to the dealing activities of the 
division, but not necessarily to the swap activities of other parts of 
the entity.\551\
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    \551\ See id.

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[[Page 30644]]

2. Commenters' Views
    A number of commenters addressed the limited designation of dealers 
in conjunction with the limited designation of major participants. Many 
of the issues those commenters raised thus are relevant to both sets of 
definitions.
a. Presumption of Full Designation
    A number of commenters objected to the proposed presumption that an 
entity would be designated as a dealer (or major participant) for all 
categories of swaps or security-based swaps and all of the person's 
activities connected to swaps or security-based swaps. Several 
commenters argued that this approach would be contrary to Congressional 
intent,\552\ conflict with the statutory language,\553\ or conflict 
with underlying policy concerns.\554\ One commenter suggested that the 
Commissions lack the statutory authority to apply swap dealer 
requirements to an entity's non-swap dealing activities.\555\
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    \552\ See letters from Cargill Incorporated (``Cargill''), CDEU 
and Investment Company Institute (``ICI'') dated February 22, 2011 
(``ICI I'').
    \553\ See letters from MetLife and WGCEF I.
    \554\ See letter from Cargill (stating that limited designation 
promotes the policy of encouraging non-financial firms that 
primarily are engaged in non-dealing businesses to continue to 
conduct limited dealing activities, adding that such firms ``do not 
present the potential systemic risks of financial firms,'' and that 
their full designation as dealers would discourage them from 
providing risk management products).
    \555\ See letter from EDF Trading.
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b. Potential Types of Limited Designations
    A number of commenters addressed potential types of limited 
designations. One expressed support for limited swap dealer 
designations for particularized business units and for particular swap 
categories,\556\ while another requested that limited swap dealer 
designations be available based on any reasonable commercial 
groupings.\557\ Some commenters urged that limited dealer designations 
should be available for the branches or business units of foreign swap 
dealers and security-based swap dealers with U.S.-based customers or 
U.S. business lines.\558\
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    \556\ See letter from Capital One.
    \557\ See letters from NCGA/NGSA II (particularly referring to 
groupings based on individual physical commodities) and WGCEF dated 
June 9, 2011 (``WGCEF VII'') (limited designation should permit 
firms to structure organization of limited purpose registrans as 
appropriate in particular circumstances).
    \558\ See letters cited in note 148, supra.
---------------------------------------------------------------------------

c. Applications for Limited Designations
    A number of commenters addressed issues relating to the application 
process for limited designations. Some commenters supported the ability 
of a person to apply for limited designations at the time of initial 
registration,\559\ while one commenter sought clarification on how and 
when a person could apply for limited swap dealer status.\560\ Some 
commenters suggested that entities should be considered to have a 
provisional limited designation upon the filing of a completed 
application for limited dealer designation.\561\
---------------------------------------------------------------------------

    \559\ See letters from MFA I (specifically requesting that the 
rules provide that an entity can receive a limited purpose 
designation at the time of their initial registration) and FSR I.
    \560\ See letter from National Futures Association (``NFA'').
    \561\ See letters from Capital One, Farm Credit Council I and 
FHLB I.
---------------------------------------------------------------------------

    Some commenters requested further clarification as to what factors 
or criteria would be considered relevant to limited designation 
determinations.\562\ One commenter stated that non-financial companies 
should have a presumption of limited swap dealer designation under 
certain circumstances.\563\ Another commenter took the view that 
commercial firms should be able to determine whether to register a 
legal entity or a division as a dealer.\564\ One commenter suggested 
the analysis consider the complexity of an entity's dealing and non-
dealing activities, and further suggested that limited designations 
should automatically be available if an entity's dealing activities do 
not exceed 50 percent of its total swap activities.\565\ Commenters 
also raised issues related to how a person's status as a financial or a 
non-financial entity affects a person's eligibility for limited 
designations.\566\
---------------------------------------------------------------------------

    \562\ See letters from BG LNG I and ISDA I.
    \563\ See letter from Cargill (arguing that a firm should be 
presumptively entitled to limited swap dealer status if: it is a 
non-financial company; its non-dealing activities include (but need 
not be limited to) production, merchandising or processing of 
physical commodities; the firm's dealing activities take place in a 
separately identifiable division or business unit with separate 
management; and dealing revenues are less than 30 percent of the 
firm's total revenues in the firm's most recent fiscal year).
    \564\ See letter from WGCEF VII (stating that so long as a 
registered swap dealer bears the onus of demonstrating compliance 
with regulatory requirements, regulators ``should not dictate'' 
whether the firm registers a legal entity or a division as a dealer; 
also requesting guidance as to how applicable regulatory 
requirements may apply to a subdivision of a legal entity that 
registers as a dealer, and requesting a safe harbor from enforcement 
action when a decision to register only a particular desk or 
division as a dealer is made in good faith).
    \565\ See letter from Capital One.
    \566\ Compare letter from Capital One (stating that all market 
participants, including financial institutions, should be allowed to 
apply for limited swap dealer designations) with letter from Cargill 
(suggesting that an entity's status as a financial company should be 
relevant to limited dealer determinations).
---------------------------------------------------------------------------

d. Application of Regulatory Requirements to Limited Dealers
    Commenters also addressed issues related to the application of 
regulatory requirements to limited dealers. One commenter recommended 
that dealer regulatory requirements generally should apply only to a 
division undertaking limited dealing activities; that commenter further 
stated that capital requirements should be calculated based only on the 
activities of that division, while recognizing that capital must be 
held by the entity as a whole.\567\ Other commenters argued that 
capital and margin requirements should only be applied to an entity on 
a limited basis.\568\
---------------------------------------------------------------------------

    \567\ See letter from Cargill.
    \568\ See letter from FSR I (recommending that to the extent 
that capital requirements are tied to swap activity or exposures, 
that only activities or exposures in the designated category be 
reflected in the calculation).
---------------------------------------------------------------------------

e. Miscellaneous Issues
    One commenter recommended that non-financial entities that are 
deemed to be limited dealers (or major participants) be permitted to be 
treated as end-users for the aspects of their businesses that are not 
subject to the limited designation.\569\ The commenter further 
suggested that the swaps ``push-out'' rule requirements of section 716 
of the Dodd-Frank Act be interpreted so that an insured depository 
institution that is a limited purpose dealer would only have to push 
out the dealing portion of its swap business, and be allowed to retain 
the other aspects of its swaps business.\570\ One commenter requested 
clarification as to whether a person that is a limited purpose dealer 
in connection with one category of swap could be a major participant in 
connection with another category (in light of the statutory language 
excluding dealers from the major participant definitions).\571\
---------------------------------------------------------------------------

    \569\ See id. (recommending that the corporate treasurer of an 
entity with a limited designation as a swap dealer for ``other 
commodity swaps'' as a result of its energy derivatives activity be 
able to hedge the entity's interest rate and currency risk without 
being subject to the business conduct, reporting, recordkeeping or 
other rules applicable to dealers and major participants).
    \570\ See id.
    \571\ See letter from NFA. As discussed below, see 752, infra, a 
person who is designated as a dealer in connection with particular 
types of swaps or security-based swaps may be major participants 
with regard to other types.
---------------------------------------------------------------------------

3. Final Rules and General Principles
    Consistent with the proposal, the final rules retain the 
presumption that a

[[Page 30645]]

person who meets one of the dealer definitions will be deemed to be a 
dealer with regard to all of its swaps or security-based swaps 
activities, unless the CFTC or SEC exercises its authority to limit the 
person's designation as a dealer to specified categories of swaps or 
security-based swaps, or specified activities.\572\ As discussed in the 
Proposing Release, moreover, a person may apply for a limited 
designation when it submits a registration application, or at a later 
time.\573\ The final rules also contain a technical change from the 
proposed rules to clarify that limited designations may be based on a 
particular type, class or category of swap or security-based-swap.\574\
---------------------------------------------------------------------------

    \572\ CFTC RegulationSec.  1.3(ggg)(3); Exchange Act rule 3a71-
1(c).
    \573\ The SEC expects to address the process for submitting an 
application for limited designation as a security-based swap dealer, 
along with principles to be used by the SEC in analyzing such 
applications, as part of separate rulemakings.
    \574\ The rules particularly have been revised from the proposal 
to add ``type'' and ``class'' language to supplement the use of the 
term ``category.'' This change is consistent with the statutory 
language. In addition, the final rules related to limited 
designations for ``security-based swap dealers'' corrects an 
erroneous reference to major participant designation.
---------------------------------------------------------------------------

a. Default Presumption of Full Designation
    Consistent with the proposal, the final rules retain the standard 
that a person that satisfies the ``swap dealer'' or ``security-based 
swap dealer'' definition in general would be considered a dealer for 
all types, classes or categories of the person's swaps or security-
based swaps, or all activities involving swaps or security-based swaps.
    The Commissions are not persuaded by the suggestion that this 
presumption is inconsistent with the statute, legislative intent or 
underlying policy. Not only is the relevant statutory language written 
as a grant of authority rather than a specific mandate to designate 
certain entities as limited purpose dealers, but the presumption also 
reasonably reflects the difficulty of separating a dealer's dealing 
activities from its non-dealing activities, and the challenges of 
applying dealer regulatory requirements to only a portion of a dealer's 
swap or security-based swap activities.\575\
---------------------------------------------------------------------------

    \575\ This approach also is consistent with the treatment of 
dealers of other types of securities under the Exchange Act. When a 
person's securities activities cause them to be a ``dealer'' for 
purposes of the Exchange Act, the statutory requirements and 
regulations applicable to dealers will apply to all of that person's 
securities activities, regardless of whether particular activities 
would not have caused the entity to fall within the ``dealer'' 
definition. For example, Exchange Act section 15(c)(3)(A) prohibits 
brokers and dealers from engaging in certain securities-related 
activity in contravention of SEC-prescribed rules with respect to 
financial responsibility or related practices. This provision does 
not distinguish between those activities that cause a person to fall 
within the ``broker'' or ``dealer'' definitions, and other 
activities that themselves do not cause that person to be a broker 
or dealer. The SEC's authority extends to all securities activities 
by those brokers or dealers.
---------------------------------------------------------------------------

    We similarly are not persuaded by the view that the Commissions 
lack the authority to apply dealer regulation to non-dealing activities 
of a registered swap dealer or security-based swap dealer.\576\ Certain 
of the statutory requirements applicable to swap dealers and security-
based swap dealers--such as capital requirements--simply do not 
distinguish between a person's dealing activities and their non-dealing 
activities.\577\ In other words, absent a limited designation, the 
statutory requirements applicable to dealers address the regulation of 
all of a dealer's swap or security-based swap activities.\578\
---------------------------------------------------------------------------

    \576\ See letter from EDF Trading.
    \577\ See, e.g., CEA section 4s(e); Exchange Act section 15F(e).
    \578\ The substantive regulations applicable to dealers, of 
course, can account for the nature of a dealer's particular swap or 
security-based swap activities.
     The SEC also intends to address limited designation issues in 
the context of a separate release addressing the application of 
Title VII to non-U.S. entities.
---------------------------------------------------------------------------

b. Demonstration of Compliance With Dealer Requirements
    The Commissions will consider limited purpose applications on an 
individual basis through analysis of the unique circumstances of each 
applicant, given that the types of entities that engage in swap or 
security-based swap dealing are diverse and their organization and 
activities are varied.\579\
---------------------------------------------------------------------------

    \579\ Consistent with this approach, applications to limit a 
person's dealer designation to ``specified categories'' of swaps or 
security-based swaps (see CFTC Regulation Sec.  1.3(ggg)(3); 
Exchange Act rule 3a71-1(c)), would not be required to interpret the 
term ``category'' consistently with the use of that term in 
connection with the major participant definitions. CFTC Regulation 
Sec.  1.3(iii) and Exchange Act rule 3a67-2, defining the terms 
``major swap category'' and ``major security-based swap category,'' 
respectively, do not apply for this purpose.
---------------------------------------------------------------------------

    Regardless of the type of limited designation being requested, the 
Commissions will not designate a person as a limited purpose dealer 
unless it can demonstrate that it can fully comply with the 
requirements applicable to dealers.
    Certain of the statutory requirements applicable to dealers 
particularly focus on the entity's swap or security-based swap 
activities and positions. These include, among other aspects, 
requirements related to trading records, documentation and 
confirmations.\580\ An applicant for a limited purpose designation 
would have to demonstrate how it would satisfy those transaction-
specific requirements in the context of a limited designation.
---------------------------------------------------------------------------

    \580\ See, e.g., CEA section 4s(h)(3), Exchange Act section 
15F(h)(3) (business conduct standards, including disclosure 
requirements, for dealers); CEA section 4s(g), Exchange Act section 
15F(g) (daily trading record requirements for dealers); CEA section 
4s(i); Exchange Act section 15F(i) (documentation requirements for 
dealers).
---------------------------------------------------------------------------

    Other statutory requirements applicable to dealers particularly 
focus on the entity itself. These include requirements related to 
registration, capital, risk management, supervision, and chief 
compliance officers.\581\ Here too, an applicant for a limited purpose 
designation would have to demonstrate how it would satisfy those 
requirements in the context of limited designations.
---------------------------------------------------------------------------

    \581\ See, e.g., CEA section 4s(a)(1), Exchange Act section 
15F(a)(1) (registration requirements for dealers); CEA section 
4s(e), Exchange Act section 15F(e) (capital and margin requirements 
for dealers). The Dodd-Frank Act provides that in setting the 
capital requirements for swap dealers and security-based swap 
dealers (as well as major participants) that are subject to a 
limited designation, the Commissions and the prudential regulators 
must take into account the risks associated with other types, 
classes, or categories of swaps or security-based swaps engaged in, 
and the other swap or security-based swap activities conducted by, 
that person ``that are not otherwise subject to regulation 
applicable to that person by virtue of the status of the person'' as 
a dealer or major participant. See CEA section 4s(e)(2)(C); Exchange 
Act section 15F(e)(2)(C). In the case of a commercial agricultural 
or energy company that obtains a limited purpose designation for a 
particular business unit, the CFTC does not expect that this 
provision will generally require the limited purpose designee to 
calculate its required capital on the basis of swaps engaged in, or 
activities conducted by, other business units within the company, to 
the extent those swaps or activities do not generate risk beyond the 
agricultural or energy company's ordinary commercial line of 
business.
---------------------------------------------------------------------------

    A limited purpose designation might be appropriate, for example, 
where a commercial agricultural company is a dealer in swaps related to 
a thinly-traded commodity, such as a particular fertilizer, but is not 
a dealer in, and does not wish to be subject to the swap dealer 
requirements with respect to its swaps that relate to broadly-traded 
commodities like corn or wheat (or where, say, a commercial energy 
company is a dealer in swaps involving a commodity to be delivered at a 
particular location and does not wish to be subject to the swap dealer 
requirements for its swaps involving that commodity to be delivered at 
other locations, for which it is not a swap dealer). A limited 
designation might also be appropriate so that the swap dealer 
requirements do not apply to interest rate or currency swaps that the 
agricultural or energy company enters into in managing its financial 
risk.

[[Page 30646]]

    A limited purpose designee could be a particular business unit 
within a company. Additionally, a limited designation might be 
considered to ``split the desk'' by applying the swap dealer 
requirements solely to the designee's limited activities involving 
swaps not entered into for the purpose of hedging a physical position 
as defined in CFTC Regulation Sec.  1.3(ggg)(6)(iii). Any particular 
limited purpose application will be analyzed in light of the unique 
circumstances presented by the applicant.
    A key challenge that any applicant to a limited dealer designation 
will face is the need to demonstrate full compliance with the 
requirements that apply to the type, class or category of swap or 
security-based swap, or the activities involving swaps or security-
based swaps, that fall within the swap dealer designation.

III. Amendments to the Definition of Eligible Contract Participant

A. Background

    The Dodd-Frank Act makes it unlawful for a person that is not an 
eligible contract participant (``ECP'') to enter into a swap other than 
on, or subject to the rules of, a DCM.\582\ In addition, section 763(e) 
of the Dodd-Frank Act makes it unlawful for a person to effect a 
transaction in a security-based swap with or for a person that is not 
an ECP unless the transaction is effected on a national securities 
exchange registered with the SEC.\583\ Moreover, section 768(b) of the 
Dodd-Frank Act makes it unlawful for a person to offer to sell, offer 
to buy or purchase, or sell a security-based swap to a person that is 
not an ECP unless a registration statement under the Securities Act of 
1933 (``Securities Act'') \584\ is in effect with respect to that 
security-based swap.\585\ These provisions mean that persons can engage 
in neither swaps nor security-based swaps transactions with persons 
that are not ECPs on SEFs, on security-based SEFs, or on a bilateral, 
off-exchange basis.
---------------------------------------------------------------------------

    \582\ In particular, section 723(a)(2) of the Dodd-Frank Act 
adds new subsection (e) to CEA section 2 (7 U.S.C. 2(e)), providing 
that ``[i]t shall be unlawful for any person, other than an eligible 
contract participant, to enter into a swap unless the swap is 
entered into on, or subject to the rules of, a board of trade 
designated as a contract market under section 5.''
    \583\ In particular, section 763(e) of the Dodd-Frank Act adds 
paragraph (l) to Exchange Act section 6 (15 U.S.C. 78f(l)), 
providing that ``[i]t shall be unlawful for any person to effect a 
transaction in a security-based swap with or for a person that is 
not an eligible contract participant, unless such transaction is 
effected on a national securities exchange registered pursuant to 
subsection (b).''
    \584\ 15 U.S.C. 77a et seq.
    \585\ In particular, section 768(b) of the Dodd-Frank Act adds 
paragraph (d) to Securities Act section 5 (15 U.S.C. 77e(d)), 
providing that ``[n]otwithstanding the provisions of section 3 or 4, 
unless a registration statement meeting the requirements of section 
10(a) is in effect as to a security-based swap, it shall be unlawful 
for any person, directly or indirectly, to make use of any means or 
instruments of transportation or communication in interstate 
commerce or of the mails to offer to sell, offer to buy or purchase 
or sell a security-based swap to any person who is not an eligible 
contract participant as defined in section 1a(18) of the Commodity 
Exchange Act (7 U.S.C. 1a(18)).'' The Commissions note that market 
participants must make the determination of ECP status with respect 
to the parties to transactions in security-based swaps and mixed 
swaps prior to the offer to sell or the offer to buy or purchase the 
security-based swap or mixed swap.
---------------------------------------------------------------------------

    The Dodd-Frank Act also amended the ECP definition by: \586\ (i) 
Providing that, for purposes of CEA sections 2(c)(2)(B)(vi) and 
2(c)(2)(C)(vii), the term ECP does not include a commodity pool in 
which any participant is not itself an ECP; (ii) raising the monetary 
threshold that governmental entities may use to qualify as ECPs, in 
certain situations, from $25 million in investments owned and invested 
on a discretionary basis to $50 million in investments owned and 
invested on a discretionary basis; \587\ and (iii) replacing the 
``total asset'' standard for individuals to qualify as ECPs with an 
``amounts invested on a discretionary basis'' standard.\588\
---------------------------------------------------------------------------

    \586\ See Sections 741(b)(10) and 721(a)(9) of the Dodd-Frank 
Act; see also Financial Regulatory Reform, A New Foundation: 
Rebuilding Financial Supervision and Regulation, available at http://www.treasury.gov/initiatives/Documents/FinalReport_web.pdf, at 48-
49 (June 17, 2009).
    \587\ See CEA section 1a(18)(A)(vii), 7 U.S.C. 1a(18)(A)(vii).
    \588\ See CEA section 1a(18)(A)(xi), 7 U.S.C. 1a(18)(A)(xi). The 
Dodd-Frank Act did not amend the monetary thresholds for individuals 
to qualify as ECPs. As such, an individual can qualify as an ECP if 
such individual has amounts invested on a discretionary basis, the 
aggregate of which is in excess of (i) $10,000,000, or (ii) 
$5,000,000 if such individual also enters into the agreement, 
contract, or transaction in order to manage the risk associated with 
an asset owned or liability incurred, or reasonably likely to be 
owned or incurred, by such individual.
---------------------------------------------------------------------------

    Commodity pools may, among other things, enter into transactions 
involving foreign currency. ECP status is important for commodity pools 
that enter into the following types of foreign currency transactions 
(such commodity pools, ``Forex Pools''): (i) Off-exchange foreign 
currency futures; (ii) off-exchange options on foreign currency 
futures; (iii) off-exchange options on foreign currency; (iv) leveraged 
or margined foreign currency transactions; and (v) foreign currency 
transactions that are financed by the offeror, the counterparty or a 
person acting in concert with the offeror or counterparty on a similar 
basis.\589\ In some cases, discussed below in detail, if a Forex Pool 
does not satisfy the ECP definition applicable to commodity pools 
engaging in the types of foreign currency transactions noted above 
\590\ and it engages in these types of foreign currency transactions 
(such transactions, ``retail forex transactions'' and such commodity 
pools, ``Retail Forex Pools''), the transactions will be subject to a 
regulatory regime that imposes certain requirements and restrictions on 
the counterparties to the Retail Forex Pool, and, if the Retail Forex 
Pool engages in retail forex transactions other than with certain 
counterparties, on the commodity pool operator (``CPO'') who operates 
the Retail Forex Pool. These requirements and restrictions do not apply 
if the Forex Pool satisfies the ECP definition applicable to commodity 
pools engaging in the types of foreign currency transactions noted 
above.
---------------------------------------------------------------------------

    \589\ See CEA sections 2(c)(2)(B)(vi) and 2(c)(2)(C)(vii), 7 
U.S.C. 2(c)(2)(B)(vi) and 7 U.S.C. 2(c)(2)(C)(vii). In this context, 
the term ``off-exchange'' means other than on or subject to the 
rules of an organized exchange, as defined in CEA section 1a(37), 7 
U.S.C. 1a(37).
    \590\ See CEA section 1a(18)(A)(iv), 7 U.S.C. 1a(18)(A)(iv); see 
also CFTC Regulation Sec.  1.3(m)(5) (exporting the look-through 
language of CEA section 1a(18)(A)(iv) to CEA section 1a(18)(A)(v)). 
The Dodd-Frank Act amended the ECP definition to include a provision 
that specifically applies to Forex Pools engaging in these types of 
foreign currency transactions. See Section 741(b)(10) of the Dodd-
Frank Act (adding a provision to CEA section 1a(18)(A)(iv), 7 U.S.C. 
1a(18)(A)(iv), stating ``provided, however, that for purposes of 
section 2(c)(2)(B)(vi) and section 2(c)(2)(C)(vii), the term 
`eligible contract participant' shall not include a commodity pool 
in which any participant is not otherwise an eligible contract 
participant.''). See part III.B below for a discussion of this 
provision. This provision applies only with respect to retail forex 
transactions. This means that a Retail Forex Pool, as defined above, 
that is not an ECP for retail forex transaction purposes could be an 
ECP for other transactions it enters into that are not retail forex 
transactions.
---------------------------------------------------------------------------

    The Commissions are adopting further definitions of the term 
``eligible contract participant'' in the following six respects: (i) 
Generally prohibiting a Forex Pool from qualifying as an ECP if such 
Forex Pool directly enters into retail forex transactions \591\ and has 
one or more direct participants that are not ECPs; \592\ (ii) 
clarifying that, in determining whether a direct participant in a Forex 
Pool is an ECP, the indirect participants in the Forex Pool will not be 
considered unless such Forex Pool, a commodity pool holding a direct or 
indirect (through one or more intermediate tiers of pools) interest in

[[Page 30647]]

such Forex Pool, or any commodity pool in which such Forex Pool holds a 
direct or indirect interest has been structured to evade Subtitle A of 
Title VII of the Dodd-Frank Act; \593\ (iii) prohibiting a commodity 
pool from qualifying as an ECP unless it has total assets exceeding $5 
million and is operated by a person described in CEA section 
1a(18)(A)(iv)(II);\594\ (iv) explicitly including swap dealers, 
security-based swap dealers, major swap participants, and major 
security-based swap participants in the definition of ECP; (v) 
permitting a non-ECP to qualify as an ECP, with respect to certain 
swaps, based on the collective net worth of its owners, subject to 
several conditions, including that the owners are ECPs; and (vi) 
permitting a Forex Pool to qualify as an ECP notwithstanding that it 
has one or more direct participants that are not ECPs if the Forex Pool 
(a) is not formed for the purpose of evading regulation under CEA 
sections 2(c)(2)(B) or (C) or related rules, regulations or orders, (b) 
has total assets exceeding $10 million and (c) is formed and operated 
by a registered CPO or by a CPO who is exempt from registration as such 
pursuant to Sec.  4.13(a)(3). In addition, the Commissions are issuing 
interpretive guidance regarding the definition of ECP to correct an 
inaccurate statutory cross-reference with respect to the ability of 
government entities to qualify as ECPs under CEA section 
1a(18)(A)(vii).\595\ The Commissions also are issuing interpretive 
guidance with respect to the ECP status of Forex Pools whose 
participants are limited solely to non-U.S. persons and which are 
operated by CPOs located outside the United States, its territories or 
possessions.
---------------------------------------------------------------------------

    \591\ In many commodity pool structures, this is the master fund 
alone.
    \592\ But see note 652, infra, with respect to single level 
Forex Pools using retail forex transactions solely to hedge.
    \593\ 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 that have been 
structured to evade'' subtitle A of Title VII (or an amendment to 
the CEA made by subtitle A).
    \594\ 7 U.S.C. 1a(18)(A)(iv)(II).
    \595\ 7 U.S.C. 1a(18)(A)(vii).
---------------------------------------------------------------------------

    The Commissions note that commenters raised interpretive and other 
issues related to the ECP definition that the Commissions may consider 
in the future.\596\
---------------------------------------------------------------------------

    \596\ These issues include: (i) The ECP status of jointly and 
severally liable borrowers and counterparties, non-ECPs guaranteed 
by ECPs, and non-ECP swap collateral providers; (ii) whether bond 
proceeds count toward the ``owns and invests on a discretionary 
basis $50,000,000 or more in investments'' element of the 
governmental ECP prong (CEA section 1a(18)(A)(vii), 7 U.S.C. 
1a(18)(A)(vii)); (iii) the relationship between the ECP and eligible 
commercial entity definitions for purposes of CEA section 
1a(18)(A)(vii), 7 U.S.C. 1a(18)(A)(vii); (iv) the scope of the 
``proprietorship'' element of the entity prong of the ECP definition 
in CEA section 1a(18)(A)(v), 7 U.S.C. 1a(18)(A)(v) (which the 
Commissions are addressing to a limited extent in the discussion of 
the new line of business ECP category in part III.F, infra, and in 
Regulation Sec.  1.3(m)(7)(ii)(C) under the CEA); (v) the meaning of 
the new ``amounts invested on a discretionary basis'' element of the 
individual prong of the ECP definition (CEA section 1a(18)(A)(xi), 7 
U.S.C. 1a(18)(A)(xi)); (vi) whether persons can be ECPs in 
anticipation of receiving, but before they have, the necessary 
assets; and (vii) that swap dealers are not among the entities 
listed in CEA section 2(c)(2)(B)(i)(II), 7 U.S.C. 2(c)(2)(B)(i)(II), 
as acceptable counterparties to non-ECPs engaging in retail forex 
transactions.
---------------------------------------------------------------------------

B. Commodity Pool Look-Through for Retail Forex Transactions

1. Statutory Provisions
    Prior to the Dodd-Frank Act, clause (A)(iv) of the ECP definition 
provided that a commodity pool was an ECP if it had $5 million in total 
assets and was operated by a person regulated under the CEA, regardless 
of whether each participant in the commodity pool was itself an 
ECP.\597\ Section 741(b)(10) of the Dodd-Frank Act added a proviso to 
clause (A)(iv) \598\ stating that a Forex Pool will not qualify as an 
ECP, solely for purposes of CEA sections 2(c)(2)(B)(vi) or 
2(c)(2)(C)(vii) (i.e., retail forex transactions) if any participant in 
the Forex Pool is itself not an ECP.\599\
---------------------------------------------------------------------------

    \597\ Clause (A)(iv) of the pre-Dodd-Frank Act ECP definition 
also included a commodity pool operated by a foreign person 
performing a similar role or function as a person regulated under 
the CEA and subject as such to foreign regulation (regardless of 
whether the foreign person was itself an ECP).
    \598\ The proviso states ``provided, however, that for purposes 
of section 2(c)(2)(B)(vi) and section 2(c)(2)(C)(vii), the term 
`eligible contract participant' shall not include a commodity pool 
in which any participant is not otherwise an eligible contract 
participant.'' CEA section 1a(18)(A)(iv); 7 U.S.C. 1a(18)(A)(iv).
    \599\ See CEA section 1a(18)(A)(iv), 7 U.S.C. 1a(18)(A)(iv). In 
other words, the proviso in section 1a(18)(A)(iv) does not reference 
or implicate ECP status for purposes of (i) CEA section 2(e), 7 
U.S.C. 2(e) (which, as discussed above, permits non-ECPs to trade 
swaps only on or subject to the rules of a DCM); (ii) Securities Act 
section 5(d) (which, as discussed above, makes it unlawful for a 
person to offer to sell, offer to buy or purchase, or sell a 
security-based swap to a person that is not an ECP unless a 
registration statement under the Securities Act is in effect with 
respect to that security-based swap); or (iii) Exchange Act section 
6(l) (which as discussed above, makes it unlawful for a person to 
effect a transaction in a security-based swap with or for a person 
that is not an ECP unless the transaction is effected on a national 
securities exchange registered with the SEC). The look-through 
proviso does not expressly state that indirect participants, as well 
as direct participants, in the Forex Pool must be ECPs for the Forex 
Pool to be an ECP. But see notes 636 and 638, infra (discussing the 
authority for such an approach).
---------------------------------------------------------------------------

    Thus, for purposes of retail forex transactions, the Dodd-Frank Act 
imposed a requirement to ``look through'' a Forex Pool--meaning that 
ECP status would be limited to Forex Pools in which each participant is 
itself an ECP. This is important for two reasons. First, a Forex Pool 
that does not qualify as an ECP can enter into a retail forex 
transaction described in CEA section 2(c)(2)(B)(i)(I) only with one of 
the federally-regulated counterparties enumerated in CEA sections 
2(c)(2)(B)(i)(II)(aa) (U.S. financial institutions),\600\ (bb) (certain 
brokers, dealers and their associated persons),\601\ (cc) (certain 
futures commission merchants (``FCMs'') and their affiliated 
persons),\602\ (dd) (certain financial holding companies) \603\ or (ff) 
(certain retail foreign exchange dealers (``RFEDs'')) \604\ (each an 
``Enumerated Counterparty'' and collectively ``Enumerated 
Counterparties''); the counterparty restriction does not apply to 
retail forex transactions described in CEA section 2(c)(2)(C)(i)(I)(bb) 
\605\ entered into by a Forex Pool that does not qualify as an ECP, 
though such transactions are subject to antifraud protections and 
related enforcement provisions if entered into with a

[[Page 30648]]

counterparty other than an Enumerated Counterparty described in CEA 
section 2(c)(2)(B)(i)(II)(aa), (bb) or (dd).\606\ Second, the operator 
of a Retail Forex Pool engaging in retail forex transactions with an 
Enumerated Counterparty that is an FCM, specified affiliated person of 
an FCM or RFED must register with the CFTC as a CPO,\607\ unless the 
CPO also is an Enumerated Counterparty under 2(c)(2)(B)(i)(II)(aa), 
(bb) or (dd) \608\ or an exemption from CPO registration applies.\609\ 
Moreover, CEA section 2(c)(2)(E)(ii)(I),\610\ which was added by 
section 742(c)(2) of the Dodd-Frank Act, prohibits an Enumerated 
Counterparty from entering into retail forex transactions described in 
CEA section 2(c)(2)(B)(i)(I) with a person that is not an ECP ``except 
pursuant to a rule or regulation of [the appropriate Federal regulator 
of such Enumerated Counterparty allowing such transactions] under such 
terms and conditions as [such regulator] shall prescribe.'' CEA section 
2(c)(2)(E)(iii)(II) \611\ requires that such rules or regulations treat 
similarly all agreements, contracts, and transactions in foreign 
currency that are functionally or economically similar to CEA section 
2(c)(2)(B)(i)(I) agreements, contracts, and transactions.
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    \600\ 7 U.S.C. 2(c)(2)(B)(i)(II)(aa). The term ``financial 
institution'' is defined in CEA Section 1a(21), 7 U.S.C. 1a(21).
    \601\ 7 U.S.C. 2(c)(2)(B)(i)(II)(bb). This category is comprised 
of each:
    (AA) [] broker or dealer registered under section 15(b) (except 
paragraph (11) thereof) or 15C of the Securities Exchange Act of 
1934 (15 U.S.C. 78o(b), 78o-5); [and] (BB) [ ] associated person of 
a broker or dealer registered under section 15(b) (except paragraph 
(11) thereof) or 15C of the Securities Exchange Act of 1934 (15 
U.S.C. 78o(b), 78o-5) concerning the financial or securities 
activities of which the broker or dealer makes and keeps records 
under section 15C(b) or 17(h) of the Securities Exchange Act of 1934 
(15 U.S.C. 78o-5(b), 78q(h)).
    \602\ 7 U.S.C. 2(c)(2)(B)(i)(II)(cc). This category is comprised 
of each:
    (cc)(AA) []futures commission merchant that is primarily or 
substantially engaged in the business activities described in 
section 1a of this Act, is registered under this Act, is not a 
person described in item (bb) of this subclause, and maintains 
adjusted net capital equal to or in excess of the dollar amount that 
applies for purposes of clause (ii) of this subparagraph; [and] (BB) 
[ ] affiliated person of a futures commission merchant that is 
primarily or substantially engaged in the business activities 
described in section 1a of this Act, is registered under this Act, 
and is not a person described in item (bb) of this subclause, if the 
affiliated person maintains adjusted net capital equal to or in 
excess of the dollar amount that applies for purposes of clause (ii) 
of this subparagraph and is not a person described in such item 
(bb), and the futures commission merchant makes and keeps records 
under section 4f(c)(2)(B) of this Act concerning the futures and 
other financial activities of the affiliated person.
    \603\ 7 U.S.C. 2(c)(2)(B)(i)(II)(dd). The enumerated 
counterparty in this category is ``a financial holding company (as 
defined in section 2 of the Bank Holding Company Act of 1956).''
    \604\ 7 U.S.C. 2(c)(2)(B)(i)(II)(ff). This category is comprised 
of each:
    retail foreign exchange dealer that maintains adjusted net 
capital equal to or in excess of the dollar amount that applies for 
purposes of clause (ii) of this subparagraph and is registered in 
such capacity with the [CFTC], subject to such terms and conditions 
as the [CFTC] shall prescribe, and is a member of a futures 
association registered under section 17 [of the CEA].
    \605\ 7 U.S.C. 2(c)(2)(C)(i)(I)(bb).
    \606\ The counterparty limitation with respect to CEA section 
2(c)(2)(B)(i)(I) retail forex transactions is a function of the fact 
that the CEA's exchange-trading requirement generally applies with 
respect to foreign currency futures, foreign currency options on 
futures, and foreign currency options. See CEA section 4(a), 7 
U.S.C. 6(a) (generally requiring futures contracts to be traded on 
or subject to the rules of a DCM); CEA section 4c(b), 7 U.S.C. 6c(b) 
(prohibiting trading options subject to the CEA contrary to CFTC 
rules, regulations or orders permitting such trading); Part 32 of 
the CFTC's rules, 17 CFR part 32 (generally prohibiting entering 
into options subject to the CEA) and CFTC Regulation Sec.  33.3(a), 
17 CFR 33.3(a) (prohibiting entering into options on futures other 
than on or subject to the rules of a DCM). Because CEA section 4(a) 
would render an off-exchange futures contract illegal but for CEA 
section 2(c)(2)(B) permitting such transactions with an Enumerated 
Counterparty, it would be illegal for a non-Enumerated Counterparty 
to enter into a futures contract described in 2(c)(2)(B)(i)(I) with 
a non-ECP. Similarly, because options can be conducted only pursuant 
to CFTC authority and the CFTC has proposed to treat commodity 
options within its jurisdiction as swaps, CEA section 2(e) would 
prohibit such options, if on foreign exchange and entered into with 
a non-ECP, but for the fact that 2(c)(2)(B) permits them if traded 
with an Enumerated Counterparty.
    The lack of a counterparty limitation with respect to CEA 
section 2(c)(2)(C)(i)(I)(bb) retail forex transactions is a function 
of the different structures of CEA sections 2(c)(2)(B) and (C). 
Whereas CEA section 2(c)(2)(B)(i) covers transactions that would be 
illegal but for compliance with CEA section 2(c)(2)(B) (due to such 
section's incorporation of the entire CEA, including, for example, 
the exchange-trading requirement discussed above), falling within 
CEA section 2(c)(2)(C)(i)(I), by that section's own terms, merely 
brings a covered transaction within the scope of CEA section 
2(c)(2)(C), which does not include the exchange-trading requirement 
of CEA section 4(a). Because CEA section 2(c)(2)(C)(i)(I) covers 
transactions that may or may not also be transactions described in 
section 2(c)(2)(B)(i)(I) and the far fewer requirements imposed by 
CEA section 2(c)(2)(C) invite characterization of such difficult-to-
categorize transactions as falling solely within CEA section 
2(c)(2)(C), the CFTC will interpret such dually characterizable 
transactions as governed by CEA section 2(c)(2)(B). If such 
transactions fall only within CEA section 2(c)(2)(C), however, 
because they would be subject to neither the exchange-trading 
requirement of CEA section 4(a) nor the CFTC's plenary options 
authority under CEA section 4c(b) (while CEA section 
2(c)(2)(C)(ii)(I), 7 U.S.C. 2(c)(2)(C)(ii)(I), reserves the CFTC's 
section 4c(b) authority, in this scenario, the contract in question 
is not an option), a person other than an Enumerated Counterparty 
may act as counterparty to a non-ECP. Such contracts would, however, 
be subject to two of the CEA's antifraud provisions, sections 4(b) 
and 4b, 7 U.S.C 6(b) and 7 U.S.C 6b, respectively, as if they were 
futures contracts. See CEA section 2(c)(2)(C)(iv), 7 U.S.C. 
2(c)(2)(C)(iv). Such contracts also would be subject to related 
enforcement provisions. See CEA section 2(c)(2)(C)(ii)(I), 7 U.S.C. 
2(c)(2)(C)(ii)(I).
    \607\ See CEA sections 2(c)(2)(B)(iv)(I) and (C)(iii)(I) 
(requiring registration for CPOs of Retail Forex Pools entering into 
retail forex transactions with FCMs, specified affiliated persons 
thereof or RFEDs). By contrast, those sections exclude from the CPO 
registration requirement CPOs of Retail Forex Pools engaging in 
retail forex transactions with Enumerated Counterparties described 
in CEA section 2(c)(2)(B)(i)(II)(aa), (bb), (ee) and (ff). While the 
cited CEA sections refer to counterparties not described in ``any of 
item (aa), (bb), (ee), or (ff)'' of subparagraph (B)(i)(II), the 
CFTC Reauthorization Act of 2008 (``CRA''), included as Title XIII 
of the Food, Conservation and Energy Act of 2008, Pub.L. 110-246, 
122 Stat. 1651 changed item (ee) to item (dd) (a financial holding 
company as defined in section 2 of the Bank Holding Company Act of 
1956) and removed item (ff) (formerly an investment bank holding 
company (as defined in section 17(i) of the Exchange Act (15 U.S.C. 
78q(i))). Therefore, the Commissions interpret the reference in CEA 
sections 2(c)(2)(B)(iv)(I)(cc) and 2(c)(2)(C)(iii)(I)(cc) to items 
(aa), (bb), (ee), or (ff) to be references to items (aa), (bb) and 
(dd). Cf. Retail Foreign Exchange Transactions; Conforming Changes 
to Existing Regulations in Response to the Dodd-Frank Wall Street 
Reform and Consumer Protection Act, 76 FR 56103 (Sept. 12, 2011) 
(providing background on related incorrect internal references in 
CEA sections 2(c)(2)(B) and (C)). See also CFTC Regulation Sec.  
5.3(a)(2)(i), 17 CFR 5.3(a)(2)(i), which requires a CPO, as defined 
in CFTC Regulation Sec.  5.1(d)(1), 17 CFR 5.1(d)(1), to register as 
such. CFTC Regulation Sec.  5.1(d)(1), in turn, defines a CPO, for 
purposes of Part 5 of the CFTC's Regulations, 17 CFR part 5, as 
``any person who operates or solicits funds, securities or property 
for a pooled investment vehicle that is not an [ECP] as defined in 
section 1a(18) of the Act, and that engages in retail forex 
transactions.'' The CFTC interprets the references in Regulation 
Sec.  5.1(d)(1) to ECPs as defined in CEA section 1a(18) to include 
the ECP definition as further defined or interpreted by the 
Commissions under authority conferred by the Dodd-Frank Act or 
otherwise amended or interpreted by the Commissions or a court. 
While the statutory CPO definition in CEA section 1a(11)(A), 7 
U.S.C. 1a(11)(A), does not include transactions described in CEA 
section 2(c)(2)(B)(i), the Commissions believe this was an 
oversight. In any case, CEA section 1a(11)(B), 7 U.S.C. 1a(11)(B), 
grants the CFTC the authority to further define the term CPO, which 
the CFTC has done in CFTC Regulation Sec.  5.1(d)(1). Therefore, a 
person operating a commodity pool engaging in transactions described 
in CEA section 2(c)(2)(B)(i) is a CPO.
    \608\ See CEA sections 2(c)(2)(B)(iv)(II) and 
2(c)(2)(C)(iii)(II). While CEA sections 2(c)(2)(B)(iv)(II) and 
2(c)(2)(C)(iii)(II) refer to counterparties described in item (aa), 
(bb), (ee), or (ff) of subparagraph (B)(i)(II), the CFTC 
Reauthorization Act of 2008 changed item (ee) to item (dd) and 
removed item (ff). Therefore, the Commissions interpret the 
reference in CEA sections 2(c)(2)(B)(iv)(II) and 2(c)(2)(C)(iii)(II) 
to items (aa), (bb), (ee), or (ff) to be references to items (aa), 
(bb) and (dd). Cf. Retail Foreign Exchange Transactions; Conforming 
Changes to Existing Regulations in Response to the Dodd-Frank Wall 
Street Reform and Consumer Protection Act, 76 FR 56103 (Sept. 12, 
2011) (providing background on related incorrect internal references 
in 2(c)(2)(B) and (C)).
    \609\ See, e.g., CFTC Regulation Sec.  4.13(a)(3) (exempting 
from CPO registration operators of commodity pools engaged in a de 
minimis amount of trading in CFTC-jurisdictional contracts).
    \610\ 7 U.S.C. 2(c)(2)(E)(ii)(I).
    \611\ 7 U.S.C. 2(c)(2)(E)(iii)(II).
---------------------------------------------------------------------------

    Separately, subclause (A)(v)(III) of the ECP definition, both 
before and after enactment of the Dodd-Frank Act, provides that a 
corporation, partnership, proprietorship,\612\ organization, trust or 
other business entity may qualify as an ECP if it has a net worth 
exceeding $1 million and ``enters into an agreement, contract, or 
transaction in connection with the conduct of the entity's business or 
to manage the risk associated with an asset or liability owned or 
incurred or reasonably likely to be owned or incurred by the entity in 
the conduct of the entity's business.'' \613\
---------------------------------------------------------------------------

    \612\ Individuals also are covered by a different prong of the 
ECP definition. An individual can qualify as an ECP under clause 
(A)(xi) of the ECP definition. See CEA section 1a(18)(A)(xi), 7 
U.S.C. 1a(18)(A)(xi).
    \613\ There are two other ways a person can qualify as an ECP 
under clause (A)(v): (i) being an entity with total assets exceeding 
$10 million; or (ii) being an entity the obligations of which under 
an agreement, contract, or transaction are guaranteed or otherwise 
supported by a letter of credit or keepwell, support, or other 
agreement by an entity with total assets exceeding $10 million or an 
entity described in clause (A)(i), (ii), (iii), (iv) or (vii), or 
paragraph (C), of the ECP definition. See CEA section 
1a(18)(A)(v)(I) and (II), 7 U.S.C. 1a(18)(A)(v)(I) and (II), 
respectively.
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2. Proposed Approach
    The Commissions stated in the Proposing Release that ``in some 
cases commodity pools unable to satisfy the conditions of clause 
(A)(iv) of the ECP definition may rely on clause (A)(v) to qualify as 
ECPs instead for purposes of retail forex'' and that permitting such 
reliance would frustrate the intent of Congress in imposing the look-
through requirement on Forex Pools in clause (A)(iv) of the ECP 
definition.\614\
---------------------------------------------------------------------------

    \614\ Proposing Release, 75 FR at 80185.
---------------------------------------------------------------------------

    The Commissions proposed to further define the term ``eligible 
contract participant'' to preclude a Forex Pool from qualifying as an 
ECP for purposes of retail forex transactions in reliance on clause 
(A)(v) of the ECP definition if

[[Page 30649]]

such Forex Pool has any participant that is not an ECP and, therefore, 
is not an ECP due to the look-through provision added to clause 
(A)(iv). Further, because commodity pools can be structured in various 
ways and can have one or more feeder funds and/or pools, the 
Commissions proposed to preclude a Forex Pool from being an ECP for 
purposes of retail forex transactions if there was any non-ECP 
participant at any level of the pool structure (e.g., the pool itself, 
a direct participant that invests in the pool, or any indirect 
participant that invests in that pool through other pools or vehicles).
3. Commenters' Views
    One commenter supported the Commissions' efforts to close the 
potential loophole of Forex Pools that are unable to qualify as ECPs 
due to the new look-through provision in clause (A)(iv) of the ECP 
definition instead qualifying as ECPs under clause (A)(v) of the ECP 
definition.\615\ This commenter indicated that it shares the 
Commissions' concern that Forex Pools that do not satisfy the amended 
ECP definition due to the look-through provision for commodity pools in 
clause (A)(iv) may alternatively rely upon clause (A)(v) of the ECP 
definition to qualify as an ECP for purposes of retail forex 
transactions.\616\ This commenter further stated that Congressional 
intent in requiring a look-through for Forex Pools would be frustrated 
if fraudulent pool operators could avail themselves of this 
alternative.\617\
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    \615\ See letter from the NFA. The NFA indicated that it 
recently took separate emergency actions against two firms that did 
not qualify under the NFA's requirements for retail forex 
transactions. In one case, the commodity pool fell short of the $5 
million total asset requirement in clause (A)(iv) of the ECP 
definition; in the other case, the firm never properly formed a 
commodity pool. The NFA cautioned in its letter, ``these cases 
illustrate that firms will attempt to obtain ECP status to shield 
themselves from the jurisdiction of regulators to the detriment of 
pool participants.''
    \616\ Id.
    \617\ Id.
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    However, several commenters recognized the importance of the 
concern about a potential loophole \618\ but stated that the 
Commissions should revise the proposal to mitigate the potential 
adverse consequences to market participants. One commenter, for 
example, commented on the expected effects of the proposed rule on 
funds of funds (``FOFs'').\619\ According to this commenter, FOFs (i) 
normally face as counterparties foreign subsidiaries of U.S. banks and 
foreign banks, and (ii) would incur substantial counterparty, 
documentation and operational costs in moving their retail forex 
transactions onto DCMs or toward the Enumerated Counterparties.
---------------------------------------------------------------------------

    \618\ See, e.g., letters from SIFMA--AMG dated September 15, 
2011 (``SIFMA AMG IV'') (acknowledging some form of ECP look-through 
is appropriate to prevent evasion where circumvention otherwise 
could occur and stating that it is sympathetic to the Commissions' 
implicit objective of ensuring that a person that would not qualify 
as an ECP not be permitted to accomplish indirectly what it is not 
permitted to do directly), Sidley Austin LLP (``Sidley'') (stating 
that the commenter fully appreciates that Congress added the look-
through language to the ECP definition to prevent unscrupulous forex 
market participants from avoiding the retail forex provisions of the 
CEA and the CFTC's rules by ``engineering'' an ECP by pooling the 
capital of a large group of retail customers, thus depriving those 
investors of the protections otherwise afforded to them), AIMA I 
(stating that ``we understand Congress has made a decision to try to 
protect retail investors by amending the definition of ECP under 
Section 1a(1[8]) of the [CEA] to include that, for a commodity pool 
to qualify as an ECP under sub-section (A)(iv), the pool's 
underlying participants must also qualify as ECPs under section 
1a(1[8])).''
    \619\ See letter from Sidley. Sidley noted that FOF managers' 
retail forex transactions are largely undertaken for hedging 
purposes and that most FOF managers offer investments to non-U.S. 
persons, a significant number of which pay for their investments in 
FOF interests using their own currency. Sidley further noted that, 
because most FOFs accept investments only in U.S. dollars, FOF 
managers must convert to U.S. dollars the foreign currency received 
from such investors and invest those dollars in underlying funds, 
and that they enter into a hedging transaction to reduce the risk of 
exchange rate changes between an investor's currency and the U.S. 
dollar.
---------------------------------------------------------------------------

    In a similar vein, two commenters advised that a substantial number 
of hedge funds, as well as publicly offered commodity pools, would, 
under the Commissions' proposal, fail to qualify as ECPs for purposes 
of retail forex transactions, as most such funds have at least one 
direct or indirect non-ECP participant.\620\ These commenters indicated 
that this would disrupt the trading strategies employed by many 
commodity trading advisors (``CTAs'') on behalf of commodity 
pools.\621\ One of these commenters suggested an anti-evasion approach 
combining a lower level of pool assets with a requirement that the 
commodity pool not be formed for the purpose of evading the regulatory 
requirements applicable to retail forex transactions.\622\
---------------------------------------------------------------------------

    \620\ See letters from Willkie Farr & Gallagher LLP (``Willkie 
Farr'') and the NYCBA Committee.
    \621\ Id.
    \622\ See letter from Willkie Farr.
---------------------------------------------------------------------------

    Another commenter argued that Congress did not include the look-
through provision in clause (A)(v) of the ECP definition because of its 
effect on bona fide hedgers.\623\ This commenter also advised that the 
primary entities affected are hedge fund and private equity fund 
managers investing in securities who use retail forex transactions 
solely to hedge investment portfolio currency risks, and/or because 
they accept subscriptions in currencies other than U.S. dollars.\624\
---------------------------------------------------------------------------

    \623\ See letter from Akin Gump Strauss Hauer & Feld LLP (``Akin 
Gump'').
    \624\ Id.
---------------------------------------------------------------------------

    Several commenters disagreed with the Commissions' statement in the 
proposal that extending the look-through provision in clause (A)(iv) of 
the ECP definition to clause (A)(v) would effectuate Congressional 
intent. Two commenters noted that there is no specific Dodd-Frank Act 
provision requiring such a change.\625\ Two other commenters argued 
that clause (v) of the ECP definition provides an independent basis for 
qualification as an ECP, which should not be affected by the changes in 
clause (A)(iv) of the ECP definition.\626\
---------------------------------------------------------------------------

    \625\ See letters from AIMA I and Ropes & Gray LLP (``Ropes & 
Gray'').
    \626\ See letters from Akin Gump, Sidley and Skadden, Arps, 
Slate, Meagher & Flom LLP (``Skadden''). Sidley also indicated that 
there seems to be no compelling reason to treat commodity pools 
worse than other sophisticated market participants with respect to 
retail forex transactions with non-Enumerated Counterparties, and no 
reason to treat them worse than a corporation or other entity with 
only $10 million in total assets that therefore qualifies as an ECP 
under clause (A)(v) of the ECP definition to trade retail forex 
transactions although it may have no particular expertise in such 
markets.
---------------------------------------------------------------------------

    One commenter indicated that the extraterritorial application of 
the proposed rules regarding the ECP definition is unclear.\627\ Among 
other things, this commenter indicated it is unnecessary to extend the 
scope of the look-through to protect possible retail investors outside 
of the U.S., especially where a CPO has not marketed a pool in the U.S. 
and does not otherwise have any U.S. investors.\628\
---------------------------------------------------------------------------

    \627\ See letter from AIMA I.
    \628\ Id.
---------------------------------------------------------------------------

    Commenters proposed several alternative approaches that they 
believed would address the Commissions' concerns. One commenter 
suggested that the Commissions create a new category of ECPs for Forex 
Pools comprised entirely of qualified eligible persons (``QEPs'') \629\ 
and operated by persons subject to regulation under the CEA.\630\ This 
commenter also suggested that the Commissions create a new category of 
ECPs for Forex Pools that satisfy a monetary threshold for total assets 
or for the minimum initial investment of a Forex Pool to be 
sufficiently large that, in general, only legitimate pools would exceed 
such thresholds.\631\ Finally, this commenter suggested that the 
Commissions create a category of ECPs

[[Page 30650]]

for non-U.S. persons.\632\ A second commenter suggested that the 
Commissions create a category of ECPs for commodity pools that are 
operated by a CPO or advised by a CTA subject to regulation by a 
foreign regulator comparable to the CFTC.\633\
---------------------------------------------------------------------------

    \629\ The term ``qualified eligible person'' is defined in CFTC 
Regulation Sec. Sec.  4.7(a)(2) and (3).
    \630\ See letter from Sidley.
    \631\ Id.
    \632\ Id. Sidley cited to the approach in Regulation S under the 
Securities Act (17 CFR 230.901 et seq.), Sections 3(c)(1) and (7) of 
the Investment Company Act of 1940 (15 U.S.C. 80a-3(c)(1) and (7)), 
and CFTC Regulation Sec.  4.7(a)(2)(xi).
    \633\ See letter from Willkie Farr.
---------------------------------------------------------------------------

    One commenter suggested (i) allowing commodity pools and their 
counterparties to rely, for the duration of an investment and each time 
commodity pool participants make an investment decision, on participant 
ECP representations provided in connection with an initial investment, 
provided that each participant covenants to update such representations 
if they become inaccurate, and (ii) providing specific relief for FOFs 
because they generally invest all or substantially all of their assets 
in underlying portfolio funds and use retail forex transactions to 
reduce foreign exchange exposure.\634\
---------------------------------------------------------------------------

    \634\ See letter from Sidley.
---------------------------------------------------------------------------

4. Final Rule
    After considering commenters' concerns, the Commissions are 
adopting final rules that have been revised from the proposal. In 
particular, consistent with the statutory text of the Dodd-Frank Act, 
CFTC Regulation Sec.  1.3(m)(5)(i) further defines the term ``eligible 
contract participant'' to prohibit a Forex Pool that directly enters 
into a retail forex transaction (i.e., a transaction-level commodity 
pool) \635\ from qualifying as an ECP under clause (A)(iv) or clause 
(A)(v) of the ECP definition, solely for purposes of entering into 
retail forex transactions, if the pool has one or more direct 
participants that are not ECPs. In response to commenters' concerns 
described above, CFTC Regulation Sec.  1.3(m)(5)(ii) is revised to 
provide that, in determining whether a commodity pool that is a direct 
participant in a transaction-level Forex Pool is an ECP, the indirect 
participants in the transaction-level Forex Pool \636\ will not be 
considered unless such Forex Pool, a commodity pool holding a direct or 
indirect (through one or more intermediate tiers of pools) interest in 
such Forex Pool, or any commodity pool in which such Forex Pool holds a 
direct or indirect interest has been structured to evade Subtitle A of 
Title VII of the Dodd-Frank Act by permitting persons that are not ECPs 
to participate in agreements, contracts, or transactions described in 
section 2(c)(2)(B)(i) or section 2(c)(2)(C)(i) of the Commodity 
Exchange Act. That is, absent evasion, the Commissions are changing the 
proposed ``indefinite look-through'' to an ``evasion-based look-
through'' in the final rule.\637\
---------------------------------------------------------------------------

    \635\ Commodity pool structures can take various forms. One 
common commodity pool structure is a ``master-feeder'' fund 
structure. In such a structure, investors purchase interests in 
``feeder funds,'' which in turn purchase interests in a ``master 
fund.'' Typically, the only fund in a commodity pool structure that 
enters into retail forex transactions (and other transactions) 
directly is the master fund; the feeder funds (and their investors) 
typically would participate indirectly by receiving the profit or 
loss from such retail forex transactions (and other transactions) as 
distributions based on the feeder funds' interests in the master 
fund. Notwithstanding that the master-feeder structure is common, 
other structures exist. Thus, each fund in a commodity pool 
structure that directly enters into retail forex transactions is a 
transaction-level commodity pool.
    \636\ A fund that does not itself engage in retail forex 
transactions but that holds an interest in a transaction-level Forex 
Pool that engages in retail forex transactions is itself a commodity 
pool. Cf. U.S. Regulation of the International Securities and 
Derivatives Markets--Greene, Beller, Rosen, Silverman, Braverman and 
Sperber, Sec.  12.13[1], n.351 and related text.
    \637\ The Commissions caution, however, that they will closely 
monitor developments in this part of the market and will not 
hesitate to revisit their decision to limit the look-through 
provision pursuant to 1.3(m)(5)(ii) should they observe a pattern of 
evasion or misconduct.
---------------------------------------------------------------------------

    In adding the look-through provision to the commodity pool prong of 
the ECP definition, Congress made a decision to protect retail foreign 
exchange investors by requiring that the participants in a Forex Pool 
qualify as ECPs for the Forex Pool itself to qualify as an ECP. The 
Commissions believe that the intent of the look-through provision--
protecting Forex Pool participants from fraudulent and abusive 
conduct--must be given effect to comply with this Congressional 
mandate. Nevertheless, the Commissions acknowledge commenters' concerns 
about potential unintended consequences of applying an indefinite look-
through to every direct and indirect participant of a Forex Pool, as 
proposed. Accordingly, to avoid unintended consequences and related 
costs for Forex Pools whose operators and managers have not 
historically presented the risks that the look-through provision was 
intended to address,\638\ the Commissions are replacing the proposed 
indefinite look-through of every participant in a Forex Pool with a 
limited, evasion-based look-through pursuant to which a transaction-
level Forex Pool will qualify as an ECP, for purposes of retail forex 
transactions, if all of such Forex Pool's direct participants are ECPs, 
and will look through a commodity pool participant in such Forex Pool 
only if it, at any level, has been structured to evade the look-through 
provision in clause (A)(iv) of the ECP definition.
---------------------------------------------------------------------------

    \638\ The proposed rule was based on the CFTC's longstanding, 
broad view of what constitutes a ``pool,'' a view recently codified 
in the ``commodity pool'' definition by section 721(a)(5) of the 
Dodd-Frank Act in CEA section 1a(10), 7 U.S.C. 1a(10), and 
recognized by courts, and thus applied the look-through provision at 
each level of a Forex Pool's investment structure. See CFTC, 
Commodity Pool Operators and Commodity Trading Advisors: Amendments 
to Compliance Obligations, 77 FR 11252 (Feb. 24, 2012) (``CPO/CTA 
Compliance Release'') (advising that ``it is the position of the 
[CFTC] that a fund investing in an unaffiliated commodity pool it 
itself a commodity pool'' and ``[t]his interpretation is consistent 
with the statutory definition of commodity pool, which draws no 
distinction between direct and indirect investments in commodity 
interests''); CFTC v. Equity Financial Group, 572 F.3d 150, 157-158 
(July 13, 2009) (concluding, in the context of a commodity pool that 
invested all of its assets with a commodity pool operated by a 
different CPO, that the CFTC's commodity pool regulations ``cover 
pools that invest in other pools'' and that ``the remedial purposes 
of the statute would be thwarted if the operator of a fund could 
avoid the regulatory scheme simply by investing in another pool 
rather than trading''). The same logic applies to a master-feeder 
structure operated by the same CPO: the remedial purpose of the 
look-through proviso in clause (A)(iv) of the statutory ECP 
definition would be thwarted if the look-through could be defeated 
simply by funneling pool participants into a master fund through a 
feeder fund.
    The proposed rule also was borne of the CFTC's long history of 
combating fraudulent practices by typically unregistered individuals 
or entities that prey upon often unsophisticated retail customers 
through complex and highly leveraged off-exchange transactions in 
foreign currency. However, the operators and managers of commodity 
pool FOFs, master-feeder structures and hedge funds for 
sophisticated investors have not generally been the subject of CFTC 
enforcement actions with respect to retail forex transactions. For 
an in depth discussion of the history of the CFTC's authority over 
retail forex transactions, the abuses giving rise to that authority, 
and related enforcement actions, see CFTC, Regulation of Off-
Exchange Retail Foreign Exchange Transactions and Intermediaries, 75 
FR 3282 (Jan. 20, 2010). Congress acted three times in a decade to 
clarify the CFTC's authority to prosecute the rampant fraud seen in 
this area--first in the Commodity Futures Modernization Act of 2000, 
Public Law 106-554, 114 Stat. 2763 (Dec. 21, 2000) in 2000, then 
again in the CRA, and finally in the Dodd-Frank Act in 2010.
---------------------------------------------------------------------------

    The Commissions believe the final rule strikes the right balance 
between implementing strong protections for non-ECP commodity pool 
participants and not imposing undue burdens or costs on CPOs, CTAs and 
commodity pool participants related to retail forex transactions. In 
addition, the Commissions believe that replacing the indefinite look-
through with the limited, evasion-based look-through alleviates many of 
the commenters' concerns. Accordingly, the Commissions believe it is 
appropriate to limit the look-through provision to the level of a 
commodity pool structure that enters into retail forex transactions and 
to look through commodity pools to their ultimate participants only in 
those

[[Page 30651]]

cases in which it is required to prevent evasion of the protections for 
those persons whom Congress intended to be subject to retail forex 
transactions restrictions.
    At the same time, the Commissions do not believe that Forex Pools 
failing to qualify as ECPs due to the look-through provision in clause 
(A)(iv) of the ECP definition should, nonetheless, be permitted 
unfettered access to ECP status under clause (A)(v).\639\ The look-
through provision for Forex Pools provides heightened investor 
protection from forex fraud for Forex Pool participants that are not 
themselves ECPs. Thus, the Commissions believe that permitting Forex 
Pools with one or more non-ECP participants to achieve ECP status by 
relying on clause (A)(v) of the ECP definition, which applies to 
business entities generally, would serve to undermine the look-through 
provision that Congress specifically imposed on Forex Pools under 
clause (A)(iv).\640\
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    \639\ In section 712(d)(2)(A) of the Dodd-Frank Act, Congress 
granted the Commissions the authority to adopt such rules regarding 
the ECP definition as the Commissions determine are necessary and 
appropriate, in the public interest, and for the protection of 
investors.
    \640\ The Commissions note that several commenters requested 
clarification regarding the relationship between the look-through 
provision set forth in CFTC Regulation Sec.  1.3(m)(5) and the 
prohibition on a commodity pool qualifying as an ECP under clause 
(A)(v) of the ECP definition if it does not qualify as an ECP under 
clause (A)(iv) of the ECP definition set forth in CFTC Regulation 
Sec.  1.3(m)(6). See, e.g., meeting with SIFMA--AMG on August 2, 
2011. The look-through provision is limited to determining ECP 
status under clause (A)(iv) or clause (A)(v) of the ECP definition 
for purposes of retail forex transactions entered into by Forex 
Pools. The look-through provision does not reference or implicate 
ECP status for purposes of CEA section 2(e) (which prohibits non-
ECPs from entering into swaps other than on or subject to the rules 
of a DCM), Securities Act section 5(d) (which prohibits a person 
from offering to sell, offering to buy or purchase, or selling a 
security-based swap to a person that is a non-ECP unless a 
registration statement under the Securities Act is in effect with 
respect to that security-based swap), or Exchange Act section 6(l) 
(which prohibits a person from effecting a transaction in a 
security-based swap with or for a person that is a non-ECP unless 
the transaction is effected on a national securities exchange 
registered with the SEC). The prohibition in CFTC Regulation Sec.  
1.3(m)(6) on a commodity pool qualifying as an ECP under clause 
(A)(v) of the ECP definition if it does not qualify as an ECP under 
clause (A)(iv) of the ECP definition does not involve any look-
through. Rather, in contrast with CFTC Regulation Sec.  1.3(m)(5), 
CFTC Regulation Sec.  1.3(m)(6) applies for purposes of all 
agreements, contracts and transactions for which ECP status is 
relevant. See part III.C, infra, for a discussion of the prohibition 
on a commodity pool qualifying as an ECP under clause (A)(v) of the 
ECP definition if it does not qualify as an ECP under clause (A)(iv) 
of the ECP definition.
---------------------------------------------------------------------------

    Moreover, developments subsequent to the issuance of the Proposing 
Release should ameliorate commenters' concerns that CEA section 
2(c)(2)(E)(ii)(I) significantly limits the universe of possible retail 
forex transaction counterparties.\641\ At the time the Commissions 
issued the Proposing Release and throughout the comment period, the 
CFTC was the only Federal regulatory agency that had issued final rules 
governing retail forex transactions by its regulated persons and 
entities.\642\ Since then, though, both the OCC and the FDIC finalized 
(effective July 15, 2011) rules governing retail forex transactions by 
Enumerated Counterparties regulated by those agencies.\643\ In 
addition, the SEC has issued interim temporary final rules (also 
effective July 15, 2011) governing retail forex transactions by 
registered broker-dealers.\644\ Also, the Federal Reserve Board 
proposed rules to govern retail forex transactions by its regulated 
banks on August 3, 2011.\645\ As a result of these regulatory actions, 
Forex Pools that are not ECPs due to the look-through provision and who 
are subject to a counterparty limitation \646\ may enter into retail 
forex transactions with any Enumerated Counterparty but for those 
regulated by the Federal Reserve Board.\647\
---------------------------------------------------------------------------

    \641\ See also part III.G, infra, discussing CFTC Regulation 
Sec.  1.3(m)(8), one effect of which is to eliminate the retail 
forex transaction counterparty restriction for Forex Pools 
qualifying as ECPs.
    \642\ See generally Part 5 of the CFTC's regulations, 17 CFR 5, 
and CFTC, Regulation of Off-Exchange Retail Foreign Exchange 
Transactions and Intermediaries, 75 FR 55410 (Sept. 10, 2010). See 
also CFTC, Retail Foreign Exchange Transactions; Conforming Changes 
to Existing Regulations in Response to the Dodd-Frank Wall Street 
Reform and Consumer Protection Act 76 FR 56103 (Sept. 12, 2011).
    \643\ See FDIC, Retail Foreign Exchange Transactions, 76 FR 
40779 (July 12, 2011) (final FDIC retail forex rules); OCC, Retail 
Foreign Exchange Transactions, 76 FR 41375 (July 14, 2011) (final 
OCC retail forex rules); see also OCC, Retail Foreign Exchange 
Transactions, 76 FR 56094 (Sept. 12, 2011) (interim final OCC retail 
forex rules for federal savings associations and their operating 
subsidiaries).
    \644\ See SEC, Retail Foreign Exchange Transactions, 76 FR 41676 
(July 15, 2011). In the release accompanying the rules, the SEC 
requested comment on broker-dealers' involvement in retail forex 
transactions to inform the SEC in developing permanent rules to 
regulate these activities. See id. at 46181-83.
    \645\ See Board, Retail Foreign Exchange Transactions 
(Regulation NN), 76 FR 46652 (Aug. 3, 2011) (proposed Board rules 
for retail forex transactions).
    \646\ See part III.B.1, supra, discussing the applicability of 
the counterparty limitation.
    \647\ Of course, upon the Board's finalization of its retail 
forex rules, U.S. financial institutions regulated by the Board also 
will be acceptable counterparties.
---------------------------------------------------------------------------

    The Commissions believe that the final rules reasonably address 
commenters' concerns. In this regard, the Commissions note that in 
applying the look-through provision, the Commissions will consider the 
indirect participants in a transaction-level Forex Pool if such Forex 
Pool, a commodity pool holding a direct or indirect (through one or 
more intermediate tiers of pools) interest in such Forex Pool, or any 
commodity pool in which such Forex Pool holds a direct or indirect 
interest has been structured to evade Subtitle A of Title VII of the 
Dodd-Frank Act by permitting persons that are not ECPs to participate 
in agreements, contracts, or transactions described in section 
2(c)(2)(B)(i) or section 2(c)(2)(C)(i) of the Commodity Exchange Act. 
One example of a scheme to evade would be if a commodity pool tier has 
been included in the structure of the Forex Pool primarily to provide 
non-ECP participants exposure to retail forex transactions rather than 
to achieve any other legitimate business purpose.\648\ One example of a 
``legitimate business purpose'' that would not trigger the look-through 
provision is a FOF operated primarily for the purpose of investing in 
underlying funds and using retail forex transactions solely to hedge 
the currency risk posed by an unfavorable change in the exchange rate 
between the currency in which underlying funds accept investments and 
the currency in which FOF investors pay for their investments in the 
FOF.\649\ Similarly, the Commissions would not consider a commodity 
pool using retail forex transactions solely for bona fide hedging 
purposes \650\ with

[[Page 30652]]

respect to currency risk as being structured to avoid the look-through 
provision.\651\ The ``participate in agreements, contracts, or 
transactions described in section 2(c)(2)(B)(i) or section 
2(c)(2)(C)(i) of the Act'' language of CFTC Regulation Sec.  
1.3(m)(5)(ii) is aimed at exposure to retail forex transactions as an 
asset class, investment strategy, or an end in itself, not at exposure 
to retail forex transactions solely designed for bona fide hedging 
purposes with respect to foreign exchange exposure arising in the 
course of a commodity pool's business.\652\
---------------------------------------------------------------------------

    \648\ Feeder funds are usually added to commodity pool 
structures for purposes such as tax efficiency. A master-feeder 
structure ``[permits] U.S. taxable investors to take advantage of 
investing in a U.S. limited partnership feeder fund, which[,] 
through certain elections made at the time the structure is 
established, is tax effective for such U.S. taxable investors'' and 
``[permits] [n]on-U.S. and U.S. tax-exempt investors [to] subscribe 
via a separate offshore feeder company so as to avoid coming 
directly within the U.S. tax regulatory net applicable to U.S. 
taxable investors.'' Effie Vasilopoulos & Katherine Abrat, The 
Benefits of Master-Feeder Fund Structures for Asian-based Hedge Fund 
Managers, Hedge Fund Monthly (April 2004), available at http://www.eurekahedge.com/news/04apr_archive_Sidley_master_feeder.asp. 
Other benefits can include efficiencies gained by the use of only a 
single trading entity, avoiding the need to split trade tickets, 
eliminating the need to duplicate agreements with counterparties and 
greater economies of scale in administering the fund. Id.
    \649\ Sidley notes that the typical FOF operates in this manner. 
See generally letter from Sidley for a more detailed discussion of 
these transactions.
    \650\ In this context, bona fide hedging purposes means bona 
fide hedging purposes within the meaning and intent of CFTC 
Regulation Sec.  1.3(z)(1), except that the requirement therein that 
the transaction or position be on a DCM or SEF that is a trading 
facility will not be a factor in the bona fide hedging purpose 
analysis. Compare CFTC Regulation Sec.  4.5(c)(2)(iii)(A) (relying 
in part on the bona fide hedging concepts in CFTC Regulations 
Sec. Sec.  1.3(z)(1) and 151.5 to provide relief from the CPO 
definition). See also CPO/CTA Compliance Release at 11256-11257 
(discussing and declining to adopt commenters' request to expand the 
definition of bona fide hedging to include risk management). Where a 
Forex Pool's counterparty, but not the Forex Pool, is hedging its 
risks, it is not the case that the Forex Pool is entering the retail 
forex transaction solely to hedge its own risk.
    \651\ The examples mentioned in text should not be construed to 
mean that any other fact pattern does or does not constitute 
evasion, which must be determined on a case-by-case basis.
    \652\ Based on the same reasoning, the Commissions do not 
believe it was the intent of the look-through proviso in CEA section 
1a(18)(A)(iv) to subject to a retail forex regime a single level 
commodity pool engaging in retail forex transactions solely for bona 
fide hedging purposes with respect to foreign exchange exposure 
arising in the course of a commodity pool's operations. 
Consequently, the Commissions will interpret such a commodity pool 
as an ECP if it otherwise satisfies the terms of CEA section 
1a(18)(A)(iv) even if such a pool has one or more non-ECP 
participants.
---------------------------------------------------------------------------

    In applying the limited look-through provision in the final rule, 
the Commissions would consider a Forex Pool's direct participants to 
include not only persons that initially hold interests in the level of 
the commodity pool structure that enters into retail forex 
transactions, but also persons that can acquire those interests or that 
subsequently hold those interests. As applied to exchange-traded 
products (``ETPs'') that are Forex Pools, any person that acquires an 
interest in the ETP Forex Pool in secondary market transactions would 
be a direct participant. ETPs typically issue shares only in the large 
aggregations or blocks (such as 50,000 ETP shares) called ``Creation 
Units.'' An authorized purchaser, usually an investment bank, broker 
dealer or large institutional investor, may purchase a Creation Unit. 
After purchasing a Creation Unit, the authorized purchaser may hold the 
Creation Unit, or sell some or all of the ETP shares in the Creation 
Unit to investors in secondary market transactions by splitting up the 
Creation Unit and selling the individual ETP shares on a national 
securities exchange or in off-exchange transactions. The ability to 
break up the Creation Unit into ETP shares permits other investors, 
such as non-ECPs, to purchase the individual ETP shares in secondary 
market transactions.
    All participants in an ETP Forex Pool must be ECPs when they 
purchase or otherwise acquire an interest in the ETP Forex Pool. In 
addition, an ETP Forex Pool will not be able to verify whether the 
persons that acquire interests in the ETP Forex Pool in exchange 
transactions are ECPs. The ability of non-ECPs to acquire interests in 
an ETP Forex Pool and the inability of the ETP Forex Pool to verify ECP 
status with respect to exchange transactions create a presumption that 
ETP Forex Pools are not ECPs and, therefore, are Retail Forex Pools. 
This presumption would not apply in the case of a Forex Pool that is 
structured in a manner that does not involve exchange trading and in 
which the Forex Pool would be able to verify the ECP status of its 
participants.
    One commenter suggested that the Commissions allow commodity pools 
and their counterparties to rely on participant ECP representations 
provided in connection with an initial investment.\653\ The Commissions 
note that the obligation to determine that the parties to retail forex 
transactions are ECPs is imposed on the CPOs of Forex Pools and the 
counterparties looking to enter into retail forex transactions with 
Forex Pools. In making that determination, the Commissions expect CPOs 
and retail forex transaction counterparties to Forex Pools to be guided 
by the principles for verifying the ECP status of a swap dealer's or 
major swap participant's counterparty discussed in the CFTC's recently 
adopted external business conduct standards, including the safe 
harbor.\654\ Thus, solely for purposes of CEA section 1a(18)(A)(iv) and 
CFTC Regulation Sec.  1.3(m)(5), the Commissions will permit CPOs and 
retail forex transaction counterparties to rely on written 
representations from, as applicable, pool participants or potential 
pool participants that the person making the representation is an ECP 
(or is a non-U.S. person; as discussed below in this section III.B.4., 
solely for purposes of CEA section 1a(18)(A)(iv) and CFTC Regulation 
Sec.  1.3(m)(5), the Commissions will consider Forex Pools whose 
participants are limited solely to non-U.S. persons (and which are 
operated by CPOs located outside of the U.S., its territories or 
possessions) to be ECPs), or from Forex Pools that the Forex Pool is an 
ECP, provided that the CPO or retail forex transaction counterparty has 
a reasonable basis to so rely, just as swap dealers and major swap 
participants are permitted to do pursuant to the safe harbor in new 
CFTC Regulation Sec.  23.430(d), 17 CFR 23.430(d). Solely for purposes 
of CEA section 1a(18)(A)(iv) and CFTC Regulation Sec.  1.3(m)(5), a CPO 
or retail forex transaction counterparty will have a reasonable basis 
to rely on such written representations if the person making the 
representation specifies therein the provision(s) of, as applicable, 
section 1a(18) of the CEA or CFTC Regulation Sec.  4.7(a)(1)(iv) 
pursuant to which the person qualifies as an ECP or a non-U.S. person, 
respectively, unless it has information that would cause a reasonable 
person to question the accuracy of the representation.\655\ Solely for 
purposes of CEA section 1a(18)(A)(iv) and CFTC Regulation Sec.  
1.3(m)(5), persons representing that they qualify as non-U.S. persons 
based on CFTC Regulation Sec.  4.7(a)(1)(iv)(D) must represent that 
they are relying on such provision as modified as discussed below 
(i.e., without the 10% carve-out for U.S. persons).
---------------------------------------------------------------------------

    \653\ See letter from Sidley.
    \654\ See CFTC, Business Conduct Standards for Swap Dealers and 
Major Swap Participants With Counterparties; Final Rule, 77 FR 9733 
(Feb. 17, 2012).
    \655\ Cf. CFTC Regulation Sec. Sec.  23.430(d), 23.402(d).
---------------------------------------------------------------------------

    Furthermore, the CFTC recognizes that, despite a counterparty's 
reasonable good faith efforts to ensure that Forex Pools do not in fact 
have any U.S. participants, a situation may arise where a Forex Pool 
does turn out to have U.S. participants. If a counterparty has 
reasonable policies and procedures in place to verify the ECP status of 
Forex Pool counterparties and, notwithstanding such reasonable good 
faith efforts and following such policies and procedures, enters into 
retail forex transactions with such a Forex Pool in good faith and it 
was subsequently determined that U.S. participants represented no more 
than a de minimis number of participants or amount of ownership of the 
Forex Pool, absent other material factors, the CFTC would not expect to 
bring an enforcement action against the counterparty for entering into 
a retail forex transaction in contravention of the requirements of the 
retail forex regime. For purposes of this analysis only, and without 
this being viewed as a de minimis threshold for purposes of this rule 
or otherwise, the CFTC would consider as de minimis, ownership of units 
of participation of a Forex Pool held by U.S. participants of less than 
10% of the beneficial interest in the Forex Pool. The fact that, absent 
other material factors, the CFTC would not expect to bring an 
enforcement action against a forex transaction counterparty in such 
case does not

[[Page 30653]]

relieve any obligation on the part of the CPO of the Forex Pool either 
to register as a CPO, claim the 4.13(a)(3) exemption therefrom or 
redeem the U.S. participants as described above.
    One commenter suggested that the Commissions allow commodity pools 
and their counterparties to rely on participant ECP representations 
provided in connection with an initial investment.\656\ The Commissions 
believe that if participants make ECP representations in connection 
with an initial investment in a Forex Pool, absent an additional 
investment (which would require a new ECP verification, other than in 
the case of automatically reinvested distributions), the subsequent 
loss of a participant's ECP status would not cause the Forex Pool to 
lose its own ECP status for purposes of retail forex transactions so 
long as the operating agreement of the Forex Pool or the subscription 
or other agreement pursuant to which the participant invested in the 
Forex Pool requires the participant to advise the CPO of the Forex Pool 
promptly of a loss of the participant's ECP status. In the event of the 
loss of ECP status of a participant, the CPO would be required to 
redeem the non-ECP from the Forex Pool at the first opportunity 
following notification to avoid the Forex Pool losing its ECP status 
for subsequent retail forex transactions.
---------------------------------------------------------------------------

    \656\ See letter from Sidley. The Commissions note that the 
obligation to determine that the parties to retail forex 
transactions are ECPs is imposed on the CPOs of Forex Pools and the 
persons looking to engage in retail forex transactions with Forex 
Pools.
---------------------------------------------------------------------------

    The Commissions are mindful that several commenters indicated that 
CPOs do not customarily include a question or representation as to ECP 
status in subscription agreements for pool participants, and stated 
that requiring CPOs to qualify or redeem existing participants due to 
the new look-through provision would be expensive, burdensome and 
disruptive.\657\ In this regard, the Commissions note that the look-
through requirement for commodity pools was imposed by statute. As a 
result of the Commissions adopting the limited look-through in the 
final rule (as compared to the proposed indefinite look-through), 
however, the number of commodity pools subject to the look-through 
provision should be dramatically reduced, reducing the number of pools 
subject to regulation of their retail forex transactions, and the 
associated costs, accordingly.\658\
---------------------------------------------------------------------------

    \657\ See, e.g., letter from SIFMA AMG IV.
    \658\ The adoption of CFTC Regulation Sec.  1.3(m)(8), discussed 
in part III.G, infra, also should reduce the number of pools subject 
to regulation of their retail forex transactions, and the associated 
costs, accordingly.
---------------------------------------------------------------------------

    Also, in response to commenter concerns that the look-through 
provision would be applied to entities other than commodity pools 
(e.g., operating companies),\659\ the Commissions revised the text of 
CFTC Regulation Sec.  1.3(m)(5)(i) to reflect their intent to apply the 
look-through provision solely to commodity pools qualifying as ECPs, if 
at all, under clause (A)(iv) and clause (A)(v) of the ECP 
definition.\660\ This is consistent with the statutory text, which is 
limited to looking through commodity pools under clause (A)(iv) of the 
ECP definition, and the intent behind the look-through provision, as it 
relates to clause (A)(v) thereof.
---------------------------------------------------------------------------

    \659\ See, e.g., letter from Sandalwood Securities, Inc. 
(expressing concern that ``the Proposed Rule extends Dodd-Frank's 
limited look-through provision to all sub-sections of section 
la(12)'').
    \660\ Thus, for example, investment companies qualifying under 
clause (A)(iii) of the ECP definition and employee benefit plans 
qualifying under clause (A)(vi) of the ECP definition (and, as 
stated in each clause, ``a foreign person performing a similar role 
or function subject as such to foreign regulation'') would not be 
covered by the look-through provision. To the extent that other 
entities would otherwise be captured by the look-through as proposed 
(such as collective investment trusts whose investors are ERISA 
plans not excluded from the commodity pool definition by CFTC 
Regulation Sec.  4.5(a)(4) and which qualify as ECPs under clause 
(A)(v) of the ECP definition), the Commissions believe that focusing 
on the level of the Forex Pool entering into the retail forex 
transactions, and such Forex Pool's direct participants (absent 
evasion), should alleviate such concerns.
---------------------------------------------------------------------------

    Commenters also stated that Retail Forex Pools will no longer be 
able to enter into retail forex transactions with foreign financial 
institutions.\661\ As discussed in section III.B.1. above, however, 
this is not the case with respect to retail forex transactions 
described in CEA section 2(c)(2)(C)(i)(I)(bb). With respect to retail 
forex transactions described in CEA section 2(c)(2)(B)i)(I), this is a 
consequence of the express statutory text of the Dodd-Frank Act, which 
removed non-U.S. financial institutions from the list of Enumerated 
Counterparties eligible to enter into retail forex transactions with 
non-ECPs.\662\
---------------------------------------------------------------------------

    \661\ Cf. letters from Sidley and Millburn Ridgefield 
Corporation (``Millburn'').
    \662\ See section 742(c) of the Dodd-Frank Act, amending CEA 
section 2(c)(2)(B)(i)(II)(aa), 7 U.S.C. 2(c)(2)(B)(i)(II)(aa).
---------------------------------------------------------------------------

    Commenters further suggested generally that the Commissions create 
additional categories of ECPs to address the Commissions' concerns 
regarding the potential loophole of Retail Forex Pools that are unable 
to qualify as ECPs due to the new look-through provision in clause 
(A)(iv) of the ECP definition qualifying as an ECP under clause (A)(v) 
of the ECP definition. While one commenter proposed adopting a new rule 
clarifying that Forex Pools comprised entirely of QEPs and operated by 
persons subject to regulation under the CEA are ECPs,\663\ Congress 
chose to look to ECP status of Forex Pool participants, not QEP status, 
as the basis for determining whether such Forex Pools are ECPs. 
Therefore, it is more appropriate to rely on Retail Forex Pool 
participants' ECP status than to rely on QEP status to establish ECP 
status.
---------------------------------------------------------------------------

    \663\ See letter from Sidley. This commenter also suggested 
deeming non-U.S. persons to be ECPs by definition. The Commissions 
have addressed this comment below in this section in response to the 
comment regarding the extraterritorial impact of the proposed ECP 
rules.
---------------------------------------------------------------------------

    One commenter stated a concern regarding what it characterized as 
the lack of clarity surrounding the extraterritoriality impact of the 
proposed ECP rules.\664\ The Commissions recognize the potential 
consequences of the broad look-through language in CEA section 
1a(18)(A)(iv) \665\ and are providing guidance as to the application of 
the look-through to Forex Pools whose participants are limited solely 
to non-U.S. persons and which are operated by CPOs located outside the 
United States, its territories or possessions.
---------------------------------------------------------------------------

    \664\ See letter from AIMA I.
    \665\ 7 U.S.C. 1a(18)(A)(iv).
---------------------------------------------------------------------------

    As discussed below, while foreign entities are not necessarily 
immune from U.S. jurisdiction for commercial activities undertaken with 
U.S. counterparties or in U.S. markets, canons of statutory 
construction ``assume that legislators take account of the legitimate 
sovereign interests of other nations when they write American laws,'' 
\666\ particularly when limited U.S. interests are at stake.\667\
---------------------------------------------------------------------------

    \666\ See F. Hoffman-LaRoche, Ltd. v. Empagran S.A., 542 U.S. 
155, 164 (2004), citing Murray v. Schooner Charming Betsy, 2 Cranch 
64, 118, 2 L.Ed. 208 (1804) (``[A]n act of congress ought never to 
be construed to violate the law of nations if any other possible 
construction remains''); Hartford Fire Insurance Co. v. California, 
509 U.S. 764 (1993) (Scalia, J., dissenting). See also Restatement 
(Third) Foreign Relations Law Sec.  403 (scope of a statutory grant 
of authority must be construed in the context of international law 
and comity including, as appropriate, the extent to which regulation 
is consistent with the traditions of the international system).
    \667\ See also CFTC, Exemption From Registration for Certain 
Foreign Persons, 72 FR 63976 (Nov. 14, 2007) (where the CFTC stated 
that:
    Given this agency's limited resources, it is appropriate at this 
time to focus [the Commission's] customer protection activities upon 
domestic firms and upon firms soliciting or accepting orders from 
domestic users of the futures markets and that the protection of 
foreign customers of firms confining their activities to areas 
outside this country, its territories, and possessions may best be 
for local authorities in such areas)
    (citing CFTC, Introducing Brokers and Associated Persons of 
Introducing Brokers, Commodity Trading Advisors and Commodity Pool 
Operators; registration and Other Regulatory Requirements, 48 FR 
35248, 35261 (Aug. 3, 1983)).

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[[Page 30654]]

    The Commissions do not believe that Congress intended for Forex 
Pools with no U.S. participants and operated by CPOs located outside 
the United States, its territories or possessions to be subject to a 
U.S. retail forex regime and, therefore, will consider Forex Pools 
whose participants are limited solely to non-U.S. persons and which are 
operated by CPOs located outside the United States, its territories or 
possessions to be ECPs for purposes of CFTC Regulation Sec.  1.3(m)(5). 
For this purpose, a Forex Pool participant is a non-U.S. person if it 
satisfies the definition of ``Non-United States person'' in CFTC 
Regulation 4.7(a)(1)(iv); provided, however, that, if a participant is 
an entity organized principally for passive investment, such as a pool, 
investment company or other similar entity, such entity will be 
considered to be a Non-United States person under paragraph (D) of CFTC 
Regulation 4.7(a)(1)(iv) for purposes of CFTC Regulation Sec.  
1.3(m)(5) solely if all units of participation in such passive 
investment vehicle participant are held by Non-United States 
persons.\668\ A broader interpretation or relief is not appropriate at 
this time.\669\
---------------------------------------------------------------------------

    \668\ CFTC Regulation Sec.  4.7(a)(i)(iv)(D) lists the following 
as one category of non-United States person:
    An entity organized principally for passive investment such as a 
pool, investment company or other similar entity; Provided, That 
units of participation in the entity held by persons who do not 
qualify as Non-United States persons or otherwise as qualified 
eligible persons represent in the aggregate less than 10% of the 
beneficial interest in the entity, and that such entity was not 
formed principally for the purpose of facilitating investment by 
persons who do not qualify as Non-United States persons in a pool 
with respect to which the operator is exempt from certain 
requirements of part 4 of the Commission's regulations by virtue of 
its participants being Non-United States persons.
    It would be inappropriate to disregard the presence of U.S. 
persons constituting as much as 10% of such entities' participants 
in the context of this interpretive guidance. As discussed elsewhere 
herein, however, entities described in CEA section 1a(18)(A)(iii) or 
(vi), 7 U.S.C. 1a(18)(A)(iii) or (vi), are not subject to the look-
through and are ECPs irrespective of the ECP status of their 
participants.
    \669\ Cf. CPO/CTA Compliance Release at 11264 (stating that ``it 
is prudent to withhold consideration of a foreign advisor exemption 
until the [CFTC] has received data regarding such firms on Forms 
CPO-PQR and/or CTA-PR * * * to enable the [CFTC] to better assess 
[which] firms * * * may be appropriate to include within the 
exemption, should the [CFTC] decide to adopt one'').
---------------------------------------------------------------------------

C. ECP Status for Commodity Pools Under Clause (A)(v) vs. Under Clause 
(A)(iv) of the ECP Definition

1. Proposed Approach
    The Commissions stated in the Proposing Release that they believe 
``some commodity pools unable to satisfy the total asset or regulated 
status components of clause (A)(iv) of the ECP definition may rely on 
clause (A)(v) to qualify as ECPs instead.'' \670\ The Commissions 
further stated in the Proposing Release that ``a commodity pool that 
cannot satisfy the monetary and regulatory status conditions prescribed 
in clause (A)(iv) should not qualify as an ECP in reliance on clause 
(A)(v) of the ECP definition.'' \671\ Based on those views, the 
Commissions proposed to further define the term ``eligible contract 
participant'' to prevent such a commodity pool from qualifying as an 
ECP pursuant to clause (A)(v) of the ECP definition. This proposal 
applied to all commodity pools, not just Forex Pools engaged in retail 
forex transactions.
---------------------------------------------------------------------------

    \670\ Proposing Release, 75 FR at 80185.
    \671\ Id.
---------------------------------------------------------------------------

2. Commenters' Views
    Two commenters argued that, had Congress wished to prevent 
commodity pools from relying on the general ECP provision for business 
entities in clause (A)(v), it could have expressly excluded commodity 
pools from clause (A)(v).\672\ Another commenter attempted to 
illustrate that clause (A)(v) of the ECP definition is an independent 
basis for qualifying as an ECP by distinguishing clause (A)(v) from 
clause (A)(iv).\673\
---------------------------------------------------------------------------

    \672\ See letters from Sidley and Skadden.
    \673\ See letter from Akin Gump. Akin Gump noted that ``[a]s 
opposed to [clause] (A)(iv), [clause] (A)(v) includes as one means 
of satisfying its criteria that the entity be entering into a 
contract for hedging purposes.'' While correct, clause (A)(v) also 
includes as another means of satisfying its criteria that an entity 
enter into agreements, contracts or transactions in connection with 
the conduct of the entity's business, which would be a much lower 
standard.
---------------------------------------------------------------------------

    One commenter expressed the view that it is unclear whether 
``subject to regulation under this Act'' in CEA section 
1a(18)(A)(iv)(II) \674\ means a registered CPO or something else (e.g., 
a person excluded from the definition of a CPO, a CPO exempt from 
registration conditioned in part upon making a filing to claim such 
relief).\675\
---------------------------------------------------------------------------

    \674\ 7 U.S.C. 1a(18)(A)(iv)(II).
    \675\ See letter from SIFMA AMG IV. CEA Section 
1a(18)(A)(iv)(II) refers to a commodity pool that ``is formed and 
operated by a person subject to regulation under this Act or a 
foreign person performing a similar role or function subject as such 
to foreign regulation (regardless of whether each investor in the 
commodity pool or the foreign person is itself an eligible contract 
participant) provided, however, that for purposes of section 
2(c)(2)(B)(vi) and section 2(c)(2)(C)(vii), the term `eligible 
contract participant' shall not include a commodity pool in which 
any participant is not otherwise an eligible contract participant.''
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3. Final Rule
    The Commissions are adopting CFTC Regulation Sec.  1.3(m)(6) as 
proposed, which states that ``[a] commodity pool that does not have 
total assets exceeding $5,000,000 or that is not operated by a person 
described in subclause (A)(iv)(II) of section 1a(18) of the Act is not 
an eligible contract participant pursuant to clause (A)(v) of such 
Section.'' \676\ As noted, the Commissions are concerned that clause 
(A)(v) of the ECP definition may undermine the protections that 
specifically apply to commodity pool participants pursuant to the 
limitations on ECP status for commodity pools set forth in clause 
(A)(iv) of the ECP definition. Allowing a commodity pool that cannot 
satisfy the monetary and regulatory status conditions prescribed for 
commodity pools in clause (A)(iv) to qualify as an ECP under clause 
(A)(v) would undermine these protections.
---------------------------------------------------------------------------

    \676\ The Commissions have made certain technical corrections to 
proposed CFTC Regulation Sec.  1.3(m)(6)(i) as concerns its 
citations to the CEA.
---------------------------------------------------------------------------

    The Commissions acknowledge the comments stating that clause (A)(v) 
of the ECP definition is an independent basis for qualifying as an ECP 
and that Congress did not explicitly provide that a commodity pool that 
fails to qualify as an ECP under clause (A)(iv) cannot do so under 
clause (A)(v). However, when specifically legislating for commodity 
pools, Congress determined that total assets of $5 million and 
operation by a person subject to regulation under the CEA (or a foreign 
equivalent) are necessary to assure appropriate protection for non-ECP 
participants in a commodity pool. Furthermore, the commenters' view 
that Congress's use of the disjunctive term ``or'' between clauses 
(A)(x) and (A)(xi) of the ECP definition means that an entity can rely 
on clause (A)(v) of the ECP definition, notwithstanding that such 
entity cannot satisfy a prong more specific to it, would largely render 
superfluous each clause under subparagraph (A) of the ECP definition 
other than clause (v) and clause (xi) (for individuals).\677\ As such, 
the Commissions believe that the final rule adopted in this release is 
consistent with Congressional intent.
---------------------------------------------------------------------------

    \677\ Interpreting statutory language as surplusage is 
disfavored. Effect should be given to every clause and word of a 
statute. See Negonsott v. Samuels, 507 U.S. 99 (1993).
---------------------------------------------------------------------------

    The Commissions also are mindful that one commenter expressed a 
concern that the Commissions' reliance on clause (A)(iv) of the ECP 
definition

[[Page 30655]]

might cause commodity pools to lose their ability to claim ECP status 
under clauses of the ECP definition, other than clause (v), and asked 
the Commissions to clarify the meaning of the phrase ``formed and 
operated by a person subject to regulation under the [CEA]'' in clause 
(A)(iv).\678\ In response, the Commissions note that a commodity pool 
that does not qualify for ECP status under clause (A)(iv) of the ECP 
definition may still qualify as an ECP under either of the two clauses 
of the ECP definition other than clause (A)(v) applicable to 
subcategories of commodity pools. Thus, registered investment companies 
and foreign equivalents may qualify as ECPs under clause (A)(iii) of 
the ECP definition, and ERISA plans and the other entities described in 
clause (A)(vi) of the ECP definition may qualify as ECPs thereunder. 
The Commissions' actions in this release do not change that result.
---------------------------------------------------------------------------

    \678\ See letter from SIFMA AMG IV.
---------------------------------------------------------------------------

    Also, with regard to that commenter's request for clarification, 
for purposes of CFTC Regulation Sec.  1.3(m)(6), the Commissions 
interpret the language ``subject to regulation under the [CEA]'' in 
clause (A)(iv) of the ECP definition as requiring lawful operation of 
the commodity pool by a person excluded from the CPO definition, a 
registered CPO, or a person properly exempt from CPO registration.\679\ 
Congress did not limit ECP status under clause (A)(iv) to commodity 
pools operated by persons registered as CPOs; it used the more 
encompassing phrase ``subject to regulation'' under the CEA.\680\ On 
the other hand, to construe that phrase to include any person operating 
a commodity pool would render the phrase superfluous.\681\ The 
commenters' view would enable a CPO that fails to register as required 
to claim that the commodity pool it operates is an ECP under clause 
(A)(v) and thus is not subject to regulation of its retail forex 
transactions. The Commissions believe that construing the phrase 
``formed and operated by a person subject to regulation under the 
[CEA]'' to refer to a person excluded from the CPO definition, 
registered as a CPO or properly exempt from CPO registration 
appropriately reflects Congressional intent.
---------------------------------------------------------------------------

    \679\ For these purposes, the Commissions would take the same 
approach to insignificant deviations from exemptive filings as the 
CFTC does in CFTC Regulation Sec.  4.7(e).
    \680\ If the Commissions interpreted the ``subject to regulation 
under this Act'' language in CEA section 1a(18)(A)(iv)(II) to mean 
that the commodity pool operator must be registered as a CPO and 
limited CPOs to claiming ECP status solely under clause (iv) of the 
ECP definition, then the operators of all commodity pools trading 
swaps would have to register as CPOs to be ECPs. While more CPOs 
will be registering with the CFTC because the CFTC has withdrawn 
CFTC Regulation Sec.  4.13(a)(4), see CPO/CTA Compliance Release, 
and the Dodd-Frank Act has expanded the scope of the transactions 
within the CFTC's jurisdiction, thus reducing the number of CPOs who 
can rely on the 5 percent threshold in CFTC Regulation Sec.  
4.13(a)(3) and thus claim the CPO registration exemption, the CFTC 
did not withdraw 4.13(a)(3), so some CPOs will be able to continue 
to rely on it. Also, not all persons operating commodity pools will 
be CPOs. See CFTC Regulation Sec.  4.5 (exclusion from the 
definition of the term ``commodity pool operator''). The Commissions 
do not believe Congress intended commodity pool ECP status to 
require CPO registration by the commodity pools' operators in all 
cases.
    \681\ If the mere act of forming or operating a commodity pool 
means that a person is ``subject to regulation'' under the CEA, then 
the ``subject to regulation'' language would not be needed.
---------------------------------------------------------------------------

D. Dealers and Major Participants as ECPs

1. Proposed Approach
    The Commissions proposed to add swap dealers, security-based swap 
dealers, major swap participants and major security-based swap 
participants to the ECP definition on the basis that such persons ``are 
likely to be among the most active and largest users of swaps and 
security-based swaps.'' \682\
---------------------------------------------------------------------------

    \682\ Proposing Release, 75 FR at 80184.
---------------------------------------------------------------------------

2. Commenters' Views
    Several commenters supported the proposed addition of swap dealers, 
security-based swap dealers, major swap participants, and major 
security-based swap participants to the ECP definition.\683\ No 
commenter opposed this aspect of the proposal.
---------------------------------------------------------------------------

    \683\ One representative commenter stated that ``the proposed 
definition in CFTC Proposed CFTC Regulation Sec.  1.3(m)(1)-(4) 
fills important gaps left by Congress by ensuring that major swap 
participants, major security-based swap participants, swap dealers 
and security-based swap dealers are treated as ECPs.'' See letter 
from Sidley.
---------------------------------------------------------------------------

3. Final Rule
    The Commissions are adopting the new ECP categories as proposed. 
The rules as adopted clarify that the terms ``swap dealer,'' 
``security-based swap dealer,'' ``major swap participant,'' and ``major 
security-based swap participant'' have their respective meanings as 
defined in the CEA and the Exchange Act and as otherwise further 
defined by the Commissions.\684\
---------------------------------------------------------------------------

    \684\ These new ECP categories are set forth in new CFTC 
Regulation Sec.  1.3(m)(1)-(4).
---------------------------------------------------------------------------

E. Government Entities: Incorrect Cross-Reference

1. Description of the Issue
    Clause (A)(vii) of the ECP definition conditions the ECP status of 
governmental entities, and their political subdivisions, agencies, 
instrumentalities and departments (collectively, ``government 
entities''), in part, on the identity of their counterparties. 
Specifically, a government entity may qualify as an ECP under the 
provision in clause (A)(vii) that requires the entity's counterparty to 
be ``listed in any of subclauses (I) through (VI) of section 
2(c)(2)(B)(ii)'' of the CEA.\685\ However, subclauses (I) through (III) 
of CEA section 2(c)(2)(B)(ii) \686\ are unrelated to counterparty types 
(rather, they describe the dollar amounts that apply for purposes of 
retail forex transactions under CEA section 2(c)(2)(B)), and subclauses 
(IV) through (VI) of CEA section 2(c)(2)(B)(ii) no longer exist in the 
statute. Read literally, then, this provision of the ECP definition is 
inherently a nullity and, thus, cannot enable government entities to 
qualify as ECPs.\687\
---------------------------------------------------------------------------

    \685\ CEA section 1a(18)(A)(vii)(cc), 7 U.S.C. 
1a(18)(A)(vii)(cc).
    \686\ 7 U.S.C. 2(c)(2)(B)(ii)(I)-(III).
    \687\ A government entity, though, can still qualify as an ECP 
under the other provisions of clause (A)(vii) if it is a certain 
type of ``eligible commercial entity'' as defined in CEA section 
1a(17), 7 U.S.C. 1a(17), or owns and invests on a discretionary 
basis $50 million or more in investments.
---------------------------------------------------------------------------

2. Commenters' Views
    One commenter traced the history of the relevant provisions and 
concluded that the reference to subclauses (I) through (VII) of CEA 
section 2(c)(2)(B)(ii) in clause (A)(vii) of the ECP definition is 
erroneous.\688\ This commenter pointed instead to CEA section 
2(c)(2)(B)(i)(II) \689\ as the reference that should be included in 
clause (A)(vii) of the ECP definition because it lists the entities 
that are eligible to serve as counterparties in retail forex 
transactions.
---------------------------------------------------------------------------

    \688\ See letter from Wells Fargo dated June 3, 2011 (``Wells 
Fargo I'').
    \689\ 7 U.S.C. 2(c)(2)(B)(i)(II).
---------------------------------------------------------------------------

    This commenter noted that the cross-reference in clause (A)(vii) of 
the ECP definition was correct when it was added to the CEA as part of 
the CFMA, but that it became incorrect in 2008 when an unrelated 
amendment to the CEA was enacted \690\ that changed the numbering of 
the CEA's provisions governing retail forex transactions but that 
failed to make a conforming amendment to clause (A)(vii) of the ECP 
definition. As a result of this 2008 amendment to the CEA, the list of 
entities that formerly appeared in subclauses (I) through (VI) of CEA 
sections 2(c)(2)(B)(ii) now appear in items (aa) through (ff) of CEA 
section

[[Page 30656]]

2(c)(2)(B)(i)(II) instead.\691\ This commenter requested that ``the 
Commissions correct this clearly erroneous reference in the definition 
of ECP through interpretive guidance, rulemaking or Commission order.'' 
\692\
---------------------------------------------------------------------------

    \690\ See section 13101 of the CRA.
    \691\ 7 U.S.C. 2(c)(2)(B)(i)(II)(aa)-(ff).
    \692\ See letter from Wells Fargo I.
---------------------------------------------------------------------------

3. Interpretive Guidance
    Clause (A)(vii) of the ECP definition contains an erroneous cross-
reference to subclauses (I) through (VI) of CEA section 2(c)(2)(B)(ii). 
Accordingly, the Commissions are issuing interpretive guidance by 
identifying the counterparties with which a governmental entity can 
enter into swaps to attain ECP status under the provision in clause 
(A)(vii) that requires the entity's counterparty to be ``listed in any 
of subclauses (I) through (VI) of section 2(c)(2)(B)(ii)'' of the CEA. 
The Commissions consider a government entity covered by the 
counterparty limitation in clause (A)(vii) to be an ECP with respect to 
an agreement, contract, or transaction that is offered by, and entered 
into with, a person that is listed in items (aa) through (ff) of 
section 2(c)(2)(B)(i)(II) of the CEA. The limitation of ECP status 
``with respect to'' a particular transaction is consistent with 
Congress' determination that, for purposes of this provision of clause 
(A)(vii), governmental entities may derive their ECP status from the 
status of their counterparty.

F. Qualification as an ECP With Respect to Swaps Used To Hedge or 
Mitigate Commercial Risk in Connection With the Conduct of an Entity's 
Business

1. Proposing Release
    In the Proposing Release, the Commissions requested comment on 
whether any additional categories should be added to the definition of 
ECP, ``such as the following categories suggested by commenters [on the 
ANPRM]: Commercial real estate developers; energy or agricultural 
cooperatives or their members; or firms using swaps as hedges pursuant 
to the terms of the CFTC's Swap Policy Statement.'' \693\ As noted 
above, the ECP definition is important because the Dodd-Frank Act 
amended the CEA to prohibit a person that is not an ECP from entering 
into swaps other than on or subject to the rules of a DCM.\694\
---------------------------------------------------------------------------

    \693\ See Proposing Release, 75 FR at 80185. The reference to 
the ``Swap Policy Statement'' is to the CFTC's Policy Statement 
Concerning Swap Transactions, 54 FR 30694 (July 21, 1989). The Swap 
Policy Statement ``identifie[d] those swap transactions which [were] 
not * * * regulated as futures or commodity option transactions 
under the [CEA] or the related regulations.'' 54 FR at 30694. One 
element of the Swap Policy Statement required that the swap be 
entered into in connection with each swap counterparty's line of 
business. Id. at 30697. The Swap Policy Statement was applicable to 
cash-settled swaps only, with foreign exchange considered to be cash 
for this purpose. Id. at 30696. The Swap Policy Statement required 
that the terms of the relevant swap be individually tailored, 
meaning that the material terms of the swap had to be negotiated, 
the parties had to make individualized credit determinations, and 
the swap documentation could not be fully standardized. Id. at 
30696-97. The Swap Policy Statement did not apply to swaps subject 
to exchange-style offset, swaps that were cleared or subject to a 
margin system, or swaps marketed to the public. Id. As noted in the 
Product Definitions Proposal, the Dodd-Frank Act supersedes the Swap 
Policy Statement. 76 FR at 29829, n. 74.
    \694\ The discussion in this section relates only to swaps and 
has no effect on the laws or regulations applicable to security-
based swaps, security-based swap agreements or mixed swaps.
    As noted above, the Dodd-Frank Act also amended the Exchange Act 
and the Securities Act to make it unlawful for a person to effect a 
transaction in a security-based swap with or for a person that is 
not an ECP unless the transaction is effected on a national 
securities exchange registered with the SEC, and to make it unlawful 
for a person to offer to sell, offer to buy or purchase, or sell a 
security-based swap to a person that is not an ECP unless a 
registration statement under the Securities Act is in effect with 
respect to that security-based swap.
---------------------------------------------------------------------------

2. Commenters' Views
    Several commenters supported the addition of categories to the 
definition of ECP because, these commenters said, not all current swap 
market participants are ECPs. Many of these commenters said that non-
ECPs have entered into swaps in reliance on the Swap Policy 
Statement.\695\ Commenters highlighted, among other things, the 
importance of the Swap Policy Statement to pass-through entities used 
by farmers,\696\ operating companies \697\ and commercial property 
developers,\698\ noting that such entities may not meet the ECP 
criteria. According to these commenters, these pass-through entities 
often are small and medium-sized businesses that enter into interest 
rate swaps with lending financial institutions in reliance on the Swap 
Policy Statement.\699\ The commenters explained that the loans usually 
are guaranteed by the principals of the entity entering into the swap, 
and that the borrower would qualify as an ECP if structured as a 
single-level corporate entity or sole proprietorship.\700\ Commenters 
said that if these non-ECP entities were limited to swaps that are 
available on or subject to the rules of a DCM, many regional bank 
borrowers would lose the ability to use swaps, real estate companies 
would have less flexibility in risk management, and smaller lenders 
would be at a competitive disadvantage.\701\ Another commenter said 
that Dodd-Frank Act provisions such as the end-user clearing exception 
indicate that Congress intended to preserve the availability of swaps 
used for business reasons rather than for investment or 
speculation.\702\
---------------------------------------------------------------------------

    \695\ See letter from CDEU. One commenter estimated that swap 
transactions completed by regional and community banks in reliance 
on the Swap Policy Statement constituted 30-40% of all of such 
banks' swaps, representing approximately 7,000 to 10,000 swaps per 
year and $15 to $20 billion in related loan principal. See letter 
from B&F I. Another commenter advised that it has entered 11 swaps, 
with a total notional of $26 million, since its formation in 2007, 
almost all of the counterparties to which ``qualified for the swap 
under the [Swap Policy Statement] business purpose exemption.'' See 
letter from Capstar. The CFTC stated when issuing the Swap Policy 
Statement that it ``reflects the [CFTC]'s view that at this time 
most swap transactions, although possessing elements of futures or 
options contracts, are not appropriately regulated as such under the 
[CEA] and [CFTC] regulations.'' Swap Policy Statement at 30694.
    \696\ See, e.g., letter from Rabobank, N.A., Rabo AgriFinance, 
Inc. and Co[ouml]peratieve Centrale Raiffeisen-Boerenleenbank B.A. 
(``Rabobank, New York Branch'') (relating that ``[f]or a variety of 
estate planning and regulatory purposes, farmers commonly hold their 
ownership interests in land, buildings and farm equipment 
indirectly, through a network of legal entities'').
    \697\ See, e.g., letter from Fifth Third Bank and Union Bank, 
N.A. (advising that ``[i]t is common for an operating business to 
organize a separate limited liability company (for tax and legal 
reasons) to acquire * * * assets * * * and to lease these assets to 
the operating company[, which] becomes the borrow[er] * * * for the 
loan used to acquire those assets'' and that ``[t]he limited 
liability company often does not maintain sufficient capital to 
qualify as an ECP'').
    \698\ See, e.g., letters from Capstar, Frost National Bank, FTN 
Financial Capital Markets, Midsize Banks and NAREIT.
    \699\ See letters from BB&T I and B&F I. Commenters said that 
these businesses may intentionally maintain less than $1 million in 
equity primarily for tax and legal reasons. See letters from Capital 
One and Columbia State Bank (stating that over 65% of its borrowers 
are structured as limited liability companies or S corporations and 
intentionally maintain less than $1 million in equity at the entity 
entering into the swap).
    \700\ See letter from Columbia State Bank. See also letter from 
BB&T I.
    \701\ See letters from BB&T I, Capital One, Capstar, Columbia 
State Bank, Midsize Banks, NAREIT and Wells Fargo II.
    \702\ See letter from FSR I.
---------------------------------------------------------------------------

    To mitigate the impact of restricting non-ECPs to swaps that are 
available on or subject to the rules of DCMs, some commenters said that 
an entity should be able to qualify as an ECP based on the financial 
qualifications of related entities, so long as various conditions 
proposed by the commenters are satisfied. Some commenters said that an 
entity should be eligible to be an ECP if its swap obligations are 
guaranteed by an ECP,\703\ or if its controlling entity qualifies as an 
ECP under clause (A)(v) of the statutory definition.\704\ Another 
commenter suggested revisions to the

[[Page 30657]]

ECP definition that included looking to the ECP status or 
sophistication of the majority owner of an entity in determining if the 
entity itself is an ECP.\705\ Other commenters suggested other 
provisions to allow non-ECPs to enter into swaps other than on or 
subject to the rules of a DCM, so long as the non-ECP meets various 
conditions indicating that the swap is used in connection with its line 
of business.\706\
---------------------------------------------------------------------------

    \703\ See letters from BB&T I, Midsize Banks and Wells Fargo II.
    \704\ See letters from CDEU and Regional Banks.
    \705\ See letter from NAREIT.
    \706\ See letters from the American Public Gas Association 
(``APGA''), Capital One and Gavilon dated December 23, 2010 
(``Gavilon I'').
---------------------------------------------------------------------------

    Other commenters argued for per se ECP qualification based on their 
status as certain types of persons, such as farmers\707\ or for ECP 
status based solely on a combination of a person's status and the swap 
being related to a person's line of business with no additional 
conditions.\708\
---------------------------------------------------------------------------

    \707\ See meeting with Ron Eliason on December 16, 2010 (in 
which Mr. Eliason contended that farmers should be able to enter 
into swaps, even if they do not meet the income or asset tests in 
the current ECP definition and, therefore, would not be permitted to 
enter into swaps other than on or subject to the rules of a DCM).
    \708\ See letter from APGA (requesting that ``the [CFTC] 
exercise its authority under section la(18)(C) of the Act and 
determine that public natural gas distribution companies, including 
member-owned co-operatives, that enter into swaps in connection with 
their business of supplying customers with natural gas are ECPs 
within the meaning of section la(18) of the Act'').
---------------------------------------------------------------------------

3. Final Rules and Interpretation
    In response to the commenters' concerns, the CFTC is adopting CFTC 
Regulation Sec.  1.3(m)(7) to permit an entity, in determining its net 
worth for purposes of subclause (A)(v)(III) of the ECP definition,\709\ 
to include the net worth of its owners, solely for purposes of 
determining its ECP status for swaps used to hedge or mitigate 
commercial risk, provided that all of its owners are themselves ECPs 
(disregarding shell companies). Under CFTC Regulation Sec.  1.3(m)(7) 
as adopted, an entity seeking to qualify under subclause (A)(v)(III) of 
the ECP definition in order to enter into a swap used to hedge or 
mitigate commercial risk is permitted to count the net worth of its 
owners in determining its own net worth, so long as all its owners are 
ECPs. This regulation applies only to entities that are otherwise 
eligible to rely on subclause (A)(v)(III) to determine ECP status; it 
does not expand or change the scope of application of that 
paragraph.\710\
---------------------------------------------------------------------------

    \709\ CEA section 1a(18)(A)(v)(III) provides that the term 
``eligible contract participant'' includes ``a corporation, 
partnership, proprietorship, organization, trust, or other entity * 
* * that (aa) has a net worth exceeding $1,000,000; and (bb) enters 
into an agreement, contract, or transaction in connection with the 
conduct of the entity's business or to manage the risk associated 
with an asset or liability owned or incurred or reasonably likely to 
be owned or incurred by the entity in the conduct of the entity's 
business.'' 7 U.S.C. 1a(18)(A)(v)(III).
    \710\ For example, if a commodity pool were precluded by CFTC 
Regulation Sec.  1.3(m)(6) from relying on clause (A)(v) of the 
statutory definition to qualify as an ECP, such pool would not be 
able to rely on CFTC Regulation Sec.  1.3(m)(7) to qualify as an 
ECP.
---------------------------------------------------------------------------

    CFTC Regulation Sec.  1.3(m)(7) as adopted applies only when 
determining ECP status for swaps used to hedge or mitigate commercial 
risk. This new regulation does not apply when determining ECP status 
for other swaps or for security-based swaps, security-based swap 
agreements, mixed swaps, or agreements, contracts or transactions that 
are not swaps (regardless of the purpose for which they are used).
    The Commissions have considered the comments indicating that, as 
currently structured, many businesses are owned by multiple legal 
entities and/or individuals, and the net worth of all the owners in the 
aggregate in some cases would satisfy the $1 million net worth 
requirement in subclause (A)(v)(III), even though the particular legal 
entity that enters into a swap does not have a net worth exceeding $1 
million.\711\ While the Commissions recognize that the requirement, in 
subclause (A)(v)(III)(aa) of the ECP definition, that the entity 
relying on that paragraph have a net worth exceeding $1 million 
evidences Congress' intent that only entities with this level of 
financial resources should be eligible for ECP status under this 
paragraph of the definition, the Commissions agree with commenters that 
application of this requirement in these circumstances would 
inappropriately limit the ability of business entities to use swaps to 
hedge or mitigate commercial risk. As a result, the Commissions are 
persuaded that in this limited situation, the entity should qualify as 
an ECP and be eligible to enter into swaps other than on or subject to 
the rules of a DCM, so long as the entity is using the swap to hedge or 
mitigate commercial risk and all of the owners of the entity are ECPs 
(other than shell companies).
---------------------------------------------------------------------------

    \711\ See, e.g., letters from B&F I (stating that ``[i]f the 
customer does not * * * [itself] meet the ECP definition, then the 
transaction would have to be guaranteed by any entity or individual 
who is an owner * * * [who] meets the $10,000,000 total asset test 
of section 1(a)(18)(A)(v)(I) of the Act or the $1,000,000 net worth 
test of section 1(a)(18)(A)(v)(III) of the Act.''), NAREIT (urging 
that the Commissions impute ECP status to non-ECP entities involved 
in specified real estate businesses to such entities whose 
``majority owner or controlling entity'' is an ECP) and Midsize 
Banks (recommending that the ECP determination be made with respect 
to a non-ECP entity's owners based on criteria including qualifying 
natural persons as ECPs based on a $1,000,000 net worth).
---------------------------------------------------------------------------

    In response to those commenters requesting per se ECP status or the 
ability to qualify as an ECP based on a combination of status and 
engaging in swaps related to a line of business, without further 
restriction, the Commissions do not believe it is necessary or 
appropriate to further define the term ECP to such an extent in order 
to address most commenters' concerns. The Commissions note that such 
approaches would undermine the prohibition in CEA section 2(e) \712\ on 
non-ECPs executing swaps other than on or subject to the rules of a 
DCM. The Commissions also note that focusing solely on a link between a 
swap and a line of business would undermine the application of the ECP 
definition to swaps in that the various prongs of the ECP generally are 
linked to dollar thresholds, regulated status, or a combination of the 
two.
---------------------------------------------------------------------------

    \712\ 7 U.S.C. 2(e).
---------------------------------------------------------------------------

    The Commissions also note that it currently is considering a draft 
petition for relief pursuant to CEA section 4(c)(6)(C) \713\ for 
certain entities described in Federal Power Act section 201(f),\714\ 
which may address the concerns of some commenters. Additionally, the 
Commissions are developing joint rules to further define the term 
``swap,'' including the forward exclusion from the swap definition 
which, in turn, may result in certain transactions not being considered 
swaps. Further, the CFTC also is considering today a form of trade 
option exemption, which may further address commenters' concerns.
---------------------------------------------------------------------------

    \713\ 7 U.S.C. 6(c)(6)(C).
    \714\ 16 U.S.C. 824(f).
---------------------------------------------------------------------------

    With respect to farmers, in response to the CFTC's Commodity 
Options and Agricultural Swaps rulemaking proposal,\715\ commenters 
generally were of the view that the ECP definition is appropriate in 
its current form.\716\ While

[[Page 30658]]

the Commissions may consider providing further relief should experience 
show, after the ECP definition becomes effective, that further relief 
is warranted, neither the ECP definition nor the various actions cited 
in the foregoing paragraph are final, so providing further relief is 
premature. The Commissions' measured approach, which builds on the 
existing net worth requirement in the general entity ECP category, 
provides broad relief to many of the commenters (e.g., borrowers 
generally) while otherwise adhering to the existing ECP categories.
---------------------------------------------------------------------------

    \715\ 76 FR 6095 (Feb. 3, 2011).
    \716\ See, e.g., letters from NCFC dated April 4, 2011 (``NCFC 
II'') (stating ``[o]n behalf of the more than two million farmers 
and ranchers who belong to one or more farmer cooperative(s), the 
[NCFC] * * * [believes] the limitation on participation [in 
agricultural swaps] to [ECPs] outside of a DCM * * * should limit 
[agricultural swap] participation to appropriate persons'' and that 
``[t]he ECP requirement with a threshold of $1 million in net worth 
to be allowed to use swaps and options, other than on a DCM, is 
appropriate for the products cooperatives offer their members''), ; 
letter from NGFA dated April 4, 2011 (``NGFA II'') (stating that 
``[t]he use of agricultural swaps has been constrained relative to 
other swaps by virtue of being subject to CFTC regulatory 
requirements, while other swaps have been exempted from CFTC 
oversight,'' ``the Dodd-Frank Act * * * institutes a number of 
safeguards, including the limitation that only [ECPs] may engage in 
swaps unless entered into on a designated contract market,'' and 
``[t]he NGFA believes that these safeguards provide more-than-ample 
protection in the swaps marketplace for both agricultural and non-
agricultural swaps and that there is no compelling reason to place 
additional burdens on agricultural swaps.'').
---------------------------------------------------------------------------

    The Commissions note that commenters said that, because of the way 
some businesses are structured for tax, estate planning or other 
purposes, they enter into swaps through a legal entity that does not, 
by itself, qualify as an ECP even though the net worth of the business 
and its owners, taken in the aggregate, would qualify as an ECP 
pursuant to subclause (A)(v)(III) of the ECP definition. The 
Commissions believe that the best way to address this concern is to 
allow such a business to consider the net worth of all its owners in 
determining whether the net worth requirement in subclause (A)(v)(III) 
is satisfied.\717\
---------------------------------------------------------------------------

    \717\ The Commissions note that this regulation provides an 
alternative means for certain business entities to qualify as ECPs. 
It neither diminishes nor qualifies in any way the requirement in 
CEA section 2(e) that persons that are not ECPs enter into swaps 
only on or subject to the rules of a DCM.
---------------------------------------------------------------------------

    CFTC Regulation Sec.  1.3(m)(7) is available only to an entity that 
seeks to qualify as an ECP under subclause (A)(v)(III) of the statutory 
definition in order to enter into a swap that will be used to hedge or 
mitigate commercial risk. The Commissions limited CFTC Regulation Sec.  
1.3(m)(7) to subclause (A)(v)(III) because this provision of the ECP 
definition is available to a business entity that uses swaps in 
connection with the conduct of its business or to manage risks 
associated with assets or liabilities related to the conduct of its 
business.\718\
---------------------------------------------------------------------------

    \718\ CEA section 1a(18)(A)(v)(III)(bb), 7 U.S.C. 
1a(18)(A)(v)(III)(bb). The Commissions note that an entity that 
would qualify as an ECP under subclause (A)(v)(III) without 
application of CFTC Regulation Sec.  1.3(m)(7) is not required to 
meet the conditions stated in, this regulation.
---------------------------------------------------------------------------

    The purpose of CFTC Regulation Sec.  1.3(m)(7) is to maintain the 
ability of business entities to enter into swaps other than on or 
subject to the rules of a DCM for limited purposes. This regulation 
therefore is available only with respect to a swap that is used to 
hedge or mitigate commercial risk within the meaning of CFTC Regulation 
Sec.  1.3(kkk).\719\ CFTC Regulation Sec.  1.3(m)(7) applies only if 
all of an entity's owners qualify as ECPs under the provision of the 
ECP definition applicable to such owner. Although some commenters 
suggested that an entity should be able to qualify as an ECP based on 
the status of its majority or controlling owners,\720\ the Commissions 
believe that CFTC Regulation Sec.  1.3(m)(7) should be available only 
when all of an entity's owners qualify as ECPs. The Commissions do not 
believe it would be appropriate to impair the protection of non-ECPs 
that flows from the requirement that non-ECPs enter into swaps only on 
or subject to the rules of a DCM.\721\ In order to maintain these 
protections and prevent evasion, CFTC Regulation Sec.  1.3(m)(7) 
provides that any shell company will be disregarded, and in order to 
determine if the underlying entity may use CFTC Regulation Sec.  
1.3(m)(7), each owner of such shell company must be an ECP.\722\
---------------------------------------------------------------------------

    \719\ See part IV.C. The use of the phrase ``hedge or mitigate 
commercial risk'' in CFTC Regulations Sec. Sec.  1.3(m)(7) and 
1.3(kkk) is similar to the use of the same phrase in the exception 
to the mandatory clearing requirement in CEA section 2(h)(7), 7 
U.S.C. 2(h)(7).
    \720\ See, e.g., letter from NAREIT.
    \721\ See CEA section 2(e), 7 U.S.C. 2(e).
    \722\ See CFTC Regulation Sec.  1.3(m)(7)(ii).
    The term ``shell company'' means any entity that limits its 
holdings to direct or indirect interests in entities that are ECPs 
through reliance on CFTC Regulation Sec.  1.3(m)(7). Any entity that 
holds at least one direct or indirect interest in an entity not 
relying on CFTC Regulation Sec.  1.3(m)(7) would not be a shell 
company. The ECP status of owners of entities that are not shell 
companies is not relevant for purposes of CFTC Regulation Sec.  
1.3(m)(7), which should permit wider financing of small businesses 
using swaps to hedge or mitigate commercial risk.
    To be clear, an individual will never be considered to be a 
shell company for purposes of CFTC Regulation Sec.  1.3(m)(7).
---------------------------------------------------------------------------

    Correspondingly, in aggregating net worth for purposes of 
determining the ECP status of an entity pursuant to CFTC Regulation 
Sec.  1.3(m)(7), if the entity is owned by a shell company, then it is 
the net worth of the owners of that shell company that is relevant, not 
the net worth of the shell company.\723\
---------------------------------------------------------------------------

    \723\ This provision may apply repeatedly in a ``chain.'' For 
example, if in determining whether an entity may rely on CFTC 
Regulation Sec.  1.3(m)(7), an owner of that entity that is a shell 
company is disregarded, then if the owner of that shell company is 
also a shell company, that second shell company also is disregarded, 
and so on.
---------------------------------------------------------------------------

    Last, also in order to prevent evasion, CFTC Regulation Sec.  
1.3(m)(7)(ii)(C) specifies that an individual may rely on the 
proprietorship provision of clause (A)(v) of the statutory definition 
for purposes of determining its status as an ECP owner of an entity 
only if the proprietorship \724\ status arises independent of the 
business conducted by such entity \725\ and the individual proprietor 
acquires his/her interest in such entity (i) in connection with the 
conduct of the individual's proprietorship or (ii) to manage the risk 
associated with an asset or liability owned or incurred or reasonably 
likely to be owned or incurred by the proprietorship.\726\ The 
Commissions are adopting CFTC Regulation Sec.  1.3(m)(7)(ii)(C) because 
they believe that the only circumstance in which a proprietorship 
should be considered an ECP for purposes of CFTC Regulation Sec.  
1.3(m)(7)(i) is if it is making an investment related to the 
proprietorship.\727\ The ECP status of an individual acting other than 
with respect to its proprietorship is determined based on the ECP 
clause applicable to individuals. The Commissions note that they have 
authority to take action to prevent evasion of the provisions regarding 
shell companies and proprietorships by entities relying on CFTC 
Regulation Sec.  1.3(m)(7) to establish ECP status.
---------------------------------------------------------------------------

    \724\ A proprietorship generally is a business that a person 
operates in a personal capacity and with respect to which that 
person directly owns all the assets and directly is responsible for 
all of the liabilities, rather than through a corporation, 
partnership or other structure conveying limited liability. See 
letters from Midmarket Banks and Wells Fargo II (stating that 
``proprietors . . . typically are not separate legal entities''); 
see also State of California Franchise Tax Board Web site (advising 
that ``[t]he business and the owner are one. There is no separate 
legal entity and thus no separate legal person''), at https://www.ftb.ca.gov/businesses/bus_structures/soleprop.shtml. A 
proprietorship is not a separate taxable entity but reports the 
income or loss of the business, which is taxed along with a sole 
proprietor's other income, on a separate schedule attached to his or 
her individual federal income tax return. See letter from Midmarket 
Banks. See also 2011 Form1040 Schedule C: Profit or Loss from 
Business (Sole Proprietorship), available at http://www.irs.gov/pub/irs-pdf/f1040sc.pdf; 2011 Instructions for Schedule C, available at 
http://www.irs.gov/pub/irs-pdf/i1040sc.pdf.
    \725\ CFTC Regulation Sec.  1.3(m)(7)(ii)(C)(I) is designed to 
ensure that the individual qualifies as a proprietorship, if at all, 
other than due to its interest in either an entity seeking to 
qualify as an ECP under CFTC Regulation Sec.  1.3(m)(7)(i) or in any 
other entity.
    \726\ See CFTC Regulation Sec.  1.3(m)(7)(ii)(C)(IV). This 
language is modeled on the language in 7 U.S.C. 
1a(18)(A)(v)(III)(bb).
    \727\ The Commissions note that this guidance regarding 
proprietorships applies only when an entity is relying on CFTC 
Regulation Sec.  1.3(m)(7). The Commissions do not intend that this 
guidance would expand or limit the circumstances when a 
proprietorship may otherwise rely on clause (A)(v) of the statutory 
definition in establishing its ECP status.

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[[Page 30659]]

G. ECP Status for Forex Pools Operated by Registered CPOs or CPOs 
Exempt From Registration Under Certain Conditions

1. Description of the Issue and Commenters' Views
    Notwithstanding the modifications to the look-through provisions 
for Forex Pools discussed above in section III.B., the Commissions 
acknowledge commenters' concerns about the potential for unintended 
consequences arising from the look-through provisions of the Dodd-Frank 
Act. Several commenters asserted that many Forex Pools are operated by 
sophisticated, professional managers that do not need the protections 
of a retail forex regime designed to protect non-ECPs that are engaging 
in retail forex transactions.\728\ More specifically, some commenters, 
based on CFTC enforcement actions involving Forex Pools, suggested that 
commodity pools of a sufficient size, and/or operated by a registered 
or exempt CPO, do not pose the risks of fraud and abuse of non-ECP 
customers that the statutory look-through provision is intended to 
address.\729\
---------------------------------------------------------------------------

    \728\ See, e.g., letters from Millburn (characterizing the 
proposed rules as ``greatly limit[ing] the ability of entities 
managed by sophisticated money managers that are subject to 
registration and examination by regulators to qualify as ECPs'') and 
Sidley (describing ``[a] commodity pool, like a registered 
investment company or an employee benefit plan, [a]s a pool of 
assets from investors of varying (and, in some cases, undetermined) 
levels of sophistication that are advised by a sophisticated 
adviser'').
    \729\ See joint letter from the Global Foreign Exchange Division 
(``GXFD'') and MFA dated January 19, 2011 (``GFXD II'') (describing 
35 CFTC Forex Pool enforcement cases from 2010 and 2011 and noting 
that in 80% of these cases, the amount at issue in the misconduct 
was less than $10 million, and that only one case involved a 
registered CPO where the amount at issue in the misconduct was more 
than $10 million; two additional cases involved misconduct involving 
CPOs exempt from registration as such under CFTC Regulation Sec.  
4.13(a). While the commenter did not characterize these amounts as 
``total assets'' (instead, the commenter used terms such as 
``fraudulently obtained'' or ``sustained losses of'' to modify the 
cited dollar amounts) in most cases, it is clear that these amounts 
are equivalent to, or subsets of, total assets. For instance, for a 
CPO to have fraudulently obtained $10 million from commodity pool 
participants, the CPO must have taken in $10 million from them, 
resulting in the commodity pool at one time having $10 million in 
total assets. See also letter from Sidley (providing 26 examples of 
CFTC Forex Pool-related enforcement cases, all but one of which 
involved Forex Pools with less than $50 million in total assets). A 
number of the cases cited by GXFD and Sidley overlap; in the 
aggregate, these commenters appear to have presented data on 45 
different cases rather than 61.
---------------------------------------------------------------------------

    As a result, commenters suggested that the look-through provision 
should not apply in determining ECP status of commodity pools that meet 
certain conditions. For example, commenters suggested that the look-
through not be applied to a commodity pool with $10 million in total 
assets paired with another or other factors, such as not being 
structured to evade,\730\ being subject to regulation under the 
CEA\731\ or the CPO being registered as such.\732\ Another commenter 
suggested requiring the total assets or minimum initial investment of a 
Forex Pool to be sufficiently large that, in general, only legitimate 
pools would exceed such thresholds.\733\ This commenter suggested a 
total asset threshold of $50 million.\734\
---------------------------------------------------------------------------

    \730\ See letter from GFXD II.
    \731\ See letters from GXFD II and Skadden.
    \732\ See meeting with SIFMA on January 20, 2012 (in which 
representatives of SIFMA proposed a new non-exclusive set of 
criteria for a Forex Pool to qualify as an ECP, which included, as 
one of several alternatives in one element of the proposed criteria, 
that a Forex Pool be operated by a registered CPO). See also letter 
from Willkie Farr (observing that ``[i]t may be time to regulate 
certain previously unregulated transactions and traders, so that 
more CPOs are registered'' and that ``many commodity pools are 
operated and advised by registered professionals'').
    \733\ See letter from Sidley.
    \734\ See id.
---------------------------------------------------------------------------

    Separately, one commenter also claimed that the statutory look-
through, if strictly implemented, might inappropriately preclude Forex 
Pools and their CPOs, many of whom are registered, from engaging in 
retail forex transactions with swap dealers because swap dealers are 
not Enumerated Counterparties (and some swap dealers also may not be 
Enumerated Counterparties in a different capacity, such as being a U.S. 
financial institution).\735\ This commenter stated that such a result 
could reduce close out netting opportunities in the event of the 
insolvency of a counterparty.
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    \735\ See joint letter from the GFXD and MFA dated January 10, 
2012 (``GFXD I''). These commenters indicated that, while
    [s]ome swap dealers may be dually licensed as a bank or a 
broker-dealer [and therefore] eligible to transact in OTC foreign 
exchange with retail investors as well as swaps with institutional 
investors * * * as an operational matter, it is not clear that firms 
will be able to and find it efficient to structure their business so 
that the retail foreign exchange platform is conducted from the same 
entity as the institutional swaps business.
---------------------------------------------------------------------------

2. Final Rule
    In response to commenters, the CFTC is adopting CFTC Regulation 
Sec.  1.3(m)(8), pursuant to which certain Forex Pools may qualify as 
ECPs notwithstanding the look-through requirement. As adopted, CFTC 
Regulation Sec.  1.3(m)(8) enables a Forex Pool that enters into a 
retail forex transaction to qualify as an ECP with respect thereto, 
irrespective of whether each participant in the Forex Pool is an ECP, 
if the Forex Pool satisfies the following conditions:
     It is not formed for the purpose of evading CFTC 
regulation under Section 2(c)(2)(B) or Section 2(c)(2)(C) of the CEA or 
related CFTC rules, regulations or orders governing Retail Forex Pools 
and retail forex transactions);
     It has total assets exceeding $10 million; and
     It is formed and operated by a registered CPO or by a CPO 
who is exempt from registration as such pursuant to CFTC Regulation 
Sec.  4.13(a)(3).
    CFTC Regulation Sec.  1.3(m)(8) as adopted requires that the Forex 
Pool not be formed for the purpose of evading CFTC regulation of Retail 
Forex Pools and retail forex transactions under CEA Section 2(c)(2)(B) 
or (C). A Forex Pool that is formed for that purpose would not be an 
ECP under new CFTC Regulation Sec.  1.3(m)(8).
    CFTC Regulation Sec.  1.3(m)(8) as adopted also requires that the 
Forex Pool have total assets exceeding $10 million to qualify as an 
ECP. The $10 million threshold is twice the current total asset 
threshold for a commodity pool to qualify as an ECP under CEA section 
1a(18)(A)(iv). The Commissions believe the $10,000,000 threshold is 
appropriate in light of the potential regulatory burdens a higher 
threshold might impose on smaller commodity pools. The Commissions 
believe that such a threshold, coupled with the other conditions of the 
rule, is sufficiently high to assure that the protections provided to 
retail forex transactions are not needed for these types of commodity 
pools. The Commissions will vigilantly monitor developments with 
respect to Forex Pools, including enforcement activity, and revisit 
this total asset threshold if warranted by subsequent events.
    Finally, CFTC Regulation Sec.  1.3(m)(8) as adopted requires that 
Forex Pool be formed \736\ and operated by a CPO registered as such 
with the CFTC or by a CPO who is exempt from registration as such 
pursuant to CFTC Regulation Sec.  4.13(a)(3). The Commissions believe 
that the registered CPO aspect of this condition is appropriate for 
several reasons, including that it will ensure

[[Page 30660]]

that the NFA oversees compliance by those registered CPOs relying on 
this new regulation.\737\ CPO registration also provides a clear means 
of addressing wrongful conduct.\738\ Although some commenters suggested 
that a CPO need only be ``subject to regulation under the CEA'' in 
order for a Forex Pool operated by that CPO to qualify as an ECP 
notwithstanding the look-through requirements, CFTC Regulation Sec.  
1.3(m)(8) instead requires that the CPO of a Forex Pool be registered 
as a CPO or be a CPO who is exempt from registration as such pursuant 
to CFTC Regulation Sec.  4.13(a)(3), alternative conditions supported 
by other commenters. The Commissions are requiring operation by a 
registered CPO, or by a CPO who is exempt from registration as such 
pursuant to CFTC Regulation Sec.  4.13(a)(3), as a condition for a 
Forex Pool to qualify for ECP status under CFTC Regulation Sec.  
1.3(m)(8) because, based on the data presented by commenters, CFTC 
enforcement actions involving Forex Pools rarely involve registered 
CPOs or CPOs exempt from registration as such.\739\
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    \736\ Given that (i) many CPOs will be registering as such for 
the first time due to the CFTC's recent rescission of the exemption 
from CPO registration set forth in CFTC Regulation Sec.  4.13(a)(4) 
or its modification of the criteria for claiming the exclusion from 
the CPO definition in CFTC Regulation Sec.  4.5 and (ii) such pools 
were formed prior to their CPOs' registration as such, commodity 
pools formed prior to December 31, 2012 need not have been 
``formed'' by a registered CPO or by a CPO exempt from registration 
as such pursuant to CFTC Regulation Sec.  4.13(a)(3) in order to be 
qualified as ECPs under the new prong, so long as they are operated 
by a registered CPO on or before such date.
    \737\ See CPO/CTA Compliance Release at 11254 (noting that 
``registration allows the Commission to ensure that all entities 
operating collective investment vehicles participating in the 
derivatives markets meet minimum standards of fitness and 
competency''). See http://www.nfa.futures.org/NFA-registration/cpo/index.html for an overview of registration and related requirements 
for CPOs, their principals and their associated persons and http://www.nfa.futures.org/NFA-compliance/NFA-commodity-pool-operators/index.html for an overview of the compliance regime for registered 
CPOs overseen by the NFA. The CFTC anticipates that more CPOs will 
register in the coming months now that it has withdrawn the CFTC 
Regulation Sec.  4.13(a)(4) exemption from CPO registration, 
increasing the number of registered CPOs, in turn increasing the 
number of CPOs who can satisfy the registered CPO alternative under 
CFTC Regulation Sec.  1.3(m)(8)(iii).
    \738\ See CPO/CTA Compliance Release at 11254 (stating that 
``the [CFTC] has clear authority to take punitive and/or remedial 
action against registered entities for violations of the CEA or of 
the [CFTC''s regulations * * * [and] to deny or revoke registration, 
thereby expelling an individual or entity from serving as an 
intermediary in the industry'' and that the CFTC's reparations 
program and the NFA's arbitration program also are available avenues 
``to seek redress for wrongful conduct by a [CFTC] registrant'').
    \739\ As discussed above in note 729, only one of the 45 unique 
cases presented by commenters involved a pool with more than $10 
million in total assets and a registered CPO. Only two of those 
cases involved a pool operated by CPOs exempt from registration: in 
both of those cases, however, the CPO raised less than $10 million. 
In addition, one of those CPOs relied on the CFTC Regulation Sec.  
4.13(a)(4) CPO registration exemption. As discussed above, the CFTC 
has withdrawn that exemption.
---------------------------------------------------------------------------

    While NFA oversight of CPOs operating Retail Forex Pools is a 
useful criterion to determine whether an exclusion from the look-
through provisions of CEA section 1a(8)(A)(iv) and CFTC Regulation 
Sec.  1.3(m)(5) is warranted, the Commissions believe that Retail Forex 
Pools operated by CPOs exempt from registration as such pursuant to 
CFTC Regulation Sec.  4.13(a)(3) also merit relief from those look-
through provisions. On September 10, 2010, the CFTC published in the 
Federal Register a final rule revising the CPO registration exemption 
in CFTC Regulation Sec.  4.13(a)(3) to incorporate retail forex 
transactions into the transactions subject to the alternative caps on 
the use of commodity interests \740\ by CPOs claiming the 
exemption.\741\ The CFTC explained in the related Federal Register 
proposing release that the proposed change to CFTC Regulation Sec.  
4.13(a)(3) was part of a proposal to adopt a comprehensive regulatory 
scheme to implement the CRA with respect to retail forex transactions 
(``CRA-Related Forex Proposal'').\742\ The CFTC also explained that 
``the NFA-specified minimum security deposit for off-exchange retail 
forex transactions would be included among the amounts that cannot 
exceed 5 percent of the liquidation value of the pool's portfolio in 
order for the operator to claim the exemption from registration under 
Regulation 4.13(a)(3)''\743\ and that ``such amounts are roughly 
equivalent to initial margin and option premiums).'' \744\ The CFTC 
also described the CRA-Related Forex Proposal as ``amend[ing] existing 
regulations as needed to clarify their application to, and inclusion 
in, the new regulatory scheme for retail forex.'' \745\ More recently, 
notwithstanding the Dodd-Frank Act's addition of the look-through 
provision in CEA section 1a(8)(A)(iv), the CFTC determined to retain 
the exemption from CPO registration under Regulation 4.13(a)(3), 
reasoning that ``overseeing entities with less than five percent 
exposure to commodity interests is not the best use of the Commission's 
resources.'' \746\
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    \740\ The term ``commodity interest'' is defined in CFTC 
Regulation Sec.  1.3(yy), and includes ``[a]ny contract, agreement 
or transaction subject to [CFTC] jurisdiction under section 2(c)(2) 
of the [CEA].'' CFTC Regulation Sec.  1.3(yy)(3).
    \741\ See CFTC, Regulation of Off-Exchange Retail Foreign 
Exchange Transactions and Intermediaries; Final Rules, 75 FR 55410 
(Sept. 10, 2010).
    \742\ CFTC, Regulation of Off-Exchange Retail Foreign Exchange 
Transactions and Intermediaries; Proposed Rules, 75 FR 3282 (Jan. 
10, 2010).
    \743\ Section 12 of the NFA's Financial Requirements impose the 
following minimum security deposit requirements for retail forex 
transactions: (i) 2% of the notional value of transactions in the 
British pound, the Swiss franc, the Canadian dollar, the Japanese 
yen, the Euro, the Australian dollar, the New Zealand dollar, the 
Swedish krona, the Norwegian krone, and the Danish krone; (ii) 5% of 
the notional value of other transactions; (iii) for short options, 
the above amount plus the premium received; and (iv) for long 
options, the entire premium. See NFA Manual, available at http://www.nfa.futures.org/nfamanual/NFAManual.aspx?RuleID=SECTION%2012&Section=7.
    \744\ CFTC, Regulation of Off-Exchange Retail Foreign Exchange 
Transactions and Intermediaries; Proposed Rules, 75 FR 3282, 3287 
(Jan. 10, 2010).
    \745\ Id. at 3282.
    \746\ CPO/CTA Compliance Release at 11261. The CFTC also stated 
that:
    [t]he Commission believes that trading exceeding five percent of 
the liquidation value of a portfolio, or a net notional value of 
commodity interest positions exceeding 100 percent of the 
liquidation value of a portfolio, evidences a significant exposure 
to the derivatives markets, and that such exposure should subject an 
entity to the Commission's oversight.
    Id. at 11263.
---------------------------------------------------------------------------

    Given that, shortly before the adoption of the Dodd-Frank Act, the 
CFTC proposed to add retail forex transactions to those that can be 
entered into by CPOs claiming relief from registration as such under 
CFTC Regulation Sec.  4.13(a)(3), that it finalized that action shortly 
after the Dodd-Frank Act was adopted and that it recently left CFTC 
Regulation Sec.  4.13(a)(3) in place despite having proposed to 
withdraw that CPO registration exemption, and for the reasons described 
above, the Commissions believe CPOs exempt from registration as such 
pursuant to CFTC Regulation 4.13(a)(3) and operating Retail Forex Pools 
should be able to continue to do so outside the retail forex regime.
    Section 712(d)(2)(A) of the Dodd-Frank Act grants the Commissions 
the authority to adopt such rules related to the ECP definition as the 
Commissions determine are necessary and appropriate, in the public 
interest, and for the protection of investors. Based on commenters' 
views, the Commissions have determined that CFTC Regulation Sec.  
1.3(m)(8) as adopted is necessary and appropriate because the statutory 
look-through provision, if strictly implemented, would subject Forex 
Pools operated by CPOs that are sophisticated, professional asset 
managers to an array of additional compliance costs and deprive them of 
access to swap dealers as counterparties when engaging in retail forex 
transactions.\747\ The Commissions also have determined that it is 
appropriate to limit the availability of ECP status under CFTC 
Regulation Sec.  1.3(m)(8) to Forex

[[Page 30661]]

Pools operated by registered CPOs or by CPOs exempt from registration 
as such pursuant to CFTC Regulation Sec.  4.13(a)(3).\748\ The 
conditions in CFTC Regulation Sec.  1.3(m)(8) also are appropriate in 
that they require Forex Pools seeking ECP status thereunder to have 
total assets exceeding $10 million. Historically, CFTC enforcement 
actions have involved fewer instances of misconduct by CPOs of Forex 
Pools with total assets above this threshold.\749\
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    \747\ The nature of a swap dealer's business activities and 
assets may detract from what is considered regulatory capital for an 
FCM or RFED engaging in retail forex transactions, thereby making it 
difficult for some swap dealers to dually register both as such and 
as an FCM or RFED in order to do retail forex business. As an ECP, a 
Forex Pool's choice of retail forex transaction counterparties will 
not be limited to Enumerated Counterparties, and thus may include 
swap dealers.
    \748\ The Commissions note that the statistics presented by 
commenters indicate that Forex Pool misconduct by registered CPOs 
and those exempt from CPO registration is significantly rarer than 
Forex Pool misconduct by otherwise unregistered CPOs. See letter 
from the GFXD II.
    \749\ See letter from Sidley (showing that 6 of the 27 cases 
presented involved more than $10 million).
---------------------------------------------------------------------------

    The Commissions have determined that CFTC Regulation Sec.  
1.3(m)(8) is in the public interest in that it will make available a 
category of counterparty (i.e., swap dealers) that likely would not 
otherwise be available, and help to assure that sophisticated, 
professional managers operating qualifying Forex Pools can continue to 
engage in retail forex transactions. The Commissions have determined 
that the conditions of CFTC Regulation Sec.  1.3(m)(8) are sufficient 
for the protection of investors for the reasons discussed above, such 
as a significant reduction in the incidence of Forex Pool misconduct 
among CPOs, whether registered as such or exempt therefrom, operating 
Forex Pools with more than $10 million in total assets. The Commissions 
intend to monitor developments in the Forex Pool area and will revisit 
the conditions of this regulation as warranted by subsequent events.

IV. Definitions of ``Major Swap Participant'' and ``Major Security-
Based Swap Participant''

    The statutory definitions of ``major swap participant''\750\ and 
``major security-based swap participant''\751\ (collectively, ``major 
participant'') encompass any person that is not a swap dealer or 
security-based swap dealer \752\ and that satisfy any one of three 
alternative statutory tests that encompass a person: (i) That maintains 
a ``substantial position'' in swaps or security-based swaps for any of 
the major swap categories as determined by the Commissions; (ii) whose 
outstanding swaps or security-based swaps create substantial 
counterparty exposure that could have serious adverse effects on the 
financial stability of the U.S. banking system or financial 
markets;\753\ or (iii) that is a ``financial entity'' that is ``highly 
leveraged'' relative to the amount of capital it holds (and that is not 
subject to capital requirements established by an appropriate Federal 
banking agency) and maintains a ``substantial position'' in outstanding 
swaps or security-based swaps in any major category as determined by 
the Commissions.\754\ The first--and only the first--of those three 
statutory tests explicitly excludes: (i) Positions held for ``hedging 
or mitigating commercial risk,'' and (ii) positions maintained by any 
employee benefit plan as defined in sections 3(3) and (32) of ERISA for 
the ``primary purpose of hedging or mitigating any risk directly 
associated with the operation of the plan.''\755\
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    \750\ CEA section 1a(33).
    \751\ Exchange Act section 3(a)(67).
    \752\ As discussed above, a person may be designated as a dealer 
for particular activities involving swaps or security-based swaps, 
or particular swap or security-based swap activities, without being 
deemed to be a dealer with regard to other categories or activities. 
See part II.E, supra. To the extent that a person is subject to that 
type of limited designation as a swap dealer or security-based swap 
dealer, the person may be subject to being a major swap participant 
or a major security-based swap participant in connection with 
positions that fall outside of that limited dealer designation.
    \753\ See CEA section 1a(33)(A)(ii); Exchange Act section 
3(a)(67)(A)(ii)(II).
    \754\ See CEA section 1a(33)(A)(iii); Exchange Act section 
3(a)(67)(A)(ii)(III).
    \755\ See CEA section 1a(33)(A)(i); Exchange Act section 
3(a)(67)(A)(ii)(I).
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    The statutory definitions require the Commissions to define the 
term ``substantial position'' at the threshold determined to be prudent 
for the effective monitoring, management, and oversight of entities 
that are systematically important or can significantly impact the 
financial system of the U.S. In setting these thresholds, the 
Commissions are required to consider the person's relative position in 
uncleared as opposed to cleared swaps and may take into consideration 
the value and quality of collateral held against counterparty 
exposures.\756\
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    \756\ See CEA section 1a(33)(B) and Exchange Act section 
3(a)(67)(B).
---------------------------------------------------------------------------

    The statutory definitions further permit the Commissions to limit 
the scope of the major participant designations so that a person may be 
designated as a major participant in certain categories of swaps or 
security-based swaps, but not all categories.\757\
---------------------------------------------------------------------------

    \757\ See CEA section 1a(33)(C); Exchange Act section 
3(a)(67)(C).
---------------------------------------------------------------------------

    In addition, the ``major swap participant'' definition excludes 
certain entities whose primary business is providing financing and that 
use derivatives for the purpose of hedging underlying commercial risks 
related to interest rate and foreign currency exposures, 90 percent or 
more of which arise from financing that facilitates the purchase or 
lease of products, 90 percent or more of which are manufactured by the 
parent company or another subsidiary of the parent company.\758\ The 
``major security-based swap participant'' definition does not contain 
this type of exclusion.
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    \758\ See CEA section 1a(33)(D).
---------------------------------------------------------------------------

    As detailed in the Proposing Release, the major participant 
definitions focus on the market impacts and risks associated with a 
person's swap and security-based swap positions.\759\ This is in 
contrast to the definitions of ``swap dealer'' and ``security-based 
swap dealer,'' which focus on a person's activities and account for the 
amount or significance of those activities only in the context of the 
de minimis exception. However, persons that meet the major participant 
definitions in large part must follow the same statutory requirements 
that will apply to swap dealers and security-based swap dealers.\760\ 
In this way, the statute applies comprehensive regulation to entities 
whose swap or security-based swap activities do not cause them to be 
dealers, but nonetheless could pose a high degree of risk to the U.S. 
financial system generally.\761\
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    \759\ See Proposing Release, 75 FR at 80185.
    \760\ In particular, under CEA section 4s and Exchange Act 
section 15F, dealers and major participants in swaps or security-
based swaps generally are subject to the same types of margin, 
capital, business conduct and certain other requirements, unless an 
exclusion applies. See CEA section 4s(h)(4), (5); Exchange Act 
section 15F(h)(4), (5). See also CFTC, Business Conduct Standards 
for Swap Dealers and Major Swap Participants with Counterparties; 
Final Rule, 77 FR 9733 (Feb. 17, 2012); Notice of Proposed 
Rulemaking: Capital requirements of swap dealers and major swap 
participants, 76 FR 27802 (May 12, 2011); and SEC, Notice of 
Proposed Rulemaking: Business Conduct Standards for Security-Based 
Swap Dealers and Major Security-Based Swap Participants, Securities 
Exchange Act Release No. 64766, 76 FR 42396 (July 18, 2011).
    \761\ As discussed below, the tests of the major participant 
definitions use terms--particularly ``systemically important,'' 
``significantly impact the financial system'' or ``create 
substantial counterparty exposure''--that denote a focus on entities 
that pose a high degree of risk through their swap and security-
based swap activities. In addition, the link between the major 
participant definitions and risk was highlighted during the 
Congressional debate on the statute. See 156 Cong. Rec. S5907 (daily 
ed. July 15, 2010) (colloquy between Senators Hagen and Lincoln, 
discussing how the goal of the major participant definitions was to 
``focus on risk factors that contributed to the recent financial 
crisis, such as excessive leverage, under-collateralization of swap 
positions, and a lack of information about the aggregate size of 
positions'').
---------------------------------------------------------------------------

    Although the two major participant definitions are similar, they 
address instruments that reflect different types of risks and that can 
be used by end-users and other market participants for

[[Page 30662]]

different purposes. Interpretation of the definitions must account for 
those differences as appropriate.
    The Commissions in the Proposing Release proposed to further define 
the ``major swap participant'' and ``major security-based swap 
participant'' definitions, by specifically addressing: (i) The 
``major'' categories of swaps or security-based swaps; (ii) the meaning 
of ``substantial position''; (iii) the meaning of ``hedging or 
mitigating commercial risk''; (iv) the meaning of ``substantial 
counterparty exposure that could have serious adverse effects on the 
financial stability of the United States banking system or financial 
markets''; and (v) the meanings of ``financial entity'' and ``highly 
leveraged.'' The proposal also addressed the period of time that a 
major participant would have to register (as well as the minimum length 
of time for being a major participant), the limited purpose 
designations of major participants, the exclusion for ERISA plan 
hedging positions, and certain additional interpretive issues.
    After considering commenters' views, the Commissions are adopting 
final rules further defining the meaning of major participant.
    As discussed below, the Commissions also are directing their 
respective staffs to report separately as to whether changes are 
warranted to any of the rules implementing the major participant 
definitions. These staff reports will help the Commissions evaluate the 
``major swap participant and ``major security-based swap participant'' 
definitions, including whether new or revised tests or approaches would 
be appropriate for identifying major participants.\762\
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    \762\ See part V, infra.
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A. ``Major'' Categories of Swaps and Security-Based Swaps

1. Proposed Approach
    The first and third tests of the statutory major participant 
definitions encompass entities that maintain a substantial position in 
a ``major'' category of swaps or security-based swaps.\763\
---------------------------------------------------------------------------

    \763\ See CEA section 1a(33)(A)(i), (iii); Exchange Act section 
3(a)(67)(a)(2)(i), (iii).
---------------------------------------------------------------------------

    In the Proposing Release, the Commissions proposed to designate 
four ``major'' categories of swaps and two ``major'' categories of 
security-based swaps. These categories sought to reflect the risk 
profiles of the various types of swaps and security-based swaps, and 
the different purposes for which end-users use those instruments. The 
Proposing Release also noted the importance of not parsing the 
``major'' categories so finely as to base the ``substantial position'' 
thresholds on unduly narrow risks and reduce those thresholds' 
effectiveness as risk measures.\764\
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    \764\ See Proposing Release, 75 FR at 80186-87.
---------------------------------------------------------------------------

    The proposed four ``major'' categories of swaps were rate swaps, 
credit swaps, equity swaps and other commodity swaps.\765\ Rate swaps 
would encompass any swap which is primarily based on one or more 
reference rates, such as swaps of payments determined by fixed and 
floating interest rates, currency exchange rates, or other monetary 
rates. Credit swaps would encompass any swap that is primarily based on 
default, bankruptcy and other credit-related risks related to, or the 
total returns on, instruments of indebtedness (including loans), 
including but not limited to any swap primarily based on one or more 
broad-based indices related to debt instruments, and any swap that is a 
broad-based index credit default swap or total return swap. Equity 
swaps would encompass any swap that is primarily based on equity 
securities, such as any swap primarily based on one or more broad-based 
indices of equity securities, including any total return swap on one or 
more broad-based equity indices. Other commodity swaps would encompass 
any swap not included in any of the first three categories, and would 
generally include, for example and not by way of limitation, any swap 
for which the primary underlying item is a physical commodity or the 
price or any other aspect of a physical commodity. The four categories 
were intended to cover all swaps, and each swap would be in the 
category that most closely describes the primary item underlying the 
swap.\766\
---------------------------------------------------------------------------

    \765\ See proposed CFTC Regulation Sec.  1.3(iii).
    \766\ The statutory definition of ``swap'' lists 22 different 
types of swaps.
---------------------------------------------------------------------------

    The Commissions proposed to designate two ``major'' categories of 
security-based swaps.\767\ The first category would encompass any 
security-based swap that is based, in whole or in part, on one or more 
instruments of indebtedness (including loans), or a credit event 
relating to one or more issuers or securities, including but not 
limited to any security-based swap that is a credit default swap, total 
return swap on one or more debt instruments, debt swaps, or debt index 
swaps. The second category would encompass any other security-based 
swaps not included in the first category, including for example, swaps 
on equity securities or narrow-based security indices comprised of 
equity securities.\768\ These proposed categories were based on the 
different uses of these types of security-based swaps, and were 
consistent with market statistics and infrastructures that distinguish 
between those types of security-based swaps.\769\
---------------------------------------------------------------------------

    \767\ See proposed Exchange Act rule 3a67-2.
    \768\ The second category also encompasses all security-based 
swaps on narrow based indices that are comprised of both debt and 
equity components.
    \769\ See Proposing Release, 75 FR at 80187.
---------------------------------------------------------------------------

2. Commenters' Views
    Certain commenters requested clarification regarding how the major 
categories would be applied. One commenter particularly requested 
additional clarity as to how the proposed categories will apply to 
mixed swaps and to swaps that are based on debt that is convertible to 
equity,\770\ while another commenter requested additional clarity as to 
the status of certain mortgage-related transactions.\771\
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    \770\ See letter from ISDA I.
    \771\ See letter from Freddie Mac.
---------------------------------------------------------------------------

    One commenter suggested that the final rules should include a 
catch-all provision to allow the Commissions to review large positions 
that appear to be structured to evade proper categorization, and that 
market participants should suggest the protocols for categorization of 
swaps or security-based swaps.\772\
---------------------------------------------------------------------------

    \772\ See meeting with Professor Darrell Duffie, Stanford 
University Graduate School of Business (``Duffie'') on February 2, 
2011.
---------------------------------------------------------------------------

    One commenter suggested that the rate swap category should be 
divided between interest rates and currencies, and that energy, 
agriculture and metals swaps should be separate categories.\773\ 
Another commenter expressed the view that creation of a separate 
category for cross currency swaps could lead to confusion among market 
participants who may feel obligated to bifurcate cross currency swaps 
between two categories.\774\ Some commenters expressed general support 
for the major categories as proposed.\775\
---------------------------------------------------------------------------

    \773\ See letter from Better Markets I.
    \774\ See letter from ACLI.
    \775\ See letters from Barnard, ISDA I and MetLife; see also 
letter from American Insurance Association (``AIA'') (agreeing that 
the defined major categories would cover substantially all 
significant swaps and security-based swaps).
---------------------------------------------------------------------------

3. Final Rules
    After considering the issue in light of comments received, the 
Commissions are adopting final rules designating ``major'' categories 
of swaps and security-based swaps consistent with the proposal. 
Accordingly, the final rules provide that the four ``major'' categories 
of swaps are rate swaps,

[[Page 30663]]

credit swaps, equity swaps and other commodity swaps.\776\ The two 
``major'' categories of security-based swaps are debt security-based 
swaps \777\ and other security-based swaps.\778\
---------------------------------------------------------------------------

    \776\ See CFTC Regulation Sec.  1.3(iii). The four major 
categories of swaps are the same as the asset classes used in the 
CFTC Regulations relating to SDRs and reporting, except that the 
asset classes for interest rate swaps and foreign exchange 
transactions are combined into the single rate swap major category 
of swaps. See CFTC, Swap Data Repositories: Registration Standards, 
Duties and Core Principles; Final Rule, 76 FR 54538 (Sept. 1, 2011) 
and Swap Data Recordkeeping and Reporting Requirements; Final Rule, 
77 FR 2136 (Jan. 13, 2012).
    \777\ The name of the first major category of security-based 
swaps has been changed to ``debt security-based swaps'' in this 
Adopting Release from ``security-based credit derivatives'' in the 
Proposing Release. This change more accurately reflects the products 
encompassed by this category, particularly total return swaps on 
debt instruments. See Exchange Act rule 3a67-2(a).
     In addition, the final rules defining the major categories for 
purposes of the major participant definitions remove a cross-
reference to the corresponding dealer definitions under the CEA or 
the Exchange Act to clarify that the rules apply only in the context 
of the major participant definitions, and not the dealer 
definitions. See CFTC Regulation Sec.  1.3(iii); Exchange Act rule 
3a67-2.
    \778\ See Exchange Act rule 3a67-2(b).
---------------------------------------------------------------------------

    The Commissions believe that it is not necessary to further divide 
the proposed categories or add new categories for swaps and security-
based swaps for purposes of the major participant definitions. We 
believe that maintaining a large number of narrow categories of swaps 
and security-based swaps would increase the possibility of confusion by 
market participants with regard to categorizing the swaps and security-
based swaps in which they transact. The Commissions also continue to 
believe that it is important not to parse the ``major'' categories so 
finely as to base the ``substantial position'' thresholds on unduly 
narrow groupings that would reduce those thresholds' effectiveness as 
risk measures. Categories that are broad and clearly delineated further 
should help prevent action to evade designation as a major participant 
in a particular ``major'' category.
    While we believe that these rules in general are sufficiently clear 
to allow each swap and security-based swap to be placed in the 
appropriate category, we are mindful of the commenters' request for 
guidance with regard to certain circumstances. In the case of mixed 
swaps, we would expect that the instrument would be placed in the 
``swap'' and ``security-based swap'' categories that are consistent 
with the underlying attributes that cause such instrument to be a mixed 
swap.\779\ Also, swaps or security-based swaps that are based on more 
than one item, instrument or risk, should be placed in the category 
that most closely describes the primary item, instrument or risk 
underlying the swap or security-based swap.\780\
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    \779\ The Commissions have proposed rules regarding the 
regulation of mixed swaps. See Product Definitions Proposal, note 3, 
supra.
    \780\ In the case of instruments on debt securities that are 
convertible into equity, in general we would expect the instrument 
to be categorized based on its status (as debt or equity) at the 
time of evaluation.
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B. ``Substantial Position''

1. Proposed Approach
    The major participant definitions require that the Commissions 
define a ``substantial position'' in swaps or security-based swaps at a 
threshold that we determine to be ``prudent for the effective 
monitoring, management, and oversight'' of entities that are 
systemically important or can significantly impact the U.S. financial 
system. The definitions further require that we consider a person's 
relative position in uncleared and cleared swaps or security-based 
swaps, and permit us to consider the value and quality of collateral 
held against counterparty exposure.\781\
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    \781\ See CEA section 1a(33)(B); Exchange Act section 
3(a)(67)(B).
---------------------------------------------------------------------------

    The proposed rules provided that a person would have a 
``substantial position'' in swaps or security-based swaps if the daily 
average current uncollateralized exposure associated with its swap or 
security-based swap positions in a major category in a calendar quarter 
amounted to $1 billion or more (or $3 billion in the case of rate 
swaps).\782\ A person also would have a ``substantial position'' if the 
daily average of the sum of the current uncollateralized exposure plus 
the potential future exposure associated with its positions in a major 
category in a calendar quarter amounted to $2 billion or more (or $6 
billion for the rate swap category).\783\
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    \782\ See proposed CFTC Regulation Sec.  1.3(jjj)(1); proposed 
Exchange Act rule 3a67-3(a)(1), (d).
    \783\ See proposed CFTC Regulation Sec.  1.3(jjj)(1); proposed 
Exchange Act rule 3a67-3(a)(2), (d).
---------------------------------------------------------------------------

    The proposed rules did not prescribe any particular methodology for 
measuring current exposure or valuing collateral posted, and instead 
provided that the method used should be consistent with counterparty 
practices and industry practices generally.\784\ The proposed rules 
also provided that an entity could calculate its current 
uncollateralized exposure by accounting for netting agreements on a 
counterparty-by-counterparty basis,\785\ and the Proposing Release set 
forth a method for allocating any residual uncollateralized exposure to 
a counterparty that remains following netting.\786\
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    \784\ See proposed CFTC Regulation Sec.  1.3(jjj)(2)(ii); 
proposed Exchange Act rule 3a67-3(a)(2)(i).
    \785\ See proposed CFTC Regulation Sec.  1.3(jjj)(2)(iii); 
proposed Exchange Act rule 3a67-3(b)(3).
    \786\ See Proposing Release, 75 FR at 80190.
---------------------------------------------------------------------------

    The proposed potential future exposure test was based on the risk-
adjusted notional amount of the entity's swap and security-based swap 
positions, consistent with a test used by bank regulators for purposes 
of setting capital standards.\787\ The test also excluded or lowered 
the potential exposure associated with certain lower-risk 
positions.\788\ In addition, the measures of potential future exposure 
would be discounted by up to 60 percent to reflect the risk mitigation 
provided by netting agreements,\789\ and would further be decreased by 
80 percent for positions subject to central clearing or daily mark-to-
market margining.\790\
---------------------------------------------------------------------------

    \787\ See id. at 80191-92.
    \788\ See proposed CFTC Regulation Sec.  1.3(jjj)(3)(iii); 
proposed Exchange Act rule 3a67-3(c)(2)(i)(C), (D).
    \789\ See proposed CFTC Regulation Sec.  1.3(jjj)(3)(ii)(B); 
proposed Exchange Act rule 3a67-3(c)(2)(ii).
    \790\ See proposed CFTC Regulation Sec.  1.3 (jjj)(3)(iii)(A); 
proposed Exchange Act rule 3a67-3(c)(3)(i). This discount for daily 
margining would be available even in the presence of a threshold or 
a minimum transfer amount, so long as the threshold and the minimum 
transfer amount (if the latter exceeds $1 million) are separately 
added to the entity's current exposure for purposes of the current 
exposure plus potential future exposure test. See proposed CFTC 
Regulation Sec.  1.3(jjj)(3)(iii)(B); proposed Exchange Act rule 
3a67-3(c)(3)(ii).
---------------------------------------------------------------------------

2. Commenters' Views
a. Basis for Regulating Major Participants and Alternative Approaches 
for Identifying ``Substantial Positions''
    Several commenters expressed the view that the major participant 
definition is intended to address entities whose swap or security-based 
swap positions pose systemic risk,\791\ while one commenter took the 
contrary view that the definition also is intended to address the 
significance of an entity's swap or security-based swap positions (as 
well as the risk those positions pose).\792\
---------------------------------------------------------------------------

    \791\ E.g., letters from BlackRock I and MFA I.
    \792\ See letter from Better Markets I.
---------------------------------------------------------------------------

    One commenter stated that the proposal inappropriately sought to 
account for the risk posed by the potential default of multiple 
entities, rather than a single entity.\793\ Some commenters suggested 
that the analysis should account for the concentration of the risk 
posed by an entity's

[[Page 30664]]

positions,\794\ and one commenter suggested that the analysis should 
not account for individual categories of swaps or security-based 
swaps.\795\
---------------------------------------------------------------------------

    \793\ See letter from BlackRock I.
    \794\ See letters from Black Rock I (suggesting a two-step 
process that accounts for the reduced risk associated with entities 
whose positions are distributed among several counterparties); CCMR 
I and APG Algemene Pensioen Groep NV (``APG'').
    \795\ See letter from NYCBA Committee.
---------------------------------------------------------------------------

b. Levels of Proposed ``Substantial Position'' Thresholds
    A number of commenters expressed the view that the proposed 
thresholds are inappropriately low.\796\ Some commenters stated the 
thresholds initially should be high, with later revisions based on 
market data.\797\
---------------------------------------------------------------------------

    \796\ See letters from ABC/CIEBA (indirectly referring to AIG 
Financial Products, and noting that it had $400 billion in notional 
positions and defaulted when it was required to post approximately 
$100 billion in collateral); BG LNG I (alluding to lack of systemic 
impact associated with Enron's failure, and suggesting that the 
Commissions convene an advisory committee to develop thresholds); 
NCGA/NGSA I (alluding to corporate financial losses involving 
derivatives that have exceeded the proposed thresholds without 
significantly impacting the U.S. financial system); ACLI (supporting 
increase in proposed thresholds under the CEA to $4 billion current 
uncollateralized exposure and $8 billion current uncollateralized 
exposure plus potential future exposure); and Chesapeake Energy.
    \797\ See letters from MFA dated February 25, 2011 (``MFA II'') 
(stating that thresholds initially should be set higher, while later 
survey-based thresholds should be based on potential systemic risk 
impact and the cost of performing the calculations); CCMR I (stating 
that the Commissions presently have insufficient data to determine 
appropriate thresholds, and that thresholds initially should be 
high); BlackRock I (stating that the Commissions should refrain from 
establishing thresholds if sufficient information is not available); 
and Freddie Mac. Two commenters particularly addressed the proposed 
thresholds applicable to rate swaps. See letters from ACLI and 
MetLife.
---------------------------------------------------------------------------

    Some commenters did not oppose the proposed thresholds or expressed 
support for the thresholds (though many of those commenters separately 
raised issues about the underlying tests),\798\ while two commenters 
supported lowering the proposed thresholds.\799\ Some commenters took 
the position that the thresholds should be adjusted over time to 
reflect factors such as inflation or market characteristics.\800\
---------------------------------------------------------------------------

    \798\ See, e.g., letters from ACLI, Fidelity, SIFMA AMG dated 
Feb. 22, 2011 (``SIFMA AMG II'') and Vanguard (supporting proposed 
limits for credit swaps, equity swaps and other commodity swaps, but 
not rate swaps).
    \799\ See letters from AFR (supporting use of a $500 million 
uncollateralized exposure threshold, or a $1 billion current 
exposure plus potential future exposure threshold, with higher 
thresholds for rate swaps) and Greenberger.
    \800\ See, e.g., letters from MFA I (referring to inflation and 
measures such as the amount of equity in the U.S. banking system) 
and ISDA I (referring to evolution of the size and fundamental 
characteristics of the markets, and changes to valuation 
methodologies and economic conditions).
---------------------------------------------------------------------------

c. Current Uncollateralized Exposure Test
    Measures of exposure and valuation of collateral--A number of 
commenters supported the Proposing Release's position that the current 
exposure analysis not prescribe any methodology for measuring exposure 
or valuing collateral.\801\ On the other hand, some commenters 
requested explicit approval of particular methodologies,\802\ a good 
faith safe harbor,\803\ or regulator-prescribed measurement 
standards.\804\ Some commenters emphasized the need to be able to post 
non-cash collateral in connection with positions.\805\ Two commenters 
requested codification of the proposal's position that operational 
delays associated with the daily exchange of collateral would not lead 
to current uncollateralized exposure for purposes of the analysis.\806\
---------------------------------------------------------------------------

    \801\ See letters from Fidelity, ICI I, ISDA I and MFA I.
    \802\ See letter from BlackRock I. Consistent with the proposal, 
the final rules contemplate the use of industry standard practices 
in the calculation of current exposure and potential future 
exposure. As with other rules adopted by the Commissions, a market 
participant may raise questions with the Commissions about the 
participant's approach to addressing the final rules--including its 
use of particular methodologies--for further guidance as may be 
necessary or appropriate.
    \803\ See letter from FSR I (particularly noting difficulty of 
valuing illiquid or bespoke positions).
    \804\ See letter from Better Markets I.
    \805\ See, e.g., letters from ACLI, CDEU and MetLife.
    \806\ See letters from SIFMA AMG II and Vanguard.
---------------------------------------------------------------------------

    Netting issues--Some commenters stated that the proposed netting 
provisions should be expanded to encompass additional products that may 
be netted for bankruptcy purposes.\807\ One commenter took the view 
that these provisions should be expanded across multiple netting 
agreements to the extent that offsets are permitted.\808\ One commenter 
asked for clarification as to the scope of the netting provisions,\809\ 
and one commenter expressed general support for the proposed netting 
provisions.\810\
---------------------------------------------------------------------------

    \807\ See letters from ISDA I (specifically addressing 
securities contracts and forward contracts); NRG Energy 
(specifically addressing forwards); and APG (specifically addressing 
securities options and forwards).
    \808\ See letter from FSR I.
    \809\ See letter from Fidelity (seeking confirmation that 
``master netting agreement'' can include an ISDA Master Agreement).
    \810\ See letter from ACLI.
---------------------------------------------------------------------------

    Allocation of uncollateralized exposure--Some commenters requested 
that the final rules incorporate the principles, articulated in the 
Proposing Release, for allocating any uncollateralized exposure that 
remains following netting.\811\ Other commenters raised concerns that 
those principles were based on an unwarranted assumption that 
collateral is specifically earmarked to particular transactions.\812\
---------------------------------------------------------------------------

    \811\ See letters from SIFMA AMG II and Vanguard.
    \812\ See letters from FSR I and ISDA I; see also letter from 
MetLife (suggesting pro rata allocation of uncollateralized current 
exposure among each major category with current exposure).
---------------------------------------------------------------------------

d. Potential Future Exposure Test
    General concerns and suggested alternative approaches--Some 
commenters disagreed with the Proposing Release's statement that the 
potential future exposure analysis would evaluate potential changes in 
the value of a swap or security-based swap over the remaining life of 
the contract; those commenters stated that the test instead should 
focus on potential volatility during the time it would take for a non-
defaulting party to close out a defaulting party's positions.\813\
---------------------------------------------------------------------------

    \813\ See letters from SIFMA AMG II and Vanguard.
---------------------------------------------------------------------------

    Some commenters criticized the tables setting forth the risk 
adjustments used to calculate potential future exposure.\814\ 
Commenters further suggested using, as alternatives, value-at-risk 
measures or other models,\815\ or the ``standardized method'' under 
Basel II.\816\ Commenters also argued that risk adjustments should 
provide a greater discount to credit swaps on ``investment grade'' 
instruments than to other credit swaps, that index CDS should be 
subject to a greater discount than single name CDS, and that there 
should be a lower discount factor for CDS of shorter maturity.\817\ One 
commenter generally supported the proposed conversion factors and 
adjustments.\818\
---------------------------------------------------------------------------

    \814\ See letters from Riverside Risk Advisors LLC (``Riverside 
Risk Advisors'') (criticizing, among other aspects, discontinuities 
in table, a failure to account for how far a swap is in or out of 
the money, the use of a single discount factor for credit default 
swaps, the fact that the risk factor for short-term equity swaps is 
lower than the risk factor for credit swaps, and the fact that 
equity swaps do not distinguish between high-volatility and low-
volatility stocks, as well as the failure to address portfolio 
effects of diversification and correlation, and ``wrong-way'' risk 
in the form of ``an adverse correlation between counterparty default 
risk and the value of its derivatives contracts''); and ISDA I 
(noting that the conversion factors were calibrated more than 15 
years ago and were not designed for later instruments such as credit 
products).
    \815\ See letters from Riverside Risk Advisors (supporting 
giving end-users the option to use a model-based approach); and 
Better Markets I (supporting use of a value-at-risk calculation).
    \816\ See letter from ISDA I.
    \817\ See letters from AIMA I and MFA I.
    \818\ See letter from MetLife.
---------------------------------------------------------------------------

    Some commenters expressed the view that measures of potential 
future exposure should be superseded by negotiated independent amounts 
or regulator-required initial margin.\819\ Some commenters also argued 
that

[[Page 30665]]

excess posted collateral or net in-the-money positions should be offset 
against potential future exposure.\820\
---------------------------------------------------------------------------

    \819\ See letters from SIFMA AMG II and Vanguard.
    \820\ See, e.g., letters from AIMA I, Fidelity, MFA I, SIFMA AMG 
II and Vanguard.
---------------------------------------------------------------------------

    Potential future exposure measures for lower-risk positions--Some 
commenters stated that the proposal to cap potential future exposure 
when a person buys credit protection using a credit default swap should 
be expanded to apply to any position with a fixed downside risk.\821\ 
Commenters also suggested that the potential future exposure associated 
with purchases of credit protection be further discounted,\822\ while 
one commenter took the position that purchases of credit default swaps 
should be excluded from the potential future exposure test.\823\ 
Commenters also addressed the appropriate discount rate for calculating 
the net present value of unpaid premiums.\824\
---------------------------------------------------------------------------

    \821\ See letters from MFA I (citing fixed portions of interest 
rate swaps), MetLife (citing purchased options as well as CDS), ACLI 
and Ropes & Gray.
    \822\ See letters from MFA I (arguing that the tightening of 
credit spreads would imply a healthy credit environment) and AIMA; 
see also meeting with MFA on February 14, 2011.
    \823\ See letter from Vanguard.
    \824\ See letter from MFA I (suggesting the possible use of the 
LIBOR/Swap rate) and AIMA I.
---------------------------------------------------------------------------

    Netting issues--One commenter stated that the proposal's netting 
provisions did not adequately account for the risk mitigation 
associated with hedged positions,\825\ while another commenter asked 
that the proposed netting provisions be clarified and simplified.\826\ 
One commenter supported the proposed netting approach.\827\
---------------------------------------------------------------------------

    \825\ See letter from ISDA I.
    \826\ See letter from SIFMA AMG II.
    \827\ See letters from ACLI.
---------------------------------------------------------------------------

    Discount for cleared or margined positions--Several commenters took 
the view that cleared positions should be excluded entirely from the 
potential future exposure analysis, rather than only being subject to 
an 80 percent discount,\828\ and some commenters also supported a 
complete exclusion for positions subject to daily mark-to-market 
margining.\829\ One commenter suggested a minimum 98 percent reduction 
for positions subject to central clearing or mark-to-market 
margining,\830\ while one commenter suggested that there be a higher 
discount for positions subject to the posting of initial margin.\831\
---------------------------------------------------------------------------

    \828\ See, e.g., letters from MFA I, SIFMA AMG II and Vanguard.
    \829\ See letters from BG LNG I, Fidelity and ICI I.
    \830\ See letter from ISDA I.
    \831\ See letter from FHLB I (suggesting 90 percent discount for 
cleared swaps and for uncleared swaps for which initial margin has 
been posted; alternatively suggesting that posted initial margin be 
subtracted from the calculated amount).
---------------------------------------------------------------------------

    Some commenters also stated that there should be a partial discount 
provided in connection with positions for which mark-to-market 
margining is done less than daily,\832\ and that there should be a 
discount for positions that are margined using security interests or 
liens.\833\ On the other hand, one commenter stated that there is no 
basis for providing any discount for marked-to-market positions.\834\
---------------------------------------------------------------------------

    \832\ See letters from Fidelity and Canadian Master Asset 
Vehicle I and Master Asset Vehicle II (``Canadian MAVs'').
    \833\ See letter from FHLB I (giving as an example swaps 
collateralized by security interests in real estate, oil or gas 
interests, or by first liens on financial assets).
    \834\ See letter from Better Markets I; see also letter from AFR 
(generally opposing use of risk adjustments, but suggesting that any 
such discounts should be larger for cleared positions).
---------------------------------------------------------------------------

    One commenter requested that the rule language codify language in 
the Proposing Release as to when a position is subject to daily mark-
to-market margining.\835\ A number of commenters addressed proposed 
rule language that was intended to clarify that the discount for daily 
mark-to-market margining would be available even in the presence of 
thresholds and minimum transfer amounts.\836\
---------------------------------------------------------------------------

    \835\ See letter from SIFMA AMG II.
    \836\ See letter from CDEU (stating that the proposal could 
overstate an entity's future exposure, and favoring use of the lower 
of the calculated potential future exposure or the CSA threshold); 
see also letters from SIFMA AMG II and Vanguard.
---------------------------------------------------------------------------

    Two commenters supported the proposed approach in general.\837\ One 
commenter specifically supported the proposed 80 percent reduction for 
positions subject to daily mark-to-market margining,\838\ and one 
commenter specifically supported a reduction for cleared 
positions.\839\
---------------------------------------------------------------------------

    \837\ See letters from ACLI and MetLife.
    \838\ See letter from Vanguard.
    \839\ See letter from Better Markets I.
---------------------------------------------------------------------------

    Additional issues regarding the potential future exposure test--
Some commenters argued that the Commissions should clarify how the 
categories in the proposed potential future exposure tables would be 
applied, given how those differ from the proposed ``major'' categories 
of swaps and security-based swaps.\840\
---------------------------------------------------------------------------

    \840\ See letters from SIFMA AMG II and Vanguard.
---------------------------------------------------------------------------

    Some commenters raised concerns that the proposed use of an 
instrument's ``effective notional'' amount is ambiguous.\841\ 
Commenters also took the position that for purposes of the potential 
future exposure calculation, notional amounts should be adjusted to 
reflect delta weighting,\842\ that the measure of duration for options 
on swaps should consider whether the underlying swap is cash-
settled,\843\ and that the adopting release should set forth examples 
of potential future exposure calculations.\844\
---------------------------------------------------------------------------

    \841\ See letters from FSR I, SIFMA AMG II and Vanguard.
    \842\ See letters from MFA I and Ropes & Gray.
    \843\ See letter from MFA I.
    \844\ See id.
---------------------------------------------------------------------------

e. Cost Concerns
    Some commenters emphasized the need to avoid an overbroad major 
participant definition, \845\ and highlighted concerns about being 
subject to unnecessary regulation.\846\
---------------------------------------------------------------------------

    \845\ See joint letter from Representatives Bachus and Lucas.
    \846\ See, e.g., letters from SIFMA AMG II (stating that the 
commenter's suggested changes in connection with the substantial 
position analysis would reduce burdens and costs to market 
participants, and more closely align the tests with the objectives 
they are meant to achieve) and ABC/CIEBA; see also letter from 
NFPEEU (reserving the right to dispute the cost-benefit analysis 
associated with the proposed dealer and major participant rules 
until all relevant Dodd-Frank Act releases could be analyzed as a 
whole).
---------------------------------------------------------------------------

f. Additional Issues
    One commenter suggested there be an explicit presumption against 
imposing major participant (or dealer) regulation on end-users.\847\ 
Some commenters requested that the current uncollateralized exposure 
test explicitly exclude cleared positions, net in-the-money positions, 
and fully collateralized out-of-the-money positions,\848\ and one 
commenter also supported excluding those positions from the potential 
future exposure analysis.\849\ That commenter also supported excluding 
swaps on government securities from the substantial position 
analysis.\850\
---------------------------------------------------------------------------

    \847\ See letter from CDEU.
    \848\ See letters from ICI I, SIFMA AMG II and Vanguard.
    \849\ See letter from ICI I.
    \850\ See letter from ICI I (noting size of government security 
market and Federal Reserve control over supply and demand, and 
stating that the proposed thresholds are ill-suited to address the 
``vast'' government securities market).
---------------------------------------------------------------------------

    One commenter requested confirmation that dealers and major 
participants would not be required to compute, assist with, or verify 
computations for counterparties that may be major participants, and 
also that market participants can enlist third-party services to assist 
in performing the calculations.\851\ One commenter requested 
clarification that the proposed focus on uncollateralized exposure does 
not mean that end-users themselves

[[Page 30666]]

should not demand collateral from dealers.\852\
---------------------------------------------------------------------------

    \851\ See letter from ISDA I.
    \852\ See letter from FHLB I.
---------------------------------------------------------------------------

3. Final Rules
a. Guiding Principles
    The final rules defining ``substantial position'' focus on 
identifying persons whose large swap and security-based swap positions 
pose market risks that are significant enough that it would be 
``prudent'' to regulate those persons. In developing these rules we 
have been mindful of the costs associated with regulating major 
participants, and have considered cost and benefit principles as part 
of the analysis of what level of swap and security-based swap positions 
reasonably form the lower bounds for identifying when it would be 
``prudent'' that particular entities be subject to monitoring, 
management and oversight of entities that may be systemically important 
or may significantly impact the U.S. financial system.\853\
---------------------------------------------------------------------------

    \853\ At the same time, as discussed above in the context of the 
de minimis exception to the dealer definitions, we are mindful that 
the benefits of financial regulation cannot be quantified. For 
example, while the regulation of major participants will comprise 
one component of Title VII's comprehensive regulatory framework that 
should be expected to help lessen the amount and frequency of 
financial crises, we cannot place a dollar figure on the 
contribution of major participant regulation to those benefits. In 
light of those factors, we believe that it would be ``prudent'' to 
regulate, as major participants, those persons whose swap or 
security-based swap positions are large enough to pose a material 
potential of causing significant counterparty impacts, consistent 
with the levels set forth in the final rules. The Commissions will 
further address the comparative costs and benefits associated with 
regulating major participants in the context of the substantive 
rules applicable to major participants.
---------------------------------------------------------------------------

    The final rules implementing the ``substantial position'' 
definition follow the basic approach that the Commissions proposed, 
including the combined use of current exposure and potential future 
exposure tests.\854\ While we have carefully considered the views of 
commenters who suggested alternative approaches, we have concluded that 
it is appropriate to adopt the basic approach that was proposed, as 
described below.
---------------------------------------------------------------------------

    \854\ As with the proposal, the final rules apply these tests to 
swap and security-based swap positions in a ``major'' category. See 
CFTC Regulation Sec.  1.3(jjj)(1); Exchange Act rule 3a67-3(a). The 
final rules have been modified from the proposal, however, by 
removing a reference to ``positions excluded from consideration.'' 
We have concluded that this reference is unnecessary because the 
first statutory major participant test explicitly provides that 
positions that are subject to the commercial risk hedging and the 
ERISA hedging exclusions of the first major participant test need 
not be considered for purposes of that test.
---------------------------------------------------------------------------

     Focus on default-related credit risks. The final rules 
implement tests that seek to reflect the credit risk that a person's 
swap or security-based swap positions would pose in the event of 
default. In arguing that the analysis should consider factors in 
addition to default-related risks, commenters have noted that certain 
regulations applicable to major participants address business conduct 
issues that are distinct from systemic risk issues.\855\ We nonetheless 
believe that the statutory definition of ``substantial position'' 
indicates that the analysis should focus on default-related credit 
risks, because a default-related approach is more closely linked to the 
statutory criteria that the definition focus on entities that are 
``systemically important'' or can ``significantly impact'' the U.S. 
financial system than would be an approach that focuses on the 
potential for disruptive market movements.\856\
---------------------------------------------------------------------------

    \855\ See, e.g., letter from Better Markets I.
    \856\ We also believe that the statutory definition should focus 
on all default-related credit risks associated with swap or 
security-based swap positions. We do not see a basis for excluding 
any class of risks (e.g., risks associated with swaps based on 
government securities) from the analysis.
---------------------------------------------------------------------------

     Failure of multiple entities close in time. The final 
rules that implement the ``substantial position'' definition seek to 
reflect the risks that would be posed by the default of multiple 
entities close in time. Although one commenter took the view that the 
purpose of major participant regulation is to prevent the credit 
exposure of a single person from having a systemic impact,\857\ we do 
not believe that the major participant definitions should be construed 
so narrowly. The events of recent years demonstrate that market stress 
may lead to the failure and near-failure of multiple entities with 
large financial positions over a relatively short time period. We do 
not believe that it would be prudent or well-reasoned to presume that 
recent history cannot repeat itself, and to assume that future failures 
of entities with large financial positions will be isolated events.
---------------------------------------------------------------------------

    \857\ See letter from BlackRock I.
---------------------------------------------------------------------------

     Aggregate risk. The final rules address the aggregate risk 
posed by an entity's swap or security-based swap positions, rather than 
seeking to focus on principles of concentration (such as by using a 
threshold that addresses an entity's largest exposure to an individual 
counterparty) or on converse principles of interconnection. The 
statutory ``substantial position'' definition is specifically written 
in terms of market risk concerns (i.e., ``systemically important'' and 
``can significantly impact the financial system of the United 
States''), and measures of aggregate risk appear to be best geared to 
reflect this standard.\858\
---------------------------------------------------------------------------

    \858\ Moreover, a test that focuses on the concentration of an 
entity's swap or security-based swap exposure toward one or a few 
individual parties potentially poses a tension with the view that 
interconnections of exposure among multiple parties are important to 
establishing systemic risk.
---------------------------------------------------------------------------

     Use of objective, quantitative criteria. The final rules 
provide for a ``substantial position'' analysis that is based on 
objective, quantitative criteria that would permit a market participant 
to determine which level of swap or security-based swap positions would 
cause it to be a major participant. Although one commenter has 
suggested the use of a two-step approach that uses thresholds as a safe 
harbor and that would be accompanied by a second-level 
determination,\859\ we do not believe that such an approach would be 
consistent with the statutory language or with principles of regulatory 
efficiency.\860\ Accordingly, a person whose swap or security-based 
swap positions satisfy the applicable thresholds will be a major 
participant, with no further layer of review provided.\861\
---------------------------------------------------------------------------

    \859\ See letter from BlackRock I.
    \860\ The major participant definitions specifically require 
that the term ``substantial position'' be defined ``by rule or 
regulation'' via a ``threshold.'' That language would not appear to 
anticipate the use of a multi-tier approach that accounts for 
subjective criteria.
     In this respect, the major participant definitions may be 
compared with section 113 of the Dodd-Frank Act, which authorizes 
the Financial Stability Oversight Council (``FSOC'') to provide for 
a non-bank financial company to be supervised by the Board if the 
FSOC ``determines that material financial distress at the U.S. 
nonbank financial company, or the nature, scope, size, scale, 
concentration, interconnectedness, or mix of the activities of the 
U.S. nonbank financial company, could pose a threat to the financial 
stability of the United States.'' Section 113 further provides that 
these designations will result from a vote of the FSOC based on a 
variety of factors. The ``major participant'' definition does not 
provide for this type of entity-specific determination, and we 
believe that the ``major participant'' definition more appropriately 
is implemented by objective factors that allow market participants 
to determine whether they will fall within the definition.
    \861\ In addition, the final rules provide that the 
``substantial position'' analysis that implements the first (and 
third) major participant test will be based on the ``major'' 
categories of swaps and security-based swaps. Notwithstanding 
commenter concerns that this approach will require market 
participants to analyze their swaps and security-based swaps in new 
ways and will result in additional costs, this focus on ``major'' 
categories is dictated by the plain language of the statute.
---------------------------------------------------------------------------

b. Current Uncollateralized Exposure Test
    Consistent with the proposal, the final rules implementing the 
``substantial position'' definition include a test that accounts for 
the current uncollateralized exposure posed by an entity's swap or 
security-based swap positions in a major

[[Page 30667]]

category.\862\ This provides a measure of the amount of potential risk 
that an entity would pose to its counterparties if the entity currently 
were to default.\863\
---------------------------------------------------------------------------

    \862\ CFTC Regulation Sec.  1.3(jjj)(1); Exchange Act rule 3a67-
3(b)(2). The final rules contain technical changes from the proposal 
to clarify the steps entailed by this calculation.
    \863\ See Proposing Release, 75 FR at 80188.
---------------------------------------------------------------------------

    As with the proposal, a person would apply this test by examining 
the positions it maintains with each of its counterparties in a 
particular major category of swaps or security-based swaps. For each 
counterparty, the person would determine the dollar value of the 
aggregate current exposure arising from each of its swap or security-
based swap positions with negative value in that major category by 
marking-to-market using industry standard practices, and deduct from 
that amount the aggregate value of the collateral the entity has posted 
with respect to the swap or security-based swap positions.\864\ The 
``aggregate uncollateralized outward exposure'' would be the sum of 
those uncollateralized amounts over all counterparties with which the 
person has entered into swaps or security-based swaps in that major 
category.\865\
---------------------------------------------------------------------------

    \864\ As we noted in the Proposing Release, we recognize that 
there may be operational delays between changes in exposure and the 
resulting exchanges of collateral, and in general we would not 
expect that operational delays associated with the daily exchange of 
collateral would be considered to lead to uncollateralized exposure 
for these purposes. See Proposing Release, 75 FR at 80189 n.92. 
Although we are not codifying this principle within the final rules, 
we will be mindful of the principle when enforcing those rules.
    \865\ CFTC Regulation Sec.  1.3(jjj)(2); Exchange Act rule 3a67-
3(b)(2).
---------------------------------------------------------------------------

    The final rules implementing this test largely are the same as the 
rules the Commissions proposed, but with certain modifications to 
address issues raised by commenters.
i. Measure of Exposure and Valuation of Collateral
    Consistent with the proposal, the final rules do not prescribe any 
particular methodology for measuring current exposure or for valuing 
collateral posted, but instead require the use of industry standard 
practices.\866\ In this regard we do not concur with commenter requests 
that we approve or prescribe particular methodologies, or provide a 
safe harbor for measures or valuations made in good faith.\867\ 
Instead, it is appropriate that the final rules provide market 
participants with the flexibility to use the same methodologies that 
they use in connection with their business activities. Accordingly, we 
would expect entities to value current uncollateralized exposure based 
on the amounts that would be payable if the transaction were 
terminated.
---------------------------------------------------------------------------

    \866\ CFTC Regulation Sec.  1.3(jjj)(2); Exchange Act rule 3a67-
3(b)(1). As we noted in the Proposing Release, collateral may be 
posted to a third-party custodian, directly to the counterparty, or 
in accordance with the rules of a derivatives clearing organization 
or clearing agency. See Proposing Release, 75 FR at 80189 n.94.
    \867\ See letters from BlackRock I, Better Markets I and FSR I.
---------------------------------------------------------------------------

    To the extent the measure of exposure or the valuation of 
collateral is subject to other rules or regulations, we also would 
expect those measures and valuations for purposes of the major 
participant calculations to be consistent with those other applicable 
rules.\868\ In addition, the ``substantial position'' analysis may take 
into account the posting of non-cash collateral to the extent that the 
posting of such collateral, and the valuation of that collateral, is 
consistent with industry standard practices or applicable 
regulation.\869\
---------------------------------------------------------------------------

    \868\ These principles should apply even in the case of valuing 
illiquid or bespoke positions. Market participants have the 
flexibility to use commercially reasonable approaches that are 
consistent with their financial statements, tax calculations and 
compliance with other regulations.
    \869\ For non-cash collateral to be considered for purposes of 
these calculations, the collateral must be available for the 
counterparty's use if the entity posting the collateral were to 
default. At a minimum, this would require that the counterparty 
possess a perfected security interest in that collateral. As we 
noted in the Proposing Release, while we expect that other 
regulatory requirements applicable to the valuation of swap or 
security-based swap positions and collateral would be relevant to 
certain calculations relating to major participant status, these 
rules would not necessarily be relevant for other purposes, such as 
in the context of capital and margin requirements. See Proposing 
Release, 75 FR at 80189 n.95.
---------------------------------------------------------------------------

ii. Netting
    The final rules build upon the proposal with regard to the measure 
of uncollateralized current exposure in the presence of netting 
arrangements. In particular, to address commenter concerns these 
provisions have been modified from the proposal to account for the fact 
that two counterparties may have multiple netting agreements for which 
offsets are permitted, and to extend the netting principles to any 
financial instruments that may be netted for purposes of applicable 
bankruptcy law (rather than limiting those instruments to swaps, 
security-based swaps and securities financing transactions).
    Accordingly, the final rules provide that an entity may calculate 
its exposure on a net basis by applying the terms of one or more master 
netting agreements with a counterparty. The entity may account for 
offsetting positions entered into with that particular counterparty 
involving swaps or security-based swaps as well as securities financing 
transactions (consisting of securities lending and borrowing, 
securities margin lending and repurchase and reverse repurchase 
agreements), and other financial instruments and agreements that are 
subject to netting offsets for purposes of applicable bankruptcy law, 
to the extent consistent with the offsets provided by those master 
netting agreements.\870\ These revisions should permit the current 
uncollateralized exposure test to more accurately reflect the degree of 
credit risk that an entity poses to its counterparty in the event of 
default.
---------------------------------------------------------------------------

    \870\ CFTC Regulation Sec.  1.3(jjj)(2)(iii); Exchange Act rule 
3a67-3(b)(3)(i). This provision provides for netting under the 
master netting agreement of any instruments, contracts or agreements 
(including contracts on physical commodities), that would qualify 
for netting under applicable bankruptcy law. As we noted in the 
Proposing Release, the proposed rules regarding possible offsets of 
various positions are for purposes of determining major participant 
status only. Other rules proposed by the Commissions may address the 
extent to which, if any, persons such as dealers and major 
participants may offset positions for other purposes. See Proposing 
Release, 75 FR at 80189 n.98. As proposed, Exchange Act rule 3a67-
3(b)(3)(i) referred to ``security-based swaps (in any swap 
category)''; this reference has been revised in the final rule to 
``security-based swaps (in any security-based category).''
---------------------------------------------------------------------------

    As discussed in the proposal, these netting provisions apply only 
to offsetting positions with a single counterparty.\871\ The provisions 
do not extend to the market risk offsets associated with an entity's 
positions with multiple counterparties, because such offsets would not 
directly mitigate the risks that an individual counterparty would face 
in the event of the entity's default.\872\
---------------------------------------------------------------------------

    \871\ CFTC Regulation Sec.  1.3(jjj)(2)(iii); Exchange Act rule 
3a67-3(b)(3)(ii).
    \872\ The fact that positions with third parties do not offset 
exposure to a particular counterparty was recently highlighted by a 
decision finding that the Bankruptcy Code does not permit excess 
collateral held by one creditor to offset amounts that the debtor 
owed to the creditor's affiliates. See In re Lehman Brothers Inc., 
Case No. 08-01420 (JMP) (SIPA), slip op. (Bankr. S.D.N.Y Oct. 4, 
2011).
---------------------------------------------------------------------------

iii. Allocation of Uncollateralized Exposure Following Netting
    The final rules build upon the proposal by codifying the method, 
discussed in the Proposing Release, related to the allocation of any 
uncollateralized exposure that remains following netting and the 
posting of collateral. This type of allocation can be necessary 
because, with netting, it otherwise may not be possible to directly 
attribute residual uncollateralized exposure to a particular major 
category of swap or security-based

[[Page 30668]]

swap.\873\ Some commenters have requested that the final rules codify 
this method to provide more certainty to market participants.\874\
---------------------------------------------------------------------------

    \873\ Such allocation would not be necessary, of course, to the 
extent that an entity has no current uncollateralized exposure to a 
counterparty following netting and the posting of collateral.
    \874\ See letters from SIFMA AMG II and Vanguard.
---------------------------------------------------------------------------

    Accordingly, the final rules incorporate a formula which, for 
purposes of the substantial position analysis, provides that the amount 
of net uncollateralized exposure that is attributable to a particular 
major category of swap or security-based swap would be allocated pro 
rata in a manner that compares the amount of the entity's out-of-the-
money positions in that major category to its total out-of-the-money 
positions in all categories that are subject to the netting 
arrangements with that counterparty.\875\ This approach does not 
require that any collateral be specifically earmarked to particular 
swaps or security-based swaps, and can be followed so long as 
collateral is posted based on the net exposure associated with all 
instruments subject to the applicable netting agreements with that 
particular counterparty.\876\
---------------------------------------------------------------------------

    \875\ CFTC Regulation Sec.  1.3(jjj)(2)(iii)(A); Exchange Act 
rule 3a67-3(b)(4). Under this formula, for example, if an entity's 
exposure to a particular counterparty is $120 million after 
accounting for netting and the posting of collateral, and, subject 
to netting, the entity has $40 million in out-of-the-money positions 
in security-based credit derivatives, $90 million in out-of-the-
money positions in other security-based swaps, and $120 million in 
out-of-the money positions in swaps and other instruments subject to 
the netting agreements, then $19.2 million in net uncollateralized 
exposure would be attributed to the ``security-based credit 
derivatives'' category (equal to $120 million [middot] ($40 million/
($40 million + $90 million + $120 million)), and $43.2 million in 
net uncollateralized exposure would be attributed to the ``other 
security-based swaps'' category (equal to $120 million [middot] ($90 
million/($40 million + $90 million + $120 million)).
    \876\ Although one commenter suggested that the analysis should 
further consider whether there are collateral posting requirements 
that are specific to a particular position, we believe that the test 
we are adopting is flexible enough to address that possibility. To 
the extent that the parties' collateral arrangements provide that 
collateral be earmarked to particular swap or security-based swap 
positions, an entity may calculate its potential future exposure 
with respect to that counterparty with regard to the applicable 
major category of swaps or security-based swaps, without accounting 
for netting across categories or instruments.
---------------------------------------------------------------------------

iv. Application of Current Exposure Test to Cleared, Fully 
Collateralized or Net In-the-Money Positions
    Although certain commenters have requested that the current 
uncollateralized exposure test explicitly exclude swap or security-
based swap positions that are cleared, fully collateralized or net in-
the-money,\877\ the final rules do not provide such exclusions. As we 
recognized in the Proposing Release, centrally cleared swaps and 
security-based swaps are subject to mark-to-market margining that would 
largely eliminate the uncollateralized exposure associated with a 
position, effectively resulting in the cleared position being excluded 
from the analysis.\878\ Also, by definition, fully collateralized 
positions are not associated with current uncollateralized exposure, 
and thus would be excluded from the analysis. As such, we do not 
believe that it would be necessary to explicitly exclude such positions 
from the analysis.\879\
---------------------------------------------------------------------------

    \877\ See letters from ICI I, SIFMA AMG II and Vanguard.
    \878\ See Proposing Release, 75 FR at 80189 n.92.
    \879\ Moreover, to the extent that such positions are associated 
with uncollateralized amounts, such as those that arise from 
thresholds or minimum transfer amounts pursuant to the applicable 
credit support annex, then those amounts present counterparty risk 
that should be considered as part of the major participant analysis.
---------------------------------------------------------------------------

    Similarly, we do not believe that it is necessary for the rules to 
explicitly exclude net in-the-money swap or security-based swap 
positions. If an entity does not have any current uncollateralized 
exposure to a particular counterparty--after accounting for the 
entity's netting agreement with that counterparty and the posting of 
collateral--then the entity may disregard its positions with that 
counterparty for purposes of calculating current uncollateralized 
exposure. Otherwise, it is appropriate to consider the contribution of 
all swaps or security-based swaps to current uncollateralized exposure, 
as determined by the allocation methodology discussed above.\880\
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    \880\ Under that allocation approach, if none of the entity's 
swap or security-based swap positions in a major category with that 
counterparty are out-of-the-money, then none of the current exposure 
resulting from the netting agreement would be attributed to that 
major category.
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c. Potential Future Exposure Analysis
    The ``substantial position'' analysis also will consider an 
entity's ``aggregate potential outward exposure,'' which would reflect 
the potential exposure of the entity's swap or security-based swap 
positions in the applicable ``major'' category of swap or security-
based swaps, subject to certain adjustments.\881\ The final rules 
implementing this test in general follow the proposed approach, but 
have been revised to address commenter concerns.
---------------------------------------------------------------------------

    \881\ CFTC Regulation Sec.  1.3(jjj)(3); Exchange Act rule 3a67-
3(c).
---------------------------------------------------------------------------

i. Purpose Underlying the Potential Future Exposure Test
    As discussed in the proposal, a potential future exposure test 
addresses the fact that a sole focus on current uncollateralized 
exposure could fail to identify risky entities until some time after 
they begin to pose the level of risk that should subject them to 
regulation as major participants.\882\ A potential future exposure test 
would allow the substantial position analysis to account for this risk 
by addressing how the value of an entity's swap or security-based swap 
positions may move against the entity over time.\883\
---------------------------------------------------------------------------

    \882\ See Proposing Release, 75 FR at 80188.
    \883\ See id. at 80191.
---------------------------------------------------------------------------

    Accordingly, consistent with the proposal, the final rules 
incorporate a potential future exposure test that seeks to estimate how 
much the value of swaps or security-based swaps might change against an 
entity over the remaining life of the contract. Although some 
commenters took the view that this test should only address potential 
volatility during the period of time it would take for a non-defaulting 
party to close out positions and liquidate collateral,\884\ we believe 
that it is more appropriate for the analysis to consider the risks that 
swaps or security-based swap positions pose over the lives of those 
positions. An exclusive focus on short-term risks would fail to account 
for the possibility that an entity's large swap or security-based swap 
positions can readily produce large losses in adverse market 
circumstances, potentially leading either to large uncollateralized 
exposure (if the posting of collateral is not required), or to large 
collateral calls that may lead to the entity's default (or to calls for 
extraordinary action) and that can threaten non-defaulting parties with 
significant costs and challenges in connection with liquidating and 
replacing those positions. The analysis should give appropriate weight 
to those risks.
---------------------------------------------------------------------------

    \884\ See letters from SIFMA AMG II and Vanguard.
---------------------------------------------------------------------------

ii. Risk Multipliers
    Subject to modifications addressed below, the final rules 
implementing the ``substantial position'' analysis incorporate a 
potential future exposure test based on the proposal's general approach 
of adjusting notional positions using risk multipliers.\885\ This 
approach incorporates and builds upon tests used by bank regulators for 
the purposes of setting prudential capital.\886\ Through

[[Page 30669]]

this methodology, the final rules implement an objective approach that 
readily can be replicated by market participants.
---------------------------------------------------------------------------

    \885\ See CFTC Regulation Sec.  1.3(jjj)(3)(ii)(A)(1); Exchange 
Act rule 3a67-3(c)(2)(i).
    \886\ See 12 CFR part 3, app. C, section 32 (Office of the 
Comptroller of the Currency capital adequacy guidelines for banks); 
12 CFR part 325, app. D, section 32 (Federal Deposit Insurance Corp. 
capital adequacy guidelines for banks); 12 CFR part 208, app. F, 
section 32 (Federal Reserve System capital adequacy guidelines for 
banks); 12 CFR part 225, app. G, section 32 (Federal Reserve System 
capital adequacy guidelines for bank holding companies).
---------------------------------------------------------------------------

    Although some commenters have suggested the use of value-at-risk 
measures or internal models to evaluate potential future exposure,\887\ 
we do not believe that such approaches would be well tailored to be 
implemented by a range of market participants, or would lead to 
comparable results across market participants with identical swap or 
security-based swap portfolios.
---------------------------------------------------------------------------

    \887\ See letters from Riverside Risk Advisors and Better 
Markets I.
---------------------------------------------------------------------------

    In adopting this approach, we are mindful of the significance of 
commenter concerns about the adequacy of the tables that set forth the 
risk multipliers that would be applied to notional positions. These 
comments address, among other issues: discontinuities in the tables; 
the failure to account for whether, and how much, a swap or security-
based swap is in-the-money or out-of-the money; the failure of the 
multipliers applicable to interest rate swaps to distinguish between 
counterparties who pay floating rates and counterparties who pay fixed 
rates; the failure of the multipliers in the credit category to account 
for the volatility of the underlying instrument or the duration of the 
swap or security-based swap; the failure of the multipliers for equity 
and commodity swaps to distinguish between high-volatility and low-
volatility stocks and commodities; the adequacy of how the test 
addresses diversification and correlation; the fact that the approach 
does not provide for delta weighting of options positions; and the fact 
that the factors do not distinguish between index and single-name 
credit default swaps.\888\ While we acknowledge that it may be possible 
to develop revised risk multipliers that are more finely tuned to 
reflect relevant risk factors, at this time we believe that it would be 
most appropriate to implement the ``substantial position'' analysis by 
building upon an existing regulatory approach that is comparatively 
simpler to implement and leads to reproducible results, rather than 
seeking to develop a brand new approach.\889\
---------------------------------------------------------------------------

    \888\ See, e.g., letters from Riverside Risk Advisors and MFA I.
    \889\ We also are not following a commenter suggestion to 
incorporate the ``standardized method'' prescribed as part of the 
``Basel II'' bank capital methodology. See letter from ISDA I. The 
standardized method relies on counterparty credit ratings provided 
by external credit rating agencies for purposes of calculating risk-
weighted capital measurements. See ``International Convergence of 
Capital Measurement and Capital Standards, A Revised Framework, 
Comprehensive Version,'' the Basel Committee on Banking Supervision, 
June 2006. Incorporating this reliance on credit ratings provided by 
external credit rating agencies into these final rules would be 
inconsistent with Section 939A of the Dodd-Frank Act, which required 
all Federal agencies to review and modify existing regulations ``to 
remove any reference to or requirement of reliance on credit ratings 
and to substitute in such regulations such standard of credit-
worthiness as each respective agency shall determine as appropriate 
for such regulations.''
---------------------------------------------------------------------------

    The final rules implementing the ``major security-based swap 
participant'' definition, however, modify the proposed risk multipliers 
in response to commenter concerns about how the ``major'' categories of 
security-based swaps should be applied to the risk multiplier 
categories. In particular, the final risk multiplier category for 
security-based swaps in the ``equity and other'' category encompasses 
all security-based swaps that are not credit derivatives, and the final 
rules eliminate the proposed category for ``other'' types of security-
based swaps.\890\
---------------------------------------------------------------------------

    \890\ See Exchange Act rule 3a67-3(c)(2)(i). Aside from making 
the risk multipliers consistent with the ``major'' categories of 
security-based swaps, this change also should allow total return 
swaps on debt to be subject to the same risk multipliers as total 
return swaps on equity, rather than causing the debt swaps to be 
subject to higher multipliers (which may not accurately reflect the 
comparative risks of those instruments).
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iii. Potential Future Exposure Measures for Certain Lower-Risk 
Positions
    Consistent with the proposal, the potential future exposure 
calculation will exclude purchases of options and other positions for 
which a person has prepaid or otherwise satisfied its payment 
obligations.\891\ Also, in response to commenter concerns, the final 
rules expand on the proposal with regard to capping the potential 
future exposure associated with certain lower-risk swap and security-
based swap positions. The final rules particularly cap--at the net 
present value of the unpaid premiums--the potential future exposure 
associated with positions by which a person buys credit protection 
using a credit default swap, and positions by which a person purchases 
an option for which the person retains additional payment obligations 
under the position.\892\ This reflects the reduced risk associated with 
such positions. The final rules do not prescribe a particular discount 
rate for purposes of this analysis, and market participants instead 
should use a commercially appropriate discount rate.
---------------------------------------------------------------------------

    \891\ See CFTC Regulation Sec.  1.3(jjj)(3)(ii)(A)(3)(ii); 
Exchange Act rule 3a67-3(c)(2)(i)(C).
    \892\ See CFTC Regulation Sec.  1.3(jjj)(3)(ii)(A)(4); Exchange 
Act rule 3a67-3(c)(2)(i)(D). The proposed rules would have applied 
this net present value caps only to the purchase of credit 
protection. The final rules expand this provision by also capping 
the potential future exposure associated with the purchases of 
options in which an entity retains payment obligations, to reflect 
the reduced risk associated with those positions.
---------------------------------------------------------------------------

    In addition, to better align the results of the potential future 
exposure analysis with the risks that a person presents, the final 
rules have been modified from the proposal to also exclude swap or 
security-based swap positions for which, pursuant to regulatory 
requirement, a person has placed in reserve an amount of cash or 
Treasury securities that is sufficient to pay the person's maximum 
possible liability under the position, when the person is prohibited 
from using that cash or those securities without also liquidating the 
swap or security-based swap position.\893\
---------------------------------------------------------------------------

    \893\ CFTC Regulation Sec.  1.3(jjj)(3)(ii)(A)(3)(iii); Exchange 
Act rule 3a67-3(c)(2)(i)(C)(3). This exclusion of such positions 
from the major participant analysis may apply, for example, to 
certain swap or security-based swap positions of insurers where 
applicable law requires an amount equal to the maximum possible 
exposure of the insurer be segregated.
---------------------------------------------------------------------------

iv. Adjustments for Netting
    Consistent with the proposal, and with the bank regulator standards 
that form the basis for these potential future exposure measures, the 
final rules provide that an entity may reduce the measure of its 
potential future exposure in a major category by up to 60 percent to 
reflect the risk mitigation effects of master netting agreements. We 
believe that this approach appropriately reflects the risk mitigating 
attributes of netting on potential future exposure. Moreover, in light 
of commenter requests for clarification of how these netting provisions 
would be applied,\894\ the final rules have been revised from the 
proposal to provide that the risk reduction associated with netting 
should be estimated using the same pro rata allocation methodology that 
will be used to measure current exposure.\895\
---------------------------------------------------------------------------

    \894\ See letter from SIFMA AMG II.
    \895\ Consistent with the proposal, the effects of netting are 
to be estimated using the formula: P Net = 0.4 x P Gross + 0.6 x NGR 
x P Gross. Under that equation, P Net is the potential exposure 
adjusted for bilateral netting; P Gross is that potential outward 
exposure without adjustment for bilateral netting; and NGR is the 
net to gross ratio. The final rule has been revised from the 
proposal to clarify that the net to gross ratio equals the current 
exposure associated with the major category as calculated using the 
pro rata methodology discussed above, divided by what the measure of 
current exposure in connection with those out-of-the-money positions 
would be in the absence of that methodology.
     Accordingly, for the example set forth in note 875, supra, the 
NGR for ``security-based credit derivatives'' and ``other security-
based swaps'' both would equal 0.48 (equal to $19.2 million net 
exposure divided by $40 million in out-of-the-money positions in the 
case of ``security-based credit derivatives,'' or $43.2 million net 
exposure divided by $90 million in out-of-the-money positions in the 
case of ``other security-based swaps''). If an entity has no current 
exposure to a counterparty following the application of netting 
arrangements and collateralization, the NGR for those positions 
would equal zero, and the potential exposure would equal 40 percent 
of what it would equal otherwise.

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[[Page 30670]]

v. Adjustments for Cleared and Margined Positions
    The final rules also provide for the measure of potential future 
exposure to be adjusted in the case of swap and security-based swap 
positions that are centrally cleared or that are subject to daily mark-
to-market margining. This is consistent with the purpose of the 
potential future exposure test, which is to account for the extent to 
which the current outward exposure of positions (though possibly low or 
even zero at the time of measurement) might grow to levels that can 
lead to high counterparty risk to counterparties or to the markets 
generally. The practice of the periodic exchange of mark-to-market 
margin between counterparties helps to mitigate the potential for large 
future increases in current exposure.
    Consistent with the proposal, the final rules reflect this ability 
to mitigate risk by providing that the potential future exposure 
associated with positions that are subject to daily mark-to-market 
margining will equal 0.2 times the amount that otherwise would be 
calculated. However, in response to commenters' opinions about the 
risk-mitigating effects of central clearing, and the additional level 
of rigor that clearing agencies may have with regards to the process 
and procedures for collecting daily margin, the final rules further 
provide that the potential future exposure associated with positions 
that are subject to central clearing will equal 0.1 (rather than the 
proposed 0.2) times the potential future exposure that would otherwise 
be calculated.\896\
---------------------------------------------------------------------------

    \896\ See CFTC Regulation Sec.  1.3(jjj)(3)(iii)(A); Exchange 
Act rule 3a67-3(c)(3)(i). The final rules further have been revised 
to clarify that the 0.1 factor applies to positions cleared by a 
registered clearing agency or by a clearing agency that has been 
exempted from registration.
---------------------------------------------------------------------------

    Although some commenters supported the complete exclusion of 
cleared positions from the potential future exposure analysis,\897\ and 
we are mindful of the risk mitigating attributes of central clearing, 
we also recognize that central clearing cannot reasonably be expected 
to entirely eliminate counterparty risk.\898\ We conclude, however, 
that the use of a 0.1 factor (in lieu of the proposed 0.2) would be 
appropriate for cleared positions, reflecting the strong risk 
mitigation features associated with central clearing, particularly the 
procedures regarding the collection of daily margin and the use of 
counterparty risk limits, while recognizing the presence of some 
remaining counterparty risk.
---------------------------------------------------------------------------

    \897\ See, e.g., letters from MFA I and SIFMA AMG II.
    \898\ Central clearing helps to mitigate counterparty credit 
risk by improving risk management and, among other things, 
mutualizing the risk of counterparty failure. If multiple members of 
a central counterparty fail beyond the level to which such risk is 
managed, however, the central counterparty would also be at risk of 
failure. Cf. Basel Committee on Banking Supervision, Consultative 
Document, ``Capitalisation of bank exposures to central 
counterparties,'' Nov. 25, 2011 (available at: http://www.bis.org/publ/bcbs206.pdf) (proposing that the capital charge for trade 
exposures to a qualifying central counterparty should carry a low 
risk weight, reflecting the relatively low risk of default of the 
qualifying central counterparty). In addition, as we discussed in 
the Proposing Release, see 75 FR at 80192 n.115, for example, 
central counterparties that clear credit default swaps do not 
necessarily become the counterparties of their members' customers 
(although even absent direct privity those central counterparties 
benefit customers by providing for protection of collateral they 
post as margin, and by providing procedures for the portability of 
customer positions in the event of a member's default). As a result, 
central clearing may not eliminate the counterparty risk that the 
customer poses to the member, although required mark-to-market 
margining should help control that risk, and central clearing would 
be expected to reduce the likelihood that an entity's default would 
lead to broader market impacts.
---------------------------------------------------------------------------

    Moreover, although some commenters opposed any deduction from the 
measure of potential future exposure for uncleared positions that are 
margined on a daily basis,\899\ we believe that the risk-mitigating 
attributes of daily margining warrant an adjustment given that the goal 
of the potential future exposure test is to account for price movements 
over the remaining life of the contract.\900\ The use of a 0.2 factor 
also reflects our expectation that the risk mitigation associated with 
uncleared but margined positions would be less than the risk mitigation 
associated with cleared positions.
---------------------------------------------------------------------------

    \899\ See letter from Better Markets I; see also letter from 
AFR.
    \900\ We do not believe that it is appropriate to have this type 
of discount when mark-to-market margining is done less than daily, 
however.
---------------------------------------------------------------------------

    While higher or lower alternatives to the 0.1 and 0.2 factors may 
also be reasonable for positions that are cleared or margined on a 
daily basis, we believe that the factors of the final rules reasonably 
reflects the risk mitigating (but not risk eliminating) features of 
those practices. The final rules also retain and clarify provisions 
addressing when daily mark-to-market margining occurs for purposes of 
this discount.\901\
---------------------------------------------------------------------------

    \901\ We recognize that at times, market participants whose 
agreements provide for the daily exchange of variation margin in 
connection with swaps or security-based swaps in practice may not 
exchange collateral daily, if the amounts at issue are relatively 
small (such as through the use of collateral thresholds and minimum 
transfer amounts). We do not believe that such practices would be 
inconsistent with providing a discount for daily margining 
practices. The proposed rules sought to accommodate those practices 
by providing that positions would be considered to be subject to 
daily mark-to-market margining for purposes of the 
``uncollateralized outward exposure'' plus ``potential outward 
exposure'' analysis, so long as the total of such thresholds, and 
the total of such minimum transfer amounts above $1 million are 
deemed to be ``uncollateralized outward exposure'' for those 
purposes.
    In light of commenter concerns, which indicated that the 
proposal was not fully clear about the mechanics and purpose of this 
approach, the relevant rule language has been revised to clarify 
that this attribution of thresholds and minimum transfer amounts is 
solely for the purpose of determining whether certain positions are 
subject to daily mark-to-market margining for purposes of the 
analysis. In addition, the final rules have been revised from the 
proposal to provide that the attribution of thresholds as 
``uncollateralized outward exposure'' for these purposes will be 
reduced by initial margin posted, up to the amount of the threshold. 
See CFTC Regulation Sec.  1.3(jjj)(iii)(B); Exchange Act rule 3a67-
3(c)(3)(ii).
---------------------------------------------------------------------------

vi. Application of ``Effective Notional'' Amounts
    Consistent with the proposal (as well as the rules implementing the 
de minimis exception to the dealer definitions), the potential future 
exposure test is based on the ``effective notional'' amount of the swap 
or security-based swap when the stated notional is leveraged or 
enhanced by the structure of the swap or security-based swap.\902\
---------------------------------------------------------------------------

    \902\ As discussed above, this may occur, for example, if the 
exchange of payments associated with an equity swap is based on a 
multiple of the return associated with the underlying equity. As is 
the case for measuring current exposure, the final rules do not 
prescribe any particular methodology for calculating the notional 
amount or effective notional amount used in the calculation of 
potential future exposure, but instead contemplate the use of 
industry standard practices.
---------------------------------------------------------------------------

    Moreover, as discussed in the Proposing Release,\903\ in the case 
of positions that represent the sale of an option on a swap or 
security-based swap (other than the sale of an option permitting the 
person exercising the option to purchase a credit default swap), we 
would view the effective notional amount of the option as being equal 
to the effective notional amount of the underlying swap or security-
based swap, and in general we would view the duration used for purposes 
of the formula as being equal to the sum of the duration of the option 
and the duration of the underlying swap or security-based swap.\904\
---------------------------------------------------------------------------

    \903\ See Proposing Release, 75 FR 80192 n.110.
    \904\ The effective notional amount of the underlying instrument 
is used for these purposes because that amount fairly reflects the 
basis for measuring the potential counterparty risk associated with 
the instrument. The sum of the duration of the option and the 
underlying instrument is used for these purposes because that sum 
reflects the length of time of the potential counterparty risk 
associated with the instrument.
    At the same time, we agree with a commenter's view that if the 
underlying swap or security-based swap is cash settled, the 
calculation of duration will only include the duration of the 
option, and not the duration of the swap, because counterparty 
exposure would exist only until the option expiration date. See 
letter from MFA I.

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[[Page 30671]]

vii. Treatment of Initial Margin or Overcollateralization
    The final rules retain the proposed approach of not modifying the 
measure of potential future exposure to reflect collateral that a 
person has posted to its counterparty in excess of current exposure. 
Although we recognize that the posting of excess collateral may 
mitigate the future credit risk that the potential future exposure 
measure is intended to estimate, that mitigating effect is not certain, 
and any such mitigation may not reflect the full value of the excess 
collateral. Moreover, while we believe that the measure of potential 
future exposure associated with swap or security-based swap positions 
reasonably estimates the credit risk that may be posed by those 
positions for purposes of the substantial position analysis, we also 
recognize that particular positions may prove to pose a far higher 
amount of credit risk.\905\ Given how the credit risk associated with a 
swap or security-based swap position can far exceed the associated 
measure of potential future exposure, we do not believe that it would 
be appropriate to offset that measure to account for 
overcollateralization.\906\
---------------------------------------------------------------------------

    \905\ For example, if a person writes a CDS that provides $10 
billion in protection on a reference entity, with the CDS being 
subject to daily mark-to-market margining, then for purposes of the 
substantial position analysis that CDS would be associated with a 
potential future exposure measure of no more than $200 million 
(reflecting the 0.1 conversion factor and the additional 0.2 
multiplier for margined positions), even before accounting for 
netting. Yet if the reference entity were to default, the writer of 
the CDS could pose up to $10 billion in credit risk to its 
counterparty.
    \906\ However, as discussed above, see note 901, supra, initial 
margin may be considered when determining if a collateral threshold 
is to be attributed to current uncollateralized exposure for 
purposes of determining whether certain positions are subject to 
daily mark-to-market margining for purposes of the substantial 
position analysis.
---------------------------------------------------------------------------

d. Thresholds
    The final rules retain the proposed thresholds for the amount of 
current uncollateralized exposure and potential future exposure that 
will cause an entity to be deemed to be a major participant. 
Accordingly, for a person to have a ``substantial position'' in a major 
category of swaps, it would be necessary for that person to have a 
daily average current uncollateralized exposure of at least $1 billion 
(or $3 billion for the rate swap category), or a daily average current 
uncollateralized exposure plus potential future exposure of $2 billion 
(or $6 billion for the rate swap category).\907\ To have a 
``substantial position'' in a major category of security-based swaps, 
it would be necessary for the person to have a daily average current 
uncollateralized exposure of at least $1 billion, or a daily average 
current uncollateralized exposure plus potential future exposure of at 
least $2 billion.\908\
---------------------------------------------------------------------------

    \907\ CFTC Regulation Sec.  1.3(jjj)(1).
    \908\ Exchange Act rule 3a67-3(a).
---------------------------------------------------------------------------

    As the Proposing Release noted, the proposed thresholds sought to 
reflect: (i) The financial system's ability to absorb losses of a 
particular size; (ii) the recognition that it would not be appropriate 
for the substantial position test to encompass entities only after they 
pose significant risks to the market through their swap or security-
based swap activity; and (iii) the need to account for the possibility 
that multiple market participants may fail close in time.\909\ While 
some commenters took the position that the proposed thresholds were 
inappropriately low, those commenters did not present empirical data or 
analysis in support of that view. Moreover, the Commissions do not 
concur with the suggestion \910\ that the major participant definitions 
can reasonably be read to require that we defer this rulemaking until 
we have gathered additional data. Instead, the definitions direct us to 
set a standard that is ``prudent,'' which is what we have sought to do.
---------------------------------------------------------------------------

    \909\ As discussed above, we do not believe it would be prudent 
to presume that entity failures will be separated in time during 
periods of financial stress.
    \910\ See letters from BlackRock I and CCMR I.
---------------------------------------------------------------------------

    Some commenters who supported an increase in the proposed 
thresholds attempted to support their positions via analogy to past 
events, with the most significant of these being an analogy to AIG 
Financial Products (``AIG FP'').\911\ The analogy to AIG FP \912\ 
actually argues against an increase in these thresholds, however, 
particularly given that the credit derivative portfolio that 
significantly contributed to the liquidity problems that AIG FP faced 
amounted to $72 billion in notional amount.\913\ Under the final rules, 
in the presence of central clearing or daily marking to market it would 
take a credit derivative portfolio in excess of that amount to trigger 
the potential future exposure threshold under the ``substantial 
position'' analysis.\914\ This indicates that the thresholds are not 
inappropriately low, particularly given our view that the major 
participant definition is intended to encompass entities before their 
swap or security-based swap positions pose significant market 
threats.\915\ Conversely, while

[[Page 30672]]

additional data and analysis may warrant a reduction of these 
thresholds in the future, commenters who supported a reduction in those 
thresholds have not persuaded us that the proposed thresholds should be 
lowered.
---------------------------------------------------------------------------

    \911\ See letter from ABC/CIEBA. One commenter's analogy to 
Enron also is unpersuasive. See letter from BG LNG I. In particular, 
the $18.7 billion in Enron derivatives exposure cited by that 
commenter does not account for collateral posted in connection with 
those positions. Also, the market impact of Enron's bankruptcy was 
substantially mitigated by the sale of Enron's derivatives trading 
arm to a third party.
    Moreover, although one commenter generally alluded to corporate 
financial losses in the derivatives markets that exceeded the 
proposed $1 billion and $2 billion thresholds, see letter from NCGA/
NGSA II, the relevant question does not focus on losses that market 
participants have incurred, but instead focuses on what degree of 
credit risk to counterparties in the swap and security-based swap 
markets presents such a potential to cause significant market impact 
that it would be prudent to regulate persons who pose that degree of 
credit risk in connection with their swap or security-based swap 
positions.
    \912\ Our discussion of how the major participant analysis may 
apply to an entity that has a portfolio of a size equivalent to that 
of AIG FP should not be read to imply that a person may engage in 
swap and security-based swap activities akin to those of AIG FP 
without registering as a swap dealer or security-based swap dealer.
    \913\ See, e.g., Congressional Oversight Panel, The AIG Rescue, 
Its Impact on Markets, and the Government's Exit Strategy 22-24 
(2010) (discussing how the risk in AIG's CDS business largely was 
the result of a ``multi-sector'' CDO book that amounted to $72 
billion notional as of September 2008, and how the losses to AIG 
were driven by 125 of the roughly 44,000 contracts entered into by 
AIG FP).
    \914\ For cleared security-based credit default swaps (in which 
we assume daily margining requirements result in no current 
uncollateralized exposure) achieving $2 billion of potential future 
exposure would require writing $200 billion notional of credit 
default swap protection (reflecting the 0.10 multiplier in the risk 
adjustment tables, and the additional 0.10 multiplier for positions 
that are cleared). Similarly, it would take a $100 billion notional 
portfolio of uncleared but marked-to-market security-based credit 
default swaps to meet that same threshold (reflecting the 0.20 
multiplier for positions that are subject to daily mark-to-market 
margining). The total might be even higher if such instruments were 
subject to counterparty netting agreements.
    Even in the absence of clearing or daily mark-to-market 
margining, it would take a minimum $20 billion notional portfolio of 
written protection on credit (reflecting the 0.10 multiplier in the 
risk adjustment tables) to meet the $2 billion potential future 
exposure threshold. Accounting for netting (which can reduce 
potential future exposure measures by up to 60 percent) could 
materially increase that required amount.
    \915\ The case of Long-Term Capital Management (``LTCM'') also 
is instructive in connection with the current exposure thresholds of 
the major participant analysis. Had LTCM failed, its top 17 
counterparties would have suffered estimated total losses of between 
$3 and $5 billion. See President's Working Group on Financial 
Markets, Hedge Funds, Leverage, and the Lessons of Long-Term Capital 
Management (April 1999) at 17 (http://www.treasury.gov/resource-center/fin-mkts/Documents/hedgfund.pdf). The government acted in 
connection with LTCM because the rushed close-out of LTCM's 
positions would have affected other market participants, and the 
spread of losses would have led to market uncertainty, likely 
causing a number of credit and interest rate markets to experience 
extreme price moves and possibly not function for a period of time. 
See Statement by William J. McDonough, President Federal Reserve 
Bank of New York before the Committee on Banking and Financial 
Services U.S. House of Representatives (October 1, 1998) (http://www.newyorkfed.org/newsevents/speeches_archive/1998/mcd981001.html).
---------------------------------------------------------------------------

e. Additional Issues
    The final rules applying the ``substantial position'' analysis and 
the major participant definitions generally apply to all types of swaps 
or security-based swaps that a person maintains. Although one commenter 
suggested that swaps on government securities should be excluded from 
the analysis, the rules will not provide such an exclusion. To the 
extent that a person presents credit risk as a result of swaps 
referencing government securities, there is no basis for disregarding 
that risk when determining whether the person is a major participant.
    In addition, in light of one commenter's concern,\916\ the 
Commissions believe that it is important to emphasize that these rules 
should not be interpreted to deter end-users from requesting margin 
from dealers or major participants who are their counterparties to 
swaps or security-based swaps.
---------------------------------------------------------------------------

    \916\ See letter from FHLB I.
---------------------------------------------------------------------------

    Also, in light of a point raised by another commenter,\917\ the 
Commissions note that these rules implementing the major participant 
definitions do not place any independent calculation or other 
obligations upon counterparties to potential major participants, and 
that the rules do not preclude a potential major participant from 
seeking the assistance of a third party to perform the relevant 
calculation.
---------------------------------------------------------------------------

    \917\ See letter from ISDA I.
---------------------------------------------------------------------------

C. ``Hedging or Mitigating Commercial Risk''

1. Proposed Approach
a. General Availability of the Proposed Exclusion
    The first test of the major participant definitions excludes 
positions held for ``hedging or mitigating commercial risk'' from the 
substantial position analysis.\918\ In the Proposing Release, we 
preliminarily concluded that positions that hedge or mitigate a 
person's commercial risk may qualify for this exclusion regardless of 
whether the entity is financial or non-financial in nature.\919\ That 
conclusion in part was prompted by the fact that the statutory major 
participant definitions do not explicitly make the exclusion 
unavailable to financial entities; in contrast to the Title VII 
exceptions from mandatory clearing requirements in connection with 
hedging commercial risk,\920\ which explicitly are unavailable to 
financial entities.\921\ The conclusion also was prompted by the 
presence of the third major participant test--which specifically 
applies the substantial position analysis to certain non-bank financial 
entities but (unlike the first test) does not exclude commercial risk 
hedging positions from the analysis.\922\
---------------------------------------------------------------------------

    \918\ See CEA section 1a(33)(A)(i)(I); Exchange Act section 
3(a)(67)(A)(i)(I).
    \919\ See Proposing Release, 75 FR at 80194.
    \920\ See CEA section 2(h)(7)(A); Exchange Act section 
3C(g)(1)(B).
    \921\ As we discussed in the Proposing Release, had the Dodd-
Frank Act intended the phrase ``hedge or mitigate commercial risk'' 
to apply only to activities of, or positions held by, non-financial 
entities, it would not have been necessary for the mandatory 
clearing exceptions to include additional provisions generally 
restricting the availability of the exceptions to non-financial 
entities. See Proposing Release, 75 FR at 80194.
    \922\ As we discussed in the Proposing Release, the third 
statutory major participant test would be redundant if the hedging 
exclusion in the first major participant test were entirely 
unavailable to financial entities. See Proposing Release, 75 FR at 
80194 n.125.
---------------------------------------------------------------------------

    In the Proposing Release, we also preliminarily concluded that the 
question of whether an activity is commercial in nature should not be 
determined solely by a person's organizational status as a for-profit, 
non-profit or governmental entity, but instead should depend on whether 
the underlying activity is commercial in nature.\923\
---------------------------------------------------------------------------

    \923\ See Proposing Release, 75 FR at 80194.
---------------------------------------------------------------------------

    The proposal did not preclude the exclusion from being available in 
connection with hedges of a person's ``financial'' or ``balance sheet'' 
risks. In addition, the proposal solicited comment as to whether the 
exclusion should extend to activities in which a person hedges an 
affiliate's risk.
b. Proposed Definition Under the CEA Exception
    The proposed interpretation of ``hedging or mitigating commercial 
risk'' for purposes of the CEA's definition of ``major swap 
participant'' premised the exclusion on the principle that swaps 
necessary to the conduct or management of a person's commercial 
activities should not be included in the calculation of the entity's 
substantial position.\924\
---------------------------------------------------------------------------

    \924\ The scope of the proposed exclusion is based on our 
understanding that when a swap or security-based swap is used to 
hedge a person's commercial activities, the gains or losses 
associated with the swap or security-based swap itself will 
generally be offset by losses or gains in the person's commercial 
activities, and hence the risks posed by the swap or security-based 
swap to counterparties or the industry will generally be mitigated.
---------------------------------------------------------------------------

    The CFTC noted first that the phrase ``hedging or mitigating 
commercial risk'' as used with respect to the major swap participant 
definition is virtually identical to Dodd-Frank provisions granting an 
exception from the mandatory clearing requirement to non-financial 
entities that are using swaps to hedge or mitigate commercial 
risk.\925\ Also noted was that although only non-financial entities 
that use swaps or security-based swaps to hedge or mitigate commercial 
risk generally may qualify for the clearing exemption, no such 
statutory restriction applies with respect to the exclusion for hedging 
positions in the first test of a major participant. We therefore 
concluded that positions established to hedge or mitigate commercial 
risk may qualify for the exclusion, regardless of the nature of the 
entity--i.e., whether or not the entity is financial (including a bank) 
or non-financial.\926\
---------------------------------------------------------------------------

    \925\ See CEA section 2(h)(7)(A); Exchange Act section 
3C(g)(1)(B) (exception from mandatory clearing requirements when one 
or more counterparties are not ``financial entities'' and are using 
swaps or security-based swaps to ``hedge or mitigate commercial 
risk'').
    \926\ The presence of the third major participant test suggests 
that financial entities generally may not be precluded from taking 
advantage of the hedging exclusion in the first test. The third 
test, which does not account for hedging, specifically applies to 
non-bank financial entities that are highly leveraged and have a 
substantial position in a major category of swaps or security-based 
swaps. That test would be redundant if the hedging exclusion in the 
first major participant test were entirely unavailable to financial 
entities.
---------------------------------------------------------------------------

    The CFTC preliminarily believed that whether a position hedges or 
mitigates commercial risk should be determined by the facts and 
circumstances at the time the swap is entered into, and should take 
into account the entity's overall hedging and risk mitigation 
strategies. However, the swap could not be held for a purpose that is 
in the nature of speculation, investing or trading. We anticipated that 
a person's overall hedging and risk management strategies would help 
inform whether or not a particular position is properly considered to 
hedge or mitigate commercial risk. Further, the exclusion under the 
Proposing Release included swaps hedging or mitigating any of a 
person's business risks, regardless of the

[[Page 30673]]

swap's status under accounting guidelines or the bona fide hedging 
exemption.
c. Proposed Definition Under the Exchange Act Exception
    For purposes of the Exchange Act's ``major security-based swap 
participant'' definition, the proposed rule defining ``hedging or 
mitigating commercial risk'' would require that a security-based swap 
position be ``economically appropriate'' to the reduction of risks in 
the conduct and management of a commercial enterprise, where those 
risks arise from the potential change in the value of assets, 
liabilities and services connected with the ordinary course of business 
of the enterprise.\927\ The Proposing Release stated that the SEC 
preliminarily planned to interpret the concept of ``economically 
appropriate'' based on whether a reasonably prudent person would 
consider the security-based swap to be appropriate for managing the 
identified commercial risk. It further stated that the SEC also 
preliminarily believed that for a security-based swap to be deemed 
``economically appropriate'' in this context, it should not introduce 
any new material quantum of risks (i.e., it could not reflect over-
hedging that could reasonably have a speculative effect) and it should 
not introduce any basis risk or other new types of risk (other than the 
counterparty risk that is attendant to all security-based swaps) more 
than reasonably necessary to manage the identified risk.\928\
---------------------------------------------------------------------------

    \927\ See proposed Exchange Act rule 3a67-4(a).
    \928\ See Proposing Release, 75 FR at 80195 n.129.
---------------------------------------------------------------------------

    The proposed rules further provided that the security-based swap 
position could not be held for a purpose that is in the nature of 
speculation or trading--a limitation that would make the exclusion 
unavailable to security-based swap positions that are held 
intentionally for the short term and/or with the intent of benefiting 
from actual or expected short-term price movements or to lock in 
arbitrage profits, including security-based swap positions that hedge 
other positions that themselves are held for the purpose of speculation 
or trading.\929\ The proposal also provided that a security-based swap 
position could not be held to hedge or mitigate the risk of another 
security-based swap position or swap position unless that other 
position itself is held for the purpose of hedging or mitigating 
commercial risk.\930\ Finally, the proposal would have conditioned the 
entity's ability to exclude these security-based swap positions on the 
entity engaging in certain specified activities related to documenting 
the underlying risks and assessing the effectiveness of the hedge in 
connection with the security-based swap positions.\931\
---------------------------------------------------------------------------

    \929\ See proposed Exchange Act rule 3a67-4(b)(1), and Proposing 
Release, 75 FR at 80195 n.131.
    \930\ See proposed Exchange Act rule 3a67-4(b)(2).
    \931\ See proposed Exchange Act rule 3a67-4(c).
---------------------------------------------------------------------------

2. Commenters' Views
a. In General
    Several commenters generally supported the broad concepts 
underlying the proposed rules for identifying hedges of commercial 
risk, and particularly supported the proposed use of an ``economically 
appropriate'' standard instead of the ``highly effective'' standard 
that is used to identify hedges for accounting purposes.\932\ On the 
other hand, one commenter stated that the definition should incorporate 
all manner of risks associated with commercial operations, including 
interest rate and currency risks, risks from incidental activities to 
commercial activities and risks from financial commodities.\933\ One 
commenter further stated that the definition should encompass positions 
that facilitate asset optimization and dynamic hedging.\934\
---------------------------------------------------------------------------

    \932\ See letters from ACLI, Barnard, CDEU, COPE I, EEI/EPSA, 
FSR I, ISDA I, Kraft, MetLife, NAIC, Philip Morris International 
Inc. (``Philip Morris'') and Utility Group.
    \933\ See letter from CDEU.
    \934\ See letter from Peabody.
---------------------------------------------------------------------------

    Commenters further stated that the exception should include any 
position taken as part of a bona fide risk mitigation strategy,\935\ 
and that Congress included ``mitigation'' in the exception for the 
purpose of covering risk reduction strategies that may not clearly be 
hedges but mitigate risk.\936\ Some commenters also criticized the 
Proposing Release's position equating the terms ``hedging'' and 
``mitigating.'' \937\ One commenter also expressed concern that 
entities would find it difficult to analyze their positions with 
respect to the Proposing Release's statement, in the context of the 
Exchange Act definition, that ``economically appropriate'' security-
based swaps would not add a new quantum of risk.\938\
---------------------------------------------------------------------------

    \935\ See letter from ISDA I.
    \936\ See letter from CDEU.
    \937\ See letters from APG, CDEU and ISDA I.
    \938\ See letter from SIFMA AMG II.
---------------------------------------------------------------------------

    Conversely, some commenters suggested that the proposed 
interpretation was too broad,\939\ and that a broad interpretation 
could allow evasion,\940\ or permit corporate end users to accumulate 
very large positions without becoming major swap participants.\941\ One 
commenter stated that to include ``financial risks'' within the 
exclusion's scope would be improper because a ``commercial risk'' is 
one that is inherent in a person's commercial activities, while 
interest rate and currency risks arise from choices about how a person 
structures and finances its operations.\942\ Some commenters stated 
that the rule should not include hedging of financial risks because 
Congress deleted the reference in an earlier version of the Dodd-Frank 
Act to hedging of ``balance sheet risk.'' \943\ One commenter urged 
that we consider using accounting hedge treatment or the bona fide 
hedging exemption as guideposts for determining the availability of the 
exclusion.\944\ Commenters also raised concerns about differences 
between the proposed approaches under the CEA and Exchange Act 
definitions of the terms.\945\
---------------------------------------------------------------------------

    \939\ See letters from AFR and AFSCME. The CFTC also received 
submissions of a substantially identical letter from approximately 
193 individuals and small businesses urging the CFTC to define 
commercial risk narrowly to include only risks arising from physical 
commodity price fluctuations, and not financial risks, and to 
construe the exception for captive finance companies narrowly. See, 
e.g., letter from Needham Oil & Air, LLC. In addition, the CFTC 
received submissions from approximately 535 individuals of a 
different letter, which also urged the CFTC to define commercial 
risk narrowly. See, e.g., letter from Christie Hakim.
    \940\ See letters from Sen. Carl Levin (``Senator Levin''), 
Commodity Markets Oversight Coalition (``CMOC'') and Greenberger and 
meeting with MFA on February 14, 2011.
    \941\ See meeting with SIFMA AMG on February 4, 2011.
    \942\ See meeting with AFR and Better Markets on March 17, 2011.
    \943\ See letters from AFR and CMOC, and meeting with Duffie on 
February 2, 2011.
    \944\ See letter from Senator Levin.
    \945\ See letters from Senator Levin, NAIC and SIFMA AMG II.
---------------------------------------------------------------------------

    One commenter suggested that the definition should be expanded to 
include as commercial risks the risks faced by government entities 
because their need to manage risk is no different than the need of 
commercial firms.\946\ Additional commenters suggested that commercial 
risk be interpreted to include risks faced by non-profit firms.\947\
---------------------------------------------------------------------------

    \946\ See letter from Milbank, Tweed, Hadley & McCloy LLP 
(``Milbank'').
    \947\ See letters from CDEU and NFPEEU.
---------------------------------------------------------------------------

    Some commenters also supported modification of the rule text for 
specific purposes such as including risks from ``transmitting'' to 
cover activities of electricity companies,\948\ to encompass risks 
``arising from'' an asset rather than just risks arising from changes 
in value

[[Page 30674]]

of the asset,\949\ and to encompass the use of swaps by structured 
finance special purpose vehicles to hedge interest rate risk in 
structured financing.\950\
---------------------------------------------------------------------------

    \948\ See letter from Edison Int'l.
    \949\ See letter from Milbank.
    \950\ See letter from American Securitization Forum (``ASR'').
---------------------------------------------------------------------------

b. Availability of Exclusion to Financial Entities
    Several commenters supported making the exclusion available to 
financial companies.\951\ Some commenters further stated that there 
should be no special limits on financial entities with regard to the 
exclusion,\952\ and that commercial risk should be defined broadly to 
include all of the commercial activities of a person, whether or not 
those activities relate to financial or non-financial commodities.\953\ 
Two commenters discussing the use of swaps by insurance companies 
stated that making the exclusion available to financial companies is 
consistent with CFTC practice in the futures markets, that there is no 
fundamental difference in how an insurance company or a commercial 
enterprise uses swaps to reduce its risk, and that commercial risk 
encompasses financial risk.\954\ In addition, these commenters noted 
that insurance regulators allow insurance companies to use swaps to 
hedge risk.\955\
---------------------------------------------------------------------------

    \951\ See letters from ACLI, American Express Company 
(``Amex''), California State Teachers' Retirement System 
(``CalSTRS'') dated Feb. 28, 2011 (``CalSTRS I''), ISDA I, MetLife, 
NAIC and Peabody.
    \952\ See letters from Amex, CalSTRS I and Peabody.
    \953\ See letter from Amex.
    \954\ See letters from ACLI and MetLife.
    \955\ Id.
---------------------------------------------------------------------------

    On the other hand, some commenters opposed allowing financial 
entities to avail themselves of the exclusion, arguing that there is no 
benefit from allowing a financial firm to avoid major participant 
regulation through the hedging exclusion,\956\ that the exclusion would 
allow financial companies to engage in risky trades,\957\ and that the 
exclusion should be narrowly interpreted to cover hedging of only risks 
related to products.\958\
---------------------------------------------------------------------------

    \956\ See letter from Senator Levin (further highlighting the 
need to add strict standards and controls to prevent evasion).
    \957\ See letters cited in note 939, supra.
    \958\ See letter from AFR.
---------------------------------------------------------------------------

c. Hedging Risks of Affiliates and Third Parties
    Some commenters expressed support for allowing persons to take 
advantage of the hedging exclusion when they use swaps to hedge the 
commercial risks of affiliates or third parties. Some commenters 
suggested that a person that aggregates and hedges risk within a 
corporate group should be allowed to use the exclusion despite the fact 
that it is the affiliates' risks that are hedged.\959\ One commenter 
further stated that providers of risk management services should be 
allowed to take advantage of the exclusion because they are hedging 
commercial risk on behalf of their clients.\960\
---------------------------------------------------------------------------

    \959\ See letters from CDEU, EDF Trading, Kraft, Metlife and 
Philip Morris.
    \960\ See letter from EDF Trading.
---------------------------------------------------------------------------

    One commenter, on the other hand, stated that the exclusion should 
be read narrowly for captive finance companies because the hedging 
entity may have to liquidate positions rapidly without access to 
affiliate's funds.\961\
---------------------------------------------------------------------------

    \961\ See meeting with Duffie on February 2, 2011.
---------------------------------------------------------------------------

d. Hedge Effectiveness and Documentation
    Many commenters suggested that the rule should not test hedge 
effectiveness, explaining that requiring demonstration of hedge 
effectiveness would impose a subjective standard and would not reduce 
systemic risk.\962\ In this regard, some commenters that addressed the 
proposed procedural requirements in the Exchange Act definition argued 
that these procedures would place unnecessary regulatory burdens on 
entities not regulated under the Dodd-Frank Act.\963\ Conversely, one 
commenter that supported testing hedge effectiveness stated that the 
subdivided parts of a hedge should line up exactly with the subdivided 
parts of the risk.\964\
---------------------------------------------------------------------------

    \962\ See letters from EEI/EPSA and EDF Trading; see also 
letters from CDEU, Kraft Metlife, NRG Energy and Philip Morris (that 
such a test would be overly prescriptive).
    \963\ See letters from FSR I and SIFMA AMG I.
    \964\ See letter from Better Markets I.
---------------------------------------------------------------------------

    Some commenters agreed that the relationship between hedging and 
risk should be documented. One commenter expressed the view that 
documentation would facilitate audits.\965\ Others took the view that a 
person should be required to demonstrate that the hedge does not create 
additional risk, that the risk may be hedged by swaps, and that there 
is a link between the swap and the risk.\966\
---------------------------------------------------------------------------

    \965\ See letter from Metlife (but opposing ongoing evaluation 
of hedge effectiveness).
    \966\ See letters from AFR and Senator Levin.
---------------------------------------------------------------------------

    Several commenters suggested that once initiated, a hedge should 
not be retested over time, regardless of whether the position continues 
to serve a hedging purpose.\967\ Other commenters disagreed, stating 
that a position that is no longer a hedge should not be covered by the 
exclusion.\968\
---------------------------------------------------------------------------

    \967\ See letters from CDEU, EDF Trading, EEI/EPSA, Kraft, 
Metlife, NRG Energy and Philip Morris.
    \968\ See letters from Better Markets I and Senator Levin.
---------------------------------------------------------------------------

e. Swaps That Hedge Positions Held for Speculative, Investment or 
Trading Purposes
    Many commenters took the view that swaps or security-based swaps 
used to hedge positions held for speculative, investment or trading 
purposes should qualify as hedges of commercial risk.\969\ A few 
commenters stated that speculation, investment and trading are 
fundamental to commercial activity, and thus cannot be differentiated 
from other types of commercial activity.\970\ Other commenters 
suggested the exclusion should cover swap positions that hedge other 
swap or security-based swap positions that are not themselves hedging 
positions.\971\ Some commenters asserted that trading is different from 
speculating (taking an outright view on market direction) and investing 
(entering into a swap for appreciation in value of the swap position), 
and that swaps held for ``trading'' should be able to qualify for the 
exclusion.\972\
---------------------------------------------------------------------------

    \969\ See letters from BG LNG II, COPE I, EPSA, FSR I, Metlife, 
Peabody, Vitol and WGCEF dated February 22, 2011 regarding the major 
swap participant definition (``WGECF II''), and meeting with Bunge; 
see also letter from ISDA I (taking the view that swaps and 
security-based swaps used to hedge speculative positions should 
qualify as hedges and stating that failure to treat them as hedges 
would ``invariably result in there being more unhedged speculative 
risk in the market'').
    \970\ See letters from Vitol and WGCEF II and meeting with 
Bunge.
    \971\ See letters from BG LNG II, FSR I, ISDA I and Metlife.
    \972\ See letters from COPE I, EPSA and Peabody.
---------------------------------------------------------------------------

    Some commenters requested that the definition under the CEA clarify 
how swaps that qualify as bona fide hedges are treated for the major 
swap participant definition if the underlying position had a 
speculative, investment or trading purpose,\973\ and clarify that while 
the hedging exclusion would not apply to swap positions that hedge 
other swap positions that are held for speculation or trading, the 
hedging provision would apply to swap positions that hedge other non-
swap positions held for speculation or trading.\974\ Commenters also 
requested that the final rules provide that the hedging exclusion be 
available for physical positions in exempt or agricultural commodities 
and arbitrage positions relating to price differences between physical 
commodities at

[[Page 30675]]

different locations.\975\ One commenter, on the other hand, suggested 
that even swap positions that hedge other swap positions which are not 
hedging positions should be treated as hedging commercial risk because 
they are risk reducing.\976\
---------------------------------------------------------------------------

    \973\ See letters from Vitol and WGCEF dated June 3, 2011 
regarding the major swap participant definition (``WGECF VI'').
    \974\ See letter from BG LNG II.
    \975\ See letters from BGLNG II and WGCEF VI.
    \976\ See letters from MetLife.
---------------------------------------------------------------------------

    Four commenters took the position that swaps held for a purpose 
that is in the nature of speculation, investing or trading should not 
qualify as hedges of commercial risk.\977\ One commenter pointed out 
that experience has shown that market participants sometimes 
inaccurately characterize positions as hedges (e.g., the inaccurate 
characterization occurs because the nature of positions change over 
time), and that excluding swap positions that hedge speculative, 
investment or trading positions would be especially inappropriate for 
financial firms that frequently use swaps to speculate, invest or 
trade.\978\ One commenter stated that any swap position hedging another 
swap position could never be considered to be hedging commercial risk 
because the second swap is only adjusting the first swap position, 
meaning that neither swap would be congruent with risk reduction.\979\ 
Another commenter stated that the hedging exclusion should not cover 
any swap hedging a speculative position.\980\
---------------------------------------------------------------------------

    \977\ See letters from AFR, Better Markets I and Senator Levin 
and meeting with Duffie on February 2, 2011.
    \978\ See letter from Senator Levin.
    \979\ See letter from Better Markets I.
    \980\ See meeting with Duffie on February 2, 2011.
---------------------------------------------------------------------------

3. Final Rules--General Availability of the Exclusions
    As with the proposed rules, the final CEA and Exchange Act rules 
implementing this exclusion are different in certain regards to reflect 
the different ways that swaps and security-based swaps may be expected 
to be used to hedge commercial risk, as well as differences in existing 
regulations under the CEA and the Exchange Act. Notwithstanding these 
differences, the two rules follow parallel approaches and address 
certain key issues in similar ways.
a. Availability to Financial Entities
    Consistent with the position we took in the Proposing Release, the 
final rules with regard to both major participant definitions do not 
foreclose financial entities from being able to take advantage of the 
commercial risk hedging exclusion in the first major participant test. 
This conclusion in part is guided by the fact that the statutory text 
implementing this hedging exclusion does not explicitly foreclose 
financial entities from taking advantage of the exclusion--in contrast 
to Title VII's exceptions from mandatory clearing requirements for 
commercial risk hedging activities. The conclusion also results from 
the need to avoid an interpretation that would cause the third major 
participant test to be redundant.\981\
---------------------------------------------------------------------------

    \981\ While we recognize that commenters have identified policy 
reasons as to why financial entities should be entirely excluded 
from being able to take advantage of the hedging exclusion, we 
continue to believe the language of the major participant 
definitions dictates a contrary approach.
---------------------------------------------------------------------------

    In reaching this conclusion, we recognize that some commenters 
stated that there would be no benefit from allowing financial firms to 
avoid regulation as a major swap participant through the hedging 
exclusion, and that the exclusion should cover only risks related to 
non-financial commercial activities, or else the exclusion would allow 
financial companies to engage in risky transactions.\982\ We believe 
that not allowing the exclusion to cover swaps or security-based swaps 
used for speculation or trading (or investments, in the case of swaps) 
will be sufficient to limit financial entities' ability to engage in 
risky transactions. We also are not persuaded that ``commercial risk'' 
should be limited to only risks related to non-financial activities.
---------------------------------------------------------------------------

    \982\ See letters from AFR and Senator Levin.
---------------------------------------------------------------------------

    We nonetheless recognize the significance of concerns that 
financial entities may seek to depict speculative positions as hedges 
to take advantage of the exclusion. We also are mindful of the need to 
give appropriate meaning to the term ``commercial risk'' within the 
exclusion. We believe that the standard set forth in the final rules, 
including the provisions that make the exclusions unavailable to swap 
or security-based swap positions of a speculative or trading nature (or 
investment purposes, in the case of swaps), apply the statutory test in 
a manner that appropriately addresses those other concerns. As 
discussed below, those standards limit the ability of financial 
entities to take advantage of the exclusion.\983\
---------------------------------------------------------------------------

    \983\ We also do not believe that the size of an entity or an 
entity's position is determinative of whether a position hedges 
commercial risk. Moreover, given that the major participant 
definitions implicitly require large swap or security-based swap 
positions as triggers, a rule that made the hedging exclusion 
unavailable to entities with large positions could negate the 
statutory hedging exclusion.
---------------------------------------------------------------------------

b. Availability to Non-Profit and Governmental Entities
    Under the final rules, a person's organizational status will not 
determine the availability of this hedging exclusion. The exclusion 
thus may be available to non-profit or governmental entities, as well 
as to for-profit entities, if the underlying activity to which the swap 
or security-based swap relates is commercial in nature.
c. Hedges of ``Financial'' or ``Balance Sheet'' Risks
    Under the final rules, the exclusion is available to positions that 
hedge ``financial'' or ``balance sheet'' risks. While we recognize that 
some commenters oppose the exclusion of those positions,\984\ we 
nonetheless believe that the exclusion would be impermissibly narrow if 
it failed to extend to the ``financial'' or ``balance sheet'' risks 
that entities may face as part of their commercial operations, given 
that those types of risks (e.g., interest rate and foreign exchange 
risks) may be expected to arise from the commercial operations of non-
financial end-users of swaps and security-based swaps. We do not 
believe the exclusion was intended to address those risks differently 
from other commercial risks, such as risks associated with the cost of 
physical inputs or the price received for selling products.\985\
---------------------------------------------------------------------------

    \984\ See notes 942 and 943, supra.
    \985\ Moreover, it is questionable as to what types of security-
based swap positions--if any--would fall within the exclusion for 
purposes of the ``major security-based swap participant'' definition 
if the exclusion did not extend to hedges of ``financial'' or 
``balance sheet'' risks. Security-based swaps such as single-name 
credit default swaps and equity swaps would not appear amenable to 
hedging a commercial entity's non-financial risks, such as price 
risks associated with non-financial inputs or sales. We do not 
believe that it would be appropriate to interpret the exclusion in 
such a way as to make it a nullity in the context of the ``major 
security-based swap participant'' definition.
---------------------------------------------------------------------------

d. Hedging on Behalf of an Affiliate
    The final rules further provide that the exclusion is not limited 
to the hedging of a person's own risks, but also would extend to the 
hedging of the risks of a person's majority-owned affiliate.\986\

[[Page 30676]]

This approach reflects the fact that a corporate group may use a single 
entity to face the market to engage in hedging activities on behalf of 
entities within the group. In our view, it would not be appropriate for 
the swap or security-based swap positions of the market-facing entity 
to be encompassed within the first major participant test if those same 
positions could have been excluded from the analysis if entered into 
directly by the affiliate.\987\ Of course, the exclusion will only be 
available to the market-facing entity if the position would have been 
subject to the exclusion--e.g., not for a speculative or trading 
purpose--had the affiliate directly entered into the position.
---------------------------------------------------------------------------

    \986\ See CFTC Regulation Sec.  1.3(kkk)(1)(i); Exchange Act 
rule 3a67-4(a)(1). For these purposes--consistent with the standards 
regarding the application of the dealer and major participant 
definitions to inter-affiliate swaps and security based swaps, see 
parts II.C and IV.G--we would view the counterparties to be 
majority-owned affiliates if one party directly or indirectly holds 
a majority ownership interest in the other, or if a third party 
directly or indirectly holds a majority interest in both, based on 
holding a majority of the equity securities of an entity, or the 
right to receive upon dissolution or the contribution of a majority 
of the capital of a partnership. See note 348, supra.
    \987\ The exclusion, however, would not be available to the 
extent that a person enters into swaps or security-based swaps in 
connection with the hedging activities of an unaffiliated third 
party. Such activities, moreover, may indicate that the person is 
acting as a swap dealer or security-based swap dealer.
---------------------------------------------------------------------------

4. Final Rules--``Major Swap Participant'' Definition Under the CEA
a. In General
    The general scope of the rule regarding ``hedging or mitigating 
risk'' will be adopted substantially as proposed.\988\ The CFTC, 
however, is adopting CFTC Regulation Sec.  1.3(kkk) with a modification 
to paragraph (1)(iii) to include a reference to qualified hedging 
treatment for positions meeting Government Accounting Standards Board 
(``GASB'') Statement 53, Accounting and Financial Reporting for 
Derivative Instruments. The CFTC believes that this minor modification 
to CFTC Regulation Sec.  1.3(kkk) is necessary in order to include 
swaps that qualify for hedging treatment issued by GASB.\989\
---------------------------------------------------------------------------

    \988\ The final rule text of CFTC Regulation Sec.  1.3(kkk)(2) 
has been revised to include the conjunction ``and'' between clauses 
(i) and (ii). In the proposed text of this rule, there was no 
conjunction between these two clauses, while the conjunction ``and'' 
was used in the parallel rule, Sec.  240.3a67-4(b), under the 
Exchange Act. Thus, the revision of the final rule text conforms the 
CEA rule to the Exchange Act rule.
    Also, the final rule text of CFTC Regulation Sec.  
1.3(kkk)(1)(E) has been revised to include interest and currency 
rates to be consistent with Sec.  1.3(kkk)(1)(F). Both provisions 
address similar financial risks arising from rate ``movements'' and 
``exposures,'' respectively.
    \989\ Local government entities that use GASB accounting 
standards may not be able to use comparable FASB hedge accounting as 
a demonstration that a swap is a hedge. Although the two standards 
are not the same, they are similar in effect and degree in respect 
of determining whether a swap hedges a risk.
---------------------------------------------------------------------------

    As noted above, the CFTC will not prohibit financial companies from 
using the hedging exclusion because the exclusion for positions held 
for hedging or mitigating commercial risk set forth in CEA section 
1a(33)(A)(i)(1) does not limit its application based on the 
characterization or status of the person or entity. Unlike the end-user 
clearing exemption of section 2(h)(7), the major swap participant 
hedging exclusion is not foreclosed to financial entities.\990\ In 
addition, the hedging exclusion will extend to entities hedging the 
risks of affiliates in a corporate group, but not to third parties 
outside of a corporate group.
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    \990\ Although CEA section 1a(33)(A)(iii), 7 U.S.C. 
1a(33)(A)(iii) provides that financial entities that are highly 
leveraged and not subject to capital requirements established by a 
Federal banking agency are effectively precluded from applying the 
hedging exclusion, other financial entities are not so precluded. 
Thus, availability of the hedging exclusion to some financial 
entities for purposes of the major swap participant definition is 
contemplated in the statutory text.
---------------------------------------------------------------------------

    Like the proposed rule, the final rule under the CEA does not 
require a demonstration of hedge effectiveness, periodic retesting or 
specific documentation in order to apply the hedging exclusion from the 
definition of major swap participant.
b. Swaps That Hedge Positions Held for Speculation, Investment, or 
Trading
    Swaps that hedge positions held for speculation, investment or 
trading will not qualify for the exclusion. In the Proposing Release, 
the CFTC explained that swap positions held for the purpose of 
speculation, investment or trading are those held primarily to take an 
outright view on market direction, including positions held for short 
term resale, or to obtain arbitrage profits.\991\ Additionally, the 
Proposing Release stated that swap positions that hedge other positions 
that themselves are held for the purpose of speculation, investment or 
trading are also speculative, investment or trading positions.\992\
---------------------------------------------------------------------------

    \991\ See 75 FR at 80195 n.128.
    \992\ Id.
---------------------------------------------------------------------------

    We note that some commenters suggested that swaps that hedge 
speculative, investment or trading positions should qualify for the 
exclusion because speculation, investment or trading are fundamental to 
commercial activity and cannot be differentiated from other types of 
commercial activity. Similarly, commenters that support allowing 
speculative, investment or trading positions to qualify for the 
exception stated that a swap hedging the risk of another swap 
(regardless of that swap's nature) is risk reducing and therefore 
hedges commercial risk. We believe that these commenters' 
interpretation of ``commercial'' is not consistent with congressional 
intent or the meaning of ``commercial'' in the Dodd-Frank Act with 
respect to the first test of the major participant definition or the 
end-user exception to the clearing mandate. We are unconvinced that 
allowing swap positions to qualify for the exception would be 
appropriate when used to hedge speculative, investment or trading 
positions because the swap would not hedge or mitigate the risks 
associated with the underlying position, or at least not in the manner 
intended by Congress. In addition, we believe that doing so would 
undermine the effectiveness of the major participant definition in that 
entities would be able to characterize positions for speculative, 
investment or trading purposes as hedges and therefore evade regulation 
as major participants.
    Under CFTC Regulation Sec.  1.3(kkk)(2)(i), swap positions executed 
for the purpose of speculating, investing, or trading are those 
positions executed primarily to take an outright view on market 
direction or to obtain an appreciation in value of the swap position 
itself, and not primarily for hedging or mitigating underlying 
commercial risks.\993\ For example, swaps positions held primarily for 
the purpose of generating profits directly upon closeout of the swap, 
and not to hedge or mitigate underlying commercial risk, are 
speculative or serve as investments. Further, as an alternative 
example, swaps executed for the purpose of offsetting potential future 
increases in the price of inputs that the entity reasonably expects to 
purchase for its commercial activities serve to hedge a commercial 
risk.
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    \993\ The Commissions note that the SEC interprets the 
availability of the hedging exclusion differently in the context of 
the ``major security-based swap participant'' definition, and that 
the SEC's guidance in this area controls for purposes of that 
definition.
---------------------------------------------------------------------------

    The CFTC notes that the use of ``trading'' in this context is not 
used to mean simply buying and selling. Rather, a party is using a swap 
for the purpose of trading under the rule when the party is entering 
and exiting swap positions for purposes that have little or no 
connection to hedging or mitigating commercial risks incurred in the 
ordinary course of business. ``Trading,'' as used in CFTC Regulation 
Sec.  1.3(kkk)(2)(i), therefore would not include simply the act of 
entering into or exiting swaps if the swaps are used for the purpose of 
hedging or mitigating commercial risks incurred in the ordinary course 
of business.\994\
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    \994\ The CFTC further clarifies that merchandising activity in 
the physical marketing channel qualifies as commercial activity, 
consistent with the Commission's longstanding bona fide hedging 
exemption to speculative position limits. See Sec.  1.3(kkk)(1)(ii).

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[[Page 30677]]

    The CFTC acknowledges that some swaps that may be characterized as 
``arbitrage'' transactions in certain contexts may also reduce 
commercial risks enumerated in CFTC Regulation Sec.  1.3(kkk)(1). The 
discussion in footnote 128 of the Proposing Release was intended to 
focus on clarifying that swaps are speculative for purposes of the rule 
if entered into principally and directly for profit and not principally 
to hedge or mitigate commercial risk. The reference to ``arbitrage 
profits'' in footnote 128 was intended to provide an example of what is 
commonly a speculative swap, not to characterize all arbitrage swaps as 
speculative.
c. ``Economically Appropriate'' Standard
    The CFTC has determined to adopt the ``economically appropriate'' 
standard as proposed. We believe that this standard will help the CFTC 
and market participants distinguish which swaps are, or are not, 
commercial hedges thereby reducing regulatory uncertainty and helping 
prevent abuse of the hedging exclusion. CFTC Regulation 1.3(kkk)(1)(i) 
of the final rules enumerates specific risk shifting practices that are 
deemed to qualify for purposes of the hedging exclusion.\995\ Whether a 
swap is economically appropriate to the reduction of risks will be 
determined by the facts and circumstances applicable to the swap at the 
time a swap is entered into. While we acknowledge that this standard 
leaves room for judgment in its application, we believe this 
flexibility is needed given the wide variety of swaps and hedging 
strategies the rule applies to. We believe the economically appropriate 
standard together with the identification of the six different 
categories of permissible commercial risks listed in final CFTC 
Regulation Sec.  1.3(kkk)(1)(i) is specific enough, when reasonably 
applied, to distinguish whether a swap is being used to hedge or 
mitigate commercial risk.
---------------------------------------------------------------------------

    \995\ In the alternative to meeting the requirements of CFTC 
Regulation Sec.  1.3(kkk)(1)(i), a swap may also be eligible for the 
hedging exclusion if the swap qualifies as a bona fide hedge for 
purposes of an exception from position limits under the CEA as 
provided in CFTC Regulation Sec.  1.3(kkk)(1)(ii), or if it 
qualifies for hedging treatment under FASB Accounting Standards 
Codification Topic 815 or under GASB Statement 53 as provided in 
CFTC Regulation Sec.  1.3(kkk)(1) (iii). Consequently, the universe 
of swaps that can qualify for the hedging exclusion is broader than 
the universe of swaps that qualify as bona fide hedges for purposes 
of an exception from position limits under the CEA as provided in 
CFTC Regulation Sec.  1.3(kkk)(1)(ii).
---------------------------------------------------------------------------

    The Commission has determined not to adopt a ``congruence'' 
standard because that standard may be too restrictive and difficult to 
use given the range of potential types of swaps and hedging strategies 
available.
5. Final Rules--``Major Security-Based Swap Participant'' Definition 
Under the Exchange Act
a. ``Economically Appropriate'' Standard
    The final rules retain the proposed ``economically appropriate'' 
standard, by which a security-based swap position that is used for 
hedging purposes \996\ would be eligible for exclusion from the first 
major participant analysis if the position is economically appropriate 
to the reduction of risks in the conduct and management of a commercial 
enterprise, when those risks arise from the potential change in the 
value of assets, liabilities and services in connection with the 
ordinary course of business of the enterprise.\997\
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    \996\ In the Proposing Release we stated that we did not believe 
the use of the term ``mitigating'' in the exclusion to mean 
something significantly more than ``hedging.'' See Proposing 
Release, 75 FR 80194 n.127. As noted above, some commenters 
disagreed, and argued that ``mitigating'' should be interpreted more 
broadly to encompass general risk mitigation strategies. See, e.g., 
letters from ISDA and CDEU. In our view, the final rules we are 
adopting--including the use of ``economically appropriate'' 
standards and the exclusions for certain positions--encompass 
positions that may reasonably be described as ``hedging'' or 
``mitigating'' commercial risk.
    \997\ Exchange Act rule 3a67-4(a)(1). Under this standard, the 
first major participant analysis need not account for security-based 
swap positions that pose limited risk to the market and to 
counterparties because the positions are substantially related to 
offsetting risks from a person's commercial operations. These 
hedging positions would include activities, such as the management 
of receivables, that arise out of the ordinary course of a person's 
commercial operations, including activities that are incidental to 
those operations. See Proposing Release, 75 FR at 80195.
    In addition, the security-based swap positions included within 
the rule would not be limited to those recognized as hedges for 
accounting purposes. See id.
---------------------------------------------------------------------------

    Consistent with the Proposing Release, we interpret the concept of 
``economically appropriate'' to mean that the security-based swap 
position cannot materially over-hedge the underlying risk such that it 
could reasonably have a speculative effect,\998\ and that the position 
cannot introduce any new basis risk or other type of risk (other than 
counterparty risk that is attendant to all security-based swaps) more 
than reasonably is necessary to manage the identified risks.
---------------------------------------------------------------------------

    \998\ In the Proposing Release, we described the ``economically 
appropriate'' standard as excluding positions that introduce ``any 
new material quantum of risks.'' See Proposing Release, 75 FR 80194 
n. 129. The interpretation in this release is consistent with that 
approach, but does not make use of the same ``quantum of risks'' 
terminology.
---------------------------------------------------------------------------

    For example, a manufacturer that wishes to hedge the risk 
associated with a customer's long-term lease of a product may purchase 
credit protection using a single-name credit default swap on which the 
customer is the reference entity. The credit default swap may be 
excluded from the first major participant analysis even if it is for a 
shorter term than the anticipated duration of the lease so long as the 
use of such a shorter-term instrument is reasonable as a hedge, such as 
due to cost or liquidity reasons.\999\ Also, the credit default swap 
may be excluded from the first major participant test if it hedges an 
amount of risk that is lower than the total amount of risk associated 
with the long-term contract.\1000\
---------------------------------------------------------------------------

    \999\ In other words, the entity may determine that the use of a 
credit default swap for a term that is shorter than the lease is 
justified if that shorter-term instrument costs less or is more 
liquid than a bespoke instrument that matches the duration of the 
contract. While the shorter-term credit default swap does not 
eliminate the underlying commercial risk, the instrument's use may 
be commercially reasonable for hedging purposes, and hence 
appropriately excluded from the first major participant test.
    \1000\ The use of a credit default swap for an amount that is 
smaller than the underlying risk may be justified as part of an 
entity's risk management strategy. For example, an entity may choose 
to engage in a partial hedge because a credit default swap for a 
smaller amount than the underlying risk may cost less or be more 
liquid than a bespoke instrument that more closely matches the 
amount of the risk.
---------------------------------------------------------------------------

    In adopting this rule, we have considered commenter views that we 
should consider limiting the exclusion to positions that are recognized 
as hedges for accounting purposes.\1001\ We nonetheless do not believe 
that the requirements that are appropriate to identifying hedging for 
accounting purposes are needed to limit the availability of the hedging 
exclusion. Moreover, linking the availability of the exclusion to 
accounting standards--which themselves may evolve over time--may lead 
the availability of the exclusion to evolve over time in unforeseen 
ways. We accordingly believe that the exclusion should be available if 
a security-based swap position is economically appropriate for hedging 
purposes (and not otherwise precluded from taking advantage of the 
exclusion).
---------------------------------------------------------------------------

    \1001\ See letter from Senator Levin.
---------------------------------------------------------------------------

    We also have considered commenter concerns that the ``economically 
appropriate'' standard is too broad,\1002\ and the additional 
suggestion that the exclusion instead should be limited to 
circumstances in which the hedge is ``congruent'' to the underlying 
risk.\1003\
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    \1002\ See letters from AFR and AFSCME.
    \1003\ See letter from Better Markets I. We nonetheless do not 
believe that such a requirement would be consistent with the 
exclusion's ``commercial risk'' terminology or underlying intent. A 
congruence standard particularly would not appear to adequately 
reflect the fact that commercially reasonable hedging activities can 
leave residual basis risk.

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[[Page 30678]]

    We recognize the significance of commenters' concerns as to the 
practical application of the ``economically appropriate'' standard, 
particularly with regard to hedges that are not perfectly correlated 
with the underlying risk.\1004\ The standard embeds principles of 
commercial reasonableness that should assuage those implementation 
concerns, however. These principles necessarily account for the fact 
that the reasonable use of security-based swaps to hedge a person's 
commercial risk may result in residual basis risk, and that the mere 
presence of this basis risk should not preclude the availability of the 
exclusion. Moreover, the mere presence of residual basis risk need not 
run afoul of the restriction against materially over-hedging the 
underlying risk, which is instead intended to prevent the hedging 
exclusion from applying to positions that are entered into for 
speculative purposes or that have speculative effect (such as by being 
based on a notional amount that is disproportionate to the underlying 
risk).\1005\
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    \1004\ See letter from SIFMA AMG II.
    \1005\ For example, non-material basis risk or a non-material 
over-hedge may occur due to the use of a standardized instrument. A 
commercial entity may reasonably determine that it is cost effective 
to use a standardized security-based swap to hedge the underlying 
risk, even if use of the standardized instrument introduces non-
material basis risk or reflects a non-material amount of over-
hedging compared to what would be the result of using a bespoke 
security-based swap to hedge that risk.
---------------------------------------------------------------------------

    We also acknowledge that an ``economically appropriate'' standard 
does not provide the compliance assurance that would accompany 
quantitative tests or safe harbors. Nonetheless, grounding the hedging 
exclusion in principles of commercial reasonableness permits the 
standard to be sufficiently flexible to appropriately address an end-
user's particular circumstances and hedging needs. Use of an 
``economically appropriate'' standard also is consistent with the fact 
that entities should be expected to use their reasonable business 
judgment when hedging their commercial risks.
    To provide additional guidance to entities hedging commercial risk, 
moreover, the final rule incorporates examples of security-based swap 
positions that, depending on the applicable facts and circumstances, 
may satisfy the ``economically appropriate'' standard.\1006\ These are:
---------------------------------------------------------------------------

    \1006\ Exchange Act rule 3a67-4(a)(2). We previously noted that 
the proposed definition would facilitate those types of security-
based swap positions. See Proposing Release, 75 FR at 80196.
---------------------------------------------------------------------------

     Positions established to manage the risk posed by a 
customer's, supplier's or counterparty's potential default in 
connection with: financing provided to a customer in connection with 
the sale of real property or a good, product or service; a customer's 
lease of real property or a good, product or service; a customer's 
agreement to purchase real property or a good, product or service in 
the future; or a supplier's commitment to provide or sell a good, 
product or service in the future.\1007\
---------------------------------------------------------------------------

    \1007\ As discussed in the Proposing Release, see 75 FR at 80196 
n.135, the references here to customers and counterparties do not 
include swap or security-based swap counterparties.
---------------------------------------------------------------------------

     Positions established to manage the default risk posed by 
a financial counterparty (different from the counterparty to the 
hedging position at issue) in connection with a separate transaction 
(including a position involving a credit derivative, equity swap, other 
security-based swap, interest rate swap, commodity swap, foreign 
exchange swap or other swap, option, or future that itself is for the 
purpose of hedging or mitigating commercial risk pursuant to the rule 
or the counterpart rule under the Commodity Exchange Act);
     Positions established to manage equity or market risk 
associated with certain employee compensation plans, including the risk 
associated with market price variations in connection with stock-based 
compensation plans, such as deferred compensation plans and stock 
appreciation rights;
     Positions established to manage equity market price risks 
connected with certain business combinations, such as a corporate 
merger or consolidation or similar plan or acquisition in which 
securities of a person are exchanged for securities of any other person 
(unless the sole purpose of the transaction is to change an issuer's 
domicile solely within the United States), or a transfer of assets of a 
person to another person in consideration of the issuance of securities 
of such other person or any of its affiliates;
     Positions established by a bank to manage counterparty 
risks in connection with loans the bank has made; and
     Positions to close out or reduce any of the positions 
addressed above.
b. Treatment of Speculative or Trading Positions
    The final rule, consistent with the proposal, provides that this 
hedging exclusion does not extend to security-based swap positions that 
are in the nature of speculation or trading.\1008\ The exclusion thus 
does not extend to security-based swap positions that are held for 
short-term resale and/or with the intent of benefiting from actual or 
expected short-term price movements or to lock in arbitrage profits, or 
to security-based swap positions that hedge other positions that 
themselves are held for the purpose of speculation or trading.\1009\
---------------------------------------------------------------------------

    \1008\ Exchange Act rule 3a67-4(b)(1). The commercial risk 
hedging exclusion for the purposes of the ``major security-based 
swap participant'' definition (in contrast to the commercial risk 
hedging exclusion in connection with the ``security-based swap 
dealer'' definition) does not turn upon whether a position is 
``primarily'' for speculative or trading purposes. For the ``major 
security-based swap participant'' definition, a security-based swap 
position with any speculative or trading purpose cannot take 
advantage of the commercial risk hedging exclusion regardless of 
whether speculation or trading constitutes the ``primary'' purpose 
of the position.
    \1009\ See generally Basel Committee on Banking Supervision, 
``International Convergence of Capital Measurement and Capital 
Standards, A Revised Framework, Comprehensive Version'' (June 2006) 
at ]] 685-689(iii) (defining the term ``trading book'' for purposes 
of international bank capital standards, and stating that positions 
that are held for short-term resale and/or with the intent of 
benefiting from actual or expected short-term price movements or to 
lock in arbitrage profits are typically considered part of an 
entity's trading book).
     In contrast to the CEA rule implementing the commercial risk 
hedging definition in the context of the ``major swap participant'' 
definition, the Exchange Act rule does not explicitly exclude 
security-based swaps held for the purpose of investing. We note, 
however, that security-based swaps held for the purpose of investing 
(i.e., held primarily to obtain an appreciation in value of the 
security-based swap position) would not meet the ``economically 
appropriate'' standard set forth above, and hence would not be 
eligible for the exclusion.
---------------------------------------------------------------------------

    The Commissions recognize that some commenters take the position 
that the exclusion should extend to security-based swap positions that 
hedge speculative or trading positions.\1010\ In support, these 
commenters have stated that the proposed approach would lead to more 
unhedged risk in the market, and that the proposed approach could lead 
entities that use security-based swaps to hedge speculative positions 
to be major participants, in contrast to unhedged (and presumably 
riskier) entities. Commenters further requested clarification regarding 
how entities may distinguish speculative or trading positions from 
other security-based swap positions.\1011\
---------------------------------------------------------------------------

    \1010\ See, e.g., letters from FSR I and ISDA I.
    \1011\ See, e.g., letter from CDEU.
---------------------------------------------------------------------------

    The Commissions nonetheless do not believe that it would be 
appropriate to extend the hedging exclusion to speculative or trading 
positions, including security-based swap positions that themselves 
hedge other positions that are for speculative or trading

[[Page 30679]]

purposes. Those limitations are appropriate to help give meaning to the 
concept of ``commercial'' risk, and to reflect the legislative intent 
to limit the impact of Title VII on commercial end-users of security-
based swaps.\1012\ Indeed, the use of security-based swap positions in 
connection with speculative and trading activity often may be expected 
either to have the purpose of locking-in arbitrage profits associated 
with those activities or producing an adjusted risk profile in 
connection with perceptions of future market behavior--neither of which 
would eliminate the speculative or trading purpose of the 
activity.\1013\ We do not believe that it would be appropriate, or 
consistent with the Dodd-Frank Act, to interpret the term ``commercial 
risk'' to accord the same regulatory treatment to security-based swap 
positions for speculative or trading purposes as is accorded to the use 
of security-based swap positions in connection with commercial 
activities such as producing goods or providing services to 
customers.\1014\
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    \1012\ In addition, this limitation is consistent with the 
exclusion from the first major participant test in connection with 
ERISA plans. That exclusion particularly addresses security-based 
swap positions with the primary purpose of ``hedging or mitigating 
any risk directly associated with the operation of the plan.'' It is 
not clear why that scope of the ERISA exclusion would need to be 
incorporated into the first major participant test if the 
``commercial risk'' exclusion already were broad enough to encompass 
hedges of trading or speculative positions.
    \1013\ As an example, one speculative/trading strategy involving 
security-based swaps can be to purchase short-dated credit 
protection in conjunction with a long-dated bond, to reflect a view 
that a particular company is likely to fail in the current credit 
environment. Combined, those positions can produce losses if the 
current credit environment did not change or if spreads were to 
widen, but could produce profits either if the company were to 
default or if spreads were to narrow and funding costs were to 
decrease. See Morgan Stanley, Credit Derivatives Insights 156-58 
(4th ed., 2008). In other words, under that strategy the purchase of 
the credit protection would offset a portion of the risks associated 
with the ownership of the bond, but for the purpose of taking a 
directional view of the market with the hope for profit if the 
purchaser's view of future market dynamics is correct (and the 
reality of losses if the purchaser's view of the market is wrong). 
It would require an extraordinarily liberal construction of 
``commercial risk'' to subsume this type of speculative security-
based swap activity.
     At the same time, we recognize that an entity hedging a 
commercial risk (in contrast to a risk arising from a speculative or 
trading strategy) reasonably may choose to use a security-based swap 
that is shorter-dated than the underlying risk, with the security-
based swap appropriately excluded from the first major participant 
definition.
    \1014\ This approach does not reflect any value judgment about 
the role of speculation in the market for security-based swaps, or 
about the relative market benefits or risks associated with 
speculation. This position simply represents an attempt to give 
meaning to the statutory use of the term ``commercial risk'' in a 
way that reflects Title VII's special treatment of commercial end-
users, and (as discussed below) avoid an interpretation that 
effectively undermines the first major participant test.
---------------------------------------------------------------------------

    Moreover, the Commissions believe that it would undermine the major 
participant definition to attribute a non-speculative or non-trading 
purpose to security-based swap positions that hedge speculative or 
trading positions. When a person uses a security-based swap position to 
help lock in profits or otherwise control the volatility associated 
with speculative or trading activity, or to cause that speculative or 
trading activity to reflect a particular market outlook or risk 
profile, the security-based swap position serves as an integral part of 
that speculative or trading activity. It thus would not appear 
appropriate or consistent with economic reality to seek to distinguish 
the security-based swap component from the other speculative or trading 
aspects of that activity. In fact, if ``hedges'' of speculative or 
trading positions were excluded from the first major participant test, 
entities could readily label a wide range of security-based swap 
positions entered into for speculative or trading purposes as being 
excluded hedges.\1015\ Taken to its natural conclusion, such an 
approach largely may exclude security-based swap positions from the 
first major participant test, effectively writing that test out of the 
statutory definition.
---------------------------------------------------------------------------

    \1015\ As noted by one participant to the roundtable on these 
definitions: ``[B]eing a hedge fund manager, there's nothing in my 
portfolio I can't claim to be hedging a risk. There's nothing. 
There's not a trade I do ever that I can't claim it to be a hedge 
against interest rates, or inflation, or against equity. You know, 
the fact of the matter is, if you're a capital market participant, 
your business is taking risks.'' Roundtable Transcript at 325 
(remarks of Michael Masters, Better Markets).
---------------------------------------------------------------------------

    We are aware of commenters' views that regulation of major 
participants has the potential to create a disincentive against certain 
entities' use of security-based swaps to manage risk in connection with 
their speculative or trading activities.\1016\ Under this view, 
regulation potentially could result in those entities electing not to 
reduce the risks that they otherwise would seek to hedge, to avoid 
being regulated as major participants.\1017\ That potential result, 
however, is an unavoidable consequence of the legislative decision to 
regulate persons whose security-based swap positions cause them to be 
major participants. It would not be appropriate to use the hedging 
exclusion to negate part of the underlying statutory definition simply 
to avoid disincentives that are an unavoidable consequence of the 
legislative decision to regulate major participants.
---------------------------------------------------------------------------

    \1016\ See letter from ISDA I.
    \1017\ Of course, this would only be the case where the entity's 
hedging and speculative activities combined were at a level in 
excess of the major participant thresholds.
---------------------------------------------------------------------------

    At the same time, we are mindful that market participants have 
requested further guidance as to how to distinguish between hedging 
positions that are subject to this exclusion, and speculative or 
trading positions that fall outside the exclusion. In our view, 
analysis of this issue is simplified by the nature of security-based 
swaps, and by the limited circumstances in which a person may be 
expected to have a commercial risk such that the use of a security-
based swap may be economically appropriate for managing that commercial 
risk (rather than being for speculation or trading purposes).
    In the case of security-based swaps that are credit derivatives, 
the final rule provides examples of the use of credit default swaps to 
purchase credit protection that, depending on the applicable facts and 
circumstances, may appropriately be excluded from the first major 
participant test (e.g., the use of a credit default swap to purchase 
credit protection in connection with the potential default of a 
customer, supplier or counterparty, or in connection with loans made by 
a bank). Certain other purchases of credit protection using credit 
default swaps--such as the purchase of credit protection to manage the 
risks associated with securities that a non-financial company holds in 
a corporate treasury and that are not held for speculative or trading 
purposes--may also meet the standard under these rules.\1018\ The sale 
of offsetting credit protection may also reasonably be expected to fall 
within the exclusion to the extent that this sale is reasonably 
necessary to address changes (particularly reductions) in the amount of 
underlying commercial risk hedged by the initial security-based swap 
position.\1019\
---------------------------------------------------------------------------

    \1018\ This is not to say that the purchase of credit protection 
on a security that a person owns would necessarily be entitled to 
the hedging exclusion. If the underlying security itself is held for 
speculative or trading purposes, the credit protection would not be 
excluded from the first major participant analysis, and in any event 
would not reasonably be construed as hedging ``commercial risk.''
    \1019\ Apart from that example, it is more difficult to foresee 
circumstances in which the sale of credit protection using a credit 
default swap would be expected to fall within the exclusion. We 
recognize, for example, that a person that has a short position in a 
security of a reference entity may have an incentive to sell credit 
protection on that reference entity to offset movements in the price 
or value of that short position (and/or lock in arbitrage profits in 
connection with that short position). While that sale of credit 
protection may mitigate the risks associated with that short 
position, or produce an arbitrage profit in connection with that 
short position, that security-based swap position would not appear 
to constitute the hedging of ``commercial risk'' for purposes of the 
exclusion.

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[[Page 30680]]

    As for security-based swaps that are not credit derivatives--such 
as equity swaps and total return swaps--the final rule provides 
examples of how the use of those security-based swaps in connection 
with certain business combinations may, depending on the applicable 
facts and circumstances, appropriately be excluded from the first major 
participant test. The use of equity swaps or total return swaps to 
manage the risks associated with securities that are held in a 
corporate treasury (and that are not held for speculative or trading 
purposes) may also appropriately be subject to the exclusion. Other 
uses of equity swaps or total return swaps to offset risks associated 
with long or short positions in securities, however, may not 
appropriately be excluded from the first major participant test, 
because such positions would be expected to have an arbitrage purpose 
or other speculative or trading purpose, and would be inconsistent with 
the ``commercial risk'' limitation to the hedging exclusion.
c. Treatment of Positions That Hedge Other Swap or Security-Based Swap 
Positions
    The final rule, consistent with the proposal, provides that the 
hedging exclusion does not extend to a security-based swap position 
that hedges another swap or security-based swap position, unless that 
other position itself is held for the purposing of hedging or 
mitigating commercial risk.\1020\ This provision allows the first major 
participant analysis to exclude a person's purchase of credit 
protection to help address the risk of default by a counterparty in 
connection with an interest rate swap, foreign exchange swap or other 
swap or security-based swap that the person has entered into for the 
purpose of hedging or mitigating commercial risk.
---------------------------------------------------------------------------

    \1020\ Exchange Act rule 3a67-4(b)(2).
---------------------------------------------------------------------------

d. Procedural Conditions
    In contrast to the proposal, the final rule does not incorporate 
procedural requirements in connection with the hedging exclusion from 
the first test of the major security-based swap participant 
definition.\1021\ In making this change, we have been mindful of 
concerns that have been expressed that such procedural requirements 
would lead to undue costs in connection with hedging activity.\1022\
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    \1021\ Those proposed provisions would have conditioned the 
exclusion on the person identifying and documenting the underlying 
risks, establishing and documenting a method of assessing the hedge 
effectiveness, and regularly assessing the effectiveness of the 
security-based swap as a hedge. See proposed Exchange Act rule 3a67-
4(c).
    \1022\ See, e.g., letter from FSR I.
---------------------------------------------------------------------------

    We understand, however, that many entities engaging in legitimate 
hedging of commercial risks do, as a matter of business practice, 
identify and document those risks and evaluate the effectiveness of the 
hedge from time to time. The presence of supporting documentation 
consistent with such procedures would help support a person's assertion 
that a security-based swap position should be excluded from the first 
major participant analysis, should the legitimacy of the exclusion 
become an issue.
    Also, although we are not requiring the entity to monitor the 
effectiveness of the hedge over time, that absence of this requirement 
does not change the underlying need for a security-based swap position 
to be economically appropriate for the commercial risks facing the 
entity to be excluded from the first major participant definition. 
Thus, for example, if a person's underlying commercial risk materially 
diminishes or is eliminated over time, a security-based swap position 
that may have been economically appropriate to the reduction of risk at 
inception at a certain point in time may, depending on the facts and 
circumstances, no longer be reasonably included within the 
exclusion.\1023\ As part of the reports required in connection with 
possible future changes to the major participant definitions,\1024\ the 
staffs are directed to address whether the continued availability of 
the hedging exclusion should be conditioned on assessment of hedging 
effectiveness and related documentation.
---------------------------------------------------------------------------

    \1023\ Factors that may be relevant to determining whether a 
security-based swap position is economically appropriate to the 
reduction of risk may include the costs associated with terminating 
or reducing that position.
    \1024\ See part V, infra.
---------------------------------------------------------------------------

D. Exclusion for Positions Held by Certain Plans Defined Under ERISA

1. Proposed Approach
    The first statutory test of the major participant definitions 
excludes swap and security-based swap positions that are ``maintained'' 
by any employee benefit plan as defined in sections 3(3) \1025\ and 
3(32) \1026\ of ERISA ``for the primary purpose of hedging or 
mitigating any risk directly associated with the operation of the 
plan.'' \1027\
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    \1025\ Section 3(3) of Title I of ERISA defines the term 
``employee benefit plan'' to include ``an employee welfare benefit 
plan or an employee pension benefit plan or a plan which is both an 
employee welfare benefit plan and an employee pension benefit 
plan.'' See 29 U.S.C. 1002(3). The terms ``employee welfare benefit 
plan'' and ``employee pension benefit plan'' are further defined in 
Sections 3(1) and (2) of ERISA. See 29 U.S.C. 1002(1) and (2).
    \1026\ Section 3(32) of Title I of ERISA defines the term 
``governmental plan'' to mean a plan that the U.S. government, state 
or political subdivision, or agencies and instrumentalities 
establish or maintain for its employees, as well as plans governed 
by the Railroad Retirement Acts of 1935 and 1937, plans of 
international organizations that are exempt from taxation pursuant 
to the International Organizations Immunities Act, and certain plans 
established and maintained by tribal governments or their 
subdivisions, agencies or instrumentalities. See 29 U.S.C. 1002(32).
    \1027\ CEA section 1a(33)(A)(i)(I); Exchange Act section 
3(a)(67)(A)(ii)(I).
---------------------------------------------------------------------------

    The proposed rules incorporated that statutory exclusion without 
additional interpretation or refinement.\1028\ In the Proposing 
Release, moreover, the Commissions expressed the preliminary view that 
we did not ``believe that it is necessary to propose a rule to further 
define the scope of this exclusion.'' We further noted that the 
exclusion for those plans identified in the statutory definition is not 
strictly limited to ``commercial'' risk, and that this may be construed 
to mean that hedging by those ERISA plans should be broadly excluded. 
The Commissions also solicited comment as to whether this exclusion 
should be made available to additional types of entities.\1029\
---------------------------------------------------------------------------

    \1028\ See proposed CFTC Regulation Sec.  1.3(hhh)(1)(ii)(A); 
proposed Exchange Act rule 3a67-1(a)(2)(i).
    \1029\ See Proposing Release, 75 FR at 80201, supra.
---------------------------------------------------------------------------

2. Commenters' Views
    Some commenters requested clarification that the ERISA hedging 
exclusion is broader than the commercial risk hedging exclusion, and 
that the ERISA hedging exclusion can encompass positions that are not 
solely for hedging purposes.\1030\ One

[[Page 30681]]

commenter cautioned against interpreting the ERISA hedging exclusion 
broadly.\1031\
---------------------------------------------------------------------------

    \1030\ See letters from BlackRock I (noting that the ERISA 
hedging exclusion applies to positions with the ``primary purpose'' 
of hedging, ``which suggests plans may exclude swap positions even 
if they serve a purpose in addition to hedging or mitigating''), the 
ERISA Industry Committee (``ERISA Industry Committee'') (stating 
that if ERISA Title I plans are not excluded from the major 
participant definition, the rules should clarify that the ERISA 
hedging exclusion is broader than the commercial hedging exclusion 
and encompasses a variety of risks associated with the value of a 
plan's assets or the measures of its liabilities; also stating that 
the ERISA exclusion should not omit positions in the nature of 
investing, and particularly discussing the use of swaps to provide 
diversification), ABC/CIEBA (expressing the view that the ERISA 
hedging exclusion extends beyond ``traditional'' hedges, and stating 
that the exclusion should encompass swaps with purposes in addition 
to hedging, and that the exclusion should encompass positions for 
the purpose of rebalancing, diversification and gaining asset class 
exposure) and CalSTRS I (requesting that regulations provide for an 
ERISA hedging exclusion that is broader than the commercial risk 
hedging exclusion, and that encompasses positions for the purpose of 
investing).
    One commenter alluded to the incorporation of efficient 
portfolio theory principles within the exception. See letter from 
Russell Investments.
    \1031\ See letter from AFSCME (stating that while the statutory 
exclusion may encompass swaps to mitigate currency risk of cash 
market investments, the exclusion should not encompass swaps used 
for investment purposes such as to gain asset class exposure or 
avoid transaction costs associated with a direct investment).
---------------------------------------------------------------------------

    Commenters also requested that the Commissions clarify that the 
ERISA hedging exclusion applies to positions maintained by trusts that 
hold plan assets,\1032\ or by pooled funds.\1033\ One commenter, in 
contrast, stated that the exclusion should not be available to trusts 
holding plan assets.\1034\
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    \1032\ See letters from ERISA Industry Committee (stating that 
the rules should provide that the exclusion applies to positions 
maintained by any trust holding plan assets) and ABC/CIEBA (stating 
that the rules should provide the relevant entity for purposes of 
the exclusion is the counterparty to the swap, further stating that 
if a trust enters into a swap as a counterparty, it is the trust 
that should be tested as a possible major participant, even if the 
trust also holds non-ERISA assets).
    \1033\ See letters from BlackRock I (discussing how plan 
fiduciaries may invest plan assets ``in pooled investment vehicles 
such as registered investment companies, private funds and bank 
maintained collective trust funds,'' and stating that not including 
pooled funds within the exclusion would limit plans' ability to 
avail themselves of the efficiencies associated with pooling), ERISA 
Industry Committee (stating that there is ``no reason'' why the 
exception should not also extend to position held by a pooled 
investment trust on behalf of multiple employee benefit plans) and 
ABC/CIEBA (stating that if a pool within a trust is the 
counterparty, it is that pool that should be tested as a possible 
major participant, and noting Department of Labor regulations 
providing that a collective investment vehicle would be viewed as 
holding plan assets if the vehicle is not a registered investment 
company, and plans hold at least 25 percent of the interests in the 
vehicle).
    \1034\ See letter from AFSCME (stating that ``it is important to 
limit the exemption to plans themselves, not to entities holding 
`plan assets' '').
---------------------------------------------------------------------------

    One commenter stated that the exception should be extended to all 
public pension plans,\1035\ and one commenter particularly took the 
view that the exclusion should be available to church plans.\1036\ Some 
commenters stated that the exclusion should be available to non-U.S. 
plans.\1037\
---------------------------------------------------------------------------

    \1035\ See letter from Russell Investments.
    \1036\ See letter from Church Alliance (stating that the 
exclusion also should encompass church plans defined in paragraph 
3(33) of ERISA, on the grounds that Congress would not have intended 
to discriminate against church plans, and that church plans are 
considered ``special entities'' that should be the beneficiaries of 
extra protection).
    \1037\ See letters from ABC/CIEBA, APG and BTPS.
     The Commissions intend to issue separate releases that address 
the application of the major participant definitions, and Title VII 
generally, to non-U.S. entities.
---------------------------------------------------------------------------

3. Final Rules
    Consistent with the position expressed in the Proposing Release, 
the Commissions interpret the ERISA hedging exclusion in the first 
statutory major participant test to be broader than that test's 
commercial risk hedging exclusion. This reflects the facts that the 
ERISA hedging exclusion is not limited to ``commercial'' risk, and that 
the ERISA hedging exclusion addresses positions that have a ``primary'' 
hedging purpose (which suggests that those positions may have a 
secondary non-hedging purpose).
a. Types of Excluded Hedging Activities
    The Commissions are mindful of commenters' request for additional 
clarity regarding the scope of the ERISA hedging exclusion. In that 
regard, we note that we generally would expect swap or security-based 
swap positions to have a primary purpose of hedging or mitigating risks 
directly associated with the operation of the types of plans identified 
in the statutory definition--and hence eligible for the exclusion--when 
those positions are intended to reduce disruptions or costs in 
connection with, among others, the anticipated inflows or outflows of 
plan assets, interest rate risk, and changes in portfolio management or 
strategies.
    Conversely, we believe that certain other types of positions would 
less likely have the primary purpose of hedging or mitigating risks 
directly associated with the operation of the plan, as anticipated by 
the statutory definition.\1038\
---------------------------------------------------------------------------

    \1038\ For example, we do not foresee that the use of a swap or 
security-based swap position to replicate exposure to a foreign 
market or to a particular asset class to be for the primary purpose 
of hedging risks directly associated with the operation of these 
types of plans. While we recognize that an asset manager may 
perceive benefits in using swaps or security-based swaps in that 
manner, it also is necessary to give effect to the statutory 
language limiting the exclusion to positions that have a ``primary 
purpose'' of hedging risks ``directly associated'' with the 
``operations'' of a plan. We recognize that lack of diversification 
may be viewed as a risk, but it is not an ``operations'' risk.
---------------------------------------------------------------------------

b. Availability of Exclusion
    The Commissions recognize the significance of comments that these 
plans may use separate entities such as trusts or pooled vehicles to 
hold plan assets, and that the exclusion should not be interpreted in a 
way that deters the use of those vehicles. We believe that the same 
principles that underpin the exclusion for hedging positions directly 
entered into by the types of plans identified in the statutory 
definition also warrant making the exclusion applicable to plan hedging 
positions that are entered into by those other parties that hold assets 
of those types of plans. Otherwise, the major participant analysis 
would have the effect of deterring efficiencies in plan operations for 
no apparent regulatory purpose.
    Accordingly, the Commissions interpret the meaning of the term 
``maintain''--in the context of the statutory provision that the swap 
or security-based swap position be ``maintained by'' an employee 
benefit plan--not only to include positions in which the plan is a 
counterparty, but also to include positions in which the counterparty 
is a trust or pooled vehicle that holds plan assets. Thus, for example, 
the exclusion would be available to trusts or pooled vehicles that 
solely hold assets of the types of plans identified in the statutory 
definition.\1039\ The exclusion further may be available to entities 
that hold such plan assets in conjunction with other assets, but only 
to the extent that the entity enters into swap or security-based swap 
positions for the purpose of hedging risks associated with the plan 
assets. The exclusion does not extend to positions that hedge risks of 
other assets, even if those are managed in conjunction with plan 
assets.\1040\
---------------------------------------------------------------------------

    \1039\ This interpretive guidance is intended solely in the 
context of the interpretation of the first test of the statutory 
major participant definitions. The guidance is not based on or 
relevant to the interpretation of other regulations relating to 
ERISA.
    \1040\ As appropriate, for purposes of the first major 
participant analysis an entity may need to allocate the exposure 
associated with swap or security-based swap positions between the 
amount that is attributable to plan assets (and hence eligible for 
exclusion) and the amount that is attributable to other assets.
---------------------------------------------------------------------------

    The Commissions also are mindful of commenter concerns that the 
exclusion should explicitly be made available to other plans, such as 
church plans and non-U.S. plans.\1041\ In this regard, the Commissions 
believe that the boundaries of the exclusion are set by the explicit 
statutory language, which states that it applies to any employee 
benefit plan as defined in paragraphs (3) and (32) of section 3 of 
ERISA. This reference is disjunctive--that is, a plan is eligible for 
the exclusion if it is within the scope of paragraph (3) (which refers 
to employee benefit plans)

[[Page 30682]]

or of paragraph (32) (which applies to government plans). Accordingly, 
the scope of the cited definitions in paragraphs (3) and (32) should be 
determined in accordance with all law that applies in the 
interpretation of ERISA.\1042\
---------------------------------------------------------------------------

    \1041\ As previously noted, the Commissions intend to issue 
separate releases that address the application of the major 
participant definitions, and Title VII generally, to non-U.S. 
entities.
    \1042\ We are not taking a view as to whether church plans or 
non-U.S. plans constitute employee benefit plans as defined by 
section 3(3) of ERISA.
---------------------------------------------------------------------------

E. ``Substantial Counterparty Exposure''

1. Proposed Approach
    The major participant definitions' second statutory test 
encompasses persons whose outstanding swaps or security-based swaps 
``create substantial counterparty exposure that could have serious 
adverse effects on the financial stability of the U.S. banking system 
or financial markets.'' \1043\ In contrast to those definitions' first 
statutory test, which relates to persons with a ``substantial 
position'' in swaps or security-based swaps in a ``major'' 
category,\1044\ this second test is not limited to positions in a 
single category. Also, unlike the first test, the second statutory test 
does not explicitly exclude certain commercial risk hedging positions 
or ERISA hedging positions.
---------------------------------------------------------------------------

    \1043\ CEA section 1a(33)(A)(ii); Exchange Act section 
3(a)(67)(A)(ii)(II).
    \1044\ CEA section 1a(33)(A)(i); Exchange Act section 
3(a)(67)(A)(ii)(I).
---------------------------------------------------------------------------

    For the ``major swap participant'' definition, the Proposing 
Release provided that a person's swap positions pose ``substantial 
counterparty exposure'' if those positions present a daily average 
current uncollateralized exposure of $5 billion or more, or present 
daily average current uncollateralized exposure plus potential future 
exposure of $8 billion or more.\1045\ For the ``major security-based 
swap'' definition, the proposal provided that a person's security-based 
swap positions pose ``substantial counterparty exposure'' if those 
positions present daily average current uncollateralized exposure of $2 
billion or more, or present daily average current uncollateralized 
exposure plus potential future exposure of $4 billion or more.\1046\
---------------------------------------------------------------------------

    \1045\ See proposed CFTC Regulation Sec.  1.3(lll).
    \1046\ See proposed Exchange Act rule 3a67-5.
---------------------------------------------------------------------------

    Under the proposal, those measures would be calculated in the same 
manner as would be used for the first major participant test, except 
that the ``substantial counterparty exposure'' analysis would consider 
all of a person's swap or security-based swap positions rather than 
solely considering positions in a particular ``major'' category, and 
that the ``substantial counterparty exposure'' analysis would not 
exclude positions to hedge commercial risks or ERISA plan risks.
    The proposed ``substantial counterparty exposure'' thresholds were 
set higher than the proposed ``substantial position'' thresholds in 
part to reflect the fact that the former test accounts for a person's 
positions across four major swap categories or two major security-based 
swap categories.\1047\ The proposed ``substantial counterparty 
exposure'' thresholds also reflected the fact that this second test 
(unlike the first major participant test) encompasses certain hedging 
positions that, in general, we would expect to pose a lesser degree of 
risk to counterparties and the markets.
---------------------------------------------------------------------------

    \1047\ Thus, these proposed thresholds in part would account for 
a person that has large positions in more than one major category of 
swaps or security-based swaps, but that does not meet the 
substantial position threshold for any single category of swaps or 
security-based swaps.
---------------------------------------------------------------------------

2. Commenters' Views

a. General Comments
    In light of the similarity between the proposed tests, a number of 
the concerns that commenters expressed with regard to the proposed 
``substantial position'' definition also apply to the proposed 
``substantial counterparty exposure'' definition. In addition, some 
commenters took the view that the proposed ``substantial counterparty 
exposure'' thresholds were too low,\1048\ with several of those 
commenters stating that the thresholds should be raised to a level that 
reflects systemic risk.\1049\ A few commenters took the view that the 
proposed thresholds were too high.\1050\ Some commenters generally 
supported the approach to the definition of ``substantial counterparty 
exposure'' proposed by the Commissions.\1051\
---------------------------------------------------------------------------

    \1048\ See, e.g., letters from ATAA (supporting higher 
thresholds to measure substantial counterparty exposure), CCMR I 
(suggesting that the thresholds be set high initially, capturing 
only a few entities until the Commissions are able to collect and 
analyze data that supports lowering the thresholds), BG LNG I 
(stating that proposed threshold should be increased substantially), 
WGCEF II (stating that the Commissions should adopt substantial 
position and substantial counterparty exposure tests that account 
for current conditions in swap markets), ABC/CIEBA (requesting that 
the Commissions raise the thresholds to better target persons 
creating or causing systemic risk as set forth in the a major swap 
participant and major security-based swap participant definitions), 
BlackRock I (stating that proposed thresholds for the substantial 
counterparty exposure test are too low so that they could encompass 
market participants that do not have systemically important swap 
positions) and ACLI (supporting increasing the thresholds under the 
CEA definition to $7 billion in daily average aggregate 
uncollateralized outward exposure or $14 billion in daily average 
aggregate uncollateralized outward exposure plus daily average 
aggregate potential outward exposure), and meeting with MFA on 
February 14, 2011 (requesting that the Commissions raise the 
thresholds for measuring substantial counterparty exposure until the 
Commissions conduct a market survey to determine how many entities 
would need to perform the calculations regularly and whether those 
entities have characteristics capable of causing systemic risk).
    \1049\ See letters from ABC/CIEBA, BlackRock I, ISDA I, WGCEF 
II, and meeting with MFA on February 14, 2011.
    \1050\ See letters from Greenberger (in connection with 
thresholds relating to substantial position) and AFR (Commissions 
should define a major swap participant or major security-based swap 
participant as any person that maintains $500 million in daily 
average, uncollateralized exposure for any category of swaps other 
than rate swaps, for which the daily average could be up to $1.5 
billion).
    \1051\ See, e.g., letters from ATAA (supporting the proposed 
definitions of ``substantial position'' and ``substantial 
counterparty exposure,'' with the caveat that higher thresholds be 
used to measure ``substantial counterparty exposure''), Dominion 
Resources (supporting the Commissions proposed definitions of 
``substantial position'' and ``substantial counterparty exposure''), 
Fidelity (threshold levels set at appropriate levels but should be 
periodically reviewed for adjustment), and Kraft (thresholds as 
proposed are appropriate).
---------------------------------------------------------------------------

    Some commenters took the view that the ``substantial counterparty 
exposure'' test should focus on the size of an entity's exposure to 
specific counterparties.\1052\ Several commenters suggested that the 
thresholds should be adjusted over time for inflation and changes in 
the swap and security-based swap markets.\1053\ One commenter urged 
that the analysis consider the interconnectedness of the entity.\1054\
---------------------------------------------------------------------------

    \1052\ See letters from MFA (stating that the calculation of 
substantial counterparty exposure should measure the exposure that a 
person has to each individual counterparty that is a systemically 
important financial institution excluding cleared swap transactions) 
and CCMR I (stating that the ``substantial counterparty exposure'' 
and ``substantial position'' thresholds should apply to the largest 
exposure that a person has to another market participant, with any 
aggregate test being set at a higher level).
    \1053\ See letters from CDEU, COPE I, Fidelity, ISDA I, and MFA 
I.
    \1054\ See letter from CDEU.
---------------------------------------------------------------------------

    One commenter addressed the application of the second major 
participant test to insurance companies, arguing that substantial 
counterparty exposure should be decided by the FSOC in consultation 
with the relevant state insurance commissioner, and that hedges should 
be excluded from the calculation for insurers.\1055\
---------------------------------------------------------------------------

    \1055\ See letter from NAIC (stating that the Commissions should 
defer to FSOC when considering the designation of insurers under the 
second test, and should exclude from the analysis swaps and 
security-based swap positions used for hedging provided that such 
positions are subject to state investment laws and ongoing 
monitoring by a state insurance regulatory authority).
---------------------------------------------------------------------------

b. Lack of Exclusion for Hedging Positions
    A number of commenters took the view that the second major 
participant

[[Page 30683]]

test should exclude commercial risk hedging positions from the 
analysis.\1056\ Some commenters also supported excluding ERISA hedging 
positions from the analysis.\1057\ One commenter opposed any such 
exclusions for hedging positions.\1058\
---------------------------------------------------------------------------

    \1056\ See letters from SIFMA AMG II (noting that the 
Commissions have suggested that hedging positions may not raise the 
same degree of risk as other swap positions), NAIC (supporting 
exclusion of commercial risk hedging positions subject to state 
investment laws and ongoing monitoring by state insurance 
regulators), AIA (supporting hedging exclusion to avoid capturing 
entities such as property-casualty insurers), CDEU (suggesting that 
inclusion of hedging positions is inconsistent with goal of 
mitigating systemic risk), APG (supporting exclusion of positions 
held by regulated foreign pension plans), and NRG Energy (suggesting 
that a lack of an exclusion would cause end-users to curtail hedging 
activities and increase systemic risk); see also letter from AIMA I 
(supporting an exemption or discount if the swap transaction is 
cleared, an off-set for the value and quality of any collateral, and 
consideration of the directional moves of particular swap 
contracts).
    \1057\ See letters from ABC/CIEBA and SIFMA AMG II. One 
commenter further requested that ERISA Title I plans be explicitly 
excluded from the second test. See letter from ERISA Industry 
Committee. Another commenter requested an exclusion for ERISA plans 
generally. See letter from CalSTRS I.
    \1058\ See letter from Better Markets I (stating that excluding 
hedging positions would be inappropriate because the Dodd-Frank Act 
did not provide for any such exclusion in the second test, hedge 
positions may still contribute to counterparty exposure, and the 
thresholds already reflect the lower level of risk posed by hedge 
positions).
---------------------------------------------------------------------------

3. Final Rules
    Consistent with the Proposing Release, the final rules defining the 
term ``substantial counterparty exposure'' generally are based on the 
same current uncollateralized exposure and potential future exposure 
tests that are used to identify a ``substantial position.'' \1059\ As 
with the Proposing Release, moreover, the ``substantial counterparty 
exposure'' analysis addresses all of a person's swap or security-based 
swap positions (rather than being limited to positions in a ``major'' 
category), and does not exclude hedging positions.\1060\ The final 
rules also incorporate the quantitative thresholds that were proposed 
for those tests.\1061\
---------------------------------------------------------------------------

    \1059\ Accordingly, changes that the final rules made to the 
proposal with regard to the ``substantial position'' definition, see 
part IV.B.3, supra, also are carried over to the definition of 
``substantial counterparty exposure.''
    \1060\ See CFTC Regulation Sec.  1.3(lll); Exchange Act rule 
3a67-5.
    \1061\ Accordingly, consistent with the proposal, the threshold 
for the ``major swap participant'' definition is $5 billion or more 
in daily average current uncollateralized exposure, or $8 billion or 
more in daily average uncollateralized exposure plus potential 
future exposure. The threshold for the ``major security-based swap 
participant'' is $2 billion or more in daily average current 
uncollateralized exposure, or $4 billion or more in daily average 
uncollateralized exposure plus potential future exposure.
---------------------------------------------------------------------------

    In adopting these final rules we have considered commenter views 
that the ``substantial counterparty exposure'' analysis should exclude 
certain commercial risk and ERISA hedging positions. We nonetheless 
believe that the structure of the major participant definitions--
particularly the fact that those definitions specifically exclude 
hedging positions from the first statutory test but not from the second 
test--necessitates the conclusion that the second test not exclude 
those hedging positions.
    We also have considered commenter views that the ``substantial 
counterparty exposure'' analysis should account for the maximum 
exposure that a person poses to any single counterparty. We nonetheless 
believe that the statutory test--particularly its focus on serious 
adverse effects on financial stability or financial markets--more 
appropriately is addressed by measures of the aggregate counterparty 
risk that an entity poses through its swap or security-based swap 
positions. Also, consistent with our views regarding the ``substantial 
position'' definition, we believe that the ``substantial counterparty 
exposure'' analysis appropriately is addressed via objective and 
quantitative criteria (rather than a multi-tier approach), and 
appropriately takes into account current uncollateralized exposure and 
potential future exposure.
    Consistent with the Proposing Release, the thresholds to implement 
the second major participant test are higher than the corresponding 
thresholds for the first major participant test. These differences 
reflect the fact that the second test encompasses four ``major'' 
categories of swaps or two ``major'' categories of security-based 
swaps, as well as the fact that this second test does not exclude 
hedging positions that would appear to pose a lesser degree of 
counterparty risk than non-hedging positions.
    While we are mindful of commenter views that the proposed 
``substantial counterparty exposure'' thresholds were too low,\1062\ we 
believe that the same principles that support the proposed standards in 
the context of the ``substantial position'' definition also support the 
proposed standards for this second test. As with the ``substantial 
position'' analysis, the ``substantial counterparty exposure'' analysis 
seeks to reflect a standard that encompasses large market participants 
before the counterparty risk posed by their swap and security-based 
swap positions present too large a problem, as well as the financial 
system's ability to absorb losses of a particular size, and the need to 
account for the possibility that multiple market participants may fail 
close in time.\1063\ Commenters have not presented empirical or 
analytical evidence in support of a different standard. In the future, 
the Commissions may review and potentially adjust these thresholds to 
reflect evolving market structures and additional data.
---------------------------------------------------------------------------

    \1062\ See notes 1051 and 1052, supra.
    \1063\ As with the ``substantial position'' analysis, our 
decision to adopt these thresholds is informed by events related to 
AIG Financial Products and LTCM. See part IV.B.3.d, supra.
---------------------------------------------------------------------------

F. ``Highly Leveraged'' and ``Financial Entity''

1. Proposed Approach
    The third statutory test of the major participant definitions 
encompasses any non-dealer that: (i) Is a ``financial entity'' (other 
than one that is ``subject to capital requirements established by an 
appropriate Federal banking agency''), (ii) is ``highly leveraged 
relative to the amount of capital it holds,'' and (iii) maintains a 
``substantial position'' in any ``major'' category of swaps or 
security-based swaps.\1064\ In contrast to the first statutory test--
which also encompasses persons with a ``substantial position'' in swaps 
or security-based swaps in a ``major'' category--this third test does 
not exclude positions that hedge commercial risk or ERISA risks.
---------------------------------------------------------------------------

    \1064\ CEA section 1a(33); Exchange Act section 3(a)(67).
---------------------------------------------------------------------------

a. ``Financial Entity''
    The Proposing Release defined the term ``financial entity'' for 
purposes of the major participant definition in the same general manner 
as Title VII defines that term for purposes of the end-user exemption 
from mandatory clearing,\1065\ but with certain technical changes to 
avoid circularity.\1066\
---------------------------------------------------------------------------

    \1065\ CEA section 2(h)(7); Exchange Act section 3C(g)(3)(A).
    \1066\ See proposed CFTC Regulation Sec.  1.3(mmm)(1); proposed 
Exchange Act rule 3a67-6(a). For both sets of rules, the ``financial 
entity'' definition would include any: commodity pool (as defined in 
section 1a(10) of the CEA); private fund (as defined in section 
202(a) of the Investment Advisers Act of 1940); employee benefit 
plan as defined in paragraphs (3) and (32) of section 3 of ERISA; 
and person predominantly engaged in activities that are in the 
business of banking or financial in nature (as defined in section 
4(k) of the Bank Holding Company Act of 1956).
     To avoid circularity, the use of the term ``financial entity'' 
in the context of the ``major swap participant'' definition also 
would encompass any ``security-based swap dealer'' and ``major 
security-based swap participant,'' but would not include any ``swap 
dealer'' or ``major swap participant'' (even though the latter terms 
also are found in the ``financial entity'' definition used for 
purposes of the end-user clearing exception). See proposed CFTC 
Regulation Sec.  1.3(mmm)(1). In the context of the ``major 
security-based swap participant'' definition, the term ``financial 
entity'' also would encompass any ``swap dealer'' or ``major swap 
participant,'' but would not include any ``security-based swap 
dealer'' and ``major security-based swap participant.'' See proposed 
Exchange Act rule 3a67-6(a).

---------------------------------------------------------------------------

[[Page 30684]]

b. ``Highly Leveraged''
    The Proposing Release set forth two alternative approaches for 
determining whether a particular entity would be deemed ``highly 
leveraged.'' \1067\ Under one approach, an entity would be ``highly 
leveraged'' if the ratio of its liabilities to equity exceeded 8 to 1; 
this proposed alternative reflected the fact that the third statutory 
major participant test excludes certain types of entities.\1068\ Under 
the alternative approach, an entity would be ``highly leveraged'' if 
the ratio of its liabilities to equity exceeded 15 to 1; this proposed 
alternative reflected standards for maximum leverage in certain 
circumstances found in Title I of the Dodd-Frank Act.\1069\ The 
proposal further provided that leverage would be measured at the close 
of business on the last business day of the applicable fiscal quarter, 
and that liabilities and equity would be determined in accordance with 
U.S. generally accepted accounting principles (``GAAP'').\1070\
---------------------------------------------------------------------------

    \1067\ See proposed CFTC Regulation Sec.  1.3(mmm)(2); proposed 
Exchange Act rule 3a67-6(b).
    \1068\ The Proposing Release particularly noted that the third 
statutory major participant test excludes financial institutions 
subject to capital requirements set by Federal banking agencies, and 
recognized the possibility those entities were excluded based on the 
presumption that they generally are highly leveraged. The Proposing 
Release noted, based on analysis of financial statements, that it 
appears that those institutions generally have a leverage ratio of 
10 to 1, and that this suggested that the ``highly leveraged'' 
threshold would have to be lower for those institutions to 
potentially be subject to the third test. See Proposing Release, 75 
FR at 80199.
    \1069\ The Proposing Release noted that Title I provides that 
the Board must require a bank holding company with total 
consolidated assets equal to or greater than $50 billion, or a 
nonbank financial company supervised by the Board, to maintain a 
debt to equity ratio of no more than 15 to 1 if the FSOC determines 
``that such company poses a grave threat to the financial stability 
of the United States and that the imposition of such requirement is 
necessary to mitigate the risk that such company poses to the 
financial stability of the United States.'' See Dodd-Frank Act 
section 165(j)(1). The Proposing Release further noted that this 15 
to 1 ratio may represent an upper limit to acceptable leverage and 
that the major participant analysis should use a lower threshold, 
or, alternatively, that the 15 to 1 ratio provides an appropriate 
test of whether an entity poses the systemic risk concerns 
implicated by the major participant definitions. See Proposing 
Release, 75 FR at 80199.
    \1070\ The Proposing Release also stated that entities that file 
quarterly reports on Form 10-Q and annual reports on Form 10-K with 
the SEC would determine their total liabilities and equity based on 
the financial statements included with such filings while all other 
entities would calculate the value of total liabilities and equity 
consistent with the proper application of U.S. GAAP. See id.
---------------------------------------------------------------------------

    In proposing these alternative standards for identifying ``highly 
leveraged'' entities, the Commissions recognized that traditional 
balance sheet measures of leverage are limited as tools for evaluating 
an entity's ability to meet its obligations--in part because such 
measures do not directly account for potential risks posed by specific 
instruments held on the balance sheet, or for financial instruments 
held off of the balance sheet. At the same time, the Commissions 
preliminarily concluded that it was not necessary to use more complex 
measures of risk-adjusted leverage for these purposes, in part because 
the third test's ``substantial position'' analysis already accounts for 
such risks. The Commissions also noted the costs that would be 
associated with causing entities to engage in complex calculations of 
risk-adjusted leverage.\1071\
---------------------------------------------------------------------------

    \1071\ See id. at 80198-99.
---------------------------------------------------------------------------

    The Proposing Release solicited comment on a variety of issues 
related to the proposed leverage ratios, including the relative merits 
of the alternative 8 to 1 and 15 to 1 standards, and potential 
alternative standards.\1072\
---------------------------------------------------------------------------

    \1072\ See id. at 80199-200.
---------------------------------------------------------------------------

2. Commenters' Views
a. ``Financial Entity''
    Some commenters recommended that certain types of entities should 
be excluded from the definition of ``financial entity,'' on the grounds 
that those types of entities are more appropriately treated as non-
financial end users of swaps for purposes of the Dodd-Frank Act.\1073\ 
Commenters specifically suggested that the ``financial entity'' 
definition exclude: (i) Centralized hedging and treasury subsidiaries 
in corporate groups; \1074\ (ii) employee benefit plans; \1075\ and 
(iii) cooperative structures.\1076\ Commenters also requested 
clarification as to which entities would not be ``subject to capital 
requirements established by an appropriate Federal banking agency,'' 
and hence not subject to the third statutory test.\1077\ In addition, 
commenters addressed the application of the ``financial entity'' 
definition to non-U.S. persons.\1078\
---------------------------------------------------------------------------

    \1073\ See, e.g., letters from CalSTRS dated June 15, 2011 
(``CalSTRS II''), Kraft, Newedge, NRU CFC I and Philip Morris.
    \1074\ See letters from Kraft and Philip Morris.
    \1075\ See letter from CalSTRS II (asserting that there is not a 
basis to treat ERISA plans as ``financial entities'' for purposes of 
the major participant definitions solely to maintain consistency 
with an ``anomalous'' statutory provision).
    \1076\ See letter from NRU CFC I.
    \1077\ See letters from ACLI (requesting confirmation that the 
exclusion from the third statutory test extends to entities subject 
to bank or financial holding companies, entities deemed systemically 
important under Title I of the Dodd-Frank Act, and any other persons 
subject to capital regulation established by a Federal banking 
regulator) and MetLife (requesting clarification that the exclusion 
extends to persons subject to regulation and capital requirements on 
a consolidated basis under federal banking law, and persons that are 
individually or systemically important financial institutions under 
Title I).
    \1078\ One commenter took the view that non-U.S. governments and 
their agencies should be excluded from the ``financial entity'' 
definition for purposes of the major participant definition and the 
Title VII end-user exemption from mandatory clearing. See letter 
from Milbank. On the other hand, one commenter favored the inclusion 
of non-U.S. governments in the ``financial entity'' definition. See 
meeting with Duffie on February 2, 2011 (suggesting that foreign 
governments and other foreign jurisdictions, such as municipalities, 
should be treated as ``financial entities'' for purposes of the 
major swap participant definition and other requirements under the 
Dodd-Frank Act on the grounds that such entities could become 
sources of systemic risk).
    The Commissions intend to issue separate releases addressing the 
application of Title VII to non-U.S. persons.
---------------------------------------------------------------------------

b. ``Highly Leveraged''
    A number of commenters supported the proposed 15 to 1 alternative 
leverage ratio over the 8 to 1 alternative, with some commenters 
further suggesting that the final rule should set a leverage ratio 
higher than 15 to 1, or that the ratio should be reconsidered when more 
information is available regarding leverage among swap users.\1079\ One 
commenter supported the proposed 8 to 1 alternative,\1080\ and one 
commenter

[[Page 30685]]

suggested that the final rule should set a leverage ratio lower than 8 
to 1.\1081\ One commenter suggested a ratio of 12 to 1, consistent with 
certain capital requirements.\1082\
---------------------------------------------------------------------------

    \1079\ See letters from ISDA I (suggesting that the wide use of 
leverage by financial institutions means that the definition should 
capture only entities with the ``very highest'' leverage ratios, and 
that the 15 to 1 ratio should be viewed as a floor for identifying 
highly leveraged entities given that it is used in Title I to 
address entities that have already been determined to pose a ``grave 
threat'' to the stability of the U.S. financial system), MFA I 
(stating that 15 to 1 is the more appropriate of the two choices, 
and that the Commissions could subsequently adjust the ratio after 
receiving market data on the use of leverage), AIMA I (encouraging 
the Commissions to adopt the 15 to 1 leverage threshold until an 
assessment of the impact of the major participant definitions can be 
completed); Amex (supporting the use of the 15 to 1 ratio, noting 
that it is consistent with the maximum leverage allowed to entities 
designated as a grave threat to financial stability under Title I of 
the Dodd-Frank Act) and CDEU (recommending use of the 15 to 1 
standard, based on its consistency with the leverage limit in Title 
I of the Dodd-Frank Act for entities posing a grave threat to the 
United States financial system and that ``it would be unreasonable 
to propose a stricter leverage threshold under the major participant 
test for nonbank financial end-users,'' and expressing concern that 
entities comfortably falling under the 8 to 1 ratio could 
unexpectedly exceed this threshold during periods of market stress 
and that sudden designation as a major participant ``could seriously 
hinder a company from meeting its obligations'').
    \1080\ See letter from Better Markets I (stating that the 8 to 1 
threshold would better serve the purposes of the Dodd-Frank Act by 
``ensuring that more, rather than fewer, financial entities are 
covered by the risk mitigation and business conduct standards that 
Congress established'' for major participants, and that use of the 
15 to 1 leverage ratio from Title I of the Dodd-Frank Act is 
inappropriate because the Title I ratio is used for the ``relatively 
draconian'' purpose of imposing leverage limits, while this ratio 
would be used for ``the more modest purpose of imposing registration 
requirements'').
    \1081\ See letter from Greenberger (suggesting that the leverage 
test should be set at a ratio that is lower than either of the two 
proposed levels).
    \1082\ See meeting with MFA on February 14, 2011 (MFA 
representatives making point that ``highly leveraged'' should be 
defined in coordination with other regulations under the Dodd-Frank 
Act, and for example, a requirement that banks hold 8% capital 
implies a leverage ratio of approximately 12:1).
---------------------------------------------------------------------------

    Commenters also suggested a variety of methods and adjustments for 
calculating leverage ratios.\1083\
---------------------------------------------------------------------------

    \1083\ The suggested adjustments were: to measure the ratio of 
net current credit exposure to Tier I capital, in a manner similar 
to that used by bank regulators (see letter from Greenberger); to 
include as liabilities all unfunded exposures on swaps, both current 
and potential (see letter from Better Markets I); and to account for 
the different risk levels of various classes of assets and 
liabilities and for other factors affecting a person's riskiness 
(see letters from CCMR I and MFA I).
---------------------------------------------------------------------------

    Some commenters further suggested that specific leverage tests be 
applied to particular types of financial entities. For employee benefit 
plans, commenters particularly stated that a plan's obligations to pay 
benefits should not be considered a liability for purposes of the 
analysis, and the value of the plan's assets should be used as the 
denominator for the ratio in lieu of using the non-applicable term 
``equity.'' \1084\ Another commenter--which obtains a substantial 
amount of funding by issuing subordinated debt, rather than equity--
expressed the view that the leverage calculation should allow it to 
treat subordinated debt as equity.\1085\
---------------------------------------------------------------------------

    \1084\ See letters from CalSTRS I (also stating that for 
purposes of determining leverage ratios, the value of the plan's 
assets should be determined as of most recent annual valuation 
rather than quarterly) and APG (stating that only investment-related 
liabilities, rather than anticipated shortfalls in benefit 
obligations, should be considered in the leverage calculation, and 
the test should be adjusted to take into account legally binding 
investment restrictions and other constraints that could be just as 
effective, or more effective, at reducing insolvency risk as capital 
requirements that would limit leverage).
    \1085\ See letter from NRU CFC I (stating that this application 
of the leverage test would be consistent with its financial 
statements).
---------------------------------------------------------------------------

    Several commenters addressed the application of the leverage ratio 
to insurance companies in light of the applicable regulatory regimes 
and their use of statutorily required accounting methods rather than 
GAAP.\1086\ Those commenters took the view that an insurance company's 
leverage should be tested based on its risk-based capital ratio or on 
its statutory accounting statements, with certain adjustments to 
account for different types of liabilities,\1087\ or based on whether 
its insurance regulator believes that it is adequately 
capitalized.\1088\ One commenter said that the leverage ratio test 
should not apply to insurance companies,\1089\ and another said that 
application of the leverage ratio test to insurance companies should be 
coordinated with the FSOC.\1090\
---------------------------------------------------------------------------

    \1086\ See letters from ACLI, FSR I, MetLife and NAIC.
    \1087\ See letters from ACLI, FSR I and NAIC.
    \1088\ See letter from MetLife.
    \1089\ See letter from FSR I.
    \1090\ See letter from NAIC.
---------------------------------------------------------------------------

3. Final Rules
a. ``Financial Entity''
    Consistent with the Proposing Release, the final rules defining 
``financial entity'' for purposes of the third major participant test 
are based on the corresponding ``financial entity'' definition used in 
the Title VII exception from mandatory clearing for end users, with 
certain adjustments to avoid circularity.\1091\ In this regard, while 
we are mindful of one commenter's views that the differences between 
the major participant definitions and the end-user clearing exception 
necessitate different ``financial entity'' definitions,\1092\ we do not 
concur with the view that the term ``financial entity'' should be 
interpreted independently in these two contexts. Both sets of 
provisions distinguish between financial and non-financial entities in 
a way that limits the impact of Title VII on the latter set of 
entities, and we believe that the definitions should be consistent in 
light of those parallel purposes.
---------------------------------------------------------------------------

    \1091\ See CFTC Regulation Sec.  1.3(mmm)(1); Exchange Act rule 
3a67-6(a). Accordingly, this general definition encompasses 
commodity pools, private funds, ERISA plans, and persons 
predominately engaged in activities that are in the business of 
banking or financial in nature, as well as certain dealers or major 
participants. See note 1066, supra.
    \1092\ See letter from CalSTRS II (ERISA plans should not be 
included in the definition of ``financial entity'' for purposes of 
the major participant definitions).
---------------------------------------------------------------------------

    The Commissions are aware, however, that the major participant 
definitions differ from the mandatory clearing requirements in how they 
address affiliates. The mandatory clearing requirements include a 
provision that specifically addresses affiliates of persons that 
qualify for the exception from mandatory clearing for end users,\1093\ 
while no such specific provision is included in the major participant 
definitions. Given this absence, the Commissions believe it is 
appropriate to modify the final rules defining ``financial entity'' for 
purposes of the major participant definitions from the proposal to 
exclude certain centralized hedging and treasury entities.\1094\ The 
Commissions understand that a primary function of such centralized 
hedging and treasury entities is to assist in hedging or mitigating the 
commercial risks of other entities within their corporate groups. 
Although those entities' activities could constitute being ``in the 
business of banking or financial in nature,'' we do not believe that it 
would be appropriate to treat a person as a ``financial entity'' for 
the purposes of the major participant definitions if the person would 
fall within that definition solely because it facilitates hedging 
activities involving swaps or security-based swaps by majority-owned 
affiliates that themselves are not ``financial entities.'' \1095\ 
Absent this change, the major participant analysis would exclude 
hedging positions that do not use centralized hedging facilities, but 
would not exclude identical hedging positions that make use of a 
centralized hedging facility.\1096\ Such a result would inappropriately 
discourage the use of centralized hedging and treasury entities.
---------------------------------------------------------------------------

    \1093\ See CEA section 2(h)(7)(D); Exchange Act section 
3C(g)(4).
    \1094\ See CFTC Regulation Sec.  1.3(mmm)(2); Exchange Act rule 
3a67-6(b).
    \1095\ Consistent with the general inter-affiliate exceptions 
from the dealer and major participant definitions, see parts II.C 
and IV.G, for purposes of these rules, the counterparties are 
majority-owned affiliates if one party directly or indirectly holds 
a majority ownership interest in the other, or if a third party 
directly or indirectly holds a majority interest in both, based on 
holding a majority of the equity securities of an entity, or the 
right to receive upon dissolution or the contribution of a majority 
of the capital of a partnership. See CFTC Regulation Sec.  
1.3(mmm)(1); Exchange Act rule 3a71-6(b)(2).
    \1096\ We also note that this result is parallel to the Title 
VII end-user exception from mandatory clearing, which extends to 
hedging activities of financial entities on behalf of non-financial 
affiliates. See CEA section 2(h)(7)(D); Exchange Act section 
3C(g)(4).
---------------------------------------------------------------------------

    While the Commissions also have considered the views of commenters 
that the ``financial entity'' definition should exclude certain other 
types of entities--such as employee benefit plans, and cooperatives--
the final rules do not provide any such exclusions. As a general 
matter, the Commissions believe that the ``financial entity'' 
definition should be the same for purposes of the major participant

[[Page 30686]]

definition as it is for purposes of the end-user exception from 
mandatory clearing.\1097\
---------------------------------------------------------------------------

    \1097\ Similarly, the Commissions in general are not adopting 
categorical requests for exclusions from the major participant 
definitions. See part IV.J, infra.
---------------------------------------------------------------------------

    We also have considered the views of some commenters that 
subsidiaries of bank holding companies, financial holding companies or 
systemically important financial institutions should be considered to 
be ``subject to capital requirements established by an appropriate 
Federal banking agency,'' and hence not subject to the third statutory 
major participant test. We nonetheless interpret the term ``subject to 
capital requirements established by an appropriate Federal banking 
agency'' to specifically apply to persons for whom a Federal banking 
agency directly sets capital requirements. We do not believe that the 
term should be interpreted to apply to other persons by virtue of their 
being part of a holding company that is subject to those capital 
requirements, or otherwise being affiliated with persons subject to 
those capital requirements, because we do not believe that the mere 
fact of that relationship is sufficient to control or mitigate the 
credit risk that those persons pose to their counterparties.
b. ``Highly Leveraged''
i. Leverage Ratio Level
    After considering commenters' views, the Commissions are adopting 
final rules that define ``highly leveraged'' to generally mean a ratio 
of liabilities to equity in excess of 12 to 1.\1098\ Our adoption of 
this 12 to 1 standard, rather than the proposed 8 to 1 or 15 to 1 
alternatives, takes into account commenters' views on the alternatives, 
as well as one commenter's support for a 12 to 1 ratio.\1099\
---------------------------------------------------------------------------

    \1098\ See CFTC Regulation Sec.  1.3(mmm)(2); Exchange Act rule 
3a67-7(a). The final rules defining ``highly leveraged'' have been 
renumbered from the proposal for the sake of clarity.
    \1099\ See note 1082, supra, and accompanying text.
---------------------------------------------------------------------------

    In general, we believe that the structure of the third statutory 
major participant test--which, unlike the first statutory test, does 
not permit the exclusion of certain hedging positions--reasonably may 
be interpreted as reflecting the determination that: (a) higher 
leverage indicates that an entity poses a heightened risk of being 
unable to meet its obligations; and (b) such entities should not be 
permitted to exclude hedging positions from the ``substantial 
position'' analysis in light of the counterparty risks those positions 
pose (even recognizing that these may be lower than counterparty risks 
posed by comparable non-hedging positions).
    Commenters who addressed the proposed leverage ratio raised diverse 
points of view in support of the 8 to 1 and 15 to 1 alternatives, or 
other standards. A number of those commenters, however, appeared to 
focus on the outcome of particular leverage ratios--i.e., that a lower 
leverage ratio likely would lead to more major participants, and that a 
higher leverage ratio likely would lead to fewer major participants--
and to base their conclusions on their views of that outcome. In 
general, the comments did not reflect an attempt to identify typical 
leverage ratios for financial entities, or to address the link between 
leverage and risk.
    Some commenters specifically supported the use of a 15 to 1 
leverage ratio in light of Title I's use of that ratio.\1100\ While 
considering this perspective, we believe it also is appropriate to 
consider the different purposes for which leverage is addressed in the 
Title I and major participant contexts. The 15 to 1 leverage provision 
in Title I reflects a maximum allowable threshold of leverage for 
certain bank holding companies and nonbank financial companies when a 
determination has been made that such entities pose a ``grave threat to 
the financial stability of the United States'' and that the imposition 
of this limitation is necessary to mitigate the risks posed by such 
entities--in essence serving as a hard leverage cap for certain 
entities that have been deemed risky to the U.S. financial 
system.\1101\ In contrast, leverage serves a type of gatekeeper 
function in the major participant definitions by identifying the amount 
of leverage that will require a non-bank financial entity to engage in 
the ``substantial position'' analysis without excluding hedging 
positions, rather than seeking to limit the maximum leverage available 
to those entities. Just as concepts of ``maximum leverage'' are 
distinct from concepts of ``high leverage,'' the use of a 15 to 1 
maximum leverage ratio in Title I does not mandate the conclusion that 
the same 15 to 1 ratio must be used for interpreting the meaning of 
``highly leveraged'' in the major participant definitions.\1102\
---------------------------------------------------------------------------

    \1100\ See, e.g., letters from Amex and CDEU.
    \1101\ See Dodd-Frank Act section 165(j)(1).
    \1102\ We also note that the use of the 15 to 1 ratio of Title I 
in this context could lead to potentially incongruous results. In 
particular, if the Commissions were to use the 15 to 1 leverage 
ratio for the ``highly leveraged'' definition, then an entity that 
is deemed to be such a threat to the United States financial system 
that its leverage has been capped pursuant to Title I also would 
effectively be excepted from the third statutory test of the major 
participant definitions due to that cap. The 12 to 1 leverage ratio 
that we are adopting today does not give rise to the same result and 
therefore does not present the same question of interpretation as to 
whether this result would be appropriate.
---------------------------------------------------------------------------

    In considering the definition of the term ``highly leveraged'' 
based on the reasoning outlined above, we also are mindful that, as the 
Proposing Release noted,\1103\ broker-dealer capital regulations 
include special provisions that apply when a broker-dealer's leverage 
exceeds 12 to 1.\1104\ While we recognize that these capital 
regulations have limitations as tools for defining ``highly leveraged'' 
for purposes of the major participant definitions due to differences in 
how leverage would be calculated,\1105\ we also believe that these 
regulations are informative regarding the use of leverage in the major 
participant context given that they highlight an existing link between 
increased regulatory oversight and the amount of leverage an entity 
maintains.
---------------------------------------------------------------------------

    \1103\ See Proposing Release, 75 FR at 80199 n.152.
    \1104\ Exchange Act rule 15c3-1 provides that a broker-dealer 
may determine its required minimum net capital, among other ways, by 
applying a financial ratio that provides that its aggregate 
indebtedness shall not exceed 1500 percent of its net capital (i.e., 
a 15 to 1 aggregate indebtedness to net capital ratio). In addition, 
Exchange Act rule 17a-11 further requires that broker-dealers that 
use such method to establish their required minimum net capital must 
provide notice to regulators if their aggregate indebtedness exceeds 
1200 percent of their net capital (i.e., a 12 to 1 aggregate 
indebtedness to net capital ratio).
    \1105\ The measure of aggregate indebtedness in rule 15c3-1 
excludes certain secured liabilities, and the measure of net capital 
excludes certain illiquid assets but includes certain subordinated 
debt. As a result, the ratios discussed above would not necessarily 
be equivalent to 15:1 or 12:1 ratios when converted to a balance 
sheet ratio of liabilities to equity.
---------------------------------------------------------------------------

    In light of the reasons noted above for using a leverage ratio 
below 15 to 1, commenter concerns that a ratio of 8 to 1 would be too 
low, one commenter's suggestion of a 12 to 1 leverage ratio, and 
leverage tests found in broker-dealer capital regulations, the 
Commissions have determined that a 12 to 1 leverage ratio reflects an 
appropriate basis for identifying ``highly leveraged'' financial 
entities. In making this determination we recognize that other 
approaches also may be reasonable (e.g., lower thresholds based on the 
analysis of the leverage of certain financial entities also may be 
reasonable, as may higher thresholds based on Title I and on other 
aspects of broker-dealer capital rules). We also recognize, however, 
that the need to implement the major participant definitions requires 
that we draw a line. In our view, a 12 to 1 ratio reflects a

[[Page 30687]]

reasonable location for this line that is appropriate for purposes of 
the third major participant test, and that reasonably accounts for 
commenter concerns and the other considerations discussed above.
ii. Leverage Ratio Calculation
    Consistent with the proposal, the final rules defining ``highly 
leveraged'' generally measure leverage as a ratio of a person's 
liabilities to equity, as determined in accordance with GAAP.\1106\ 
Also, consistent with the proposal, these leverage ratios should be 
calculated as of the close of business on the last business day of the 
applicable fiscal quarter, as we do not believe there is any relevant 
difference among financial entities that would require timing 
variations.
---------------------------------------------------------------------------

    \1106\ See CFTC Regulation Sec.  1.3(mmm)(2); Exchange Act rule 
3a67-7(b). The accounting standard setters are currently working on 
a number of projects that may impact how leverage would be 
calculated using GAAP. The Commissions will review and potentially 
adjust their rules in the future to reflect changes in GAAP.
---------------------------------------------------------------------------

    In general, moreover, the Commissions believe that all types of 
financial entities should be subject to the same methods of measuring 
leverage, to facilitate the even application of the leverage test. At 
the same time, we are mindful of the significance of commenter concerns 
that calculating leverage as a ratio of liabilities to equity 
consistent with GAAP would lead to inappropriate results for certain 
types of financial instruments or financial entities.
    We believe that these concerns are significant enough to warrant 
one modification of the proposed approach to measuring leverage. In 
particular, the final rules provide that certain employee benefit plans 
may: (i) Exclude obligations to pay benefits to plan participants from 
their measure of liabilities for purposes of the leverage calculation; 
and (ii) substitute the total value of plan assets for equity for 
purposes of the leverage calculation.\1107\ We believe that this change 
will allow the measure of leverage to more appropriately reflect the 
risk that those entities pose.
---------------------------------------------------------------------------

    \1107\ See CFTC Regulation Sec.  1.3(mmm)(2)(ii); Exchange Act 
rule 3a67-7(b). These provisions specifically apply to employee 
benefit plans as defined by paragraph (3) and (32) of section 3 of 
ERISA, consistent with the ERISA exclusion from the first statutory 
major participant test.
---------------------------------------------------------------------------

    Otherwise, we do not believe that it would be appropriate to depart 
from GAAP measures of equity and liabilities for purposes of 
identifying highly leveraged entities.\1108\
---------------------------------------------------------------------------

    \1108\ Although commenters raised issues with regard to the 
application of leverage ratios to insurers, see, e.g., letter from 
FSR I, we do not believe that it would be appropriate to create a 
special leverage test for insurers. We note that insurers that are 
publicly traded companies already file financial statements 
consistent with GAAP. Also, smaller insurers that do not file GAAP-
based financial statements would be able to take advantage of the 
safe harbor from the major participant calculations. See part IV.M, 
infra.
---------------------------------------------------------------------------

G. Application to Inter-Affiliate Swaps and Security-Based Swaps

1. Proposed Approach and Commenters' Views
    In the Proposing Release, we stated that the major participant 
analysis should consider the economic reality of swaps and security-
based swaps between affiliates, and preliminarily concluded that swaps 
or security-based swaps among wholly owned affiliates ``may not pose 
the exceptional risks to the U.S. financial system that are the basis 
for the major participant definitions.''\1109\
---------------------------------------------------------------------------

    \1109\ See Proposing Release, 75 FR at 80202.
---------------------------------------------------------------------------

    A number of commenters concurred that swaps among affiliates should 
be excluded from the major participant analysis.\1110\ At the same 
time, no commenters expressed support for the Proposing Release's 
suggestion that this interpretation be limited to transactions among 
wholly owned subsidiaries. Instead, several commenters expressed the 
view that the swaps or security-based swaps should not be counted for 
purposes of the major participant analysis when the counterparties are 
under common control,\1111\ or otherwise are affiliates.\1112\ One 
commenter suggested that the analysis exclude swaps or security-based 
swaps between entities that are under common control and whose 
financial statements are consolidated.\1113\
---------------------------------------------------------------------------

    \1110\ See, e.g., letters from COPE I, FSR I and Encana 
Marketing (USA) Inc. dated February 22, 2011 (``Encana I'').
     Some commenters explained the widespread use of central hedging 
desks to allocate risk within affiliate groups or to gather risk 
from within a group and lay off that risk on the market. See, e.g., 
letters from CDEU, EEI/EPSA, Encana I and FSR I. Also, some 
commenters noted that including these inter-affiliate transactions 
within the major participant analysis would result in many cases in 
double-counting of an entity's swap or security-based swap activity. 
See letters from CDEU and FSR I.
    \1111\ See letter from Amex and CDEU. One commenter specifically 
suggested that we adopt the definition of ``control'' found in the 
Bank Holding Company Act. See joint letter from The Bank of Tokyo-
Mitsubishi UFJ, Ltd., Mizuho Corporate Bank, Ltd. and Sumitomo 
Mitsui Banking Corporation.
    \1112\ See, e.g., letters from COPE I, EEI/EPSA, FSR I, Encana I 
and Utility Group.
    \1113\ See joint letter from ABA Securities Association, ACLI, 
FSR, FIA, Institute of International Bankers, ISDA and SIFMA.
---------------------------------------------------------------------------

2. Final Rule
    After considering commenters' views, we have concluded that the 
major participant definitions should not encompass a person's swaps or 
security-based swaps for which the counterparty is a majority-owned 
affiliate. As noted in our discussion of inter-affiliate activities in 
the context of the dealer definitions, market participants may enter 
into such inter-affiliate swaps or security-based swaps for a variety 
of purposes. When swaps and security-based swaps are entered into to 
allocate risk within a corporate group and do not pose a high 
likelihood of risk to the broader market--as we believe would be the 
case with majority ownership--we do not believe that their swaps and 
security-based swaps raise the systemic risk and other concerns that 
major participant regulation is intended to address. For this reason, 
we do not believe that this interpretation needs to be limited to swaps 
or security-based swaps among wholly owned affiliates, as the Proposing 
Release had indicated.
    Accordingly, the final rules provide that a person may exclude 
particular swaps or security-based swaps from the analysis of whether 
the person is a major participant, so long as the counterparties to 
those swaps or security-based swaps are majority-owned 
affiliates.\1114\
---------------------------------------------------------------------------

    \1114\ See CFTC Regulation Sec.  1.3(hhh)(4); Exchange Act rule 
3a67-3(e). A person's market-facing swap or security-based swap 
positions, including those taken to lay off risk assumed from a 
majority-owned affiliate, must still be included in the person's 
substantial position and counterparty exposure calculations.
     For the purposes of this rule, and consistent with the general 
inter-affiliate exception from the dealer definitions, see part 
II.C, supra, counterparties are majority-owned affiliates if one 
party directly or indirectly owns a majority interest in the other, 
or if a third party directly or indirectly owns a majority interest 
in both, based on the right to vote or direct the vote of a majority 
of a class of voting securities of an entity, the power to sell or 
direct the sale of a majority of a class of voting securities of an 
entity, or the right to receive upon dissolution or the contribution 
of a majority of the capital of a partnership.
---------------------------------------------------------------------------

    In taking this approach, we have also considered alternatives 
suggested by commenters. For example, while one commenter suggested 
that we allow the exclusion of all swaps or security-based swaps 
between entities under common control, we believe that such an approach 
would be overly inclusive for the purpose of identifying transactions 
that should be excluded from the major participant analysis, given that 
common control by itself does not ensure that two entities' economic 
interests are sufficiently aligned.\1115\ Also, one commenter suggested 
that the inter-affiliate exclusion should apply to swaps and security-
based swaps between affiliates whose financial statements are 
consolidated, but, as we

[[Page 30688]]

addressed in the context of the dealer definitions, we do not believe 
that the scope of this exclusion should be exposed to the risk of 
future changes in accounting standards.\1116\
---------------------------------------------------------------------------

    \1115\ See part II.C.2, supra.
    \1116\ See text accompanying note 350, supra.
---------------------------------------------------------------------------

H. Application to Positions of Affiliated Entities and to Guarantees

1. Proposed Approach
    The Proposing Release expressed the preliminary view that when a 
parent is the majority owner of a subsidiary entity, the subsidiary's 
swap or security-based swap positions may be aggregated at the parent 
for purposes of the major participant analysis, on the grounds that the 
parent effectively is the beneficiary of the transaction. At the same 
time, the Proposing Release acknowledged that there could remain 
questions as to whether the requirements applicable to major 
participants--such as capital, margin and business conduct 
requirements--should be placed upon the parent or the subsidiary.\1117\
---------------------------------------------------------------------------

    \1117\ The Proposing Release further recognized that it may be 
appropriate at times to place the requirements upon the subsidiary 
to the extent the subsidiary is acting on behalf of the parent. See 
Proposing Release, 75 FR at 80202.
---------------------------------------------------------------------------

    The Proposing Release solicited comment on a number of aspects of 
these issues, including whether attribution would be appropriate when 
there is less than majority ownership, or when a parent provides 
guarantees on behalf of its subsidiaries. The Proposing Release also 
solicited comment with regard to implementation issues.\1118\
---------------------------------------------------------------------------

    \1118\ See id.
---------------------------------------------------------------------------

2. Commenters' Views
    A number of commenters expressed the view that the Commissions 
should not aggregate the positions of affiliates to the parent, arguing 
that legal separation should be respected unless there is some evidence 
that separate affiliates are being used to evade regulation.\1119\ 
Other commenters took the view that aggregation of affiliates' 
positions may be appropriate in some circumstances, such as when 
aggregation would accurately reflect the structure of a corporate group 
or its participation in the derivatives market.\1120\ One commenter 
recommended that if the Commissions choose to require the aggregation 
of affiliate positions for purposes of the major participant test, the 
Commissions also should provide a mechanism for entities to receive 
``disaggregation'' relief upon a showing that the affiliates are acting 
autonomously.\1121\
---------------------------------------------------------------------------

    \1119\ See letters from FSR I, ISDA, MetLife and Newedge. 
Certain of those commenters also warned of problems that could arise 
if the positions of international affiliates were aggregated, due to 
conflicting regulations potentially applicable to such entities. See 
letters from ISDA I, MetLife and Newedge. The Commissions are 
addressing issues related to the application of the major 
participant definitions to non-U.S. persons in separate releases.
    \1120\ See letters from CDEU (suggesting that control should be 
interpreted narrowly for purposes of the major participant test such 
that affiliated positions would only be aggregated if there is whole 
ownership or consolidation for accounting purposes, and exercise of 
actual control in terms of ownership and management) and ACLI 
(suggesting flexibility such that an entity with independent credit 
and no guarantee or credit support from a parent could be treated 
separately, but a corporate group could consolidate its affiliates' 
positions if that would accurately reflect its participation in the 
derivatives market).
    \1121\ See letter from Newedge.
---------------------------------------------------------------------------

    Some commenters argued that positions should not be consolidated 
for purposes of the major participant analysis even when a parent 
guarantees the obligations of a subsidiary.\1122\ Other commenters, 
however, expressed less opposition to aggregation in the presence of a 
guarantee or credit support.\1123\
---------------------------------------------------------------------------

    \1122\ See letters from APG (stating that the aggregation of 
inter-affiliate guaranteed transactions would raise costs without 
providing a corresponding benefit to the financial system, and that 
principal obligors and guarantors pose separate credit risks, which 
are already priced into the positions, and that guarantees are not 
traditionally regulated as swaps), CDEU (objecting to attributing 
the positions of an end-user affiliate that relies on a parent for 
credit support, primarily out of concern that an end-user that might 
otherwise avail itself of the end-user clearing exception might be 
forced to clear its transactions if they were attributed to the 
major participant parent), ISDA I and Twelve Firms (stating that the 
statutory major participant definitions do not indicate that they 
encompass contingent credit support arrangements, and that credit 
exposures of subsidiaries already will be addressed through 
regulation of the subsidiary).
    \1123\ See letters from FSR I (suggesting that there may be some 
situations in which the positions of different entities in a 
corporate group should be aggregated, such as when ``a parent entity 
guarantees the obligations of its subsidiaries that are engaging in 
swaps'') and MetLife (stating that ``it is not appropriate to 
require aggregation of subsidiaries' swaps at the parent level 
unless the parent is providing a guarantee or credit support for the 
subsidiaries' obligations''); see also letter from ACLI (stating 
that the positions of entities that do not have a guarantee or 
credit support from a parent are entitled to an individualized 
determination of their status under the major participant test).
---------------------------------------------------------------------------

    Commenters also addressed the application of these principles to 
particular types of entities. Some commenters took the view that 
positions guaranteed by financial guarantors should not be attributed 
to those entities for purposes of the major participant analysis.\1124\ 
Other commenters stated that the positions of a special purpose vehicle 
should not be aggregated with its sponsor where there is no recourse to 
the sponsor for the vehicle's obligations.\1125\ One commenter 
requested clarification that positions of joint ventures would not be 
aggregated with those of another entity if the positions are not 
consolidated on the other entity's balance sheet.\1126\ Commenters 
further took the view that ERISA plans should not be aggregated with 
those of plan sponsors for purposes of the major participant tests, 
noting that plans and sponsors are separate legal entities, file 
separate financial statements, are subject to separate regulatory 
schemes, and that plan sponsors are prohibited from providing credit 
support or guarantees to ERISA Title I plans.\1127\
---------------------------------------------------------------------------

    \1124\ See letters from AFGI (arguing against attribution on the 
grounds that the guarantors are typically not exposed to a 
fluctuating termination value of interest rate swaps for these types 
of transactions due to the fact that they do not guarantee that 
amount, but rather only guarantee continued payments of these 
policies, and also that they are subject to the standard 
underwriting process and thus are subject to comprehensive 
regulation) and joint letter from MBIA Inc., MBIA Insurance Corp. 
and National Public Finance Guarantee Corp. (``MBIA'') (arguing 
against attribution on the grounds that the economic exposure to the 
financial guarantor is the equivalent of having underwritten a fixed 
rate bond issued by the particular municipal entity, and such 
exposures are subject to the normal underwriting process and 
significant risk management and regulatory oversight).
    \1125\ See letters from American Securitization Forum 
(suggesting that aggregation is not appropriate when the risk is 
contained within the special purpose vehicle, and noting that 
special purpose vehicles often bear the entire economic risk of a 
security-based swap transaction and are bankruptcy remote, so the 
failure of a special purpose vehicle to meet its obligations would 
not have a rippling effect onto its sponsor) and FSR I (stating that 
the major participant determination should focus on a special 
purpose entity itself, and not its sponsor or transferor, in 
circumstances where securitization vehicles have been consolidated 
with sponsors or transferors for financial accounting purposes but a 
counterparty would have to conduct a separate credit analysis on the 
special purpose entity, and its obligations are nonrecourse to the 
sponsor or transferor).
    \1126\ See letter from CDEU (noting that non-consolidated joint 
ventures typically enter into their own swaps and these transactions 
are not included on the balance sheet of a minority holder in a 
joint venture).
    \1127\ See letters from CDEU and ERISA Industry Committee.
---------------------------------------------------------------------------

    Two commenters addressed operational compliance issues that would 
be raised if positions are aggregated for purposes of the major 
participant analysis. One commenter suggested that a corporate group 
that falls within the major participant definition due to its aggregate 
positions should be able to designate a single entity to undertake 
compliance on behalf of the other affiliates.\1128\ Another commenter 
stated that when the aggregated positions of a corporate group results 
in major participant designation, the Commissions should

[[Page 30689]]

exempt from major participant regulation all affiliates in the 
corporate group that otherwise would qualify for the end-user clearing 
exception.\1129\
---------------------------------------------------------------------------

    \1128\ See letter from FSR I (suggesting that a corporate group 
should be permitted to designate a single entity or a small number 
of entities as the registered major participant, with other entities 
in the group relying on that entity for compliance).
    \1129\ See letter from CDEU.
---------------------------------------------------------------------------

3. Final Interpretation
    After considering commenter concerns and the underlying issues, we 
are revising certain of the preliminary views we expressed in the 
Proposing Release. In particular, we no longer take the position that a 
subsidiary's swap or security-based swap position as a matter of course 
should be attributed to the subsidiary's majority-owner parent. 
Instead, consistent with the approach discussed below with regard to 
managed accounts,\1130\ an entity's swap or security-based swap 
positions in general would be attributed to a parent, other affiliate 
or guarantor for purposes of the major participant analysis to the 
extent that the counterparties to those positions would have recourse 
to that other entity in connection with the position. Positions would 
not be attributed in the absence of recourse.\1131\ We believe this 
approach in general appropriately reflects the risk focus of the major 
participant definitions by providing that entities will be regulated as 
major participants when they pose a high level of risk in connection 
with the swap and security-based swap positions they guarantee.\1132\ 
Indeed, the events surrounding the failure of AIG FP highlights how the 
guarantees can cause major risks to flow to the guarantor.\1133\
---------------------------------------------------------------------------

    \1130\ See part IV.I, infra.
    \1131\ In taking this position, we are not suggesting that the 
presence of a guarantee would be determinative of other issues 
arising under Title VII. For example, the fact that a parent that is 
a ``financial entity'' guarantees a subsidiary's swap or security-
based swap positions would not foreclose the subsidiary from taking 
advantage of the exception from mandatory clearing that is available 
to commercial end-users.
    \1132\ In reaching this conclusion, we have been mindful of 
views expressed by some commenters that the mere fact of a guarantee 
should not be enough to require the attribution of a position to a 
guarantor. We believe, however, that this approach is best suited to 
address the risk focus of the major participant definitions. We 
further believe that the statutory definition's language that 
addresses persons who ``maintain'' substantial positions or 
``whose'' positions create substantial counterparty exposure is 
consistent with this approach.
    We also have considered arguments that the major participant 
definition should not extend to financial guarantee insurers. We 
nonetheless believe that when an insurer guarantees the performance 
of other parties' swap or security-based swap positions, in an 
amount that is greater than the applicable major participant 
thresholds, it would be appropriate to regulate that entity as a 
major participant. When the guaranteed positions are large enough, 
the risks associated with those positions and the repercussions of 
the guarantor's default would appear to be within the ambit of the 
risks that that the major participant definitions were intended to 
capture. In reaching this conclusion, the Commissions are not 
expressing a view regarding whether financial guarantee insurance is 
a swap or security-based swap. See Product Definitions Proposal, 
note 3, supra.
    \1133\ ``AIGFP's obligations were guaranteed by its highly-rated 
parent company * * * an arrangement that facilitated easy money via 
much lower interest rates from the public markets, but ultimately 
made it difficult to isolate AIGFP from its parent, with disastrous 
consequences.'' The AIG Rescue, Its Impact on Markets, and the 
Government's Exit Strategy, note 913, supra, at 20.
---------------------------------------------------------------------------

    Even in the presence of a guarantee, however, we do not believe 
that it is necessary to attribute a person's swap or security-based 
swap positions to a parent or other guarantor if the person already is 
subject to capital regulation by the CFTC or SEC (i.e., swap dealers, 
security-based swap dealers, major swap participants, major security-
based swap participants, FCMs and broker-dealers) or if the person is a 
U.S. entity regulated as a bank in the United States. Positions of 
those regulated entities already will be subject to capital and other 
requirements, making it unnecessary to separately address, via major 
participant regulations, the risks associated with guarantees of those 
positions.\1134\
---------------------------------------------------------------------------

    \1134\ As a result of this interpretation, holding companies 
will not be deemed to be major participants as a result of 
guarantees to certain U.S. entities that already are subject to 
capital regulation. The Commissions intend to address guarantees 
provided to non-U.S. entities, and guarantees by non-U.S. holding 
companies, in separate releases.
---------------------------------------------------------------------------

    We recognize that attribution of swap or security-based swap 
positions to a parent or guarantor for purposes of the major 
participant analysis can raise special issues with regard to 
operational compliance. These include, for example, issues as to the 
application of the transaction-focused requirements applicable to 
registered major participants (e.g., certain requirements related to 
trading records and transaction confirmations), given that the entity 
that directly is the party to the swap or security-based swap may be 
better positioned to comply with those requirements. For those 
transaction-focused requirements, we believe that an entity that 
becomes a major participant by virtue of swaps or security-based swaps 
directly entered into by others must be responsible for compliance with 
all applicable major participant requirements with respect to those 
swaps or security-based swaps (and must be liable for failures to 
comply), but may delegate operational compliance with transaction-
focused requirements to entities that directly are party to the 
transactions. The entity that is the major participant, however, cannot 
delegate compliance duties with the entity-level requirements 
applicable to major participants (e.g., requirements related to 
registration and capital).\1135\
---------------------------------------------------------------------------

    \1135\ This type of attribution may also be expected to raise 
special issues of application in the context of guarantees involving 
swap or security-based swap positions of non-U.S. entities. The 
Commissions intend to address those issues in separate releases.
---------------------------------------------------------------------------

I. Application to Managed Accounts

1. Proposed Approach
    The Proposing Release expressed the preliminary view that the major 
participant definitions should not be interpreted to cause asset 
managers or investment advisers to be major participants by virtue of 
the swap and security-based swap positions of the accounts that they 
manage.\1136\ In addition, the Proposing Release expressed the 
preliminary view that the managed positions for which a person is a 
beneficial owner should be aggregated with the person's other positions 
for the purpose of determining whether the beneficial owner is a major 
participant.\1137\
---------------------------------------------------------------------------

    \1136\ In reaching this preliminary conclusion, we considered 
the text of the major participant definitions, as well as a colloquy 
on the Senate floor that addressed the status of managed accounts 
for purposes of the major participant definitions. See Proposing 
Release, 75 FR at 80201 & n.162.
    The Proposing Release also noted that the Commissions have anti-
evasion authority to the extent that persons seek to allocate swaps 
or security-based swaps among different accounts to seek to evade 
the regulations applicable to major participants. See id. at 80201.
    \1137\ See id.
---------------------------------------------------------------------------

2. Commenters' Views
    Numerous commenters supported the view that the major participant 
definitions should not be construed to aggregate the accounts managed 
by asset managers or investment advisers when determining whether a 
manager or adviser itself is a major participant.\1138\ One commenter 
requested that the final rules codify this principle.\1139\
---------------------------------------------------------------------------

    \1138\ See, e.g., letters from BlackRock I and Fidelity.
    \1139\ See letter from Fidelity (particularly addressing fund 
managers).
---------------------------------------------------------------------------

    Some commenters opposed the possibility that the swap or security-
based swap positions of mutual funds would be attributed to fund 
investors for purposes of the major participant analysis, emphasizing 
that the fund is the entity that bears the credit exposure.\1140\ Some 
commenters also opposed the possibility that a swap or security-based 
swap position of a managed account may be attributed to the account's 
beneficial owner when the counterparty to the position does not

[[Page 30690]]

have recourse to the beneficial owner's assets.\1141\
---------------------------------------------------------------------------

    \1140\ See letter from BlackRock and joint letter from ICI and 
SIFMA AMG.
    \1141\ See letters from SIFMA AMG II (stating that ISDA Master 
Agreements commonly provide that the counterparty to the transaction 
does not have recourse to the accountholder's other assets held in 
different accounts) and Fidelity (stating that when counterparties 
look solely to the credit and assets of an individual account, the 
actual risks to the counterparty are tied to and limited by the 
activities of the account; also stating that requiring aggregation 
of separate accounts based on beneficial ownership would be 
complicated, costly, and present substantial operational and legal 
complexities); see also letter from BlackRock I (stating the 
understanding that the Proposing Release's reference to beneficial 
ownership to require that separate account positions be attributed 
to the owner of the separate account, and stating that this result 
would be consistent with the definitions' focus on the persons whose 
positions create credit risk).
    Commenters also emphasized potential impracticalities of 
requiring asset managers to be responsible for making major 
participant determinations on behalf of beneficial owners. See, 
e.g., letter from SIFMA AMG II.
---------------------------------------------------------------------------

    One commenter encouraged the Commissions to consider developing 
anti-evasion measures if necessary, but cautioned that the rules should 
recognize that there are legitimate business reasons to structure 
separate, individually managed funds.\1142\ Another commenter dismissed 
concerns that entities may spread assets among many asset managers or 
use separate trading agreements to avoid regulation.\1143\
---------------------------------------------------------------------------

    \1142\ See letter from AIMA I.
    \1143\ See letter from SIFMA AMG II (arguing that it would be 
unlikely for this sort of evasion to actually occur since such 
tactics would be prohibitively expensive and operationally 
burdensome, and further stating that the Commissions could address 
such concerns through their anti-evasion authority).
    Also, one commenter suggested that major participant obligations 
should be limited in their territorial scope and should only apply 
to U.S. funds or those funds that are otherwise regulated in the 
U.S. See letter from AIMA I. The Commissions are addressing issues 
related to the application of the major participant definitions to 
non-U.S. persons in separate releases.
---------------------------------------------------------------------------

    In addition, commenters raised related issues regarding the 
potential attribution of positions for purposes of the major 
participant analysis. Some commenters expressed the view that insurance 
company separate accounts should be excluded from the major participant 
determination for the insurer, because those separate accounts 
generally are segregated from the insurance company's other 
accounts.\1144\ Two commenters requested clarification as to how swap 
and security-based swap positions of funds with a ``master-feeder'' 
structure should be allocated for the major participant 
determinations.\1145\
---------------------------------------------------------------------------

    \1144\ See letters from ACLI, FSR I and MetLife.
    \1145\ See letters from MFA I (stating that in master-feeder 
fund structures, money that is invested flows to the master fund for 
actual investing or trading, and further explaining that the master 
fund: Is the party to the master trading agreements; negotiates the 
individual transactions; holds assets; receives the margin calls; is 
ultimately responsible for posting collateral; and is the entity to 
whom recourse is generally limited) and CCMR I.
---------------------------------------------------------------------------

3. Final Interpretation
    Consistent with the approach set forth in the Proposing Release, 
the Commissions do not believe that it is necessary to consider the 
swap or security-based swap positions of the client accounts managed by 
asset managers or investment advisers when determining whether those 
entities are major participants. In reaching this conclusion we 
particularly are influenced by the fact that the statutory definitions 
specifically address entities that ``maintain'' substantial positions 
or ``whose'' outstanding swaps and security-based swaps create 
substantial counterparty exposure. Our conclusion also is influenced by 
the fact that it would not appear appropriate to impose certain 
regulations applicable to major participants (e.g., capital) upon those 
entities.\1146\
---------------------------------------------------------------------------

    \1146\ We do not believe that it is necessary to codify this 
interpretation.
---------------------------------------------------------------------------

    Separately, after carefully considering commenters' views and the 
purposes of major participant regulation, we are modifying the 
preliminary views expressed in the Proposing Release regarding the 
application of the major participant analyses to the beneficial owners 
of managed swap and security-based swap positions. In particular, we 
conclude that the major participant analysis that applies to the 
beneficial owners of those positions should focus on where the risk 
associated with those positions ultimately resides, given how the 
statutory major participant definitions focus on the risks posed by 
large swap or security-based swap positions. Thus, for example, if the 
counterparties to a swap or security-based swap position within a 
managed account have recourse only to the assets of that account in the 
event of default--and lack recourse to other assets of the beneficial 
owners--we do not believe that it would be appropriate to attribute 
that position to its beneficial owner. \1147\ Conversely, to the extent 
that the counterparty to that position also has recourse to the 
beneficial owner, it would be appropriate to attribute the positions to 
the beneficial owner for purposes of the major participant 
analysis.\1148\
---------------------------------------------------------------------------

    \1147\ Thus, for example, there would not be recourse to the 
owners of shares in a registered investment company that maintains 
swap or security-based swap positions.
    \1148\ For example, under some circumstances the positions 
within the managed account may make use of a credit support annex 
entered into by the beneficial owner. In that case, the counterparty 
to the account's swaps and security-based swaps may have legal 
recourse to the beneficial owner, making it appropriate to attribute 
the position to the beneficial owner for purposes of the major 
participant analysis.
---------------------------------------------------------------------------

    We believe that this general approach of attributing positions when 
recourse is possible also is applicable with respect to related issues 
raised by commenters, including issues related to insurance company 
separate accounts and master-feeder fund arrangements. For those 
situations the same principle would apply--positions within an account 
or entity may be attributed to another entity for purposes of the major 
participant analysis if the counterparties to those positions can seek 
recourse from that other entity.

J. Requests for Exclusion of Certain Entities From the Major 
Participant Definitions

1. Proposed Approach
    In advance of the Proposing Release, a number of commenters argued 
that the Commissions should exclude various types of entities from the 
major participant definitions.\1149\ While the proposed rules did not 
incorporate any such exclusions, the Proposing Release solicited 
comment as to potential exclusions for: Entities that maintain legacy 
portfolios, investment companies, ERISA plans, registered broker-
dealers and/or registered FCMs, sovereign wealth funds, banks, state-
regulated insurers, private and state pension plans, and registered 
DCOs or clearing agencies.\1150\
---------------------------------------------------------------------------

    \1149\ These comments were submitted in response to the ANPRM. 
See notes 4 and 5, supra.
    \1150\ See Proposing Release, 75 FR at 80202-03.
---------------------------------------------------------------------------

2. Commenters' Views
    Several commenters supported categorical exclusions from the major 
participant definitions for various types of entities. Commenters 
particularly urged the Commissions to provide exclusions for:
     Entities that maintain legacy portfolios of swaps and 
security-based swaps that are in run-off;\1151\
---------------------------------------------------------------------------

    \1151\ See, e.g., letters from Canadian MAVs, ISDA I and MBIA.
---------------------------------------------------------------------------

     Registered investment companies and related investment 
advisers;\1152\
---------------------------------------------------------------------------

    \1152\ See letters from Fidelity and Vanguard and joint letter 
from ICI and SIFMA AMG.
---------------------------------------------------------------------------

     ERISA plans, other pension funds, and endowments;\1153\
---------------------------------------------------------------------------

    \1153\ See letters from CDEU, ERISA Industry Committee and SIFMA 
AMG II (addressing ERISA plans); see also letters from ABC/CIEBA, 
CalSTRS I, Fidelity and SIFMA AMG II, (addressing government plans) 
and letter from Government of Singapore Investment Corp. (``GIC'') 
(addressing other pension plans and endowments). But see letter from 
AFSCME (urging caution with respect to a full exclusion of plan 
swaps from major participant consideration).

---------------------------------------------------------------------------

[[Page 30691]]

     Insurance companies;\1154\
---------------------------------------------------------------------------

    \1154\ See letters from AFGI (supporting exclusion for state-
regulated insurers), NAIC (supporting exclusion for state-regulated 
insurers to the extent they are using derivatives for the purpose of 
hedging and not engaging in systemically significant derivatives 
activities determined by the Financial Stability Oversight Counsel), 
ACLI (supporting exclusion for life insurers) and AIA (supporting 
exclusion for property-casualty insurers).
---------------------------------------------------------------------------

     Certain registered FCMs and broker-dealers.\1155\
---------------------------------------------------------------------------

    \1155\ See letter from Newedge (supporting exclusion for 
registered FCMs and broker-dealers that engage principally in 
customer swap facilitation activities but not in other activities of 
swap or security-based swap dealers).
---------------------------------------------------------------------------

     End users; \1156\ and
---------------------------------------------------------------------------

    \1156\ Commenters making this point varied in their phrasing of 
the requested exclusion. One request asked for the exclusion of any 
company (regardless of its primary business) that uses swaps 
predominantly to hedge business risks and that does not pose 
systemic risk. See letter from CDEU. Another commenter asked for the 
exclusion of any end user employing prudent risk management. See 
letter from NAIC. And one commenter asked for the exclusion of 
energy companies that use swaps to hedge commercial risks. See 
letter from EDF Trading.
---------------------------------------------------------------------------

     Various types of non-U.S. persons, including: foreign 
governments and their agencies and instrumentalities (such as central 
banks, treasury ministries, export agencies and governmental financing 
authorities),\1157\ international organizations and multilateral 
development banks,\1158\ sovereign wealth funds,\1159\ and non-U.S. 
entities subject to comparable foreign regulation.\1160\
---------------------------------------------------------------------------

    \1157\ See letters from Milbank Tweed and Norges Bank Investment 
Management and meeting with Kreditanstalt f[uuml]r Wiederaufbau 
(``KfW'').
    \1158\ See letter from World Bank Group.
    \1159\ See letters from China Investment Corporation (``CIC'') 
and GIC.
    \1160\ See letters from Newedge and SIFMA AMG II.
---------------------------------------------------------------------------

    Commenters articulated a range of rationales in support of such 
exclusions. These included arguments that particular types of entities: 
(i) Are unlikely to meet one or more of the major participant tests; 
\1161\ (ii) already are subject to regulation (and in some cases are 
subject to prudential limits on their use of swaps or security-based 
swaps);\1162\ (iii) do not pose systemic risk \1163\ and/or the type of 
counterparty risk contemplated by Title VII; \1164\ or (iv) do not 
raise concerns given that they would remain subject to the clearing, 
exchange trading, and reporting requirements of Title VII.\1165\ Also, 
some commenters maintained that regulating non-U.S. entities as major 
participants would raise issues with respect to extra-territoriality, 
international comity and sovereignty.\1166\
---------------------------------------------------------------------------

    \1161\ See letters from AIMA I (addressing hedge fund managers 
registered as investment advisers); AIA (addressing property-
casualty insurers) and Newedge (addressing FCMs and broker-dealers).
    \1162\ See letters from Fidelity and Vanguard and joint letter 
from ICI and SIFMA AMG (addressing registered investment companies 
and their advisors), ABC/CIEBA, CDEU, ERISA Industry Committee and 
Fidelity (addressing ERISA plans and government benefit plans), ACLI 
(addressing life insurers), AIA (addressing property-casualty 
insurers), NAIC (addressing state-regulated insurers), Newedge 
(addressing FCMs and broker-dealers) and GIC (addressing sovereign 
wealth funds).
    \1163\ See letters from ABC/CIEBA and CDEU (addressing ERISA 
plans), ICI I and Vanguard (addressing registered investment 
companies), ACLI (addressing life insurers), CDEU and NAIC 
(addressing end users), and letter from CIC and meeting with Weil 
(addressing sovereign wealth funds).
    \1164\ See letters from CDEU and ERISA Industry Committee 
(addressing ERISA plans) and letter from GIC and meeting with Weil 
(addressing sovereign wealth funds).
    \1165\ See letters from Vanguard (addressing registered 
investment companies), Newedge (addressing FCMs and broker-dealers), 
and CIC (addressing sovereign wealth funds).
    \1166\ See letters from CIC, GIC, and Milbank Tweed and meeting 
with KfW (addressing foreign governments and their agencies and 
instrumentalities), meeting with Weil (addressing sovereign wealth 
funds)and letter from World Bank Group (addressing international 
organizations and multilateral development banks).
---------------------------------------------------------------------------

    In contrast to these requests, one commenter urged that the 
benefits arising from regulation of major participants be considered in 
determining whether to create carve-outs from the participant 
definitions that are not provided in the statute.\1167\
---------------------------------------------------------------------------

    \1167\ See letter from AFSCME.
---------------------------------------------------------------------------

3. Final Rules
    After considering the comments received and the underlying issues, 
the Commissions have determined not to provide categorical exclusions 
from the major participant definitions for the types of entities 
discussed by commenters.
a. Entities That Maintain Legacy Portfolios
    Commenters that supported the exclusion of entities with legacy 
portfolios of swaps or security-based swaps emphasized that those 
portfolios are in run-off, and that those entities generally do not 
engage in ongoing swap or security-based swap activity.\1168\ Several 
of those commenters further expressed concerns that imposing the 
regulations applicable to major participants--particularly margin and 
capital rules--upon these entities could cause them to default on their 
obligations and lead to market disruption.\1169\
---------------------------------------------------------------------------

    \1168\ See letters from AFGI, BlackRock I, Canadian MAVs, ISDA I 
and MBIA and meetings with Athilon Structured Investment Advisors 
(``Athilon'') on April 18, 2011 and with Cypress Group, Invicta 
Financial Group, Primus Asset Management, Inc., and Quadrant 
Structured Investment Advisors on April 7, 2011.
    Although the Proposing Release specifically addressed granting 
an exclusion in connection with legacy positions entered into by 
monoline insurers and credit derivative product companies, 
commenters expressed the view that such an exclusion should apply to 
other types of entities that maintain legacy portfolios, such as 
certain special purpose vehicles. See letters from BlackRock I, 
Canadian MAVs and ISDA.
    \1169\ See letters from Athilon, BlackRock I, Canadian MAVs, and 
ISDA I.
---------------------------------------------------------------------------

    In the view of the Commissions, the fact that these entities no 
longer engage in new swap or security-based swap transactions does not 
overcome the fact that entities that are major participants will have 
portfolios that are quite large and could pose systemic risk to the 
U.S. financial system.
    We are mindful of the significance of concerns that regulating 
entities that maintain legacy portfolios has the potential to lead to 
defaults and disruption. We do not believe, however, that these 
concerns are best addressed by excluding those entities from major 
participant regulation. Instead, in adopting substantive rules 
applicable to major participants, the Commissions intend to pay 
particular attention to the special issues raised by the application of 
those rules to legacy portfolios.\1170\ Moreover, to the extent that 
these types of concerns remain following the promulgation of those 
final substantive rules, the Commissions may entertain requests for 
relief or guidance on a case-by-case basis.
---------------------------------------------------------------------------

    \1170\ For example, in conjunction with the SEC's proposed 
margin and capital rules applicable to major participants, the SEC 
expects to request comment on how the rules should apply to entities 
with legacy portfolios.
---------------------------------------------------------------------------

b. Other Domestic Entities
    Commenters also raised concerns regarding duplicative regulation 
for entities that already are subject to other types of regulation 
(e.g., state-regulated insurers, SEC-regulated registered investment 
companies and broker-dealers, and CFTC-regulated registered FCMs). The 
final rules nonetheless provide no such exclusion. The Dodd-Frank Act 
provided for the regulation of major participants against the backdrop 
of existing state and federal regulation, without opting to 
categorically exclude particular types of entities. Indeed, the 
definitions explicitly anticipate that

[[Page 30692]]

pension plans \1171\ and banks \1172\--both of which are subject to 
existing regulation--may be major participants. Major participant 
regulation provides a regulatory structure prescribed by the Dodd-Frank 
Act to address the risks posed by entities whose swap or security-based 
swap positions are large enough to satisfy the major participant 
definitions. Other types of regulations to which these entities may be 
subject serve different objectives \1173\ that are not substitutes for 
major participant regulation.\1174\
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    \1171\ The first major participant test (but not the second or 
third tests) excludes positions maintained by certain employee 
benefit plans for the primary purpose of hedging or mitigating any 
risk directly associated with the operation of the plan. See CEA 
section 1a(33)(A)(i)(II); Exchange Act section 3(a)(67)(A)(ii)(I). 
This tailored exclusion of certain pension plan positions suggests 
that Congress did not intend to broadly exclude such plans from the 
other two prongs or from the major participant definitions as a 
whole. The fact that, as two commenters noted (see letters from ABC/
CIEFA and CDEU), the CFTC previously has relied on the regulatory 
structure already governing ERISA plans as a basis to not regulate 
these plans in other certain unrelated contexts does not alter this 
conclusion.
    \1172\ The third major participant test excludes entities that 
are subject to bank capital standards, which suggests that such 
entities may be eligible to be major participants under the first 
and second tests. Also, the capital and margin requirements 
applicable to major swap participants and major security-based swap 
participants (see Dodd-Frank Act sections 731 and 764, respectively) 
do not apply to major participants subject to capital rules set by 
bank regulators, which further indicates that such entities may be 
major participants.
    \1173\ As some commenters noted, entities excluded from the 
major participant definitions nonetheless may be subject to other 
requirements of general applicability imposed by Title VII, such as 
clearing, trade execution, and reporting requirements. Even where 
that is the case, though, these requirements serve separate and 
independent purposes. They do not stand as a substitute for the 
protections that Congress has prescribed with respect to major 
participants in particular.
    \1174\ For example, as noted above, some commenters stated that 
the major participant definitions should not apply to investment 
companies registered under the ICA. See, e.g., letters from 
Fidelity, ICI I and Vanguard. However, we are not adopting any such 
exclusions in part because the major participant definitions focus 
on the market impacts of an entity's swap and security-based swap 
positions and the risk to the U.S. financial system generally, areas 
that are not the focus of the regulation of investment companies 
under the ICA. Moreover, based on our understanding of the swap and 
security-based swap activity of registered investment companies, we 
believe that registered investment companies generally are not 
likely to meet the thresholds of the major participant definitions. 
We will continue to monitor the effects of the rules we are adopting 
today to help ensure that they do not result in any inadvertent 
consequences for registered investment companies, or other entities 
registered with the SEC or CFTC.
---------------------------------------------------------------------------

    The Commissions expect that only a very few entities within a given 
category may meet the test of being a major swap participant--or even 
be close to the various thresholds for meeting that test. Entities that 
do not meet the thresholds of the major participant definitions do not 
need an exclusion from those definitions. Further, as noted elsewhere 
in this Adopting Release, the Commissions are permitting entities to 
rely on a ``safe harbor'' when their positions are far below any 
threshold for any particular quarter. Some of the entities for which 
exclusion has been sought may be expected to fall within the safe 
harbor. Those comparatively fewer entities that will be closer to a 
particular threshold, by contrast, should not be excused on a per se 
basis from completing the calculations set forth in these rules and, if 
the calculations demonstrate that the entity meets the test of a major 
participant, from compliance with the requirements for major 
participants set forth by Congress.
    At the same time, the Commissions recognize the benefits of 
efficiently regulating major participants that are separately 
registered with and regulated by the CFTC or SEC (such as registered 
FCMs or broker-dealers).\1175\ If any such registrants are required 
also to register as major participants, the CFTC and SEC would seek to 
coordinate their regulatory oversight as appropriate to achieve the 
independent purposes of major participant regulation and those separate 
regulatory requirements, while avoiding unnecessary duplication.\1176\
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    \1175\ The Commissions also sought comment as to whether the 
major participant definitions should apply to derivatives clearing 
organizations or clearing agencies, but received no comments in 
response to this inquiry. Nonetheless, the Commissions do not 
believe that Congress intended derivatives clearing organizations 
registered with the CFTC or clearing agencies registered with the 
SEC to be registered or regulated as major participants. The CFTC 
and the SEC already exercise substantive regulatory oversight over 
these clearinghouses, authority that was enhanced by Title VII. 
Further, Title VIII of the Dodd-Frank Act provides for the 
supervision of systemically important derivatives clearing 
organizations and clearing agencies. See Dodd-Frank Act Title VIII. 
We do not believe that Congress intended to place a third layer of 
oversight on those entities by subjecting them to additional 
regulation as major participants, and we do not interpret the major 
participant definitions to do so.
    \1176\ For many years, the Commissions have coordinated their 
examination of dually-registered FCM/BDs through working groups 
including the Joint Audit Committee and the Intermarket Financial 
Surveillance Group. Moreover, pursuant to Title IV of the Dodd-Frank 
Act, the CFTC and SEC have issued joint reporting rules for advisors 
to private funds that are dually registered with the SEC as 
investment advisers and with the CFTC as commodity pool operators or 
commodity trading advisors. See CFTC and SEC, Reporting by 
Investment Advisers to Private Funds and Certain Commodity Pool 
Operators and Commodity Trading Advisors on Form PF; Final Rule, 76 
FR 71127 (Nov. 16, 2011).
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c. Foreign Entities
    Commenters \1177\ discussed the major participant definitions in 
the context of foreign governments and various entities related to 
foreign governments \1178\ (i.e., foreign central banks,\1179\ 
international financial institutions \1180\ and sovereign wealth 
funds). The CFTC provides the following guidance with respect to the 
major swap participant definition and the swap dealer definition.\1181\
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    \1177\ See letters from CIC, GIC, Milbank Tweed, Norges Bank 
Investment Management and the World Bank, and meetings with KfW and 
Weil.
    \1178\ For this purpose, we consider that the term ``foreign 
government'' includes KfW, which is a non-profit, public sector 
entity responsible to and owned by the federal and state authorities 
in Germany, mandated to serve a public purpose, and backed by an 
explicit, full, statutory guarantee provided by the German federal 
government.
    \1179\ For this purpose, we consider the Bank for International 
Settlements, in which the Federal Reserve and foreign central banks 
are members, to be a foreign central bank. See http://www.bis.org/about/orggov.htm.
    \1180\ For this purpose, we consider the ``international 
financial institutions'' to be those institutions defined as such in 
22 U.S.C. 262r(c)(2) and the institutions defined as ``multilateral 
development banks'' in the Proposal for the Regulation of the 
European Parliament and of the Council on OTC Derivative 
Transactions, Central Counterparties and Trade Repositories, Council 
of the European Union Final Compromise Text, Article 1(4a(a)) (March 
19, 2012). There is overlap between the two definitions, but 
together they include the following institutions: the International 
Monetary Fund, International Bank for Reconstruction and 
Development, European Bank for Reconstruction and Development, 
International Development Association, International Finance 
Corporation, Multilateral Investment Guarantee Agency, African 
Development Bank, African Development Fund, Asian Development Bank, 
Inter-American Development Bank, Bank for Economic Cooperation and 
Development in the Middle East and North Africa, Inter-American 
Investment Corporation, Council of Europe Development Bank, Nordic 
Investment Bank, Caribbean Development Bank, European Investment 
Bank and European Investment Fund. (The term international financial 
institution includes entities referred to as multilateral 
development banks. The International Bank for Reconstruction and 
Development, the International Finance Corporation and the 
Multilateral Investment Guarantee Agency are parts of the World Bank 
Group.)
    \1181\ The SEC intends to address issues related to the 
application of the major security-based swap participant definition 
to non-U.S. entities as part of a separate release that the SEC is 
issuing in connection with the application of Title VII to non-U.S. 
persons. The SEC is also able to address concerns related to the 
individual substantive rules applicable to major security-based swap 
participants on a case-by-case basis.
---------------------------------------------------------------------------

    As an initial matter, foreign entities are not necessarily immune 
from U.S. jurisdiction for commercial activities undertaken with U.S. 
counterparties or in U.S. markets.\1182\ In accordance with

[[Page 30693]]

the general rule, a per se exclusion for foreign entities from the 
CEA's major swap participant or swap dealer definition, therefore, is 
inappropriate. A foreign entity's swap activity may be commercial in 
nature and may qualify it as a swap dealer or major swap participant. 
Registration and regulation as a swap dealer or major swap participant 
under such circumstances may be warranted.\1183\ This is particularly 
true for foreign corporate entities and sovereign wealth funds, which 
act in the market in the same manner as private asset managers.
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    \1182\ See Foreign Sovereign Immunities Act of 1976, 28 U.S.C. 
1602 (``under international law, states are not immune from the 
jurisdiction of foreign courts insofar as their commercial 
activities are concerned * * * Claims of foreign states to immunity 
should henceforth be decided by courts of the United States and of 
the States in conformity with the principles set forth in this 
chapter.''). See also Mendaro v. World Bank, 717 F.2d 610 (DC Cir. 
1983) (multilateral development banks generally do not have immunity 
in connection with their commercial dealings in the United States); 
Osseiran v. International Financial Corp., 552 F.3d 836 (DC Cir. 
2009) (same); Vila v. Inter-American Investment Corp., 570 F.3d 274 
(DC Cir. 2009) (same).
    \1183\ Such a registration requirement would have to satisfy the 
requirements of CEA section 2(i), 7 U.S.C. 2(i), which provides that 
the provisions of Title VII relating to swaps ``shall not apply to 
activities outside the United States unless those activities--(1) 
Have a direct and significant connection with activities in, or 
effect on, commerce of the United States; or (2) contravene such 
rules or regulations as the Commission 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 of the Dodd-
Frank Act.
---------------------------------------------------------------------------

    On the other hand, the sovereign or international status of foreign 
governments, foreign central banks and international financial 
institutions that themselves participate in the swap markets in a 
commercial manner is relevant in determining whether such entities are 
subject to registration and regulation as a major swap participant or 
swap dealer. Canons of statutory construction ``assume that legislators 
take account of the legitimate sovereign interests of other nations 
when they write American laws.'' \1184\ There is nothing in the text or 
history of the swap-related provisions of Title VII to establish that 
Congress intended to deviate from the traditions of the international 
system by including foreign governments, foreign central banks and 
international financial institutions within the definitions of the 
terms ``swap dealer'' or ``major swap participant,'' thereby requiring 
that they affirmatively register as swap dealers or major swap 
participants with the CFTC and be regulated as such.\1185\ The CFTC 
does not believe that foreign governments, foreign central banks and 
international financial institutions should be required to register as 
swap dealers or major swap participants.
---------------------------------------------------------------------------

    \1184\ See F. Hoffman-LaRoche, Ltd. v. Empagran S.A., 542 U.S. 
155, 164 (2004), citing Murray v. Schooner Charming Betsy, 2 Cranch 
64, 118, 2 L.Ed. 208 (1804) (``[A]n act of congress ought never to 
be construed to violate the law of nations if any other possible 
construction remains''); Hartford Fire Insurance Co. v. California, 
509 U.S. 764 (1993) (Scalia, J., dissenting). See also Restatement 
(Third) Foreign Relations Law Sec.  403 (scope of a statutory grant 
of authority must be construed in the context of international law 
and comity including, as appropriate, the extent to which regulation 
is consistent with the traditions of the international system).
    \1185\ To the contrary, section 752(a) of the Dodd-Frank Act 
requires the CFTC to consult and coordinate with other regulators 
``on the establishment of consistent international standards with 
respect to the regulation (including fees) of swaps [and] swap 
entities * * *''
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K. Financing Subsidiary Exclusion From Major Swap Participant 
Definition

    In connection with the definition of major swap participant, CEA 
section 1a(33)(D) excludes certain entities from the definition of a 
major swap participant whose primary business is providing financing 
and uses derivatives for the purpose of hedging underlying commercial 
risks related to interest rate and foreign currency exposures, 90 
percent or more of which arise from financing that facilitates the 
purchase or lease of products, 90 percent or more of which are 
manufactured by the parent company or another subsidiary of the parent 
company (the ``captive finance company exception'').\1186\ This 
provision of the Dodd-Frank Act is not applicable to major security-
based swap participants.
---------------------------------------------------------------------------

    \1186\ 7 U.S.C. 1a(33)(D).
---------------------------------------------------------------------------

1. Proposal
    The Proposing Release restated the statutory captive finance 
company exception but did not further define or detail its scope or 
parameters. Accordingly, the CFTC did not propose a specific rule 
excluding certain financing subsidiaries from the definition of major 
swap participant in the Proposing Release.
2. Commenters' Views
    Commenters generally believed that the captive finance company 
exception should be broadly construed to cover financing of products 
being sold by the parent company or its authorized dealers, financing 
of service and labor, financing of component parts and attachments, and 
other general financing of the distribution network.\1187\ One 
commenter said the exception should be read narrowly, because the 
physical positions (in inventory, etc.) related to swaps may not be 
able to be liquidated to mitigate the risks of the swaps.\1188\
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    \1187\ See letters from CDEU, U.S. Chamber of Commerce, Center 
for Capital Markets Competiveness (``Chamber'') dated December 30, 
2011 (``Chamber II'') and NRU CFC I.
    \1188\ See meeting with Duffie on February 2, 2011. In addition, 
another commenter also suggested that the exception not be 
interpreted broadly due to concerns regarding potential abuse. See 
letter from CMOC.
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3. Final Rules
    The CFTC believes that the exception set forth in CEA section 
1a(33)(D) should be construed (consistent with the statute) to provide 
practical relief to those captive finance companies whose ``primary 
business'' is financing and who uses swaps for the purpose of hedging 
named underlying commercial risks related to interest rate and foreign 
currency exposures. As an initial matter, the Commission notes that a 
captive finance subsidiary or other similar entity is required to 
provide financing as its primary business, i.e., this is not a 
supplementary or complementary activity of the entity.\1189\
---------------------------------------------------------------------------

    \1189\ Commenters generally did not focus on this initial 
requirement instead commenting on other issues relating to 
application of the exception.
---------------------------------------------------------------------------

    In connection with the exception, commenters generally focused on 
the second part of Section 1a(33)(D) of the CEA, requesting the CFTC to 
interpret the phrase ``90% or more of which are manufactured by the 
parent company or another subsidiary of the parent company'' to include 
component parts, attachments, systems and other products that may be 
manufactured by others but sold together with the company's products as 
well as attachments and labor costs that are incidental to the primary 
purchase.\1190\
---------------------------------------------------------------------------

    \1190\ See letters from CDEU and Chamber II. Another commenter 
suggested that it should be viewed as a captive finance subsidiary 
of the entities that own it in a cooperative structure. See letter 
from NRU CFC I. This commenter also discussed whether the captive 
finance company exception should be available when it provides 
financing to its member-owners to support their general business 
activities, rather than to finance purchases from its member-owners. 
The CFTC does not believe it would be appropriate to apply the 
captive finance company exception in this situation.
---------------------------------------------------------------------------

    The CFTC believes that the captive finance exception must be 
interpreted in a manner consistent with the intention of Congress. As a 
result, a person that seeks to fall within the exemption must be in the 
``primary business'' of providing financing of purchases from its 
parent company. Consistent with this initial requirement, the CFTC 
maintains that the captive finance exception can be applied when this 
financing activity finances the purchase of the products sold by the 
parent company in a broad sense, including service, labor, component 
parts and attachments that are related to the products.

[[Page 30694]]

L. Implementation Standard, Re-Evaluation Period and Minimum Period of 
Status

1. Proposed Approach
    The proposed rules provided that a person would be deemed to be a 
major participant upon the earlier of: (i) The date on which it submits 
a complete application for registration, or (ii) two months after the 
end of the quarter in which a person meets the definition of major 
participant.\1191\
---------------------------------------------------------------------------

    \1191\ See proposed CFTC Regulation Sec.  1.3(hhh)(3); proposed 
Exchange Act rule 3a67-7(a).
---------------------------------------------------------------------------

    The proposed rules also provided that a person that has met the 
criteria for designation as a major participant as a result of its swap 
or security-based swap activities in a fiscal quarter, but without 
exceeding any applicable threshold by more than 20 percent, would not 
immediately be subject to the timing requirements discussed above. 
Instead, the person would be subject to the timing requirements noted 
above as soon as its daily average swap or security-based swap 
positions over any fiscal quarter exceed any of the applicable daily 
average thresholds.\1192\
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    \1192\ See proposed CFTC Regulation Sec.  1.3(hhh)(4); proposed 
Exchange Act rule 3a67-7(b).
---------------------------------------------------------------------------

    Finally, the proposed rules provided that a person would retain the 
status of a major participant if its swap positions or security-based 
swap positions do not fall below all of the thresholds for four 
consecutive quarters.\1193\ At that time, such entity may de-register 
as a major swap participant or major security-based swap participant.
---------------------------------------------------------------------------

    \1193\ See proposed CFTC Regulation Sec.  1.3(hhh)(5); proposed 
Exchange Act rule 3a67-7(c).
---------------------------------------------------------------------------

2. Commenters' Views
    Some commenters took the view that the time for compliance should 
be more than two months.\1194\ One commenter suggested that entities be 
given the flexibility to have an additional evaluation period if 
abnormal market events or price movements cause the failure of the 
first reevaluation.\1195\ Some commenters further expressed the view 
that the minimum amount of time a person would have to be registered as 
a major participant would be two quarters, rather than four 
quarters.\1196\
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    \1194\ See letters from BlackRock I (requesting that market 
participants have eight months after they have exceeded any of the 
applicable thresholds to complete the registration process and come 
into compliance with applicable rules) and MetLife (suggesting that 
one year would be an adequate amount of time to come into compliance 
with the applicable rules); see also letters from ISDA I (suggesting 
a grace period of three quarters following the effectiveness of the 
proposed rules to permit analysis of whether a person is a major 
participant) and Capital One (recommending establishment of an 18 
month provisional registration period for major participants and for 
dealers, as well as a phase-in period for applicable regulatory 
requirements).
    \1195\ See letter from MFA I.
    \1196\ See, e.g., letters from ACLI, BG LNG I, MetLife and MFA I 
(also suggesting that there be an alternative method of termination 
if an entity falls below an applicable threshold by more than 20 
percent).
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3. Final Rules
a. Timing
    Consistent with the proposal, the final rules provide that a person 
would be deemed to be a major participant upon the earlier of the date 
on which it submits a complete application for registration, or two 
months after the end of the quarter in which it meets the criteria to 
be a major participant.\1197\ In adopting these rules, the Commissions 
are mindful of commenters' concerns that market entities be given an 
adequate amount of time to come into compliance with the requirements 
applicable to major participants. At the same time, it is important to 
recognize that a person may submit a completed application for major 
participant registration prior to the time in which it must come into 
compliance with the requirements applicable to major 
participants.\1198\ We believe that two months provides a reasonable 
amount of time for a person to submit a completed application for 
registration as a major participant.\1199\
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    \1197\ See CFTC Regulation Sec.  1.3(hhh)(3); Exchange Act rule 
3a67-8(a).
    \1198\ The proposed rules regarding the registration of major 
security-based swap participants would provide that a person who 
files a completed registration application will be conditionally 
registered as a major security-based swap participant for four 
months (unless a person files a certification with the SEC, which 
would extend the conditional registration for an additional 30 
days). See proposed Exchange Act rules 15Fb2-1(d)(1) and 15Fb3-
1(b)(2), 76 FR 65784, 65821, 65823 (Oct. 24, 2012). In other words, 
under this proposal, a person who meets the criteria for being a 
major security-based swap participant may have up to six months, or 
longer, to come into compliance with the requirements applicable to 
major security-based swap participants.
    \1199\ The SEC has estimated that it would take an entity 
approximately one week to be able to complete and file Form SBSE, 
the most complex application form for registration as a major 
security-based swap participant. The other forms for application as 
a major security-based swap participant are simpler, and the SEC 
estimates that they would take less time to complete. See 76 FR at 
65814 at nn.130, 131, 133.
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b. Re-Evaluation Period
    Consistent with the proposal, the final rules provide that if any 
entity meets the criteria for qualifying as a major participant, but 
does not exceed any applicable threshold by more than 20 percent in 
that particular quarter, the entity will not immediately be subject to 
the timing requirements noted above, but will become subject to the 
timing requirements at the end of the next fiscal quarter if such 
entity exceeds any of the applicable daily average thresholds in that 
next fiscal quarter.\1200\ We believe that this standard will 
appropriately help to avoid applying major participant requirements to 
entities that meet the major participant criteria for only a short time 
due to unusual activity.\1201\
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    \1200\ See CFTC Regulation Sec.  1.3(hhh)(4); Exchange Act rule 
3a67-8(b).
    \1201\ While we are mindful that one commenter suggested that 
this standard be extended from one quarter to four quarters, see 
letter from ISDA I, we do not believe that approach would be 
consistent with the goal of not causing persons to become major 
participants as a result of short-term unusual activity.
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c. Minimum Period of Status
    Consistent with the proposal, the final rules provide that a person 
would retain major participant status until it does not exceed any of 
the applicable thresholds for four consecutive quarters following 
registration.\1202\ We believe that this time period appropriately 
addresses the concern that persons may move in and out of major 
participant status on a rapid basis. While we recognize that some 
commenters requested that this period be reduced to two quarters, we 
believe that a shorter period likely would lead to administrative 
confusion and burdens, as a shorter time period may be expected to lead 
entities to move in and out of major participant status more 
frequently.
---------------------------------------------------------------------------

    \1202\ See CFTC Regulation Sec.  1.3 (hhh)(5); Exchange Act rule 
3a67-8(c).
---------------------------------------------------------------------------

M. Calculation Safe Harbor

1. Proposed Approach and Commenters' Views
    In the Proposing Release, we expressed the understanding that only 
a limited number of persons currently have swap or security-based swap 
positions of a size that potentially could cause them to fall within 
the major participant definitions.\1203\ Without disagreeing with that 
view, some commenters expressed concern about the costs and burdens 
associated with performing the applicable calculations on a daily 
basis, particularly citing the calculations' complex nature.\1204\ 
Certain commenters further suggested

[[Page 30695]]

that participants in the swap and security-based swap markets may 
perceive an obligation to conduct the relevant calculations on a daily 
basis even if they are not reasonably likely to be major participants. 
Those commenters requested that the Commission adopt a safe harbor by 
which persons with swap or security-based swap positions below a 
certain notional threshold would not have to perform the major 
participant calculations, or by which persons would not have to perform 
those calculations more than monthly when the results of those 
calculations are significantly below the levels required to be a major 
participant.\1205\
---------------------------------------------------------------------------

    \1203\ For example, in connection with the major security-based 
swap participant definition, we preliminarily estimated that no more 
than ten entities that would not otherwise be security-based swap 
dealers would have uncollateralized mark-to-market positions or 
combined uncollateralized exposure and potential future exposure 
that may rise close enough to the proposed thresholds to necessitate 
monitoring to determine whether they meet those thresholds. See 
Proposing Release, 75 FR at 80207-08.
    \1204\ See letters from MFA I and Vanguard.
    \1205\ See letters from SIFMA AMG I (recommending safe harbor 
when the notional amount of a person's positions is less than the 
applicable thresholds for current uncollateralized exposure plus 
potential future exposure, or when a person's end-of-month analysis 
indicates exposures that are at least 50 percent below the 
definitions' applicable current exposure plus potential future 
exposure thresholds), Association of Institutional Investors 
(``AII'') and Vanguard.
---------------------------------------------------------------------------

2. Final Rule
    We continue to believe that under the rules we are adopting only a 
limited number of persons potentially may be major participants. 
Nonetheless, we recognize the significance of commenter concerns that 
some persons may perceive an obligation to conduct the major 
participant calculations as part of their compliance procedures even 
when there is not a significant likelihood that they would be major 
participants. We thus believe that a safe harbor can promote certainty 
and regulatory efficiency by helping market participants appropriately 
focus their compliance efforts and avoid undue compliance costs in 
circumstances when they would be highly unlikely to be major 
participants.
    Accordingly, the Commissions are adopting a rule to incorporate a 
safe harbor into the major participant analysis. A person may take 
advantage of this safe harbor in any of three situations. First, a 
person will not be deemed to be a major participant if: (i) the express 
terms of the person's arrangements relating to swaps and security-based 
swaps with its counterparties at no time would permit the person to 
maintain a total uncollateralized exposure of more than $100 million to 
all such counterparties, including any exposure that may result from 
the application of thresholds or minimum transfer amounts established 
by credit support annexes or similar arrangements; \1206\ and (ii) the 
person does not maintain notional swap or security-based swap positions 
of more than $2 billion in any major category of swaps or security-
based swaps, or more than $4 billion in aggregate.\1207\
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    \1206\ See CFTC Regulation Sec.  1.3(hhh)(6)(i)(A); Exchange Act 
rule 3a67-8(a)(1)(i).
    \1207\ See CFTC Regulation Sec.  1.3(hhh)(6)(i)(B); Exchange Act 
rule 3a67-8(a)(1)(ii). For purposes of this second condition, the 
measure of swap or security-based swap positions in a major category 
shall include all positions in that major category. This measure 
shall not exclude the hedging or ERISA positions that are excluded 
from the first major participant test.
---------------------------------------------------------------------------

    Alternatively, a person will not be deemed to be a major 
participant if: (i) The express terms of the person's arrangements 
relating to swaps and security-based swaps with its counterparties at 
no time would permit the person to maintain a total uncollateralized 
exposure of more than $200 million to all such counterparties, 
including any exposure that may result from thresholds or minimum 
transfer amounts; \1208\ and (ii) the person performs the major 
participant calculations (e.g., the ``substantial position'' and 
``substantial counterparty exposure'' calculations associated with the 
major participant tests) as of the end of every month, and the results 
of each of those monthly calculations indicate that the person's swap 
or security-based swap positions lead to no more than one-half of the 
level of current exposure plus potential future exposure that would 
cause the person to be a major participant.\1209\
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    \1208\ See CFTC Regulation Sec.  1.3(hhh)(6)(ii)(A); Exchange 
Act rule 3a67-8(a)(2)(i).
    \1209\ See CFTC Regulation Sec.  1.3(hhh)(6)(ii)(B); Exchange 
Act rule 3a67-8(a)(2). In the case of security-based swaps, for 
example, the monthly test must indicate that the person has no more 
than $1 billion in aggregate uncollateralized current exposure plus 
potential future exposure in a major category (equal to one-half the 
thresholds of the first and third major participant tests). A person 
also must have no more than $2 billion in aggregate uncollateralized 
current exposure plus potential future exposure with regard to all 
of its security-based swap positions (equal to one-half the 
thresholds of the second major participant test).
    For purposes of conducting this analysis with regard to 
positions in a major category, if the person is subject to the third 
major participant test (i.e., the person is a highly leveraged 
financial entity that is not subject to bank capital requirements), 
the analysis must account for all of the person's swap or security-
based swap positions in that major category (without excluding 
hedging positions). If the person is not subject to the third major 
participant test (i.e., the person is not ``highly leveraged'' or is 
not a ``financial entity'' potentially subject to the test) the 
analysis may exclude those hedging positions that also are excluded 
from the first major participant test.
    For purposes of conducting this analysis with regard to all of 
its swap or security-based swap positions, the analysis may not 
exclude hedging positions (consistent with the lack of a hedging 
exclusion in the second major participant test).
---------------------------------------------------------------------------

    Finally, a person will not be deemed to be a major participant if 
the person's current uncollateralized exposure is in connection with a 
major category of swaps or security-based swaps is less than $500 
million (or less than $1.5 billion with regard to the rate swap 
category) and the person performs certain modified major participant 
calculations (e.g., the ``substantial position'' and ``substantial 
counterparty exposure'' calculations, simplified based on assumptions 
that are adverse to the person) \1210\ as of the end of every month, 
and the results of each of those monthly calculations indicate that the 
person's swap or security-based swap positions in each major category 
of swaps or security-based swaps are less than one-half of the 
substantial position threshold.\1211\ This test addresses the commenter 
suggestion that a safe harbor be set at one-half of the threshold 
triggering major participant designation.\1212\ In addition, we have 
provided a more simplified alternate version of this test whereby a 
person will not be deemed to be a major participant if its monthly 
calculations indicate that the person's swap or security-based swap 
positions across all major categories of swaps or security-based swaps 
are significantly less than the substantial counterparty exposure 
threshold.\1213\ This alternative provides a simple safe harbor for 
entities to apply without undertaking additional analysis to divide 
their swap or security-based

[[Page 30696]]

swap positions into major categories.\1214\
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    \1210\ See CFTC Regulation Sec.  1.3(hhh)(6))iii)(A); Exchange 
Act rule 3a67-9(a)(3). The simplifications and assumptions applied 
to this portion of the safe harbor include the fact that a person 
must use the exposure reports of its dealer counterparties when 
calculating aggregate uncollateralized outward exposure to such 
entities, and that potential future exposure must be calculated 
without taking into account offsets for clearing, mark-to-market 
margining, or netting.
    \1211\ See CFTC Regulation Sec.  1.3(hhh)(6)(iii)(A); Exchange 
Act rule 3a67-9(a)(3)(i)(A).
    \1212\ As identified above, three commenters requested that the 
Commissions provide a ``safe harbor'' in connection with the status 
of a major participant. See letters from AII, SIFMA AMG II and 
Vanguard. For example, one commenter stated that ``market 
participants that are otherwise required to perform the calculations 
should be able to do so on a less frequent basis if the entity is 
below every applicable threshold by at least 50%.'' See letter from 
SIFMA AMG I at 5.
    \1213\ See CFTC Regulation Sec.  1.3(hhh)(6)(iii)(B); Exchange 
Act rule 3a67-9(a)(3)(i)(B). The thresholds for this version of the 
safe harbor are consistent with the thresholds for the safe harbor 
set forth in CFTC Regulation Sec.  1.3(hhh)(6)(iii)(A) and Exchange 
Act rule 3a67-9(a)(3)(i)(A), other than with respect to interest 
rate swaps. We recognize that the major participant thresholds for 
swaps and security-based swaps across all major categories (i.e., 
substantial counterparty exposure) are much larger than those for 
each individual major category (i.e., substantial position). 
However, given the purposes of the safe harbor, we do not believe 
that it is appropriate to use a higher level for the test related to 
all major categories as compared to the test for each individual 
category.
    \1214\ When calculating its potential future exposure across all 
major swap or security-based swap categories for purposes of this 
portion of the safe harbor, the person must use the same specified 
conversion factor for all swaps or security-based swaps, with such 
factor reflecting the highest risk weight applied to a major 
category of swaps or security-based swaps, as applicable. See CFTC 
Regulation Sec.  1.3(hhh)(6)(iii)(B)(2); Exchange Act rule 3a67-
9(a)(3)(i)(B)(2).
     Also, for all three tests within the safe harbor, the person 
should use the effective notional amount of a position rather than 
the stated notional amount of that position if the stated notional 
amount is leveraged or enhanced by the structure of the position. 
See CFTC Regulation Sec.  1.3(hhh)(6)(iv); Exchange Act rule 3a67-
9(b).
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    In each of these circumstances, we believe that a safe harbor would 
be warranted because it would be sufficiently unlikely that the 
person's swap or security-based swap positions would cause the entity 
to be a major participant.\1215\ The Commissions believe that for 
compliance purposes, persons should be able to rely on the proposed 
safe harbors noted above. This would benefit the swap and security-
based swap marketplace and related market participants by avoiding 
unnecessary costs for various entities that, because of compliance 
concerns, would engage in major participant calculations even though it 
would be very unlikely that the major participant thresholds would be 
met.
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    \1215\ Although commenters suggested a safe harbor based on a 
notional standard or on monthly testing, the rule we are adopting 
also accounts for the maximum exposure that is possible under a 
person's counterparty arrangements (including the aggregate amount 
of thresholds and minimum transfer amounts provided for by the 
applicable credit support annexes). This is intended to better focus 
the application of the safe harbor toward those entities that are 
highly unlikely to be, or become, major participants.
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    The rule further provides that even if a person does not meet the 
conditions required to take advantage of the safe harbor, that fact by 
itself will not lead to a presumption that a person is required to 
perform the calculations required to determine if it is a major 
participant.\1216\ This is consistent with the safe harbor's intent to 
promote certainty and efficiency in compliance efforts. While we are 
not prescribing when a person should perform the major participant 
calculations, participants in the swap and security-based swap markets 
should be mindful that they are responsible for determining whether 
they meet the major participant definitions, and that they will face 
liability if they knowingly or unknowingly meet one of those 
definitions without registering as a major participant.
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    \1216\ See CFTC Regulation Sec.  1.3(hhh)(6)(v); Exchange Act 
rule 3a67-8(c).
---------------------------------------------------------------------------

N. Limited Designation as a Major Swap Participant or Major Security-
Based Swap Participant

1. Proposed Approach
    The ``major swap participant'' and ``major security-based swap 
participant'' definitions provide that the Commissions may designate a 
person as a major participant for a single category of swap or 
security-based swap.\1217\ Unlike the limited designation provisions of 
the dealer definitions, the major participant definitions do not refer 
to limited designations in connection with particular swap and 
security-based swap activities. Also, unlike the dealer definitions 
(which refer to limited designations in connection with a particular 
``type,'' ``class'' or ``category'' of swap or security-based swap), 
the major participant definitions specifically state that a person may 
be designated as a major participant for one or more ``categories'' of 
swap or security-based swap, without being a major participant for all 
``classes'' of swap or security-based swap.
---------------------------------------------------------------------------

    \1217\ See CEA section 1a(33)(C); Exchange Act section 
3(a)(67)(C).
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    The proposal provided that a person who is a major participant in 
general would be considered to be a major participant with respect to 
all categories of swaps or security-based swaps, unless the person's 
designation is limited.\1218\ We further stated that we anticipated 
that a major participant could seek a limited designation at the same 
time as its initial registration or at a later time, and we observed 
the difficulty of setting out the conditions that would allow a person 
to receive a major participant limited designation.\1219\
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    \1218\ See proposed CFTC Regulation Sec.  1.3(hhh)(2); proposed 
Exchange Act rule 3a71-1(c).
    \1219\ See Proposing Release, 75 FR at 80200-80201.
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2. Commenters' Views
    As discussed above, commenters generally addressed concerns 
regarding limited purpose major participant designations in conjunction 
with comments regarding limited purpose dealer designations.\1220\ A 
few comments addressed these issues specifically in the context of the 
major participant definitions.
---------------------------------------------------------------------------

    \1220\ See part II.E.2, supra.
---------------------------------------------------------------------------

    One commenter recommended that persons that exceed the first major 
participant threshold in a major category should presumptively be 
considered a limited major participant only for those categories of 
swaps or security-based swaps for which they crossed the 
threshold.\1221\ Another suggested a similar approach when a major 
participant's swaps are concentrated in one major category.\1222\ Two 
commenters suggested that limited major participant designations should 
not be confined to the proposed major swap categories.\1223\
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    \1221\ See letter from ICI I (recommending that entities that 
exceed the thresholds of the first major participant test be 
registered as major participants only for the relevant major 
category, while those entities qualifying as major participants 
under the other tests would be designated as major participants for 
all categories, but would still be able to apply for limited 
designations).
    \1222\ See letter from BG LNG I (recommending that if 50 percent 
of a major participant's swaps fall within one category of swaps, 
and its swaps in other categories would not separately exceed any of 
the proposed thresholds, that should be presumed to be a major 
participant for only that one category of swap).
    \1223\ See letters from BG LNG I (specifically addressing energy 
firms); and NCGA/NGSA I (asserting that while the major participant 
definition is to be based on the major categories, the limited 
designations should be based on a finer set of categories).
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3. Final Rules and General Principles Applicable to Limited Major 
Participant Designations
    Consistent with the proposal, the final rules retain the 
presumption that a person that meets one of the major participant 
definitions will be deemed to be a major participant in connection with 
all categories of swaps or security-based swaps.\1224\ As discussed in 
the Proposing Release, a person may apply for a limited designation 
when it submits a registration application, or later.\1225\ The final 
rules also contain one change from the proposal, in that the provisions 
of the final rules related to limited major participant designation do 
not refer to the major participant's activities in connection with 
swaps or security-based swaps, in contrast to the proposal, because the 
relevant statutory provisions do not refer to limited designations 
related to activities.
---------------------------------------------------------------------------

    \1224\ See CFTC Regulation Sec.  1.3(hhh)(2); Exchange Act rule 
3a71-1(c).
    \1225\ See Proposing Release, 75 FR at 80200. The SEC expects to 
address the process for submitting an application for limited 
designation as a major security-based swap participant, along with 
principles to be used by the SEC in analyzing such applications, as 
part of separate rulemakings.
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    Many of the principles discussed above in the context of limited 
designation of dealers also are relevant to the limited designation of 
major participants. Significantly, as with limited dealer designations, 
it is appropriate for major participants to be subject to a default 
presumption that they should be regulated as major

[[Page 30697]]

participants for all of their swaps or security-based swaps.\1226\
---------------------------------------------------------------------------

    \1226\ See part II.E.3.a, supra, discussing the statutory and 
policy basis for this presumption.
---------------------------------------------------------------------------

    Although a commenter suggested that different principles should 
apply in the context of the first major participant test \1227\--which 
is based on an entity's swap or security-based swap position in a 
single major category--we do not concur. The substantive requirements 
applicable to major participants do not contemplate treating entities 
that exceed the first and third thresholds of the major participant 
definition differently than those exceeding the second threshold. 
Instead, those requirements indicate that each entity that falls within 
the major participant definition must comply with registration and 
other substantive requirements triggered by such designation for all of 
its swap or security-based swap positions and activities. This 
conclusion also is supported by the fact that the limited designation 
authority provided to the Commissions is permissive rather than 
mandatory, and by the challenges of demonstrating compliance with the 
substantive requirements applicable to major participants in the 
context of a limited designation.
---------------------------------------------------------------------------

    \1227\ See letter from ICI I.
---------------------------------------------------------------------------

    Indeed, as with limited dealer designation, one of the key 
requirements to overcoming the default presumption of full designation 
is an applicant's ability to comply with major participant regulation 
in the context of a limited designation. As with limited dealer 
designation, the Commissions will not designate a person as a limited 
purpose major participant unless the person can demonstrate compliance 
with the statutory and regulatory requirements applicable to major 
participants. Accordingly, an applicant to limited purpose designations 
must not only demonstrate the ability to comply with the transaction-
level major participant requirements (e.g., certain business conduct 
standards and requirements related to trading records, documentation 
and confirmations) in the context of a limited designation, but also to 
entity-level major participant requirements (e.g., requirements related 
to registration, capital, risk management, supervision, and chief 
compliance officer).

V. Commission Staff Reports

    To review and evaluate the operation of the ``swap dealer,'' 
``security-based swap dealer,'' ``major swap participant'' and ``major 
security-based swap participant'' definitions, the CFTC and SEC are 
directing their respective staffs to undertake future studies regarding 
the rules being adopted in connection with these definitions and the 
related interpretations. These studies will include the analysis of 
market data and the input of public comment.
    The CFTC staff is further directed to report the results of this 
study to the CFTC on a date that is no later than 30 months following 
the date that a swap data repository first receives swap data under the 
CFTC's regulations.\1228\ The SEC staff is further directed to report 
the results of this study to the SEC no later than three years 
following the later of: (i) the last compliance date for the 
registration and regulatory requirements for security-based swap 
dealers and major security-based swap participants under Section 15F of 
the Exchange Act; and (ii) the first date on which compliance with the 
trade-by-trade reporting rules for credit-related and equity-related 
security-based swaps to a registered security-based swap data 
repository is required.\1229\ These staff reports will be made 
available for public comment.
---------------------------------------------------------------------------

    \1228\ The CFTC has designated a period of 30 months to ensure 
that the report reflects two years of security-based swap 
transaction data, and six months for the staff to analyze the data 
and prepare the report. The Commissions expect that swap data 
repositories and security-based swap data repositories will begin to 
receive data at different times. Currently, swap data repositories 
are expected to begin to receive swap data approximately 60 days 
after publication of the rules further defining the term ``swap.'' 
See CFTC, Final Rule: Swap Data Recordkeeping and Reporting 
Requirements, 77 FR 2136 (Jan. 13, 2012); CFTC, Final Rule: Swap 
Data Repositories: Registration Standards, Duties and Core 
Principles, 76 FR 54538 (Sept. 1, 2011). The SEC has not yet adopted 
final rules for the receipt of security-based swap data by security-
based swap data repositories. Because of this difference, the timing 
of the changes to the de minimis thresholds for swaps and security-
based swaps will be different.
    \1229\ The SEC has designated a period of three years to ensure 
that the report reflects two years of security-based swap 
transaction data, and one year for the staff to analyze the data and 
prepare the report.
---------------------------------------------------------------------------

A. Objectives of the CFTC Staff Report

    In general, the CFTC's staff report--together with the associated 
public comment--is intended to help the CFTC thoroughly evaluate the 
practical implications and effects of the ``swap dealer'' and ``major 
swap participant'' definitions following the regulation of dealers and 
major participants under Title VII. In addition, the staff report is 
intended to assist the CFTC in evaluating whether new or revised tests 
or approaches would be appropriate for identifying swap dealers and 
major swap participants or for providing greater clarity as to whether 
particular entities do or do not fall within these definitions. The 
staff report is also intended to assist the CFTC more specifically in 
evaluating the potential implications of terminating the phase-in 
thresholds associated with the de minimis exception to the definition 
of a ``swap dealer.''
    To this end, the staff report generally should review each 
significant aspect of the rules being adopted in connection with the 
definitions and related interpretations. With respect to the ``swap 
dealer'' definition, such aspects include: (i) the factors associated 
with the definition (including the application of the dealer-trader 
distinction for identifying swap dealing activity); (ii) the extent of 
the exclusion of swaps entered into in connection with the origination 
of loans; (iii) the exclusion of certain swaps from the dealer analysis 
(i.e., swaps between affiliated parties, swaps between a cooperative 
and its members and swaps entered into for the purpose of hedging as 
defined in the rule); and (iv) the tests and thresholds used to 
implement the de minimis exception. With respect to the ``major swap 
participant'' definition, such aspects include: (i) The tests and 
thresholds associated with the ``substantial position'' definition; 
(ii) the definition of ``hedging or mitigating commercial risk''; (iii) 
the tests and thresholds associated with the ``substantial counterparty 
exposure'' definition; and (iv) the definition of ``highly leveraged''.
    To facilitate this review, the CFTC staff report should address--as 
may be practicable in light of the data made available under the swap 
regulatory reporting regime or otherwise--a range of descriptive 
analytics that may be helpful in characterizing the nature of the swap 
market, its participants, and their activities. Such descriptive 
analytics could help inform the CFTC as to how the definitions in the 
final rules are being applied in practice and whether any adjustments 
to such definitions should be considered. For example, these analytics 
could indicate whether the population of registered swap dealers and 
major swap participants is substantially larger or smaller than 
expected, and, to some extent, what elements of the definitions are 
responsible for any significant differences. These analytics could also 
illuminate dynamics in the market that may require new or different 
treatment in the definitions. These analytics may also assist the CFTC 
in considering whether it would be practical and appropriate to apply 
new or different objective and readily verifiable tests or standards 
for determining whether particular entities are or are not swap dealers 
or major swap participants,

[[Page 30698]]

including through the possible use of safe harbors, presumptions, 
thresholds, or defaults based on these tests or standards.
    Depending on the availability and reliability of data and the 
developments in the market and regulatory framework, among other 
factors, the CFTC staff report could consider: how swaps differ among 
registered swap dealers, registered major swap participants and 
unregistered entities; differences among swaps in the major swap 
categories; differences among swap dealing activity of entities at 
various levels, including around the de minimis threshold; and 
estimates of quantitative information regarding use of swaps, including 
notional values, effective notional values, and collateralized and 
uncollateralized exposure.
    The CFTC staff report should also address, as may be practicable, 
the nature and extent of the impact that the final rules and 
interpretations implementing the definitions have had on certain 
aspects of the swap market. Depending on the available information and 
other factors, the CFTC staff report could address the impact of these 
final rules and interpretations on competition in the swap market, 
market participants' ability to enter into swaps with various 
registered and unregistered entities, including IDIs, and the terms of 
swaps.

B. Objectives of the SEC Staff Report

    In general, the report of the SEC staff--together with the 
associated public comment--is intended to help the SEC thoroughly 
evaluate the practical implications and effects of the dealer and major 
participant definitions following the regulation of dealers and major 
participants pursuant to Title VII. In addition, the staff report is 
intended to assist the SEC in evaluating whether new or revised tests 
or approaches would be appropriate for identifying dealers and major 
participants or for providing greater clarity as to whether particular 
entities do or do not fall within these definitions. The staff report 
also is intended to assist the SEC more specifically in evaluating 
whether it is necessary or appropriate to set higher or lower 
thresholds for the de minimis exception to the definition of 
``security-based swap dealer.''
    To this end, the staff report generally should review each 
significant aspect of the rules being adopted in connection with the 
definitions and related interpretations. With respect to the security-
based swap dealer definition, such aspects include: (i) The factors 
associated with the definition (including the application of the 
dealer-trader distinction for identifying dealing activity); (ii) the 
exclusion of inter-affiliate transactions from the dealer analysis 
(including the provisions limiting that exclusion to transactions among 
majority-owned affiliates); and (iii) the tests and thresholds used to 
implement the de minimis exception. With respect to the major security-
based swap participant definition, such aspects include: (i) The tests 
and thresholds associated with the ``substantial position'' and 
``substantial counterparty exposure'' definitions; (ii) the definition 
of ``hedging or mitigating commercial risk'' (including whether the 
definition inappropriately permits the exclusion of certain positions 
from the first test of the major participant definitions, and whether 
the continued availability of the exclusion should be conditioned on 
assessments of hedging effectiveness and related documentation); (iii) 
the definition of ``highly leveraged''; and (iv) the exclusion of 
inter-affiliate transactions from the major participant analysis 
(including the provision limiting that exclusion to transactions among 
majority-owned affiliates).

C. Descriptive Analytics in the SEC Report

    To facilitate this review, the report of the SEC staff should 
address--as may be practicable in light of the data made available 
under the applicable regulatory reporting regime or otherwise \1230\--a 
range of descriptive analytics that may be helpful in characterizing 
the nature of the security-based swap market, as well as entities 
within that market and those entities' activities. Such descriptive 
analytics could help inform the SEC as to how the definitions in the 
final rules are being applied in practice and whether any adjustments 
to such definitions should be considered. For example, these analytics 
could indicate whether the populations of dealers and major 
participants are substantially larger or smaller than expected, and, to 
some extent, what elements of the definitions are responsible for any 
significant differences. These analytics could also illuminate dynamics 
in the security-based swap market that may require new or different 
treatment in the definitions. For example, the analytics could indicate 
that the activity in certain segments of the security-based swap 
market--e.g., equity swaps--has significantly increased or decreased 
since the adoption of the final rules. These analytics may also assist 
the SEC in considering whether it would be practical and appropriate to 
apply new or different objective and readily verifiable tests or 
standards for determining whether particular entities are or are not 
dealers or major participants, including through the possible use of 
safe harbors, presumptions, thresholds or defaults based on these tests 
or standards.
---------------------------------------------------------------------------

    \1230\ The Dodd-Frank Act mandates that market participants 
publicly report certain security-based swap transaction and pricing 
data. See Exchange Act section 13(m). The SEC has proposed rules to 
implement these requirements, which will give the Commissions and 
the general public additional insight into the security-based swap 
markets. See Regulation SBSR--Reporting and Dissemination of 
Security-Based Swap Information, 75 FR 75208 (Dec. 2, 2010).
---------------------------------------------------------------------------

    The precise nature of the descriptive analytics included in the SEC 
staff report of course will depend on a number of considerations, 
including the availability and reliability of data and the developments 
in the market and regulatory framework. However, some salient 
candidates for descriptive analysis that could be considered at the 
time of the staff report include:
     Characteristics of, and differences among, the security-
based swap transactions and positions of three segments of participants 
in those respective markets--registered dealers, any registered major 
participants, and unregistered entities.\1231\
---------------------------------------------------------------------------

    \1231\ Such characteristics could include: (i) The types of 
market participants in each segment; (ii) their activity and 
positions (in terms of notional value, number of transactions, 
average aggregate uncollateralized outward exposures, and average 
aggregate potential outward exposure); (iii) the type and number of 
their counterparties (including the registered/unregistered status 
of such counterparties); and (iv) a network analysis of the 
concentration of activity by counterparty.
---------------------------------------------------------------------------

     Characteristics of, and differences among, security-based 
swap transactions and positions connected with the broad product 
segments identified in the final rules (e.g., credit default swaps and 
other security-based swaps).\1232\
---------------------------------------------------------------------------

    \1232\ Such characteristics could include: (i) The types of 
market participants in each segment, including their registration 
status; (ii) the amount of their activity (in terms of notional 
value and number of transactions); and (iii) the type and number of 
their counterparties.
---------------------------------------------------------------------------

     Characteristics of, and differences among, the apparent 
dealing activity of entities at various levels (including the $3 
billion and $150 million de minimis levels established in the final 
rule in connection with the security-based swap dealer definition) 
based on their transactions and positions; \1233\
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    \1233\ Such characteristics could include a range of 
quantitative criteria indicative of apparent dealing activity, 
similar in some respects to the approach taken in the CDS Data 
Analysis. Differences that could be reviewed include variations in 
the number and size of trades and counterparties.

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[[Page 30699]]

     Characteristics of the security-based swap trading 
activity of ``special entities''; \1234\
---------------------------------------------------------------------------

    \1234\ Such characteristics could include: (i) The size and 
nature of their counterparties; (ii) the registration status of 
their counterparties; and (iii) the size and number of their 
transactions.
---------------------------------------------------------------------------

     Characteristics of entities entering and exiting the 
security-based swap markets, using a variety of baselines; \1235\
---------------------------------------------------------------------------

    \1235\ Such characteristics could include: (i) The extent to 
which those entities bear indicia of dealing activity, including 
those identified in the CDS Data Analysis; and (ii) the extent to 
which those entities have registered as security-based swap dealers. 
Potential baseline could include, for example: (i) The adoption of 
these final rules; (ii) December 31, 2011, the end of the time 
period considered by the CDS Data Analysis; and (iii) the last 
effective date of the registration and regulatory requirements for 
security-based swap dealers and major security-based swap 
participants under Section 15F of the Exchange Act.
---------------------------------------------------------------------------

     Estimates of security-based swap entities' current 
uncollateralized exposure and potential future exposure at various 
levels of security-based swap positions; \1236\ and
---------------------------------------------------------------------------

    \1236\ Such estimates could be useful in ascertaining the 
application of the various ``substantial position'' thresholds used 
in connection with the ``major security-based swap participant'' 
definition.
---------------------------------------------------------------------------

     Estimates of security-based swap entities' ratios of total 
liabilities to equity.\1237\
---------------------------------------------------------------------------

    \1237\ Such estimates could be useful in connection with 
evaluating the operation of the third prong of the major participant 
definition.
---------------------------------------------------------------------------

D. Additional Analyses in the SEC Staff Report

    To further facilitate this review, the SEC staff report should also 
address, as may be practicable, the nature and extent of the impact 
that the final rules and interpretations implementing the definitions 
have had on certain aspects of the security-based swap market. However, 
many economic, regulatory, and other factors--both related and 
unrelated to the implementation of Title VII--could impact the market 
going forward. The extent to which the staff report will be able to 
provide retrospective analyses regarding the effect of the definitions 
on the security-based swap markets (and the robustness of any such 
analysis) in significant part will be based on the nature and role of 
future exogenous factors that have also affected the market. Depending 
on these future factors and the potential challenges associated with 
addressing them in the staff reports, some salient candidates for 
retrospective impact analysis that could be considered at the time of 
the report include:
     Effects on competition. The report may be able to explore 
connections between the definitions and the entry and exit of various 
entities in the security-based swap markets. For example, to what 
extent is an entity's entry or exit correlated with its registration 
status or its approaching or crossing any of the thresholds established 
by the definitions (e.g., the de minimis thresholds for dealers or the 
``substantial position'' thresholds for major participants)? Has the 
current concentration of the dealer market dissipated, persisted, or 
strengthened over time? \1238\
---------------------------------------------------------------------------

    \1238\ See notes 478 through 485 and accompanying text, supra.
---------------------------------------------------------------------------

     Effects on investor protection. The report may be able to 
explore connections between the definitions and the nature and scope of 
transactions with certain classes of counterparties. For example, to 
what extent do unregistered entities in the security-based swap markets 
transact with counterparties such as ``special entities,'' natural 
persons, small businesses, or commercial entities? Have the nature and 
scope of trades by special entities or other classes of counterparties 
changed since 2011? Have unregistered entities--such as dealers 
operating under the de minimis threshold--emerged to engage in 
transactions with special entities or other particular classes of 
counterparties?
     Effects on access. The report may be able to explore 
connections between the definitions and the ability of certain classes 
of counterparties to access products in the security-based swap market. 
For example, to what extent is an entity's registration status or its 
approaching or crossing any of the thresholds established by the 
definitions correlated with the entity ceasing transactions with 
certain classes or sizes of counterparties?
     Effects of the dealer-trader distinction. The report may 
be able to explore connections between market dynamics and quantifiable 
metrics indicative of dealing activity. For example, are there 
identifiable, objective differences between the registered security-
based swap dealers and unregistered market participant populations in 
terms of number of counterparties, buy/sell ratios, posting of initial 
margin, concentrations by counterparty or otherwise? If so, how does 
the amount of the activity (in terms of notional value and number of 
transactions) of those entities change when they move above or below 
the thresholds implied by those differences? How do the characteristics 
of their counterparties (in terms of number and nature) change?
     Effects of de minimis thresholds. The report may be able 
to explore connections between market dynamics and the de minimis 
thresholds established by the definitions. For example, how does the 
amount of the activity (in terms of notional value and number of 
transactions) of security-based swap entities change when they move 
above or below the de minimis thresholds? How do the characteristics of 
their counterparties (in terms of number and nature) change?
     Effects of major participant thresholds. The report may be 
able to explore connections between market dynamics and the major 
participant thresholds established by the definitions. For example, how 
have total notional security-based swap positions changed over time for 
large market participants that are not registered and that do not bear 
any indicia of dealing activity? For those large participants, have 
overall notional levels moved toward, or away from, the levels required 
to trigger the major participant thresholds?
     Other effects of the definitions. To what extent do 
entities registered security-based swap dealers have overall trading 
characteristics suggesting that they may not be dealers? To what extent 
have entities not registered as dealers have trading characteristics 
suggesting that they may be acting as dealers? In either case, do any 
discrepancies between firms' registration status and their trading 
characteristics suggest any gaps or areas of uncertainty regarding the 
scope of the dealer definitions that may require potential 
modifications?

VI. Effective Date and Implementation

    Consistent with sections 754 and 774 of the Dodd-Frank Act, these 
final rules will be effective on 60 days following publication in the 
Federal Register. The Commissions, however, are providing for a phase-
in period for persons engaged in dealing activity below certain 
amounts.
    If any provision of these joint rules, or the application thereof 
to any person or circumstance, is held to be invalid, such invalidity 
shall not affect other provisions or application of such provisions to 
other persons or circumstances that can be given effect without the 
invalid provision or application.

A. CEA Rules

    As explained below and as noted elsewhere in this Adopting Release, 
the compliance date for various regulatory requirements is contingent 
upon the adoption and effectiveness of other,

[[Page 30700]]

related, regulatory provisions and definitions. Because the CFTC 
believes that the suite of rules implementing the Dodd-Frank Act are 
complex and interconnected, it has determined that implementation in 
certain cases can best be accomplished through separate rulemakings. 
The Commissions received comments related to implementation and phase-
in that largely resulted from the CFTC's re-opening of the comment 
period for several rulemakings, and a request for comment on the order 
in which it should consider final rulemakings made under the Dodd-Frank 
Act.\1239\ The CFTC notes that swap dealers and major swap participants 
will require an implementation or compliance period based on separate 
registration and regulatory requirements that are the subject of 
separate rulemakings by the Commission.\1240\
---------------------------------------------------------------------------

    \1239\ See CFTC, Reopening and Extension of Comment Periods for 
Rulemakings Implementing the Dodd-Frank Wall Street Reform and 
Consumer Protection Act, 76 FR 25274 (May 4, 2011).
    \1240\ See CFTC, Final Rule: Registration of Swap Dealers and 
Major Swap Participants, 775 FR 713792613 (Jan. 19, 2012).
---------------------------------------------------------------------------

    As the CFTC stated recently in another rulemaking related to CPOs:

[while t]he [CFTC] recognizes that entities will need time to come 
into compliance with the [CFTC]'s regulations * * * [b]ased on the 
comments received indicating that a certain portion of entities 
currently claiming relief [from CPO registration] under Sec.  
4.13(a)(4) already have robust controls in place independent of 
[CFTC] oversight, the [CFTC] believes that entities currently 
claiming relief under Sec.  4.13(a)(4) should be capable of becoming 
registered and complying with the [CFTC]'s regulations within 12 
months following the issuance of the final rule. For entities that 
are formed after the effective date of the rescission, the 
Commission expects the CPOs of such entities to comply with the 
Commission's regulations upon formation and commencement of 
operations.\1241\
---------------------------------------------------------------------------

    \1241\ CPO/CTA Compliance Release at 11265.

    The Commissions are taking the same approach with respect to 
implementing CFTC Regulations Sec. Sec.  1.3(m)(5) and 1.3(m)(6). The 
loss of ECP status for Forex Pools currently operating other than 
pursuant to the retail forex regime of a federal regulator described in 
CEA section 2(c)(2)(E)(i) \1242\ may involve significant structural and 
operational changes. The loss of a commodity pool's ability to rely on 
CEA section 1a(18)(A)(v) if it does not fall within CEA section 
1a(18)(A)(iv) may require significant structural and operational 
changes. Because additional time may enable a Forex Pool affected by 
CFTC Regulation Sec.  1.3(m)(5) to restructure to avoid being subject 
to the retail forex regime (e.g., by redeeming U.S. non-ECP 
participants) and may allow a commodity pool affected by CFTC 
Regulation Sec.  1.3(m)(6) time to satisfy the terms of CEA section 
1a(18)(A)(iv) (e.g., by the pool's CPO registering as such or claiming 
an exemption therefrom or by the pool raising its level of total assets 
above $5 million), the Commissions are delaying the effective date of 
CFTC Regulations Sec. Sec.  1.3(m)(5) and 1.3(m)(6) until December 31, 
2012, which is the compliance date for commodity pools no longer 
permitted to claim exemption from CPO registration pursuant to recently 
withdrawn CFTC Regulation 4.13(a)(4).\1243\
---------------------------------------------------------------------------

    \1242\ 7 U.S.C. 2(c)(2)(E)(i).
    \1243\ See CPO/CTA Compliance Release.
---------------------------------------------------------------------------

    CFTC Regulation Sec.  1.3(m)(8) conditions ECP status in part on a 
requirement that a commodity pool be ``formed and operated'' by a 
registered CPO or by a CPO who is exempt from registration as such 
pursuant to CFTC Regulation Sec.  4.13(a)(3). Due to the revocation of 
CFTC Regulation Sec.  4.13(a)(4), the Commissions anticipate that many 
CPOs will be registering as such in the future. However, the compliance 
date for registration for CPOs required to register as such due to the 
withdrawal of CFTC Regulation Sec.  4.13(a)(4) is December 31, 2012. 
Furthermore, such CPOs may have formed the commodity pools that they 
currently operate when such CPOs were not registered as such.
    Consequently, compliance with the formation element of CFTC 
Regulation Sec.  1.3(m)(8)(iii) is not required with respect to a 
commodity pool formed prior to December 31, 2012. To be clear, however, 
while pools in existence before December 31, 2012 need not have been 
formed by a registered CPO, or by a CPO who is exempt from registration 
as such pursuant to CFTC Regulation Sec.  4.13(a)(3), in order to 
satisfy the formation aspect of CFTC Regulation Sec.  1.3(m)(8)(iii), 
such commodity pools nevertheless must be operated by a registered CPO, 
or by a CPO who is exempt from registration as such pursuant to CFTC 
Regulation Sec.  4.13(a)(3), on December 31, 2012 to satisfy the 
``operated by a registered CPO'' element of CFTC Regulation Sec.  
1.3(m)(8)(iii).

B. Exchange Act Rules

    Because the SEC has not yet promulgated final rules implementing 
the substantive requirements imposed on dealers and major participants 
by Title VII of the Dodd-Frank Act, persons determined to be dealers or 
major participants under the regulations adopted in this Adopting 
Release need not register as such until the dates provided in the SEC's 
final rules regarding security-based swap dealer and major security-
based swap participant registration requirements, and will not be 
subject to the requirements applicable to those dealers and major 
participants until the dates provided in the applicable final 
rules.\1244\
---------------------------------------------------------------------------

    \1244\ See Securities Exchange Act Release No. 64678 (June 15, 
2011), 76 FR 36287 (June 22, 2011) (``Effective Date Release'') 
(granting exemptive relief and providing guidance in connection with 
Exchange Act provisions concerning security-based swaps that were 
added or amended by Title VII).
---------------------------------------------------------------------------

    Moreover, as discussed above in the context of the de minimis 
exception to the security-based swap dealer definition,\1245\ the SEC 
is making an extended compliance period available to persons engaged in 
dealing activity involving credit default swaps between $3 billion and 
$8 billion in trailing annual notional amount, and to persons engaged 
in dealing activity involving other types of security-based swaps 
between $150 million and $400 million in trailing annual notional 
amount. Persons taking advantage of that extended compliance period 
will be deemed not to be security-based swap dealers during that 
period, and will not be subject to registration requirements and other 
requirements associated with status as a security-based swap dealer 
during that period.
---------------------------------------------------------------------------

    \1245\ See part II.D.5, supra.
---------------------------------------------------------------------------

    The SEC previously provided limited exemptive relief in connection 
with Exchange Act section 6(l),\1246\ added by the Dodd-Frank Act, 
which prohibits any person from effecting a security-based swap 
transaction with a person that is not an ECP, unless effected on a 
national securities exchange. That relief expires as of the effective 
date of final rules further defining ECP.\1247\ Accordingly, following 
the effective date of these final rules, dealers and major 
participants--and all other persons--will be subject to the prohibition 
of section 6(l) under the definition of ECP as amended by Title VII and 
as further defined by the rules.\1248\
---------------------------------------------------------------------------

    \1246\ 15 U.S.C. 78f(l).
    \1247\ See Effective Date Release, 76 FR at 36307.
    \1248\ Because the exemptive relief that the SEC granted in 
connection with section 6(l) will expire as of the effectiveness of 
the ECP definition, the relief that the SEC provided from the 
rescission provisions of Exchange Act section 29(b) in connection 
with section 6(l) also will expire at that time. See id.

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[[Page 30701]]

VII. Administrative Law Matters--CEA Revisions (Definitions of ``Swap 
Dealer'' and ``Major Swap Participant,'' and Amendments to Definition 
of ``Eligible Contract Participant'')

A. Regulatory Flexibility Act

    The Regulatory Flexibility Act (``RFA'') requires Federal agencies 
to consider the impact of its rules on ``small entities.'' \1249\ A 
regulatory flexibility analysis or certification typically is required 
for ``any rule for which the agency publishes a general notice of 
proposed rulemaking pursuant to'' the notice-and-comment provisions of 
the Administrative Procedure Act, 5 U.S.C. 553(b).\1250\ In its 
proposal, the CFTC stated that ``[t]he rules proposed by the CFTC 
provide definitions that will largely be used in future rulemakings and 
which, by themselves, impose no significant new regulatory 
requirements. 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 economic impact on a substantial number of small 
entities.''\1251\
---------------------------------------------------------------------------

    \1249\ 5 U.S.C. 601 et seq.
    \1250\ 5 U.S.C. sections 601(2), 603, 604 and 605.
    \1251\ 75 FR 80203.
---------------------------------------------------------------------------

    In response to the Proposing Release, one commenter stated that the 
CFTC's ``rule-makings [are] an accumulation of interrelated regulatory 
burdens and costs on non-financial small entities like the NFPEEU 
members, who seek to transact in energy commodity swaps only to hedge 
the commercial risks of their not-for-profit public service 
activities.'' \1252\ In general, the commenter said that since the 
Small Business Administration (``SBA'') has determined that many rural 
electric cooperatives are ``small entities'' for purposes of the RFA, 
if the definition of swap dealer were to cover a substantial number of 
rural electric cooperatives the rule further defining swap dealer may 
have a significant economic impact on a substantial number of small 
entities.\1253\ Thus, the commenter concluded that the CFTC should 
conduct a regulatory flexibility analysis for each of its rulemakings 
under the Dodd-Frank Act, including this rulemaking.
---------------------------------------------------------------------------

    \1252\ See letter from NFPEEU.
    \1253\ See letter from NFPEEU and meeting with NFPEEU on January 
19, 2011.
---------------------------------------------------------------------------

    The commenter also said that the requirement in section 2(e) of the 
CEA, as amended by the Dodd-Frank Act, that a person who is not an ECP 
must execute swaps on a designated contract market would have the 
potential to have a significant economic impact on a substantial number 
of small entities if a substantial number of rural electric 
cooperatives were not covered by the definition of ECP.\1254\ Another 
commenter said that in considering the economic impact on small 
entities of the swap dealer definition rules, the CFTC should consider 
whether the availability and cost of swaps to small entities could be 
affected by potential uncertainty among persons who engage in the 
activities covered by the definition about whether they are required to 
register as swap dealers.\1255\
---------------------------------------------------------------------------

    \1254\ See letter from NFPEEU.
    \1255\ See letter from Dominion Resources.
---------------------------------------------------------------------------

    The commenters did not provide specific information on how the 
further defining swap dealer would have a significant economic effect 
on a substantial number of small entities. Nonetheless, the CFTC has 
reevaluated this rulemaking in light of the statements made to it by 
these commenters. After further consideration of those statements, the 
CFTC has again determined that this final rulemaking will not have a 
significant economic effect on a substantial number of small 
businesses. With regard to the definition of swap dealer, the CFTC 
expects that if any small entity were to engage in the activities 
covered by the definition, most such entities would be eligible for the 
de minimis exception from the definition.\1256\ Additionally, the 
Commission does not expect that the small entities identified by NFPEEU 
will be subject to registration with the Commission as a major swap 
participant, as most entities with total electric output not exceeding 
4 million megawatt hours are not expected to maintain outstanding swap 
positions that would exceed the applicable thresholds. In general, the 
major swap participant definition applies only to persons with very 
large swap positions, and therefore the definition of major swap 
participant is incompatible with small entity status.
---------------------------------------------------------------------------

    \1256\ The number of small entities that could conceivably be 
covered by the definition of swap dealer is likely to be further 
reduced if transactions between entities described in section 201(f) 
of the Federal Power Act (which generally includes rural electric 
cooperatives) are exempted from the requirements of the CEA, as 
contemplated by section 4(c)(6) of the CEA.
---------------------------------------------------------------------------

    With regard to the definition of ECP, the CFTC notes that the costs 
of executing swaps on a designated contract market raised by the 
commenter arise from a requirement of the CEA, and not from any rule 
promulgated by the CFTC. Last, regarding the comment that there may be 
an economic impact on small entities in terms of the availability and 
cost of swaps, the definition of swap dealer is being adopted to limit 
uncertainty with respect to which entities will be required to register 
as a swap dealer. Thus, the definition of swap dealer is intended to 
avoid creating the substantial economic effect which concerns the 
commenter.
    Accordingly, the Chairman, on behalf of the CFTC, certifies, 
pursuant to 5 U.S.C. 605(b), that the actions to be taken herein will 
not have a significant economic impact on a substantial number of small 
entities.

B. Paperwork Reduction Act

    The Paperwork Reduction Act (``PRA'') \1257\ imposes certain 
requirements on Federal agencies in connection with their conducting or 
sponsoring any collection of information as defined by the PRA. The 
Proposing Release stated that the proposed rules would not impose any 
new recordkeeping or information collection requirements, or other 
collections of information that require approval of the Office of 
Management and Budget (``OMB'') under the PRA, and invited public 
comment on the accuracy of the CFTC's estimate that no additional 
recordkeeping or information collection requirements or changes to 
existing collection requirements would result from the proposed 
rules.\1258\
---------------------------------------------------------------------------

    \1257\ 44 U.S.C. 3501 et seq.
    \1258\ 75 FR 80203.
---------------------------------------------------------------------------

    One commenter said that the regulatory requirements imposed on swap 
dealers and major swap participants (including swap end users that may 
potentially be misclassified as swap dealers or major swap 
participants) will entail reporting and record keeping 
requirements.\1259\ Specifically, the commenter noted that the CFTC 
stated in the Proposing Release that ``any entity determined to be a 
swap dealer or major swap participant would be subject to registration, 
margin, capital, and business conduct requirements * * * all activities 
that will have associated reporting and additional recordkeeping 
requirements.'' \1260\ Another commenter said that the CFTC should 
consider the implications under the PRA of all of its rulemakings under 
the Dodd-Frank Act as a whole.\1261\
---------------------------------------------------------------------------

    \1259\ See letter from Dominion Resources.
    \1260\ See id. at 6.
    \1261\ See letter from NFPEEU.
---------------------------------------------------------------------------

    As with the proposed rules, these final rules will not impose any 
new information collection requirements that require approval of OMB 
under the PRA. All reporting and recordkeeping

[[Page 30702]]

requirements applicable to swap dealers and major swap participants 
instead result from other rulemakings, for which the CFTC has sought 
OMB approval. The CFTC submitted an information collection request to 
OMB for each proposed rulemaking containing reporting or recordkeeping 
requirements, including the recordkeeping and reporting requirements 
referenced by the first commenter,\1262\ which estimated the 
implications of the proposed collections on prospective 
respondents.\1263\
---------------------------------------------------------------------------

    \1262\ See, e.g., 75 FR 71379, 71386 (Nov. 23, 2010) (proposed 
registration rules); 75 FR 70881, 70884 (Nov. 19, 2010), 75 FR 
71397, 71401 (Nov. 23, 2010), 75 FR 71391, 71394 (Nov. 23, 2010), 75 
FR 80638, 80656 (Dec. 22, 2010), and 76 FR 33066, 33076 (Jun. 7, 
2011); and 76 FR 27802, 27819 (May 12, 2011) (collectively, the 
information collection requests for the proposed business conduct 
rules).
    \1263\ See 44 U.S.C. 3506 (PRA program requirements) and 3507 
(PRA submission requirements).
---------------------------------------------------------------------------

    Moreover, in appropriate rulemakings, the CFTC sought to rely upon 
information collections that already had been proposed, in order to 
avoid imposing unnecessary additional burdens upon prospective 
respondents.\1264\ Parties wishing to review the CFTC's information 
collections on a global basis may do so at www.reginfo.gov, at which 
OMB maintains an inventory aggregating each of the CFTC's currently 
approved information collections, as well as the information 
collections that presently are under review.
---------------------------------------------------------------------------

    \1264\ See, e.g., 75 FR 80638, 80656 (Dec. 22, 2010).
---------------------------------------------------------------------------

C. Cost Benefit Considerations

    CEA section 15(a) requires the CFTC to consider the costs and 
benefits of its action before promulgating a regulation under the CEA, 
specifying 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.\1265\
---------------------------------------------------------------------------

    \1265\ 7 U.S.C. 19(a).
---------------------------------------------------------------------------

1. Introduction
    The terms ``major swap participant'' and ``swap dealer'' are 
defined in CEA sections 1a(33) and 1a(49), as added by the Dodd-Frank 
Act, to include any person that holds swap positions above a certain 
level (in the case of the term ``major swap participant'') or that 
engages in certain activities (in the case of the term ``swap 
dealer''), with certain exclusions and exceptions, all as discussed in 
parts II and IV of this Adopting Release. Section 712(d)(1) of the 
Dodd-Frank Act directs the CFTC and the SEC, in consultation with the 
Board, jointly to further define these and other terms. Also, CEA 
section 1a(49)(D) directs the CFTC to promulgate regulations to 
establish factors with respect to the making of the determination to 
apply the de minimis exception to the definition of the term ``swap 
dealer.''
    The provisions of the Dodd-Frank Act that direct the further 
definition of the terms ``swap dealer'' and ``major swap participant'' 
should be viewed in the context of Congress' consideration of the 
consequences that would arise from regulating persons and activities 
that were previously free from regulation. The Dodd-Frank Act is, in 
part, a response to a financial crisis in which unregulated swaps 
played a major role.\1266\ It includes provisions to regulate swap 
dealers and major swap participants in order to address concerns about 
this previously unregulated market. In this context, the Dodd-Frank Act 
requires that rules should ``further define'' the terms ``swap dealer'' 
and ``major swap participant'' by establishing and providing guidance 
with respect to the criteria for determining if a person is covered by 
one of the statutory definitions and therefore should be subject to 
certain regulatory requirements under Title VII; the Dodd-Frank Act 
does not direct the Commissions to define those terms in a vacuum. So, 
even in the absence of these rules, Title VII would require the 
regulation of persons that act as swap dealers or hold positions 
causing them to be major swap participants. Consequently, a large part 
of the costs and benefits resulting from the regulation of swap dealers 
and major swap participants result from the Dodd-Frank Act itself and 
not from these definitional rules.
---------------------------------------------------------------------------

    \1266\ See, e.g., S.Rep. 111-176, The Restoring American 
Financial Stability Act of 2010 at 29.
---------------------------------------------------------------------------

2. General Cost and Benefit Considerations
    In considering the comments on the proposed rules and the various 
alternatives available for the final rules, the CFTC sought to 
promulgate final rules that will help swap market participants and the 
public to apply the statutory definitions of the terms ``swap dealer'' 
and ``major swap participant'' in an efficient, uniform and accurate 
manner. We believe that doing so will protect market participants and 
the public, promote the efficiency, competitiveness and financial 
integrity of the swap markets, facilitate price discovery, encourage 
sound risk management practices and advance the public interest in 
general. That is, by providing direction and guidance as to which 
factors are relevant in applying the statutory definitions, and how to 
apply those factors to particular situations in the swap markets, the 
CFTC believes the final rules will provide benefits by reducing the 
cost of determining whether a particular person is covered by the 
statutory definitions, helping to make similar determinations for 
persons that are similarly situated, and promoting application of the 
terms ``swap dealer'' and ``major swap participant'' in conformity with 
the statutory definitions.
    The costs and benefits considered in this final rule fall in two 
categories: First, those an entity will experience in determining 
whether it is a ``swap dealer'' or ``major swap participant'' as 
further defined in this rulemaking; and second, those attributable to 
the fact that, as interpreted in this rule, a greater or fewer number 
of entities at the boundaries of the statutory definitions may be 
deemed within them.
    With respect to the first category, and as discussed further in 
sections V.A.3.j. and V.A.4.b. below, the CFTC has endeavored to 
approximate the costs of making these determinations. At the same time, 
the CFTC believes that the careful consideration of, and detailed 
response in this Adopting Release to, comments regarding the 
application of the statutory definitions will provide useful, practical 
guidance, yielding a substantial if unquantifiable benefit to entities 
making such determinations.
    The costs and benefits in the second category--those associated 
with the rules being more or less inclusive--were a primary concern of 
the CFTC and commenters throughout this rulemaking. Commenters stated 
that if the CFTC's final rules were to lead to interpretations of the 
statutory definitions that are over-inclusive, the result would be that 
entities would likely incur significant, unjustifiable costs 
attributable to various regulatory requirements intended for actual 
swap dealers and major swap participants.\1267\ Other commenters were 
concerned that if the rules were to lead to under-inclusive 
interpretations, the benefits expected from Title VII would be 
dampened.\1268\
---------------------------------------------------------------------------

    \1267\ See letters from API I, Atmos Energy, BG LNG I, Dominion 
Resources, Hess, NCGA/NGSA I, NFPEEU, Vitol and WGCEF VIII.
    \1268\ See letters from AFR, Better Markets I and Greenberger.
---------------------------------------------------------------------------

    The CFTC does not dismiss these potential unintended results and we

[[Page 30703]]

have responded to these comments in the policy determinations made 
above.\1269\ We recognize that these definitional rules are ``gating'' 
rules, and that this gating function will affect whether entities at 
the boundaries of the statutory definitions incur costs attributable to 
the regulatory regime that Congress has prescribed and the CFTC has 
implemented through other substantive regulations. Correspondingly, 
these definitional rules will also affect the extent of benefits for 
the swap market and the public resulting from those regulations. It is 
important to also recognize, however, that as stated above, the 
regulation of persons acting as swap dealers or who hold positions 
causing them to be major swap participants is required by the Dodd-
Frank Act. For entities that are not on the boundaries of the statutory 
definitions, but rather squarely within them or entirely outside of 
them, these rules will not affect the costs and benefits that result 
from their inclusion or exclusion. The latter group of costs and 
benefits are a consequence of the statutory definitions prescribed by 
Congress.
---------------------------------------------------------------------------

    \1269\ See, e.g., parts II.A.4.g, II.D.3.a and IV.B.3.a.
---------------------------------------------------------------------------

    In this rulemaking, we considered that more inclusive rules and 
guidance would cause some entities at the boundaries of the definitions 
to be covered by one of the definitions and therefore incur both 
initial and recurring direct costs of complying with Dodd-Frank Act 
requirements, while less inclusive rules and guidance would have the 
opposite effect.\1270\ Thus, as more or fewer entities are covered by 
the definitions, the amount of such direct compliance costs incurred by 
entities in the aggregate will vary. However, this variance in the 
aggregate compliance costs resulting from the CFTC's definitional 
guidance in this rulemaking must be distinguished from the compliance 
costs that any particular entity will incur stemming from the other 
rulemakings prescribing regulations applicable to swap dealers and 
major swap participants. Consideration of the specific costs and 
benefits attendant to various substantive regulations applicable to 
swap dealers and major swap participants is beyond the limited scope of 
this rulemaking.
---------------------------------------------------------------------------

    \1270\ For example, the final rules specify criteria related to 
application of the de minimis exception, the range of transactions 
that are eligible for the exclusion of swaps in connection with the 
origination of loans, and the requirements for limited designation 
as a swap dealer, each of which will impact the total number of 
entities that are subject to swap dealer regulation. The final rules 
also specify criteria related to the thresholds for major swap 
participant status, factors that may be considered in the major swap 
participant calculations, and the threshold for ``highly leveraged'' 
status, each of which will impact the number of entities that are 
major swap participants.
---------------------------------------------------------------------------

    Moreover, the variance in aggregate compliance costs resulting from 
this rulemaking will not track, on a ``one for one'' basis, the number 
of entities included in the definitions as the rules are more or less 
inclusive. This is because the initial and recurring compliance costs 
for any particular swap dealer or major swap participant will depend on 
the size, existing infrastructure, level of swap activity, practices 
and cost structure of the entity designated as such.\1271\ Another 
reason that the aggregate costs resulting as more or fewer entities are 
included in the definitions will not precisely track the number of such 
entities is that indirect costs are likely to result as market 
participants seek to avoid the regulations attendant to swap dealer or 
major swap participant status by, among other things, reducing their 
swap activities.\1272\ We do not expect that the extent of these 
indirect costs will be directly related to the number of entities 
included in the definitions.
---------------------------------------------------------------------------

    \1271\ It is likely that a swap dealer or major swap participant 
would incur direct compliance costs related to technology, personnel 
and capital. See CFTC, Registration of Swap Dealers and Major Swap 
Participants; Final Rule, 77 FR 2613 (January 19, 2012); CFTC, 
Business Conduct Standards for Swap Dealers and Major Swap 
Participants With Counterparties; Final Rule, 77 FR 9733 (February 
17, 2012) and CFTC, Swap Dealer and Major Swap Participant 
Recordkeeping, Reporting, and Duties Rules; Futures Commission 
Merchant and Introducing Broker Conflicts of Interest Rules; and 
Chief Compliance Officer Rules for Swap Dealers, Major Swap 
Participants, and Futures Commission Merchants; Final Rule, 77 FR 
20128 (April 3, 2012).
    \1272\ For example, those entities would lose the profits they 
may have gained from those activities, and potentially from related 
business activities if their customers cut back their business 
relationships because the abstaining entities no longer engage in 
those swap activities.
    We recognize that small entities are more likely than large 
entities to abstain from swap activities in order to avoid being 
covered by the swap dealer definition. Smaller entities are less 
likely to have existing technology and procedures that would comply 
with new regulations and therefore their initial costs of compliance 
with the requirements applicable to swap dealers are likely to be 
larger. Moreover, the same fixed costs will have a proportionally 
greater effect on small entities.
    Other market participants may also bear some costs if entities 
abstain from dealing activities or if large users of swaps reduce 
their activities to avoid major swap participant status. These costs 
could include transition costs as the other market participants 
identify new counterparties with which to enter into the same swaps. 
In addition, and likely more important, as more entities abstain 
from swap activities, other entities that are seeking to enter into 
swaps may have a reduced choice of counterparties, which may lead to 
unfavorable financial terms for swaps and imperfect matches between 
risks and the swaps that are available. These factors may increase 
the cost of risk mitigation in general, as entities use more costly 
risk management strategies in place of swaps.
    See generally letters from API I, BG LNG I, BOK dated February 
22, 2011 (``BOK III''), COPE I, Midsize Banks, NEM, NCGA/NGSA I, 
NGFA I, Chevron Federal Credit Union, M&T I, Sidley and WGCEF I. See 
also Roundtable Transcript at 39 (remarks of Eric Chern, Chicago 
Trading Company), 133-34 (remarks of Brenda Boultwood, 
Constellation).
---------------------------------------------------------------------------

    The CFTC likewise acknowledges that more or less inclusive 
definitions may increase or decrease the systemic benefits expected 
from the composite regulation of swap dealers and major swap 
participants. These include improved transparency and market 
orderliness, as well as the reduction of excess leverage and systemic 
risk. The CFTC believes that less inclusive final rules could 
negatively impact these interests in several ways: Those who engage in 
swaps with entities that elude swap dealer or major swap participant 
status and the attendant regulations could be exposed to increased 
counterparty risk; customer protection and market orderliness benefits 
that the regulations are intended to provide could be muted or 
sacrificed, resulting in increased costs through reduced market 
integrity and efficiency; \1273\ and entities that elude swap dealer or 
major swap participant status may gain an unwarranted competitive 
advantage over other market participants.\1274\
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    \1273\ More uniform compliance with regulations leads to more 
uniform expectations that market participants may reasonably have 
about the financial integrity of various swap dealers and major swap 
participants. Less uniform compliance, on the other hand, could 
introduce additional uncertainty about the financial integrity of an 
individual swap dealer or major swap participant. This could result 
in reduced market efficiency. Moreover, foreseeable ``network 
effects'' could magnify these costs. That is, since requirements 
promoting transparency and orderly documentation are expected to 
increase market participants' general level of certainty about the 
swap positions held by others in the market, the wider the market 
application the greater the benefit. For example, in the 2008 
financial crisis, uncertainty about the potential obligations of 
various market participants led to actions to restrict credit and 
reduce leverage that may not have been taken if there was greater 
confidence about market participants in general; this uncertainty 
also hampered regulatory efforts. Significant pockets of unregulated 
swap activity attributable to less inclusive definitions of the 
terms ``swap dealer'' and ``major swap participant'' may result in 
costs related to uncertainty and lack of information.
    \1274\ The extent of any such competitive advantage would depend 
on the number of entities that are inaccurately not covered by the 
definitions and the extent of their swap activities relative to the 
market in which they are active.
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    Generally, rules that capture more entities are likely to increase 
these benefits, while rules that capture fewer entities are likely to 
have the opposite effect, though there are several additional factors 
that also have a bearing on the presence and magnitude of increased or 
decreased benefits. These factors include the number and size of 
entities whose status changes

[[Page 30704]]

under more or less inclusive rules, the number of swaps they engage in, 
their connectedness to other institutions and role in the financial 
system, and the types of financial instruments they would have utilized 
in the absence of swap dealer and major swap participant regulations.
    At this time, it is also not possible to quantify the impact of 
these rules on the direct and indirect costs and benefits that result 
from changing the status of an entity that is on the boundaries of the 
Dodd-Frank Act's definitions of the terms ``swap dealer'' or ``major 
swap participant.'' The CFTC does not have adequate information about 
market participants' swap activities to determine which entities will 
change their activities in response to the definitions, which would be 
necessary in order to determine the significance of the impact on costs 
and benefits of including or excluding those entities from the 
regulations pertaining to swap dealers and major swap participants. 
Costs may not be estimated in an accurate or meaningful way for many 
reasons, including because all of the regulations pertaining to swap 
dealers and major swap participants have not yet been issued in their 
final form, and because the CFTC does not have adequate information 
about market participants' existing technology, infrastructure, use of 
swaps, or cost structure.\1275\ Changes in the total benefits resulting 
from the definitional regulations are also difficult to quantify, since 
many of the benefits of the swap dealer and major swap participant 
regulations are indirect, rather than direct. As a consequence, the 
CFTC may recognize and describe the impact of these rules on the 
overall costs and benefits deriving from swap dealer and major swap 
participant regulations, but it is not possible to quantify them at 
this time.
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    \1275\ Currently, prior to the implementation of Title VII, the 
U.S. swap market generally is not subject to substantive regulation, 
and market participants generally do not disclose detailed 
information about their swap activities and positions. This lack of 
data reduces our ability to analyze the swap activities of 
individual market participants, as well as the market as a whole, 
and thus impacts our ability to analyze the costs and benefits of 
these rules. Our analysis, out of necessity, is based on data that 
currently is available.
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    The applicable provisions of the Dodd-Frank Act regarding the term 
``eligible contract participant'' are somewhat different, in that the 
statute modifies a particular clause in the pre-existing statutory 
definition of the term and also provides general authority to further 
define the term. The final rules adopted in this regard provide 
guidance for the application of these provisions.
3. Comments on the Discussion of Costs and Benefits in the Proposing 
Release
    Some commenters suggested that the discussion in the Proposing 
Release of the costs and benefits of the proposed rules further 
defining the terms ``swap dealer, '' ``major swap participant'' and 
``eligible contract participant'' was ina