[Federal Register Volume 77, Number 146 (Monday, July 30, 2012)]
[Rules and Regulations]
[Pages 44441-44456]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-18383]


=======================================================================
-----------------------------------------------------------------------

COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 50

RIN 3038-AD60


Swap Transaction Compliance and Implementation Schedule: Clearing 
Requirement Under Section 2(h) of the CEA

AGENCY: Commodity Futures Trading Commission.

ACTION: Final rule.

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

SUMMARY: The Commodity Futures Trading Commission (Commission or CFTC) 
is adopting regulations to establish a schedule to phase in compliance 
with the clearing requirement under new section 2(h)(1)(A) of the 
Commodity Exchange Act (CEA or Act), enacted under Title VII of the 
Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank 
Act). The schedule will provide additional time for compliance with 
this requirement. This additional time is intended to facilitate the 
transition to the new regulatory regime established by the Dodd-Frank 
Act in an orderly manner that does not unduly disrupt markets and 
transactions.

DATES: The rules will become effective September 28, 2012.

FOR FURTHER INFORMATION CONTACT: Sarah E. Josephson, Deputy Director, 
202-418-5684, sjosephson@cftc.gov; Brian O'Keefe, Associate Director, 
202-418-5658. bokeefe@cftc.gov; or Peter Kals, Attorney-Advisor, 202-
418-5466, pkals@cftc.gov, Division of Clearing and Risk, Commodity 
Futures Trading Commission, Three Lafayette Centre, 1155 21st Street 
NW., Washington, DC 20581.

SUPPLEMENTARY INFORMATION: 

Table of Contents

I. Background
II. Comments on the Notices of Proposed Rulemaking
    A. Comment Period
    B. Harmonization
    C. Cross-Border and Affiliate Transactions
    D. Comprehensive Implementation Schedule
    E. Prerequisite Rules
    F. Definitions
    1. Active Fund
    2. Third-Party Subaccount
    3. Category 1 and Category 2 Entities
    G. Compliance Schedule for the Clearing Requirement
    4. Application to All Swap Types
    5. Timing of Implementation Schedules
III. Cost-Benefit Considerations
IV. Related Matters
    A. Regulatory Flexibility Act
    B. Paperwork Reduction Act

I. Background

    Section 723(a)(3) of the Dodd-Frank Act amended the CEA to provide, 
under new section 2(h)(1)(A) of the CEA, that it shall be unlawful for 
any person to engage in a swap unless that person submits such swap for 
clearing to a derivatives clearing organization (DCO) that is 
registered under the CEA or a DCO that is exempt from registration 
under the CEA if the swap is required to be cleared (the Clearing 
Requirement).\1\ Section 2(h)(2) charges the Commission with the 
responsibility for determining whether a swap is required to be cleared 
(a Clearing Requirement determination), through one of two avenues: (1) 
Pursuant to a Commission-initiated review; or (2) pursuant to a 
submission from a DCO of each swap, or any group, category, type, or 
class of swaps that the DCO ``plans to accept for clearing.'' \2\ The 
Commission is proposing its first Clearing Requirement determination 
concurrently with its adoption of this compliance schedule rule. The 
finalization of that proposal will trigger the compliance schedule 
provided for under this adopting release.
---------------------------------------------------------------------------

    \1\ Section 2(h)(7) of the CEA provides an exception to the 
Clearing Requirement when one of the counterparties to a swap (i) is 
not a financial entity, (ii) is using the swap to hedge or mitigate 
commercial risk, and (iii) notifies the Commission how it generally 
meets its financial obligations associated with entering into a non-
cleared swap.
    \2\ Under section 2(h)(2)(B)(ii), the Commission must consider 
swaps listed for clearing by a DCO as of the date of enactment of 
the Dodd-Frank Act.
---------------------------------------------------------------------------

    On September 20, 2011, the Commission published proposed Sec.  
39.5(e) \3\ to phase in compliance of the Clearing Requirement upon the 
Commission's issuance of a Clearing Requirement determination pursuant 
to Sec.  39.5(b) or (c).\4\ That notice of proposed rulemaking (NPRM) 
also included an implementation schedule for the requirement pursuant 
to amended section 2(h)(8)(A), which requires a swap subject to the 
Clearing

[[Page 44442]]

Requirement to be executed on a designated contract market (DCM) or 
swap execution facility (SEF), unless no SEF or DCM makes the swap 
available to trade (the Trade Execution Requirement). The Commission is 
hereby adopting proposed Sec.  39.5(e), as newly designated Sec.  
50.25, to establish a schedule for compliance only for the Clearing 
Requirement. A separate rulemaking will promulgate the final 
implementation schedule for the Trade Execution Requirement.\5\
---------------------------------------------------------------------------

    \3\ Commission regulations referred to herein are found at 17 
CFR Ch. 1.
    \4\ See 76 FR 58186 (Sept. 20, 2011).
    \5\ The Commission will address the proposed compliance 
schedules for trading documentation and margining under section 4s 
of the CEA, 76 FR 58176 (Sept. 20, 2011), at the same time that it 
finalizes the underlying documentation and margin rules.
---------------------------------------------------------------------------

    The compliance schedule for the Clearing Requirement is based on 
the type of market participants entering into a swap subject to the 
Clearing Requirement. The compliance schedule balances several goals. 
First, the Commission believes that some market participants, such as 
certain managed accounts, referred to under Sec.  50.25 as ``Third-
Party Subaccounts,'' may require additional time to bring their swaps 
into compliance with the Clearing Requirement. Pursuant to Sec.  
39.5(e) (finalized as Sec.  50.25), these market participants would be 
afforded additional time to clear their swaps so that they will be able 
to document new client clearing arrangements, connect to market 
infrastructure such as DCOs, and prepare themselves and their customers 
for the new regulatory requirements.
    Another goal of the compliance schedule is to have adequate 
representation of market participants involved at the outset of 
implementing a new regime for requiring certain swaps to be cleared. 
The Commission believes that having a cross-section of market 
participants involved at the outset of formulating and designing the 
rules and infrastructure under which the Clearing Requirement is 
implemented will best meet the needs of all market participants.
    The compliance schedule set forth in Sec.  50.25 defines three 
categories of market participants: Category 1 Entities,\6\ Category 2 
Entities,\7\ and all other market participants. As described in Sec.  
50.25(b), a swap between two Category 1 Entities must comply with the 
Clearing Requirement no later than 90 days after the publication of the 
Clearing Requirement determination in the Federal Register.\8\ A swap 
between a Category 2 Entity and a Category 1 Entity or another Category 
2 Entity must comply within 180 days, and all other swaps must be 
submitted for clearing no later than 270 days after the Clearing 
Requirement determination is published in the Federal Register. To 
clarify, the swap is subject to the latest compliance date for one of 
the counterparties. In other words, if a Category 1 Entity enters into 
a swap with a Category 2 Entity, both parties have 180 days to submit 
the swap for clearing. However, the counterparty entitled to the later 
compliance date may elect to clear the swap earlier, and in that event, 
its counterparty is required to oblige.
---------------------------------------------------------------------------

    \6\ A Category 1 Entity is defined under Sec.  50.25(a) to 
include a swap dealer; security-based swap dealer; major swap 
participant; major security-based swap participant; or active fund 
(also defined by Sec.  50.25(a)).
    \7\ A Category 2 Entity is defined under Sec.  50.25(a) to 
include a commodity pool; a private fund as defined in section 
202(a) of the Investment Advisers Act of 1940 other than an active 
fund; or a person predominantly engaged in activities that are in 
the business of banking, or in activities that are financial in 
nature as defined in section 4(k) of the Bank Holding Company Act of 
1956, provided that, in each case, the entity is not a Third-Party 
Subaccount. As proposed, this category contained employee benefit 
plans under the Employee Retirement Income and Security Act of 1974, 
but under the final rule, these plans will not be included in 
Category 2. See below for further discussion.
    \8\ As proposed, the rule required compliance within 90, 180, or 
270 days after the effective date set by the Commission for a 
Clearing Requirement determination. In order to clarify precisely 
when the compliance period will commence, the Commission has 
modified the rule to indicate that the compliance periods begin as 
of the date of publication of final Clearing Requirement 
determination rules in the Federal Register. From this point, market 
participants have either 90, 180, or 270 days to come into 
compliance.
---------------------------------------------------------------------------

II. Comments on the Notices of Proposed Rulemaking

    The Commission received 26 comments during the six-week public 
comment period following publication of the NPRM. The Commission 
considered each of these comments in formulating the final regulation, 
Sec.  39.5(e) (finalized as Sec.  50.25).

A. Comment Period

    The Commission published the NPRM in the Federal Register on 
September 20, 2011, and the public comment period closed on November 4, 
2011.
    Financial Services Roundtable (FSR) comments that the public should 
be able to comment on an implementation schedule for each swap subject 
to the Clearing Requirement because the characteristics of one 
particular swap may necessitate a very different schedule from another.
    Pursuant to Sec.  39.5(b)(5) in the case of swap submissions and 
Sec.  39.5(c)(2) in the case of Commission-initiated reviews, the 
public will have an opportunity to comment on each of the Commission's 
proposed Clearing Requirement determinations, and to comment on whether 
the Commission should employ the compliance schedule for that 
determination. In this manner, the public will have an opportunity to 
comment on whether use of the compliance schedule is appropriate for a 
given Clearing Requirement determination covering particular swaps.

B. Harmonization

    The NPRM reflects consultation with the staff of the Securities and 
Exchange Commission (SEC), prudential regulators, and international 
regulatory authorities. With respect to the latter, the Commission is 
mindful of the benefits of harmonizing its regulatory framework with 
that of its counterparts in foreign countries. The Commission therefore 
has monitored global advisory, legislative, and regulatory proposals, 
and has consulted with foreign regulators in developing the final 
regulations.
    Vanguard, the Federal Home Loan Banks (FHLBs), and the Investment 
Company Institute (ICI) each recommend that the Commission coordinate 
the compliance schedule for the Clearing Requirement, as well as 
implementation schedules concerning other Dodd-Frank Act requirements, 
with the SEC, the prudential regulators, and international regulators 
to avoid market disruption and avoid regulatory arbitrage. The American 
Council of Life Insurers (ACLI) urges the Commission to coordinate with 
the SEC and international regulators to achieve reductions in 
compliance costs. A joint letter by the Futures Industry Association, 
the International Swaps and Derivatives Association, and the Securities 
Industry and Financial Markets Association (FIA/ISDA/SIFMA) urges the 
Commission to coordinate implementation schedules with those introduced 
by the SEC, the National Futures Association, self-regulatory 
organizations, and market infrastructure providers.
    In addition to the regulators referenced above, the Commission has 
consulted with other U.S. financial regulators including: (1) The Board 
of Governors of the Federal Reserve System; (2) the Office of the 
Comptroller of the Currency; and (3) the Federal Deposit Insurance 
Corporation. Staff from each of these agencies has had the opportunity 
to provide oral and/or written comments to this adopting release, as 
well as to the proposal.

[[Page 44443]]

C. Cross-Border and Affiliate Transactions

    The NPRM did not differentiate between domestic and foreign swap 
dealers (SDs), major swap participants (MSPs) or their counterparties, 
and did not address affiliate transactions.
    MarkitSERV and the Alternative Investment Management Association 
(AIMA) each comment that the NPRM, as well as other proposals setting 
forth implementation schedules for complying with Dodd-Frank Act 
requirements, should clarify the status of cross-border transactions. 
Better Markets states that trading relationships between an SD or MSP 
and its affiliate or an international counterparty should not be 
treated any differently than any other trading relationship. FIA/ISDA/
SIFMA comments that the Commission should publish guidance concerning 
the extraterritorial application of Title VII prior to the commencement 
of any implementation schedule.
    The Commission separately has issued guidance on the cross-border 
application of Title VII, including the Clearing Requirement.\9\ With 
regard to inter-affiliate transactions, the Commission will be 
considering this issue in an upcoming proposal.
---------------------------------------------------------------------------

    \9\ See Cross-Border Application of Certain Swaps Provisions of 
the Commodity Exchange Act, 77 FR 41213 (July 12, 2012).
---------------------------------------------------------------------------

D. Comprehensive Implementation Schedule

    This adopting release pertains exclusively to the implementation of 
the Clearing Requirement.
    The Coalition for Derivatives End-Users (CDE), a joint letter by 
the Edison Electric Institute, the National Rural Electric Cooperative 
Association, and the Electric Power Supply Association (Joint 
Associations); ICI; and MarkitSERV each argue that the Commission 
should create an implementation plan addressing all of its final Dodd-
Frank rules and that the Clearing Requirement compliance schedule 
should be part of that comprehensive schedule. CDE comments further 
that a comprehensive schedule is important to end-users, particularly 
in the areas of recordkeeping and reporting. The Joint Associations 
also comment that a comprehensive schedule should detail compliance 
dates, both specific and market-wide, for each registered entity and 
that the Commission should request further comment on this subject as 
more final rules are published.
    Vanguard comments that in implementing Title VII, the Commission 
should focus first on systemic risk issues and then issues relating to 
transparency and trade practices. Implementation schedules should be 
organized by type of participant and asset class. The schedules should 
also allow for voluntary compliance.
    ACLI argues that the Commission has not provided sufficient 
guidance concerning new rules and effective dates in order for market 
participants to conduct a prudent review of resource planning. ACLI 
maintains that complying with only some rules creates a risk that 
documents will have to be renegotiated when other rules are phased in.
    In this adopting release, the Commission is focused on providing 
additional time to market participants that may require more time to 
comply with one of the key elements of the Dodd-Frank Act--the Clearing 
Requirement. The compliance schedule that is the subject of this 
adopting release was proposed at the same time as three other 
compliance schedules--schedules for the Trade Execution Requirement and 
two important requirements under section 4s of the CEA, documentation 
and margin for uncleared swaps. Each of these proposed compliance 
schedules responded to particular concerns from market participants, 
especially those that are not required to register with the Commission. 
The Commission also has published compliance dates for phasing in 
implementation in nearly all of its final rules.\10\ In addition, the 
Commission has twice published on its Web site general schedules 
regarding the sequence and timing for its own consideration of final 
rules.\11\
---------------------------------------------------------------------------

    \10\ See, e.g., Swap Data Recordkeeping and Reporting 
Requirements, 77 FR 2136, 2195-2196 (Jan. 13, 2012); Business 
Conduct Standards for Swap Dealers and Major Swap Participants with 
Counterparties, 77 FR 9734, 9803 (Feb. 17, 2012); and Derivatives 
Clearing Organization General Provisions and Core Principles, 76 FR 
69334, 69408 (Nov. 8, 2011).
    \11\ See http://www.cftc.gov/LawRegulation/DoddFrankAct/index.htm.
---------------------------------------------------------------------------

    In response to ACLI, as discussed further below, the Commission has 
finalized all the documentation requirements necessary for compliance 
with the Clearing Requirement.\12\ With regard to Vanguard's comment, 
the Commission intends to implement the Clearing Requirement based on 
specific classes of swaps, beginning with those asset classes that are 
currently being cleared. The Commission believes that implementation of 
the Clearing Requirement will serve to reduce systemic risk by 
mitigating counterparty credit risk through the use of the marking-to-
market, margining, and risk mutualization provided by central 
counterparties. The adoption of this compliance schedule is an 
important step toward implementing that requirement. In addition, the 
compliance schedule expressly allows for voluntary clearing prior to 
the required compliance date, and market participants currently are 
free to clear all swaps offered for clearing by DCOs on a voluntary 
basis.
---------------------------------------------------------------------------

    \12\ See Customer Clearing Documentation, Timing of Acceptance 
for Clearing, and Clearing Member Risk Management, 77 FR 21278 
(April 9, 2012).
---------------------------------------------------------------------------

E. Prerequisite Rules

    The preamble to the NPRM stated that prior to requiring compliance 
with any Clearing Requirement determination, the Commission must 
publish the following final rules: Definitions of swap, SD, and MSP; 
End-User Exception to Mandatory Clearing of Swaps; and Protection of 
Cleared Swaps Customer Collateral.
    The FHLBs comment that the rule text of an implementation rule 
should state that the compliance schedule will not take effect until 
the Commission has published applicable final rules. The FHLBs believe 
that it is insufficient for the preamble to make this point.
    The Joint Associations state that they cannot comment on the 
adequacy of either the compliance schedule for the Clearing Requirement 
or other implementation schedules until various final rules have been 
published, including the definitions of swap, SD, and MSP. The Joint 
Associations want to see how many of their comments to these rules have 
been adopted because this will affect how long it will take their 
members to comply with Title VII requirements. ICI comments that 
parties cannot prepare for centralized clearing until the Commission 
publishes the final rule concerning the definition of swap.
    Citadel, FHLBs, and FIA/ISDA/SIFMA each recommend that the 
Commission publish final rules related to clearing, such as customer 
clearing documentation, timing of acceptance for clearing, and clearing 
member risk management, prior to phasing in the Clearing Requirement. 
FHLBs state that the prior publication of the Customer Clearing 
Documentation, Timing of Acceptance for Clearing, and Clearing Member 
Risk Management rules is important so that market participants can 
fully appreciate risks and not have to renegotiate documentation.
    The Committee on Investment of Employee Benefit Assets (CIEBA) 
recommends that the Commission not impose the Clearing Requirement 
until full physical segregation is available for margin of cleared 
swaps. CIEBA also

[[Page 44444]]

comments that if the Commission publishes final segregation rules for 
cleared swaps customer collateral at the same time that it phases in 
the Clearing Requirement, then market participants' limited resources 
would be overwhelmed. ICI comments that parties cannot prepare for 
centralized clearing until the Commission publishes the final rule 
concerning the Protection of Cleared Swaps Customer Collateral. ICI 
also argues that the documentation requirements under section 4s(i) of 
the CEA must be finalized before market participants are required to 
comply with mandatory clearing.
    CME recommends that the Commission finalize the DCO Conflicts of 
Interest rules prior to requiring compliance with the Clearing 
Requirement.
    The American Bankers Association (ABA) believes that end-user banks 
not be required to comply with the Clearing Requirement until 180 days 
after the Commission determines whether end-user banks will be exempt 
from the Clearing Requirement.
    AIMA believes the Commission should publish final rules concerning 
the Margin Requirement, as well as customer collateral protection 
rules, prior to phasing in the Clearing Requirement.
    The Commission has finalized all four of the rules identified in 
the NPRM that it needed to be completed prior to requiring compliance 
with the Clearing Requirement (namely, the End-User Exception to 
Mandatory Clearing of Swaps; \13\ Protection of Cleared Swaps Customer 
Collateral; \14\ the Further Definition of ``Swap Dealer,'' ``Security-
Based Swap Dealer,'' ``Major Swap Participant,'' ``Major Security-Based 
Swap Participant'' and ``Eligible Contract Participant''; \15\ and the 
Further Definition of ``Swap,'' ``Security-Based Swap,'' and 
``Security-Based Swap Agreement''; Mixed Swaps; Security-Based Swap 
Agreement Recordkeeping).\16\ In addition, the Commission has finalized 
rules related to Customer Clearing Documentation, Timing of Acceptance 
for Clearing, and Clearing Member Risk Management.\17\ Finalizing these 
rules addresses the FHLBs' concerns about having to revise 
documentation more than once and provides certainty as to swap 
processing requirements and expectations regarding risk management for 
clearing members. On the other hand, in response to CME's comment, the 
Commission does not believe it is necessary for final DCO Conflicts of 
Interest rules to be in effect before requiring compliance with the 
Clearing Requirement because these rules do not relate directly to the 
clearing process, customer connectivity, clearinghouse risk management, 
or other matters that would affect the implementation of the Clearing 
Requirement.
---------------------------------------------------------------------------

    \13\ End-User Exception to the Clearing Requirement for Swaps, 
adopted by the Commission on July 10, 2012, available at 
www.cftc.gov.
    \14\ Protection of Cleared Swaps Customer Contracts and 
Collateral; Conforming Amendments to the Commodity Broker Bankruptcy 
Provisions, 77 FR 6336 (Feb. 7, 2012).
    \15\ Further Definition of ``Swap Dealer,'' ``Security-Based 
Swap Dealer,'' ``Major Swap Participant,'' ``Major Security-Based 
Swap Participant'' and ``Eligible Contract Participant,'' 77 FR 
30596 (May 23, 2012).
    \16\ Further Definition of ``Swap,'' ``Security-Based Swap,'' 
and ``Security-Based Swap Agreement''; Mixed Swaps; Security-Based 
Swap Agreement Recordkeeping, Section VII, adopted by the Commission 
on July 10, 2012, available at www.cftc.gov.
    \17\ Customer Clearing Documentation, Timing of Acceptance for 
Clearing, and Clearing Member Risk Management, 77 FR 21278, (April. 
9, 2012).
---------------------------------------------------------------------------

    In response to the FHLBs' request that the implementation rule text 
include a provision that the rule is not effective until the 
definitions of SD, MSP, and swap are finalized, the Commission 
reiterates that all of the pre-requisite rules for the Clearing 
Requirement have been adopted. With regard to CIEBA's comment about 
full physical segregation, the Commission published its final rule 
concerning Protection of Cleared Swaps Customer Collateral on February 
7, 2012.\18\ In that rulemaking, the Commission indicated that it may 
address issues related to collateral held in third-party safekeeping 
accounts at some point in the future. However, given that a fully 
operational segregation regime is required to be in place by November 
8, 2012, the Commission does not believe that it is necessary for this 
additional matter to be resolved prior to requiring compliance with the 
Clearing Requirement.
---------------------------------------------------------------------------

    \18\ 77 FR 6336 (Feb. 7, 2012).
---------------------------------------------------------------------------

    In response to ICI's comment, the Commission clarifies that 
finalization of the swap trading relationship documentation 
requirements for SDs and MSPs under section 4s(i) of the CEA is not 
required for compliance with the Clearing Requirement because the 
documentation that is the subject of those rules relates primarily to 
bilaterally-executed, uncleared swap transactions, and none of the 
provisions in proposed Sec.  23.504 pertain directly to the Clearing 
Requirement. Similarly, in response to AIMA's comment, final margin 
rules for uncleared swaps are not required to be finalized prior to 
requiring compliance with the Clearing Requirement as these are 
related, but distinct, provisions under the Dodd-Frank Act.

F. Definitions

    Under Sec.  39.5(e)(1), the Commission proposed definitions of the 
terms ``Category 1 Entity,'' ``Category 2 Entity,'' ``Active Fund,'' 
and ``Third-Party Subaccount.'' The definitions set forth in proposed 
Sec.  39.5(e) (now Sec.  50.25) would apply specifically to provisions 
contained in part 39 (now part 50) and only those other rules that 
explicitly cross-reference these definitions. The Commission is 
adopting the definitions as proposed, with the exceptions discussed 
below.
1. Active Fund
    As proposed under Sec.  39.5(e)(1), ``any private fund as defined 
in section 202(a) of the Investment Advisers Act of 1940, that is not a 
third-party subaccount and that executes 20 or more swaps per month'' 
would be defined as an ``Active Fund'' and subject to the shortest 
implementation schedule for compliance with the Clearing Requirement.
    Numerous commenters, such as Better Markets, Chris Barnard, and 
AIMA, agree with the Commission that using a market participant's 
average monthly trading volume would be an appropriate proxy for 
determining an entity's ability to comply with the Clearing Requirement 
and would be better than a proxy based on notional volume or open 
interest. AIMA agrees with the NPRM's proposal that Active Funds be 
subject to the 90-day deadline.
    Other commenters express concerns about solely relying on monthly 
volumes as a proxy, especially without further defining the types of 
swaps that would be included in the calculation. ACLI states that the 
frequency of trading is not an appropriate indicator of a market 
participant's experience or resources. The Association of Institutional 
Investors (AII) states that the definition should specify the type of 
swaps that count towards the threshold. CDE recommends a minimum 
average monthly notional threshold to avoid capturing smaller end-
users. CDE also states that hedges and inter-affiliate swaps should be 
excluded from this monthly average threshold. Managed Funds Association 
(MFA) similarly requests clarification regarding those swaps that would 
be included in the monthly swap calculation. Specifically, MFA requests 
clarification as to whether novations, amendments, or partial tear-ups 
would be included.
    Commenters also focus on the average monthly threshold of 20 swaps 
per

[[Page 44445]]

month for the preceding 12 months. FIA/ISDA/SIFMA proposes that the 
threshold be an average of 200 trades per month. Vanguard proposes a 
similar threshold. Both AII and MFA think the proposed threshold was 
overly inclusive. MFA also highlights its belief that the proposed 
definition would be difficult to administer, while unnecessarily 
creating another tier of market participants for the purposes of the 
implementation schedules.
    In response to these comments, the Commission is increasing the 
average monthly threshold to 200 swap trades per month for the 
preceding 12 months. The Commission believes that monthly trading 
volume is a suitable proxy for determining the appropriate 
implementation schedule for a swap counterparty. By increasing the 
threshold to 200, as recommended by FIA/ISDA/SIFMA, as well as 
Vanguard, the risk of capturing smaller, less experienced swap 
counterparties should be substantially diminished. The market 
participants engaging in this level of swap activity should be able to 
access the resources necessary to meet the 90-day implementation 
schedule. In light of the number of transactions currently being 
cleared on a voluntary basis by funds, the Commission does not believe 
that an increase in the threshold of monthly swap trades will 
negatively impact the goal of broad market participation in the 
implementation of the Clearing Requirement. The Commission believes 
this increase in the average monthly threshold also addresses CDE's 
concerns about smaller market participants using swaps only to hedge 
risk.
    Further, by maintaining the concept of Active Fund, the Commission 
believes that it will continue to ensure adequate representation across 
the spectrum of market participants during the first phase of the 
implementation of the Clearing Requirement. As a result of this 
participation, processes and infrastructure will be established to 
serve all segments of the market, not just SDs and MSPs, which are 
included in the initial phase of the compliance schedule for the 
Clearing Requirement.
    In response to AII and MFA, the Commission clarifies that the 
average monthly threshold of swaps applies to new swaps that the entity 
enters into, and it does not apply to novations, amendments, or partial 
tear-ups. In addition, the Commission clarifies that the 200 swap 
threshold includes any swap, as defined under the CEA and Sec.  1.3, 
and not just those swaps that would be subject to the relevant Clearing 
Requirement determination and attendant compliance schedule.
2. Third-Party Subaccount
    Under Sec.  39.5(e) (finalized herein as Sec.  50.25), Third-Party 
Subaccounts are excluded from the definitions of Category 1 Entity and 
Category 2 Entity, with the effect that such subaccounts will have 270 
days, the longest period, in which to comply with the Clearing 
Requirement. The NPRM defined Third-Party Subaccounts as ``a managed 
account that requires the specific approval by the beneficial owner of 
the account to execute documentation necessary for executing, 
confirming, margining, or clearing swaps.'' The purpose of excluding 
Third-Party Subaccounts from the defined categories was to ensure that 
investment managers, who may be faced with bringing numerous accounts 
into compliance, would have adequate time to do so.
    Commenters question whether the definition was broad enough to 
provide sufficient time for Third-Party Subaccounts to comply with the 
Clearing Requirement. ICI noted that Third-Party Subaccounts, whether 
subject to the specific execution authority of the beneficiary or not, 
require managers to work closely with clients when entering into 
trading agreements on the customer's behalf. As such, ICI feels that no 
distinction should be made based on specific execution authority or 
lack thereof. ICI comments that all Third-Party Accounts should be 
uniformly classified and be given 270 days to comply. AII similarly 
states that the definition is too narrow given the administrative work 
required to manage an account, regardless of the execution authority. 
Further, AII states that execution authority is not an industry 
standard. The term, as proposed, therefore divides the universe of 
managed accounts inappropriately. FIA/ISDA/SIFMA recommends that all 
accounts managed by third parties, regardless of the execution 
authority, should be given the most time to comply with the Clearing 
Requirement.
    Based on the comments received, the Commission is revising the 
definition of Third-Party Subaccount to mean ``an account that is 
managed by an investment manager that (1) is independent of and 
unaffiliated with the account's beneficial owner or sponsor, and (2) is 
responsible for the documentation necessary for the account's 
beneficial owner to clear swaps.'' In modifying this definition, the 
Commission is taking into account the point made by AII, FIA/ISDA/
SIFMA, and ICI that all investment managers will need additional time 
to comply with a Clearing Requirement regardless of whether they have 
explicit execution authority. However, the definition retains the nexus 
between the investment manager and the documentation needed for 
clearing swaps. In other words, if the investment manager has no 
responsibility for documenting the clearing arrangements, then that 
account would be required to clear its swaps subject to required 
clearing within 180 days. For those accounts under the revised 
definition, however, the Commission believes that the 270-day deadline 
is more appropriate. Given the general notice investment managers have 
had about the Dodd-Frank Act's Clearing Requirement since the enactment 
of the statute in July, 2010, managers should have been able to 
consider and plan the infrastructure and resources that are necessary 
for all of their accounts, including Third-Party Subaccounts, to comply 
with the Clearing Requirement. Thus, the 180- and 270-day deadlines 
should provide adequate time to accommodate all managed accounts.
3. Category 1 and Category 2 Entities
    The compliance schedule is organized according to the type of 
market participant. To the extent that the Commission determines that a 
compliance schedule is warranted in connection with a Clearing 
Requirement determination (i.e. to comply with the Clearing 
Requirement) a market participant defined as a Category 1 Entity will 
have 90 days to comply, a Category 2 Entity will have 180 days, and all 
others will have 270 days. According to the proposed definitions, a 
Category 1 Entity includes an SD, a security-based swap dealer, an MSP, 
a major security-based swap participant, or an Active Fund. A Category 
2 Entity includes a commodity pool, a private fund, as defined by the 
Investment Advisers Act of 1940, an ERISA plan, or a person 
predominantly engaged in banking or other financial activities, as 
defined by section 4(k) of the Bank Holding Company Act. A Category 2 
Entity would not include an Active Fund or a Third-Party Subaccount.
    Encana Marketing (USA) Inc. (Encana) and the Joint Associations 
comment that non-financial end users should be expressly included in 
the category with the longest timeframe. CDE argues that financial end-
users should be treated identically to non-financial end-users because 
they do not pose systemic risk, and, therefore, should be given the 
most time to comply with the Clearing Requirement, and not included in 
Category 2. ICI seeks clarification that a market participant can 
determine whether it is an MSP for purposes of the compliance schedule 
for the Clearing

[[Page 44446]]

Requirement at the same time that it is required to review its status 
as an MSP under other Commission and SEC rules.
    CIEBA states that in-house ERISA funds should be in the group with 
the longest compliance time, and not Category 2 Entities. CIEBA notes 
that such funds do not pose systemic risk, and they typically rely upon 
third-party managers for some portion of their fund management. 
Splitting in-house and external accounts (i.e. those accounts meeting 
definition of Third-Party Subaccount and permitted 270 days) of the 
same ERISA plan will impact risk management given different 
implementation schedules. CIEBA also states that this distinction will 
cause pension funds to bear the costs of compliance because they will 
need to comply prior to their third-party managers, who would be better 
positioned to provide insight and service in this regard.
    The Commission believes that the definitions of Category 1 Entity 
should be finalized as proposed, but that the definition of Category 2 
Entity should be modified by removing the reference to ERISA plans. In 
response to Encana and the Joint Associations, non-financial end users 
are adequately addressed in Sec.  39.5(e)(2)(iii) (now Sec.  
50.25(b)(3))--unless the swap transactions are eligible to claim the 
exception from the Clearing Requirement under section 2(h)(7) of the 
CEA, the parties are given 270 days to comply with the Clearing 
Requirement. With respect to issues raised by CDE regarding those 
financial entities included in Category 2, based on numerous meetings 
with participants in the swap market, the Commission believes that 
financial entities are capable of complying with the Clearing 
Requirement 90 days sooner than non-financial entities. Accordingly, 
the compliance schedule has correctly situated Category 2 Entities 
based upon their ability to meet the requirements of the underlying 
regulations. Moreover, the distinction between financial and non-
financial entities has a statutory basis in section 2(h)(7) of the CEA.
    The Commission recognizes the concerns raised by CIEBA regarding 
splitting in-house and external accounts (i.e., those accounts meeting 
the definition of Third-Party Subaccount and permitted 270 days) of the 
same ERISA plan. In response to these concerns, the Commission is 
removing the reference to employee benefit plans as defined in 
paragraphs (3) and (32) of section 3 of the Employee Retirement Income 
and Security Act of 1974. As a result, these ERISA plans will be 
afforded the longest compliance period (270 days).
    With regard to ICI's comment, a potential MSP can review its 
obligation to register as an MSP at the same time it is reviewing where 
it fits under the Clearing Requirement compliance schedule. In many 
instances, MSPs will have to review their registration obligations 
ahead of complying with the Clearing Requirement. However, if an entity 
discovers that it has crossed the threshold established under the MSP 
rules and is required to register during the 90-day period for Category 
1 Entities, the Commission would consider allowing that entity to 
petition for additional time to come into compliance with the Clearing 
Requirement.\19\
---------------------------------------------------------------------------

    \19\ Similarly, the Commission would consider allowing entities 
to petition for additional time to comply to the extent that they 
discover that they have exceeded the de minimis threshold under the 
swap dealer definition and are required to register during the 90-
day period for Category 1.
---------------------------------------------------------------------------

G. Compliance Schedule for the Clearing Requirement

    As mentioned above, Sec.  39.5(e)(2) provides that when the 
Commission determines that an implementation schedule is appropriate in 
connection with a given Clearing Requirement determination, market 
participants within the definition of Category 1 will have 90 days to 
comply, those within the definition of Category 2 will have 180 days, 
and all others 270 days to implement the Clearing Requirement.
4. Application to All Swap Types
    The Clearing Requirement compliance schedule is based upon the 
nature of a given swap market participant, considering the 
participant's risk profile, compliance burden, resources, and 
expertise. The schedule does not contemplate different implementation 
timeframes based upon the characteristics of particular swaps.
    AIMA states that it does not believe further implementation 
schedules are necessary based on the nature of the swap itself. Better 
Markets, Citadel, and MFA comment that the compliance schedule should 
apply, however, to all swaps within a ``group'' or ``class,'' as 
defined by the Commission's Clearing Requirement determination.
    Commenters such as CDE state that the Commission should publish an 
implementation schedule specific to the characteristics of a particular 
type of swap. CDE comments that because it is unlikely that end-users, 
and other entities relied upon by end-users, will be able to meet the 
requirements necessary to comply with clearing determinations for all 
swap products at the same time, the Commission should phase in 
implementation deadlines by swap type, according to the amount of 
systemic risk posed by a particular swap.
    MarkitSERV asserts that all Dodd-Frank Act requirements should be 
phased-in by asset class, taking into account that different asset 
classes have various levels of product standardization, 
electronification, volumes, and types of counterparties. FIA/ISDA/SIFMA 
also states that there should be a separate compliance schedule for 
each asset class. FIA/ISDA/SIFMA also states that the Commission should 
require credit default swaps and interest rate swaps to be cleared 
first because those products are already being cleared. Commodity and 
equity swaps, according to FIA/ISDA/SIFMA, should be required to be 
cleared later because the marketplace is currently clearing fewer of 
those products.
    AIMA, CDE, ICI, and MarkitSERV state that the compliance schedule 
should require the Commission to phase in each Clearing Requirement 
determination as set forth in Sec.  39.5(e). FHLB and ICI comment that 
the Commission should have the flexibility to extend clearing 
implementation dates, but not shorten them. Citadel counters that the 
compliance schedule should only be triggered when a determination is 
issued for a new category of swaps.
    This rule affords the Commission discretion to determine whether to 
apply the compliance schedule in connection with a particular Clearing 
Requirement determination. The Commission agrees that while the 
schedule may be necessary in connection with some Clearing Requirement 
determinations, especially those covering new classes of swaps, there 
also may be determinations that are sufficiently similar to prior ones 
that no compliance schedule is necessary. As such, the Commission will 
determine whether or not to apply the Sec.  39.5(e) (now Sec.  50.25) 
compliance schedule as part of its analysis in connection with each 
Clearing Requirement determination.
    Further, it remains the Commission's intention that those swaps 
currently being cleared will be subject to the first Clearing 
Requirement determinations. As a result, market participants initially 
will comply with the Clearing Requirement using established platforms 
and technology. This should limit a market participant's burden in 
transitioning to clearing, as the use of existing infrastructure will 
mean less time and expense necessary to develop independent programs, 
technology, or platforms to clear such transactions.

[[Page 44447]]

5. Timing of Implementation Schedules
    Citadel and Better Markets comment that they agree with the 
proposed compliance schedule because market participants have had 
notice of the movement towards clearing for one to three years, and the 
clearing infrastructure already exists with regard to interest rate and 
credit default swap products. Citadel and Tradeweb believe the proposed 
schedule correctly staggers compliance according to category of market 
participant. Citadel does not support extending the 270-day timeframe 
because 270 days would grant sufficient time to market participants 
without providing so much time as to engender a material, competitive 
advantage or regulatory arbitrage. AIMA believes the proposed schedule 
grants sufficient time to each category of market participant so that 
they will be able to comply with the Clearing Requirement. Similarly, 
the Joint Associations and The Westpac Group (Westpac) generally agree 
with phasing in implementation with the Clearing Requirement according 
to category of participant.
    CIEBA states that because SDs, MSPs, and Active Funds will be the 
first focus for all third party vendors, ERISA plans will be competing 
for these resources only after the first implementation deadline has 
passed, leaving only 90 days for a crowded market place to comply. With 
limited resources, such a tight timeframe may lead to inadequate 
agreements and/or increased risk exposure. Further, inadequate 
agreements caused by lack of resources and rushed documentation will 
create even further cost disparity for clearing between U.S. pension 
plans and European ones that will not be required to clear swaps. As 
such, CIEBA recommends that Category 2 Entities have more than 180 days 
to comply. Likewise, FIA/ISDA/SIFMA note that the compliance schedule 
should be lengthened and that buy-side entities, which may currently be 
categorized as Category 1 Entities, should not be required to commence 
clearing until the second quarter of 2013 at the earliest.
    CDE argues that SDs and MSPs should comply before establishing 
other end-user deadlines. CDE believes that if Category 1 Entities 
cannot comply, then that will compound problems for Category 2 and 3 
Entities. If an implementation schedule must be set, the CDE recommends 
one year for end-users, in light of their limited internal resources 
and the competition for external resources.
    ACLI comments that complex issues will surface as market 
participants try to combine the agency framework presently existing in 
the futures markets (i.e., customer-futures commission merchant) with 
the principal-to-principal framework that has existed in the over-the-
counter swaps market. In addition to executing the necessary 
agreements, insurers will want to ensure they enter into agreements 
with parties that serve them best. The combination of these factors 
means that timeframes are too short and may result in smaller firms 
accepting unfavorable agreements with fewer counterparties, possibly 
concentrating risk. ACLI also highlights that insurers face an 
additional burden in ensuring that compliance with the Clearing 
Requirement is consistent with their state regulatory obligations.
    Vanguard argues that additional time will be required to enter into 
the new agreements necessitated by the move to a cleared derivatives 
market. Vanguard highlights the large volume of such agreements and the 
lack of market standards. ICI also finds the compliance schedule to be 
too short in light of the needs to build and test new systems, adapt to 
new regulatory requirements, and educate customers about these changes.
    Mastercard Worldwide urges the Commission to give non-bank firms at 
least 270 days to comply with the Clearing Requirement in respect of 
their foreign currency hedging activities, even if the firm is covered 
by section 4(k) of the Bank Holding Company Act. Westpac comments that 
Category 1 Entities should have at least 180 days to comply with the 
Clearing Requirement, noting that not all SDs, particularly smaller 
ones, are currently DCO members. Regional Banks also request that small 
SDs have at least 180 days to comply with the Clearing Requirement in 
light of their relative lack of resources and experience, as compared 
to larger SDs.
    ACLI and FSR believe that the compliance schedule for the 
respective entity categories should run consecutively rather than 
concurrently. For example, the 180 days given to Category 2 Entities to 
comply with the Clearing Requirement should begin only after the 
expiration of the 90 days given to Category 1 Entities.
    FSR does not believe there are sufficient resources, either 
internally, at market participants, or externally, at third party 
vendors, for the compliance schedule to run concurrently. If the 
schedule were to run concurrently, then resources would be allocated 
sequentially to the detriment of entities in the later implementation 
groups. ACLI, Joint Associations, and the Coalition of Physical Energy 
Companies (COPE) each express concern that the proposed compliance 
schedule does not provide sufficient time for the software companies 
and other vendors, upon which many smaller market participants rely, to 
develop, test, and debug the software and other technology that will be 
needed to ensure compliance with the Clearing Requirement. The Joint 
Associations and COPE each suggests the Commission take affirmative 
steps to solicit feedback from these software makers, particularly from 
vendors that provide ``position and trade capture software,'' in order 
to determine the amount of time market participants will need to 
implement software necessary to comply with the Clearing Requirement.
    The Commission is finalizing the compliance schedule for the 
Clearing Requirement as proposed, except for the changes described 
above for ERISA plans and Third-Party Subaccounts. The Commission 
believes that the 90-, 180-, and 270-day implementation periods will 
give market participants sufficient time to comply with the Clearing 
Requirement. The Commission agrees with commenters such as Citadel and 
Better Markets that the move to required clearing has been proceeding 
for two years under the Dodd-Frank Act. This period should have allowed 
parties to contemplate and design implementation plans and to identify 
the resources needed to execute those plans. With the Commission's 
decision to focus on those swaps that are currently cleared when 
considering its initial Clearing Requirement determinations, market 
participants will be working with clearing offerings that are seasoned 
and established, justifying the timeframes provided for in the 
compliance schedule. For these reasons, the Commission also declines to 
change the concurrent nature of the compliance schedule.
    Given the final rules for the definitions of swap dealers, and the 
threshold used in terms of annual notional volume of swaps for such 
swap dealers, the Commission does not believe it necessary to further 
distinguish between larger swap dealers and smaller ones for purposes 
of the implementation periods related to Clearing Requirements.\20\ 
Similarly, the Commission does not believe it practicable to make 
distinctions between entities covered by section 4(k) of the Bank 
Holding Company Act for the purpose of establishing a 180-day

[[Page 44448]]

implementation period as compared to a 270-day period.
---------------------------------------------------------------------------

    \20\ Further Definition of ``Swap Dealer,'' ``Security-Based 
Swap Dealer,'' ``Major Swap Participant,'' ``Major Security-Based 
Swap Participant'' and ``Eligible Contract Participant,'' 77 FR 
30596 (May 23, 2012).
---------------------------------------------------------------------------

    In response to CDE, the Commission also notes that certain swaps 
would not be subject to the Clearing Requirement under section 2(h)(7) 
of the CEA when one of the counterparties to a swap (i) is not a 
financial entity, (ii) is using the swap to hedge or mitigate 
commercial risk, and (iii) notifies the Commission how it generally 
meets its financial obligations associated with entering into a non-
cleared swap. If a market participant can claim an exemption, the 
Clearing Requirement will not be applicable. In all other cases, the 
implementation schedule for a Clearing Requirement would provide for up 
to 180 or 270 days for such market participants.
    In response to concerns that state regulatory obligations for 
insurance companies might create obstacles to compliance with 
implementation schedules as suggested by ACLI, the Commission observes 
that those insurers would have a minimum of six months to work with 
their state regulators to address the matter. If no solution could be 
found within that time period, an affected insurer would be able to 
petition the Commission for specific relief.
    The Commission also has taken affirmative steps to ensure that 
external providers of services to derivative market participants, such 
as derivatives software providers, have been included in the dialogue 
concerning implementation scheduling. At the May 2011 Implementation 
Roundtable, these vendors voiced their opinions with respect to how an 
implementation schedule could provide sufficient time for market 
participants relying on ``off-the-shelf'' derivatives tracking software 
to deploy such software such that they could comply with the Clearing 
Requirement. The Commission will continue to develop its understanding 
of technology issues and will solicit comment on this issue in 
forthcoming proposed Clearing Requirement determinations.

III. Cost-Benefit Considerations

A. Pre-Dodd-Frank Context

    Prior to the enactment of the Dodd-Frank Act,\21\ swaps were not 
subject to required clearing. However, the limited market data that is 
available suggests that over-the-counter (OTC) swap markets have been 
migrating into clearing over the last few years in response to natural 
market incentives as well as in anticipation of the Dodd-Frank Act's 
clearing requirement. LCH.Clearnet data, for example, shows that the 
outstanding volume of interest rate swaps cleared by LCH has grown 
steadily since at least November 2007, as has the monthly registration 
of new trade sides. Together, those facts indicate increased demand for 
LCH clearing services related to interest rate swaps, a portion of 
which preceded the Dodd-Frank Act.\22\ Data available through CME and 
TriOptima indicate similar patterns of growing demand for interest rate 
swap clearing services, though their publicly available data does not 
provide a picture of demand prior to the passage of the Dodd-Frank Act 
in July 2010.\23\ The trend toward increased clearing of swaps is 
likely to continue as the Commission begins determining that certain 
swaps are required to be cleared (Clearing Requirement determination). 
In fact, the Tabb Group estimates that 60-80% of the swaps market 
measured by notional amount will be cleared within five years of the 
time that the Dodd-Frank Act is implemented.\24\
---------------------------------------------------------------------------

    \21\ Dodd-Frank Wall Street Reform and Consumer Protection Act, 
Pub. L. No. 111-203, 124 Stat. 1376 (2010).
    \22\ See http://www.lchclearnet.com/swaps/volumes/.
    \23\ See http://www.cmegroup.com/trading/interest-rates/cleared-otc/index.html#data and http://www.trioptima.com/repository/historical-reports.html.
    \24\ See Tabb Group, ``Technology and Financial Reform: Data, 
Derivatives and Decision Making.''
---------------------------------------------------------------------------

B. Dodd-Frank Act Section 723(a)(3)

    In the wake of the financial crisis of 2008, Congress determined, 
among other things, that swaps shall be cleared upon Commission 
determination. Specifically, section 723(a)(3) of the Dodd-Frank Act 
amended section 2(h)(1)(A) of the CEA to make it ``unlawful for any 
person to engage in a swap unless that person submits such swap for 
clearing to a derivatives clearing organization that is registered 
under this Act or a derivatives clearing organization that is exempt 
from registration under this Act if the swap is required to be 
cleared.'' \25\ The statutory swap clearing requirement is designed to 
standardize and reduce counterparty risk associated with swaps, and, in 
turn, mitigate the potential systemic impact of such risks and reduce 
the likelihood for swaps to cause or exacerbate instability in the 
financial system.\26\ It reflects a fundamental premise of the Dodd-
Frank Act: The use of properly functioning central clearing can reduce 
systemic risk.
---------------------------------------------------------------------------

    \25\ Section 2(h)(2) of the CEA charges the Commission with 
responsibility for determining whether a swap is required to be 
cleared (a Clearing Requirement determination).
    \26\ When a bilateral swap is moved into clearing, the 
clearinghouse becomes the counterparty to each of the original 
participants in the swap. This standardizes counterparty risk for 
the original swap participants in that they each bear the same risk 
attributable to facing the clearinghouse as counterparty. In 
addition, clearing mitigates counterparty risk to the extent that 
the clearinghouse is a more creditworthy counterparty relative to 
those that each participant in the trade might have otherwise faced. 
This is because a clearinghouse benefits from netting with 
counterparties and may compel counterparties to post additional 
initial margin as collateral or force them to reduce their 
outstanding positions when markets move against them. Clearinghouses 
have demonstrated resilience in the face of past market stress. Most 
recently, they remained financially sound and effectively settled 
positions in the midst of turbulent events in 2007-2008 that 
threatened the financial health and stability of many other types of 
entities.
---------------------------------------------------------------------------

C. Final Rule

    The rule contained in this adopting release addresses one aspect of 
required swap clearing under section 2(h) of the CEA: Implementation 
scheduling following a Commission determination that a class of swaps 
is required to be cleared. In other words, is immediate clearing 
required or is implementation subject to some delay. On September 20, 
2011, the Commission published a NPRM.\27\ The Commission proposed a 
phased-in compliance schedule for swaps subject to Clearing Requirement 
determinations that distinguishes among Category 1 Entities, Category 2 
Entities, and all other entities (referred to for purposes of this 
section III as ``Category 3 Entities''); those entities, respectively, 
would have 90 days, 180 days, and 270 days, from the date of the 
Clearing Requirement determination to comply with the Clearing 
Requirement.\28\ The NPRM also requested comment with respect to the 
costs and benefits of the proposed schedule, including, specifically, 
data, assumptions, calculations, or other information to quantify its 
costs and benefits, as well as alternatives to it. The Commission 
received 26 comment letters in response, none of which provided 
quantitative analysis regarding the costs or benefits of the proposed 
compliance schedule.\29\
---------------------------------------------------------------------------

    \27\ See 76 FR 58186.
    \28\ The schedule contained in the NPRM, like the one contained 
in this adopting release, can be used at the option of the 
Commission when issuing Clearing Requirement determinations.
    \29\ ACLI provides an estimate for one member's information 
technology and legal costs to comply with all Title VII 
requirements. The estimate does not include any calculations and 
does not separate out any costs they believe are directly 
attributable to this rule.
---------------------------------------------------------------------------

    These comments touch upon a variety of issues, and include a number 
that supported the Commission's approach as proposed. Others note 
certain areas of concern about costs or benefits under

[[Page 44449]]

the rule as proposed, and either expressly propose alternatives or 
raise issues that have caused the Commission to consider alternatives 
to it. Among other things, commenters responded to the phased approach, 
the entities included in Category 1, Category 2, and Category 3, the 
amount of time that the schedule provides for entities in each 
category, and the optionality of the schedule.
    In the absence of this rule, market participants would be required 
to comply with the Clearing Requirement immediately upon issuance of a 
Clearing Requirement determination by the Commission. Pursuant to the 
rule, however, when the Commission deems it appropriate, market 
participants will be provided additional time as prescribed in the 
rule's schedule to comply with Clearing Requirement determinations. 
Category 1 entities, which include, among others, SDs, MSPs, and Active 
Funds,\30\ will have 90 days from the date that a Clearing Requirement 
determination is published in the Federal Register to comply. Category 
2 Entities, which include commodity pools; private funds as defined by 
the Investment Advisers Act of 1940, other than Active Funds; and 
banks; but not Third-Party Subaccounts, will have 180 days to comply 
with a new Clearing Requirement determination. Category 3 Entities are 
those with Third-Party Subaccounts, as well as any other entity not 
eligible to claim an exception under section 2(h)(7) of the CEA, 
including ERISA plans, and they will have 270 days to comply with a 
Clearing Requirement determination once it is published in the Federal 
Register.
---------------------------------------------------------------------------

    \30\ An ``Active Fund'' is any private fund as defined in 
section 202(a) of the Investment Advisers Act of 1940, that is not a 
third-party subaccount and that executes 200 or more swaps per 
month. The Commission does not intend to use the designation for any 
purpose beyond this rule.
---------------------------------------------------------------------------

    The discussion that follows considers the costs and benefits of, 
and alternatives to, the rule in this adopting release.

D. Statutory Mandate To Consider the Costs and Benefits of the 
Commission's Action: CEA Section 15(a)

    Section 15(a) of the CEA \31\ requires the Commission to consider 
the costs and benefits of its actions before promulgating a regulation 
under the CEA or issuing certain orders. Section 15(a) further 
specifies that the costs and benefits shall be evaluated in light of 
five broad areas of market and public concern: (1) Protection of market 
participants and the public; (2) efficiency, competitiveness, and 
financial integrity of futures markets; (3) price discovery; (4) sound 
risk management practices; and (5) other public interest 
considerations. The Commission considers the costs and benefits 
resulting from its discretionary determinations with respect to the 
section 15(a) factors.
---------------------------------------------------------------------------

    \31\ 7 U.S.C. 19(a).
---------------------------------------------------------------------------

    In this rulemaking the Commission is not imposing clearing 
requirements, but is exercising its discretion to stagger required 
clearing implementation according to a particular schedule and subject 
to the conditions specified in these rules. For purposes of this 
analysis, the Commission considers the costs and benefits attributable 
to its choices in this rulemaking--e.g., to stagger the implementation 
of clearing requirements and to do so in the manner prescribed--against 
those that would arise absent this Commission action--i.e., if 
implementation of the Dodd-Frank Act's Clearing Requirement for those 
swaps that the Commission separately determines to be subject to 
clearing was not staggered according to the rule's schedule.
    For reasons discussed in more detail below, the cost and benefits 
associated with requiring clearing immediately upon the Clearing 
Requirement determination for a swap class, or after some longer versus 
shorter period of delay, are not susceptible to meaningful 
quantification. As described above, these are not the costs and 
benefits of implementing Clearing Requirement determinations, but 
rather the costs and benefits of implementing them more slowly than 
would be required in the absence of this rule. The Commission is not 
aware of any analog to either an immediate or delayed requirement to 
establish the capability to clear that would produce data that the 
Commission could use to estimate the difference in costs and benefits 
between the two. Moreover, any data that might be gleaned from the 
experiences of an individual market participant establishing a 
relationship with a futures commission merchant (FCM) during normal 
market conditions would not reflect the influence of a number of 
effects that are likely to result from the simultaneous implementation 
of many market participants in a series of three waves. This 
coordinated movement creates both costs and benefits that cannot be 
quantified using data drawn from current market conditions. 
Notwithstanding these limitations, the Commission identifies and 
considers the costs and benefits of this rule in qualitative terms.

E. Costs and Benefits of This Rule

    Determining whether to implement required clearing immediately upon 
Commission determination or after some period of delay necessarily 
involves cost and benefit tradeoffs. On the one hand, delaying required 
clearing implementation also delays the benefits of clearing of certain 
swaps, including reduced counterparty risk and increased stability in 
the financial system. These benefits are substantial, and any delay in 
their realization represents a cost to the market and the public. On 
the other hand, requiring implementation immediately or within a very 
compressed timeframe creates certain costs for industry participants. 
Reducing these costs--enumerated below--by extending the implementation 
schedule represents a benefit.
    First, to meet pressing timelines, some firms will need to contract 
additional staff or hire vendors to handle some necessary tasks or 
projects. Additional staff hired or vendors contracted in order to meet 
more pressing timelines represent an additional cost for market 
participants. Moreover, a tightly compressed timeframe raises the 
likelihood that more firms will be competing to procure services at the 
same time; this could put firms that conduct fewer swaps at a 
competitive disadvantage in obtaining those services, making it more 
difficult for them to meet required timelines.\32\ In addition, it 
could enable service providers to command a pricing premium when 
compared to times of ``normal'' or lesser competition for similar 
services. That premium represents an additional cost when compared to a 
longer implementation timeline.
---------------------------------------------------------------------------

    \32\ See letter from CIEBA.
---------------------------------------------------------------------------

    Second, if entities are not able to comply with Clearing 
Requirement determinations by the required date, they may avoid 
transacting swaps that are required to be cleared until such a time as 
they are able to comply. In this event, liquidity that otherwise would 
result from those foregone swaps would be reduced, making the swaps 
more expensive for market participants taking the other side. Moreover, 
firms compelled to withdraw from the market pending implementation of 
required clearing measures will either leave certain positions un-
hedged--potentially increasing the firm's own default risk, and 
therefore the risk to their counterparties and the public. 
Alternatively, firms compelled to withdraw from the market for a period 
of time could attempt to approximate

[[Page 44450]]

their foregone swap hedges using other, likely more expensive, 
instruments. And to the extent the withdrawing entities are market 
makers, they will forsake the revenue potential that otherwise would 
exist for the period of their market absence.
    Third, firms may have to implement technological solutions, sign 
contracts, and establish new operational procedures before industry 
standards have emerged that address new problems effectively. To the 
extent that this occurs, it is likely to create costs. Firms may have 
to incur additional costs later to modify their technology platforms 
and operational procedures further, and to renegotiate contracts--
direct costs that a more protracted implementation schedule would have 
avoided.\33\ Moreover, costs created by the adoption of standards that 
fail to address certain problems, or attributable to undesired 
competitive dynamics resulting from such standards, may be 
longstanding.
---------------------------------------------------------------------------

    \33\ See e.g., ACLI letter.
---------------------------------------------------------------------------

    Given the factors identified above, this rulemaking aims to strike 
the optimal cost-balance tradeoff amidst the competing concerns. 
Shorter timelines will tend to push greater numbers of swaps into 
clearing more quickly, reducing the counterparty and systemic exposures 
in ways that were intended by the Dodd-Frank Act--a benefit. But, 
shorter timelines also increase the costs as discussed above. Longer 
timelines have the opposite effect, decreasing the costs described 
above, but increasing the amount of time during which counterparty and 
systemic exposures that would otherwise be mitigated by required 
clearing persist.
    In theory, the optimal tradeoff between the two is the point at 
which the marginal cost of an additional one-day delay in 
implementation equals the marginal benefits of the same incremental 
delay. But it is not possible, at this stage, to determine the marginal 
costs or benefits of each day of delay. To estimate such values 
reliably requires data that does not yet exist--i.e., data gleaned in 
the midst of the transition process. Therefore, neither the Commission 
nor commenters are able to assert conclusively that any particular 
schedule is more or less advantageous relative to all others that the 
Commission might have considered. Thus, in the face of these practical 
limitations, the Commission has relied on qualitative considerations, 
informed by commenters, to guide the necessary tradeoff determinations.
    The Commission, informed by its consideration of comments and 
alternatives, discussed in the sections above and below, believes that 
the approach contained in this adopting release is reasonable and 
appropriate in light of the tradeoffs described above. The schedule 
established here gives the Commission the opportunity to provide 
additional time to entities in ways that generally align with: (1) 
Their resources and expertise, and therefore their ability to comply 
more quickly; and (2) their level of activity in the swap markets, and 
therefore the possible impact of their swap activities on the stability 
of the financial system. Entities with the most expertise in, and 
systems capable to transact, swaps also are likely to be those whose 
swaps represent a significant portion of all transactions in the swap 
markets. They are more likely to be able to comply quickly, and the 
benefits of requiring them to do so are greater than would be the case 
for less active entities. On the other hand, entities with less system 
capability and in-house swap expertise may need more time to comply 
with Clearing Requirement determinations, but it is also likely that 
their activities represent a smaller proportion of the overall market, 
and therefore are less likely to create or exacerbate shocks to the 
financial system.\34\ The Commission believes that Category 1 
encompasses entities likely possessing more advanced systems and 
expertise, and whose swap activities constitute a significant portion 
of overall swap market transactions, while Categories 2 and 3 encompass 
those likely to have relatively less developed infrastructure and whose 
swap activities constitute a less significant proportion of the market.
---------------------------------------------------------------------------

    \34\ OCC data demonstrates that among insured U.S. commercial 
banks, ``the five banks with the most derivatives activity hold 96 
percent of all derivatives, while the largest 25 banks account for 
nearly 100% of all contracts.'' The report is limited to insured 
U.S. commercial banks, and also includes derivatives that are not 
swaps. However, swap contracts are included among the derivatives in 
the report, constituting approximately 63 percent of the total 
notional value of all derivatives. These statistics suggest that a 
relatively small number of banks hold the majority of swap positions 
that could create or contribute to distress in the financial system. 
Data is insufficient, however, to generalize the conclusions to non-
banking institutions. See ``OCC's Quarterly Report on Bank Trading 
and Derivatives Activities: Fourth Quarter 2011'' at 11. http://www.occ.treas.gov/topics/capital-markets/financial-markets/trading/derivatives/dq411.pdf.
---------------------------------------------------------------------------

    The Commission notes that clearing of certain swaps, and in 
particular interest rate and credit default swaps, has been occurring 
for some time; by implication, this indicates that the requisite 
technology, contractual terms, and operational standards among 
clearinghouses, clearing members, and some clients exist.\35\ The 
Commission also notes that it is likely that the degree to which firms 
have already implemented such technology, contracts, and operational 
patterns varies considerably, particularly among potential customers of 
FCMs, and that the legal, technological, and operational changes that 
are necessary for less frequent swap market participants may be more 
substantial. However, given the availability of FCMs (through which 
market participants may clear swaps) as well as the technology and 
contractual standards necessary to clear swaps, the Commission believes 
that a number of firms can reduce the costs associated with meeting 
compliance timelines by forming necessary FCM relationships and 
contracts, and implementing the necessary technology, before the 
Commission begins issuing Clearing Requirement determinations.\36\ 
Nonetheless, the Commission considered these concerns, among other 
issues, when determining to grant Category 2 and Category 3 Entities an 
extended 180 and 270 days, respectively, rather than requiring them to 
comply at the same time as Category 1 Entities.
---------------------------------------------------------------------------

    \35\ For example, CME and ICE both began clearing credit default 
swaps (CDS) in 2009. As of March 2012, ICE had cleared more than $11 
trillion notional in CDS, and had 26 clearing members in CDS. CME 
began clearing interest rate swaps in 2010 and currently has open 
interest of $210 billion notional and 15 clearing members in 
interest rate swaps. Moreover, by March of 2010, 26 of the largest 
market makers were clearing interest rate derivatives. At that time, 
ISDA asserted that ``In excess of 90% of new dealer-to-dealer volume 
in Eligible Trades of Interest Rate Derivative products, and total 
dealer-to-dealer volume in Eligible Trades of Credit Derivative 
products is now cleared through CCPs.'' See http://www.newyorkfed.org/newsevents/news/markets/2010/100301_letter.pdf.
    \36\ The Commission understands approximately 2.5 months is 
sufficient for some market participants to enter into a clearing 
arrangement with an FCM for purposes of clearing swaps. See External 
Meeting with Blackrock, 4/2/2012. http://www.cftc.gov/LawRegulation/DoddFrankAct/ExternalMeetings/dfmeeting_040212_1463.
---------------------------------------------------------------------------

    Moreover, use of the schedule contained in this release is at the 
Commission's discretion; in situations where the Commission determines 
that the benefits of delayed implementation do not justify the 
additional costs of such a delay, the Commission may require immediate 
compliance with Clearing Requirement determinations. Therefore, in 
situations where the Commission determines that a swap must be cleared, 
and further believes that clearing the swap will not necessitate 
significant changes to market participants' technology, legal 
arrangements, or operational patterns, the Commission is likely to 
determine that immediate compliance is

[[Page 44451]]

warranted. In these cases, the benefits of required clearing will be 
realized immediately.
    The discretionary nature of the schedule contained in the adopting 
release, however, may create some uncertainty for market participants, 
and consequently may create some costs as market participants take 
steps to protect themselves from the impact of such uncertainty. For 
example, if a market participant believes that the Commission may issue 
a determination that a particular swap must be cleared, but is not 
certain whether clearing will be required immediately or according to 
the schedule contained in this release, that entity may begin 
developing the capacity to clear such a swap prior to a determination 
by the Commission in order to reduce the risk that it would be forced 
to stop trading the swap while it comes into compliance. If that 
participant's belief that the Commission will require the swap to be 
cleared is incorrect, the participant will have unnecessarily borne the 
cost of preparing for such a possibility. The Commission considered 
this cost, but believes that the notice and comment approach that the 
Commission will use when issuing Clearing Requirement determinations 
mitigates it. Each proposed Clearing Requirement determination will be 
published in the Federal Register and will be available for public 
comment for a period of at least 30 days; the Commission anticipates 
clarifying in each proposed Clearing Requirement determination whether 
compliance will be required immediately upon the final determination or 
according to the schedule contained in this rule. This approach will 
provide market participants with notice regarding the expected timeline 
for compliance, which will mitigate costs associated with uncertainty 
about compliance timelines.

F. Consideration of Comments and the Costs and Benefits of Alternatives

    Commenters propose or otherwise highlight points that suggest 
alternatives with respect to various aspects of the NPRM.\37\ These 
aspects, as categorized for discussion below, are: (1) Phased approach; 
(2) entity categorization; (3) schedule increments; and (4) schedule 
discretion.
---------------------------------------------------------------------------

    \37\ Other commenters raise issues beyond the scope of this 
rule--i.e., implementation timing of required clearing--that, 
consequently, are beyond, and not appropriate for Commission 
consideration in, this rulemaking. Specifically, some commenters 
request that the Commission establish a comprehensive schedule for 
implementation of all rules and requirements pursuant to the Dodd-
Frank Act. (See Barnard, MFA.) Others request a comprehensive 
schedule of clearing requirement determinations (See, e.g., CDEU), 
an issue already addressed by the Dodd-Frank Act and the rule 
regarding the Process for Review of Swaps for Mandatory Clearing. 
See section 2(h)(2)(B)(ii) of the CEA; 76 FR 44473.
---------------------------------------------------------------------------

Phased Approach
    A number of commenters express support generally for additional 
time to comply with Clearing Requirement determinations and for a 
phased approach that distinguishes between various types of 
entities.\38\ Commenters note that the additional clarity provided by 
the schedule will encourage industry participants to commit resources 
to overcoming structural and economic barriers that prevent widespread 
clearing.\39\ Some commenters, however, maintain that the phased 
approach used to implement clearing requirement determinations should 
not be applied to exchange trade requirements.\40\ The AIMA believes 
that effective required clearing will enable execution of swaps on SEFs 
and DCMs and that linking the trading and clearing compliance schedules 
could delay the transition into central clearing. In response to these 
comments, the Commission has decided to limit the scope of this rule to 
Clearing Requirement determinations, to retain the phased approach to 
required clearing, and to address implementation of trade execution in 
a separate rule.
---------------------------------------------------------------------------

    \38\ See letters from Encana, Vanguard, ICI, FSR, MFA, FIA/ISDA/
SIFMA, AII, MarkitSERV, and AIMA.
    \39\ See MFA letter.
    \40\ See letters from AIMA and MFA.
---------------------------------------------------------------------------

    Some commenters note that a phased approach could complicate 
implementation for large investor advisor firms that may have multiple 
funds in separate categories. Specifically, AII expresses concern that 
it may be difficult for institutional advisers to execute block trades 
for multiple clients during the implementation period because they will 
have to consider whether each client must comply with the Clearing 
Requirement. Nevertheless, AII recommends retaining the phased approach 
with at least 18 months for entities to comply. The Commission 
recognizes that such complexities exist and could introduce certain 
costs for large investor adviser firms. However, it is not clear that 
delaying the implementation period would alleviate this concern, 
although prolonging the implementation period likely would exacerbate 
the issue by extending the time during which such concerns are 
relevant. Moreover, the Commission notes that the benefits of required 
clearing are substantial and that further delays create costs borne by 
market participants and the public. In these circumstances, the 
Commission considers the latter consideration most compelling and, 
accordingly, has determined not to delay implementation beyond what is 
set forth in the schedule in the adopting release.
    Finally, relative to the alternative of immediate implementation 
following a Commission Clearing Requirement determination--the result 
in the absence of this rule--the Commission believes that the phased 
approach reflected in this adopting release is superior. The immediate 
implementation alternative would not mitigate the costs, enumerated 
above, to market participants and the public. In contrast, while 
delaying implementation also entails a different set of costs, also 
discussed above, the Commission has carefully tailored the rule's 
phased approach to contain and dampen them.
Entity Categorization
    Commenters generally agree that some buy-side representation in 
Category 1 is valuable in order to ensure that buy-side interests are 
represented as technological and legal standards begin to form,\41\ 
though commenters express varied views about whether Active Funds 
should play that role, and what entities should be included in that 
group. Some commenters state their belief that transaction volume is an 
appropriate proxy for a firm's level of expertise in conducting swaps 
and, therefore, is a useful criterion for identifying the buy-side 
entities that are best equipped to make the transition as part of 
Category 1.\42\ Some express concern, however, that as defined in the 
NPRM, the term ``Active Fund'' could be over-inclusive and recommend 
raising the threshold number of swaps or excluding swaps that are 
hedges or have a notional value below $10 million.\43\
---------------------------------------------------------------------------

    \41\ See AIMA letter.
    \42\ See letters from Barnard and AIMA.
    \43\ See letters from AII and CDEU.
---------------------------------------------------------------------------

    The Commission's intent in selecting Active Funds to participate in 
Category 1 is to identify those market participants that are larger and 
have significant experience in the swap markets. To ensure that the 
rule effectively selects for these entities, and in response to 
commenters, the Commission has raised the threshold number of swaps 
from a trailing average of 20 swaps per month over the previous twelve 
months, to a trailing average of 200 swaps per month over the previous 
twelve months. The Commission, however, believes that

[[Page 44452]]

further criteria restricting the swaps that are included against that 
count would create incremental administrative and operational costs 
that do not justify the resulting benefit, and therefore has not placed 
further restrictions on the types of swaps that count against the 
threshold. However, per commenters' request for clarification, the 
Commission is clarifying that the average monthly threshold of swaps 
applies to new swaps that the entity enters into, and it does not apply 
to novations, amendments, or partial tear-ups.
    ACLI maintains that there is diversity among buy-side participants 
in their use of swaps, and expresses concern that Active Funds may not 
be able to effectively represent diverse buy-side interests, and those 
of insurance companies in particular. ACLI, however, does not describe 
or quantify specific costs that it believes would result from this 
circumstance.\44\ The Commission acknowledges that buy-side market 
participants are diverse and may have specific needs reflecting 
concerns or interests unique to individual industries or even 
individual entities. However, the Commission also notes that the fact 
of certain differences among firms does not exclude the possibility of 
remaining similarities. Further, it believes that realizing the 
benefits provided by some buy-side representation in Category 1 is 
preferable to a scenario in which these benefits are foregone by 
removing Active Funds from Category 1 for required clearing 
implementation. Moreover, in the absence of any input as to how 
dissimilarities may specifically impact the compliance implementation 
process, the apparent solution to ACLI's concern would be to include 
insurance companies in Category 1 to assure representation of their 
interests earlier in the implementation process. While any Category 2 
Entity or any other entity may elect to comply sooner than the schedule 
requires (and are encouraged by the Commission to do so), the 
Commission finds no basis to believe that the benefits of requiring all 
insurance companies to participate in Category 1 warrant the additional 
costs that such an approach would create for them.
---------------------------------------------------------------------------

    \44\ See ACLI letter.
---------------------------------------------------------------------------

    MFA expresses concern that questions related to the term ``Active 
Fund'' could create an additional burden for fund operations and 
Commission staff, and proposed that all private funds be placed in 
Category 2 in order to eliminate this burden.\45\ MFA, however, does 
not specify what these questions are, nor the cost to funds associated 
with addressing them. In the absence of more specific information about 
the nature of the potential questions and their associated costs, the 
Commission has insufficient basis to conclude that costs to clarify 
Active Fund issues--either for fund operators or itself--are likely to 
be significant. Accordingly, it believes that the benefits of early-
stage, buy-side representation warrant retention of the Category 1 
Active-Fund component.
---------------------------------------------------------------------------

    \45\ See MFA letter.
---------------------------------------------------------------------------

    Some commenters express concern about the definition of the term 
Third-Party Subaccounts. They maintain that the Third-Party Subaccount 
category should include any managed accounts, regardless of the level 
of authority granted in the advisory agreement to enter into trading 
agreements, on grounds that the operational and contractual challenges 
for moving swaps related to these accounts into clearing will be much 
the same regardless of whether the accounts' investment management 
agreements have ``specific approval'' requirements.\46\ Similarly, some 
commenters advocate in favor of including all ERISA plans in Category 3 
given their expectations that (1) Category 2 entities will bear more 
``start-up'' costs related to required clearing than those in Category 
3, and (2) putting some ERISA plans in Category 2 and others in 
Category 3 will make overlays more difficult and costly.\47\ 
Conversely, AIMA specifically states that making all funds Category 3 
Entities is not a suitable approach because it would eliminate buy-side 
representation during the early stages of implementation, and, 
consequently, urges the Commission not to adopt this approach.\48\
---------------------------------------------------------------------------

    \46\ See e.g., letters from ICI and AII.
    \47\ See CIEBA letter.
    \48\ See AIMA letter.
---------------------------------------------------------------------------

    Furthermore, AIMA and FSR asserted that some Third-Party 
Subaccounts may be ``private funds'' as defined in the Investment 
Advisers Act of 1940 that would otherwise qualify as Active Funds; AIMA 
expresses concern that allowing such funds 270 days to comply with 
clearing requirements could provide them a competitive advantage 
relative to other Active Funds that are not Third-Party Subaccounts for 
the period of time between the compliance dates for Categories 1 and 3. 
To level this playing field, AIMA proposes placing all Active Funds in 
Category 1, regardless of whether the funds also meet the criteria for 
a Third-Party Subaccount. In support of this proposition, AIMA opines 
that large institutional managers of large numbers of Third-Party 
Subaccounts are likely to have sufficient resources to make the 
transition within the 90 days required of Category 1 Entities.
    The Commission recognizes that some managed funds that do not 
require third party sign-off for clearing agreements, nevertheless, may 
choose to involve their clients in negotiation of relevant documents, 
and that some costs may result from placing some managed funds and 
ERISA plans in Category 2 and others in Category 3. After considering 
the alternatives posed by commenters, the Commission has modified the 
definition of Third-Party Subaccount to include managed accounts for 
which the investment manager is responsible for clearing documentation, 
regardless of whether the investment manager has explicit execution 
authority. In addition, the Commission has determined not to include 
ERISA plans in Category 2. The Commission has made these changes 
despite the fact that commenters do not attempt to quantify the costs 
associated with these provisions, nor do they recognize that such costs 
must be considered against the costs of further delaying required 
clearing implementation by a number of managed funds and ERISA plans. A 
fundamental premise of the Dodd-Frank Act is that central clearing 
minimizes risk to counterparties and the financial system as a whole; 
therefore, further delaying implementation of one or more groups of 
market participants creates costs associated with prolonged exposure of 
the financial system to a greater number of un-cleared swaps. 
Nonetheless, the Commission believes it appropriate to permit certain 
market participants an additional 90 days to come into compliance with 
the clearing requirement based on the comments received.
Schedule Increments
    Some commenters express the opinion that 90, 180, and 270 days is 
sufficient for Category 1, 2, and 3 Entities, respectively, to comply 
with Clearing Requirement determinations.\49\ Several other commenters, 
however, expressed concern that the additional time provided in this 
rule may not be sufficient for some entities to comply.\50\ In that 
vein, commenters state that the

[[Page 44453]]

schedules may not be sufficient for contract negotiations to be 
completed,\51\ that pressing timelines could undermine the ability of 
some entities to negotiate effectively,\52\ and that rapid compliance 
may lead to the creation of industry standards that are not fair or 
prudent.\53\ Some commenters also express concern that entities in 
Categories 2 and 3 may not be able to find vendors able to provide 
sufficient support to meet the deadlines effectively.\54\
---------------------------------------------------------------------------

    \49\ See e.g., letters from Better Markets and MFA. MFA 
qualifies its support, stating that certain additional rules should 
be adopted prior to the schedule becoming effective, and also 
requests changes to the entities included in each category, but 
still generally supports the 90-, 180-, and 270-day implementation 
schedule.
    \50\ See e.g., letters from AII, CIEBA, ICI, FIA/ISDA/SIFMA, and 
FSR.
    \51\ See e.g., ACLI letter.
    \52\ See letters from ACLI, AII, and CIEBA.
    \53\ See letters from ACLI and ICI.
    \54\ See letters from ACLI, CDEU, CIEBA, COPE, and EEI. COPE and 
EEI specifically requested that the Commission determine whether 
``off the shelf'' software is available to meet the needs of 
entities that do not yet have necessary technology. Further 
conversation clarified that both were concerned about technologies 
that extend beyond those directly related to Clearing Requirements 
established by the Act.
---------------------------------------------------------------------------

    It is impossible to quantify the costs and benefits of one 
particular schedule phase-in increment relative to another--e.g., 90 
days to comply versus 110--and the permutations of such an exercise 
would be endless, even if possible. Similarly, as discussed above, 
whether the schedule included in this adopting release mitigates costs 
to a greater degree than other increments the Commission might have 
adopted as an alternative to immediate implementation of required 
clearing (the result in the absence of this rule) is also a question 
that cannot be resolved with precision. In light of these limitations, 
however, the Commission has drawn upon its historical experience 
monitoring clearing, as well as its consideration of the qualitative 
feedback offered by market participants, in determining to incorporate 
the 90-, 180-, and 270-day benchmark features within the schedule 
adopted in this release. In so doing, the Commission believes that it 
has selected a reasonable schedule that is appropriate and well-suited 
to mitigate compliance pressures for market participants, and fairly 
accommodate the various competing interests involved.
    As is stated above, the Commission recognizes that extending the 
compliance schedule for one or more entities will reduce compliance 
costs for market participants in a number of different ways, but will 
also increase the amount of time during which market participants and 
the public do not benefit from the protections provided by mandatory 
clearing.
Scheduling Discretion
    Some commenters support the Commission's retention of discretion to 
override the schedule in this release to require immediate clearing 
when it believes that the benefits do not justify the associated 
costs.\55\ These commenters note that over time market participants 
will gain experience to enable swifter compliance with later Clearing 
Requirement determinations, and maintain that, over time, the 
compliance schedules will not be warranted for Clearing Requirement 
determinations for new types, groups, or categories of swaps within an 
asset class that are already subject to a prior Clearing 
Requirement.\56\ Other commenters, however, support application of the 
schedule to all Clearing Requirement determinations in order to reduce 
uncertainty and facilitate orderly transitions to compliance.\57\
---------------------------------------------------------------------------

    \55\ See letters from Barnard and MFA.
    \56\ See letters from Barnard and MFA.
    \57\ See letters from FHLB and ICI.
---------------------------------------------------------------------------

    As discussed below, the Commission believes that the challenges of 
compliance are likely to vary depending on whether previous Clearing 
Requirement determinations have been made for other swaps in the same 
class, how long previous Clearing Requirement determinations for swaps 
in that class have been in place, the similarities between the swaps 
addressed by a determination and swaps subject to previous 
determinations, and a number of other factors. Therefore, the 
Commission believes that the tradeoff between the costs and benefits of 
more rapid compliance will vary as well. Where Clearing Requirement 
determinations pertain to swaps that have important points of 
similarity with swaps already required to be cleared, it is likely that 
the costs associated with more rapid compliance will be significantly 
less, and therefore the balance will shift in favor of a shorter 
compliance deadline than would be allowed under the schedule contained 
in this rule. Also, by including the applicable compliance schedule 
within its public notifications of a proposed Clearing Requirement 
determination, the Commission will mitigate uncertainty costs that 
could result.

G. Consideration of Section 15(a) Factors

(1) Protection of Market Participants and the Public
    Category 1 includes, among others, SDs as well as MSPs and Active 
Funds. If SDs were not able to comply immediately with a Clearing 
Requirement determination, and were not given additional time to 
comply, they could choose to withdraw from the market as they work 
toward compliance. Such withdrawal would create lost opportunities for 
them as they fail to capture business that they would have otherwise 
conducted during that period. If MSPs or Active Funds choose to 
withdraw from the market while they work to come into compliance, it 
could become more costly for them to either effectively create or hedge 
certain exposures, which could also prompt them to leave certain risks 
un-hedged that they would otherwise mitigate through the use of swaps. 
By giving Category 1 Entities an additional 90 days to comply with 
Clearing Requirement determinations, the schedule contained in this 
adopting release reduces the likelihood of these entities withdrawing 
from the swap markets while they work toward compliance; this, in turn, 
reduces the probability that these Category 1 Entities will bear the 
potential costs of un-hedged risk exposure.
    Moreover, the Commission believes that SDs are an important source 
of liquidity for swap market participants. If SDs withdraw from the 
market while they work toward compliance, it could negatively impact 
swap liquidity, increasing costs for market participants forced to 
hedge certain risks through less efficient means (or not at all) for a 
period of time. The costs of not hedging certain risks would be borne 
not only by the firms that choose such an approach, but by the public 
in the form of increased counterparty risk throughout the financial 
system. Again, by providing additional time for SDs to comply with 
Clearing Requirement determinations, the schedule in the adopting 
release facilitates an orderly transition and reduces the likelihood 
that the costs associated with SDs withdrawing from the market for a 
period of time would materialize. The Commission considered this 
benefit in light of the cost associated with delayed compliance among 
Category 1 Entities and believes that an appropriate balance has been 
struck.
    The Commission also anticipates that the staggered compliance 
schedule contained in this rule will, to some extent, enable Category 2 
and 3 Entities to adopt technological, legal, and operational standards 
developed by Category 1 Entities. To the extent that this occurs, it 
will reduce the number of entities that are working in parallel to 
develop solutions to the same problems by allowing Category 2 and 3 
Entities some time to wait for Category 1 Entities and vendors to 
develop viable solutions to technological, legal, and operational 
challenges. Some of those solutions are likely to be proprietary, while 
others

[[Page 44454]]

will likely relate to non-proprietary standards that must be shared in 
order to be effective. Both types of advances can reduce costs for 
Category 2 and 3 Entities. In the case of non-proprietary standards, 
Category 2 and 3 entities will benefit from the opportunity to adopt 
them without having to invest in their development. In the case of 
proprietary solutions, some of them are likely to be owned by vendors 
marketing them to multiple market participants, thereby spreading the 
development costs among their clients. Each of these consequences is 
likely to reduce overall development costs for the industry, and 
development costs for Category 2 and 3 Entities, in particular.\58\
---------------------------------------------------------------------------

    \58\ As indicated in the NPRM, to the extent that Category 1 
Entities bear a larger portion of the industry wide ``start-up'' or 
development costs, the Commission believes this is appropriate since 
they are likely to be among the most active participants in these 
markets.
---------------------------------------------------------------------------

    In weighing the tradeoff between shorter versus longer compliance 
timelines, the Commission believes Category 2 Entities are likely to be 
less well-resourced and less active in these markets. Therefore the 
dynamic between more or less rapid compliance tips in favor of 
providing additional time for these entities. As stated above, by 
providing 180 days, it becomes more likely that Category 2 Entities 
will be able to draw from lessons learned and standards established by 
Category 1 Entities. It also increases the likelihood that where 
Category 2 Entities will depend on vendors for help developing and 
implementing necessary technology, legal agreements, and operational 
patterns, they will not have to compete as directly with Category 1 
Entities for those resources.
    The Commission believes that entities with Third-Party Subaccounts 
have an additional challenge of transitioning hundreds (or in some 
cases, thousands) of subaccounts into compliance with Clearing 
Requirement determinations, which may require formalizing new 
agreements with each of their customers, and educating their customers 
about how the Clearing Requirement will impact costs and operations. In 
the Commission's view, this additional challenge justifies additional 
time for compliance beyond what is allowed for Category 2 Entities.\59\
---------------------------------------------------------------------------

    \59\ As stated in the NPRM, Category 2 and 3 Entities that want 
to come into compliance sooner than the 180- and 270-day deadlines 
are allowed, and encouraged, to do so.
---------------------------------------------------------------------------

    As described above, the Commission recognizes that delaying 
implementation creates some additional costs in the form of delayed 
protections that central clearing of swaps would otherwise provide--
standardized and reduced counterparty risk for swaps that are required 
to be cleared, and associated reductions in the overall level of 
systemic risk. However, the Commission believes that this approach 
appropriately balances the tradeoff by requiring firms that are likely 
to be the most active in these markets to comply first and allowing 
additional time for those whose positions are less likely to pose 
significant risk to the financial system as a whole.
(2) Efficiency, Competitiveness, and Financial Integrity of Futures 
Markets
    As suggested above, Category 1 Entities are likely to establish 
technological, legal, and operational standards that will influence or 
be adopted by Category 2 and 3 Entities. This will (1) serve to reduce 
development costs that Category 2 and 3 Entities otherwise would face, 
(2) focus responsibility for shaping new platforms and standards on 
those firms that possess greater cleared swap experience, and (3) 
support the likelihood that new platforms and standards will reflect 
current best practices. Each of these elements promotes the efficiency 
and integrity of the markets. Moreover, by reducing the number of 
entities necessarily working in parallel to develop such standards, and 
allowing Category 2 and 3 Entities to learn from and build on the 
solutions developed by Category 1 Entities, the phased schedule 
contained in this adopting release holds the potential to foster 
compatibility and interoperability, which reduces the cost and 
complexity of interconnectedness.
    The phased schedule as adopted also will promote an implementation 
plan in which similar entities (i.e., those that usually compete with 
one another) generally have the same compliance timelines, thereby 
protecting competition during the transition period. One commenter 
states, ``A phased approach to compliance will allow the Commission to 
balance its goal of obtaining adequate representation at each stage of 
the regulatory roll-out with the goal of avoiding anti-competitive 
concerns.'' \60\
---------------------------------------------------------------------------

    \60\ See ICI letter.
---------------------------------------------------------------------------

    That said, however, the Commission also has to balance the goal of 
maintaining a level playing field with other priorities. In particular, 
the Commission deems it important to ensure representation of both buy 
and sell side firms in the earliest stages of compliance. Moreover, the 
Commission believes that, in certain circumstances, variance in 
compliance burden among competitors warrants placing them in different 
implementation categories. Some competitive consequences may result 
from the need to balance these various priorities. The Commission 
believes, however, that it has built sufficient flexibility into the 
phased schedule to mitigate such consequences; specifically, the 
schedule preserves entities' ability to respond to competitive 
incentives to move into clearing voluntarily prior to the date required 
by the compliance schedule. The Commission believes that providing 
flexibility to allow expression of competitive market incentives is 
preferable to the alternative of imposing a more compressed compliance 
schedule for purposes of maintaining a level playing field. As 
discussed above, a shorter schedule could also increase the likelihood 
that industry standards established during the implementation period 
could create and perpetuate undesirable competitive dynamics. In sum, 
the Commission anticipates that any temporary impacts on competitive 
dynamics created by the phased implementation approach it is adopting 
are likely to be less costly than an approach that increases the 
likelihood of sustained competitive disparities, and therefore has 
chosen not to shorten the compliance schedule as a remedy to address 
the risk of competitive advantages that may be conferred on market 
participants that have later compliance dates.
    As discussed above, for the 90-, 180-, and 270-day periods that 
Clearing Requirements are delayed, the markets are exposed to the risks 
that the Clearing Requirements would mitigate. However, the Commission 
has considered this cost for the limited delay durations prescribed in 
light of the benefits--reduced implementation costs, greater degrees of 
compatibility and interoperability, and lessened risk of market 
disturbances from the withdrawal of entities that are not able to 
comply immediately--and considers the tradeoff reflected in the rules 
warranted.
(3) Price Discovery
    Neither the Commission nor commenters have identified consequences 
for price discovery that are expected to result from this rule.
(4) Sound Risk Management Practices
    An orderly transition for swaps subject to a Clearing Requirement 
determination promotes sounder risk management practices, particularly 
during the transition period. As mentioned above, in the absence of the

[[Page 44455]]

schedule provided in this rule, some entities might exit swap markets 
while taking steps to come into compliance. This result could reduce 
liquidity, particularly if the withdrawing entities are SDs. Reduced 
liquidity likely would increase the cost of using swaps to manage risk 
by increasing spreads, and make it more difficult for entities to enter 
and exit positions in a timely manner. It could also prompt some 
entities to maintain exposures that they would otherwise use swaps to 
mitigate, which would elevate the risk profile of those entities and 
the level of risk that their counterparties bear as a consequence. By 
providing a timetable for orderly transition, this rule encourages 
continued participation in the swap markets and use of swaps for risk 
mitigation purposes during the transition.
    Clearing Requirement delay does prolong existing costs associated 
with not having counterparty credit risk monitored and managed 
effectively by a DCO. More prompt implementation of Clearing 
Requirements would have the benefit of preventing losses from 
accumulating over time through the settlement of variation margin 
between a DCO's clearing members each day. The settlement of variation 
margin each day (and in some cases, multiple times per day) reduces the 
size of exposures a clearinghouse faces should one of its 
counterparties default, and the mechanisms that a clearinghouse has to 
ensure its own solvency reduce the probability that it would default on 
obligations to clearing members. Moreover, more prompt implementation 
also promotes the use of initial margin as a performance bond against 
potential future losses such that if a party fails to meet its 
obligation to pay variation margin, resulting in a default, the DCO may 
use the defaulting party's initial margin to cover most or all of any 
loss based on the need to replace the open position. The Commission 
believes, however, that (1) it has tailored the rule to limit the 
degree, and thereby these costs attributable to, clearing 
implementation delay and (2) the benefits afforded by the schedule's 
operation when the Commission elects to use it warrant the costs of the 
tailored implementation delay.
(5) Other Public Interest Considerations
    The schedule allows market participants to comply with the 
requirements of the Dodd-Frank Act and provides a sound basis for 
achieving the overarching Dodd-Frank Act goals of reducing counterparty 
risk and promoting stability of the financial system.

IV. Related Matters

A. Regulatory Flexibility Act

    The Regulatory Flexibility Act (RFA) requires that agencies 
consider whether the rules they propose will have a significant 
economic impact on a substantial number of small entities and, if so, 
provide a regulatory flexibility analysis respecting the impact.\61\ As 
stated in the NPRM, the subject of this rulemaking provides a 
compliance schedule for a new statutory requirement, section 2(h)(1)(A) 
of the CEA, and does not itself impose significant new regulatory 
requirements.\62\ Accordingly, the Chairman, on behalf of the 
Commission, certified pursuant to 5 U.S.C. 605(b) that the proposed 
rule would not have a significant economic impact on a substantial 
number of small entities. The Commission then invited public comment on 
this determination.
---------------------------------------------------------------------------

    \61\ 5 U.S.C. 601 et seq.
    \62\ 76 FR 58192-58193 (Sept. 20, 2011).
---------------------------------------------------------------------------

    FSR comments that the NPRM failed to evaluate the impact of the 
proposed compliance schedule for the Clearing Requirement on a 
substantial number of small entities. FSR argued that small entities 
may have to bear a more significant burden than larger entities in 
establishing clearing arrangements with FCMs because larger entities 
will be able to enter into such arrangements first.
    In response, the Commission points out that the compliance schedule 
for the Clearing Requirement will affect only eligible contract 
participants (ECPs). Pursuant to section 2(e) of the CEA, only ECPs may 
enter into swaps, unless the swap is listed on a DCM. The Clearing 
Requirement will affect only ECPs because all persons that are not ECPs 
are required to execute their swaps on a DCM, and all contracts 
executed on a DCM must be cleared by a DCO, as required by statute and 
regulation; not by operation of any Clearing Requirement.
    The Commission has previously determined that ECPs are not small 
entities for purposes of the RFA.\63\ However, in their comment letter, 
the Joint Associations assert that certain members of the National 
Rural Electric Cooperative Association (NRECA) may both be ECPs under 
the CEA and small businesses under the RFA. These members of NRECA, as 
the Commission understands, have been determined to be small entities 
by the Small Business Administration (SBA) because they are ``primarily 
engaged in the generation, transmission, and/or distribution of 
electric energy for sale and [their] total electric output for the 
preceding fiscal year did not exceed 4 million megawatt hours.'' \64\ 
Although the Joint Associations do not provide details on whether or 
how the NRECA members that have been determined to be small entities 
use the types of swaps that will be subject to the Clearing 
Requirement, the Joint Associations do state that NRECA members 
``engage in swaps to hedge commercial risk.'' \65\ Because the NRECA 
members that have been determined to be small entities would be using 
swaps to hedge commercial risk, the Commission expects that they would 
be able to use the end-user exception from the Clearing Requirement and 
therefore would not be affected to any significant extent by the 
Clearing Requirement.
---------------------------------------------------------------------------

    \63\ See 66 FR 20740, 20743 (Apr. 25, 2001).
    \64\ Small Business Administration, Table of Small Business Size 
Standards, Nov. 5, 2010.
    \65\ See Joint Associations' comment letter, at 2. The letter 
also suggests that NRECA members are not financial entities. See 
id., at note 5, and at 5 (the associations' members ``are not 
financial companies'').
---------------------------------------------------------------------------

    Thus, because nearly all of the ECPs that may be subject to the 
Clearing Requirement are not small entities, and because the few ECPs 
that have been determined by the SBA to be small entities are unlikely 
to be subject to the Clearing Requirement, the Chairman, on behalf of 
the Commission, hereby certifies pursuant to 5 U.S.C. 605(b) that the 
rule herein creating the compliance schedule for the Clearing 
Requirement will not have a significant economic impact on a 
substantial number of small entities.

B. Paperwork Reduction Act

    The Paperwork Reduction Act (PRA) \66\ imposes certain requirements 
on federal agencies (including the Commission) in connection with 
conducting or sponsoring any collection of information as defined by 
the PRA. As stated in the NPRM, this rulemaking will not require a new 
collection of information from any persons or entities.\67\
---------------------------------------------------------------------------

    \66\ 44 U.S.C. 3507(d).
    \67\ 76 FR 58186, 58193 (Sept. 20, 2011).
---------------------------------------------------------------------------

V. List of Subjects

List of Subjects in 17 CFR Part 50

    Business and industry, Clearing, Swaps.

    In consideration of the foregoing, and pursuant to the authority in 
the Commodity Exchange Act, as amended, and in particular section 2(h) 
of the Act, the Commission hereby adopts an amendment to Chapter I of 
Title 17 of the Code of Federal Regulation by adding a new part 50 as 
follows:

[[Page 44456]]

PART 50--CLEARING REQUIREMENT

    Authority: 7 U.S.C. 2 as amended by Pub. L. 111-203, 124 Stat. 
1376.


Sec.  50.25  Clearing requirement compliance schedule.

    (a) Definitions. For the purposes of this paragraph:
    Active Fund means any private fund as defined in section 202(a) of 
the Investment Advisers Act of 1940, that is not a third-party 
subaccount and that executes 200 or more swaps per month based on a 
monthly average over the 12 months preceding the Commission issuing a 
clearing requirement determination under section 2(h)(2) of the Act.
    Category 1 Entity means a swap dealer, a security-based swap 
dealer; a major swap participant; a major security-based swap 
participant; or an active fund.
    Category 2 Entity means a commodity pool; a private fund as defined 
in section 202(a) of the Investment Advisers Act of 1940 other than an 
active fund; or a person predominantly engaged in activities that are 
in the business of banking, or in activities that are financial in 
nature as defined in section 4(k) of the Bank Holding Company Act of 
1956, provided that, in each case, the entity is not a third-party 
subaccount.
    Third-party Subaccount means an account that is managed by an 
investment manager that is independent of and unaffiliated with the 
account's beneficial owner or sponsor, and is responsible for the 
documentation necessary for the account's beneficial owner to clear 
swaps.
    (b) Upon issuing a clearing requirement determination under section 
2(h)(2) of the Act, the Commission may determine, based on the group, 
category, type, or class of swaps subject to such determination, that 
the following schedule for compliance with the requirements of section 
2(h)(1)(A) of the Act shall apply:
    (1) A swap between a Category 1 Entity and another Category 1 
Entity, or any other entity that desires to clear the transaction, must 
comply with the requirements of section 2(h)(1)(A) of the Act no later 
than ninety (90) days from the date of publication of such clearing 
requirement determination in the Federal Register.
    (2) A swap between a Category 2 Entity and a Category 1 Entity, 
another Category 2 Entity, or any other entity that desires to clear 
the transaction, must comply with the requirements of section 
2(h)(1)(A) of the Act no later than one hundred and eighty (180) days 
from the date of publication of such clearing requirement determination 
in the Federal Register.
    (3) All other swaps for which neither of the parties to the swap is 
eligible to claim the exception from the clearing requirement set forth 
in section 2(h)(7) of the Act and Sec.  39.6, must comply with the 
requirements of section 2(h)(1)(A) of the Act no later than two hundred 
and seventy (270) days from the date of publication of such clearing 
requirement determination in the Federal Register.
    (c) Nothing in this rule shall be construed to prohibit any person 
from voluntarily complying with the requirements of section 2(h)(1)(A) 
of the Act sooner than the implementation schedule provided under 
paragraph (b).

    Issued in Washington, DC, on July 24, 2012, by the Commission.
Sauntia Warfield,
Assistant Secretary of the Commission.

    Appendices to Swap Transaction Compliance and Implementation 
Schedule: Clearing Requirement under Section 2(h) of the CEA--
Commission Voting Summary and Statements of Commissioners

    Note: The following appendices will not appear in the Code of 
Federal Regulations.

Appendix 1--Commission Voting Summary

    On this matter, Chairman Gensler and Commissioners Sommers, 
Chilton, O'Malia and Wetjen voted in the affirmative; no 
Commissioner voted in the negative.

Appendix 1--Statement of Chairman Gary Gensler

    I support the final rule to establish a schedule to phase in 
compliance with the clearing requirement provisions in the Dodd-
Frank Wall Street Reform and Consumer Protection Act.
    The rule gives market participants an adequate amount of time to 
comply and helps facilitate an orderly transition to the new 
clearing requirements for the swaps market. The rule provides 
greater clarity to market participants regarding the timeframe for 
bringing their swaps into compliance with the clearing requirement.

[FR Doc. 2012-18383 Filed 7-27-12; 8:45 am]
BILLING CODE 6351-01-P