Further Definition of “Swap Dealer,” “Security-Based Swap Dealer,” “Major Swap Participant,” “Major Security-Based Swap Participant” and “Eligible Contract Participant”, 80174-80218 [2010-31130]
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Federal Register / Vol. 75, No. 244 / Tuesday, December 21, 2010 / Proposed Rules
COMMODITY FUTURES TRADING
COMMISSION
17 CFR Part 1
RIN 3038–AD06
SECURITIES AND EXCHANGE
COMMISSION
17 CFR Part 240
[Release No. 34–63452; File No. S7–39–10]
RIN 3235–AK65
Further Definition of ‘‘Swap Dealer,’’
‘‘Security-Based Swap Dealer,’’ ‘‘Major
Swap Participant,’’ ‘‘Major SecurityBased Swap Participant’’ and ‘‘Eligible
Contract Participant’’
Commodity Futures Trading
Commission; Securities and Exchange
Commission.
ACTION: Joint proposed rule; proposed
interpretations.
AGENCY:
In accordance with Section
712(d)(1) of Title VII of the Dodd-Frank
Wall Street Reform and Consumer
Protection Act of 2010 (‘‘Dodd-Frank
Act’’), the Commodity Futures Trading
Commission (‘‘CFTC’’) and the Securities
and Exchange Commission (‘‘SEC’’)
(collectively, the ‘‘Commissions’’), in
consultation with the Board of
Governors of the Federal Reserve
System, are proposing rules and
interpretative guidance under the
Commodity Exchange Act (‘‘CEA’’), 7
U.S.C. 1 et seq., and the Securities
Exchange Act of 1934 (‘‘Exchange Act’’),
15 U.S.C. 78a et seq., to further define
the terms ‘‘swap dealer,’’ ‘‘security-based
swap dealer,’’ ‘‘major swap participant,’’
‘‘major security-based swap participant,’’
and ‘‘eligible contract participant.’’
DATES: Submit comments on or before
February 22, 2011.
ADDRESSES: Comments may be
submitted by any of the following
methods:
CFTC:
• Agency Web site, via its Comments
Online process: https://
comments.cftc.gov. Follow the
instructions for submitting comments
through the Web site.
• Mail: David A. Stawick, Secretary,
Commodity Futures Trading
Commission, Three Lafayette Centre,
1155 21st Street, NW., Washington, DC
20581.
• Hand Delivery/Courier: Same as
mail above.
• Federal eRulemaking Portal:
Comments also may be submitted at
https://www.regulations.gov. Follow the
instructions for submitting comments.
emcdonald on DSK2BSOYB1PROD with PROPOSALS2
SUMMARY:
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‘‘Definitions’’ must be in the subject field
of responses submitted via e-mail, and
clearly indicated on written
submissions. All comments must be
submitted in English, or if not,
accompanied by an English translation.
All comments provided in any
electronic form or on paper will be
published on the CFTC Web site,
without review and without removal of
personally identifying information. All
comments are subject to the CFTC
Privacy Policy.
SEC
Electronic Comments
• Use the Commission’s Internet
comment form (https://www.sec.gov/
rules/proposed.shtml);
• Send an e-mail to rulecomments@sec.gov. Please include File
Number S7–39–10 on the subject line;
or
• Use the Federal eRulemaking Portal
(https://www.regulations.gov). Follow the
instructions for submitting comments.
Paper Comments
• Send paper comments in triplicate
to Elizabeth M. Murphy, Secretary,
Securities and Exchange Commission,
100 F Street, NE., Washington, DC
20549–1090.
All submissions should refer to File
Number S7–39–10. This file number
should be included on the subject line
if e-mail is used. To help us process and
review your comments more efficiently,
please use only one method. The
Commission will post all comments on
the Commission’s Internet Web site
(https://www.sec.gov/rules/
proposed.shtml). Comments are also
available for Web site viewing and
printing in the Commission’s Public
Reference Room, 100 F Street, NE.,
Washington, DC 20549, on official
business days between the hours of 10
a.m. and 3 p.m. All comments received
will be posted without change; we do
not edit personal identifying
information from submissions. You
should submit only information that
you wish to make available publicly.
FOR FURTHER INFORMATION CONTACT:
CFTC: Mark Fajfar, Assistant General
Counsel, at 202–418–6636,
mfajfar@cftc.gov, Julian E. Hammar,
Assistant General Counsel, at 202–418–
5118, jhammar@cftc.gov, or David E.
Aron, Counsel, at 202–418–6621,
daron@cftc.gov, Office of General
Counsel, Commodity Futures Trading
Commission, Three Lafayette Centre,
1155 21st Street, NW., Washington, DC
20581; SEC: Joshua Kans, Senior Special
Counsel, Jeffrey Dinwoodie, Attorney
Advisor, or Richard Grant, Attorney
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Advisor, at 202–551–5550, Division of
Trading and Markets, Securities and
Exchange Commission, 100 F Street,
NE., Washington, DC 20549–7010.
SUPPLEMENTARY INFORMATION:
I. Background
On July 21, 2010, President Obama
signed the Dodd-Frank Act into law.1
Title VII of the Dodd-Frank Act 2
established a comprehensive new
regulatory framework for swaps and
security-based swaps. The legislation
was enacted, among other reasons, to
reduce risk, increase transparency, and
promote market integrity within the
financial system, including by:
(1) Providing for the registration and
comprehensive regulation of swap
dealers, security-based swap dealers,
major swap participants and major
security-based swap participants;
(2) imposing clearing and trade
execution requirements on swaps and
security-based swaps, subject to certain
exceptions; (3) creating rigorous
recordkeeping and real-time reporting
regimes; and (4) enhancing the
rulemaking and enforcement authorities
of the Commissions with respect to,
among others, all registered entities and
intermediaries subject to the
Commissions’ oversight.
More specifically, the Dodd-Frank Act
provides that the CFTC will regulate
‘‘swaps,’’ and the SEC will regulate
‘‘security-based swaps.’’ The Dodd-Frank
Act also adds to the CEA and Exchange
Act definitions of the terms ‘‘swap
dealer,’’ ‘‘security-based swap dealer,’’
‘‘major swap participant,’’ ‘‘major
security-based swap participant,’’ and
‘‘eligible contract participant.’’ These
terms are defined in Sections 721 and
761 of the Dodd-Frank Act and, with
respect to the term ‘‘eligible contract
participant,’’ in Section 1a(18) of the
CEA,3 as re-designated and amended by
Section 721 of the Dodd-Frank Act.
Section 712(d)(1) of the Dodd-Frank
Act provides that the CFTC and the
SEC, in consultation with the Board of
Governors of the Federal Reserve
System, shall jointly further define the
terms ‘‘swap,’’ ‘‘security-based swap,’’
‘‘swap dealer,’’ ‘‘security-based swap
dealer,’’ ‘‘major swap participant,’’
‘‘major security-based swap participant,’’
‘‘eligible contract participant,’’ and
‘‘security-based swap agreement.’’
1 See Dodd-Frank Wall Street Reform and
Consumer Protection Act, Public Law 111–203, 124
Stat. 1376 (2010). The text of the Dodd-Frank Act
may be accessed at https://www.cftc.gov./
LawRegulation/OTCDERIVATIVES/index.htm.
2 Pursuant to Section 701 of the Dodd-Frank Act,
Title VII may be cited as the ‘‘Wall Street
Transparency and Accountability Act of 2010.’’
3 See 7 U.S.C. 1a(18).
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Further, Section 721(c) of the DoddFrank Act requires the CFTC to adopt a
rule to further define the terms ‘‘swap,’’
‘‘swap dealer,’’ ‘‘major swap participant,’’
and ‘‘eligible contract participant,’’ and
Section 761(b) of the Dodd-Frank Act
permits the SEC to adopt a rule to
further define the terms ‘‘security-based
swap,’’ ‘‘security-based swap dealer,’’
‘‘major security-based swap participant,’’
and ‘‘eligible contract participant,’’ with
regard to security-based swaps, for the
purpose of including transactions and
entities that have been structured to
evade Title VII of the Dodd-Frank Act.4
In light of the requirements in the
Dodd-Frank Act noted above, the CFTC
and the SEC issued a joint Advance
Notice of Proposed Rulemaking
(‘‘ANPRM’’) on August 13, 2010,
requesting public comment regarding
the definitions of ‘‘swap,’’ ‘‘securitybased swap,’’ ‘‘security-based swap
agreement,’’ ‘‘swap dealer,’’ ‘‘securitybased swap dealer,’’ ‘‘major swap
participant,’’ ‘‘major security-based swap
participant,’’ and ‘‘eligible contract
participant’’ in Title VII of the DoddFrank Act.5 The Commissions reviewed
more than 80 comments in response to
the ANPRM. The Commissions also
informally solicited comments on the
definitions on their respective Web
sites.6 In addition, the staffs of the CFTC
and the SEC have met with many
market participants and other interested
parties to discuss the definitions.7
In this release, the Commissions
propose to further define ‘‘swap dealer,’’
‘‘security-based swap dealer,’’ ‘‘major
swap participant,’’ ‘‘major security-based
swap participant’’ and ‘‘eligible contract
participant,’’ and propose related rules,
and also discuss certain factors that are
relevant to market participants when
determining their status with respect to
the defined terms. In developing these
proposals, the Commissions have been
mindful that the markets for swaps and
security-based swaps are evolving, and
that the rules that we adopt will, as
intended by the Dodd-Frank Act,
4 The definitions of the terms ‘‘swap,’’ ‘‘securitybased swap,’’ and ‘‘security-based swap agreement,’’
and regulations regarding mixed swaps are the
subject of a separate rulemaking by the
Commissions.
5 See Definitions Contained in Title VII of DoddFrank Wall Street Reform and Consumer Protection
Act, Exchange Act Rel. No. 34–62717, 75 FR 51429
(Aug. 20, 2010). The comment period for the
ANPRM closed on September 20, 2010.
6 Comments were solicited by the CFTC at
https://www.cftc.gov/LawRegulation/DoddFrankAct/
OTC_2_Definitions.html and the SEC at https://
www.sec.gov/spotlight/regreformcomments.shtml/.
7 The views expressed in the comments in
response to the ANPRM, in response to the
Commissions’ informal solicitation, and at such
meetings are collectively referred to as the views of
‘‘commenters.’’
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significantly affect those markets. The
rules not only will help determine
which entities will be subject to
comprehensive regulation of their swap
and security-based swap activities, but
may also cause certain entities to
modify their activities to avoid being
subject to the regulations. As a result,
we are aware of the importance of
crafting these rules carefully to
maximize the benefits of the regulation
imposed by the Dodd-Frank Act, and to
do so in a way that is flexible enough
to respond to market developments.
While we preliminarily believe that
these proposals, if adopted, would
appropriately effect the intent of the
Dodd-Frank Act, we are very interested
in commenters’ views as to whether we
have achieved this purpose, and, if not,
how to improve these proposals.8
II. Definitions of ‘‘Swap Dealer’’ and
‘‘Security-Based Swap Dealer’’
The Dodd-Frank Act defines the terms
‘‘swap dealer’’ and ‘‘security-based swap
dealer’’ in terms of whether a person
engages in certain types of activities
involving swaps or security-based
swaps.9 Persons that meet either of
those definitions are subject to statutory
requirements related to, among other
things, registration, margin, capital and
business conduct.10
The two definitions in general
encompass persons that engage in any of
the following types of activity:
8 In addition, we recognize that the
appropriateness of these proposals also should be
considered in light of the substantive requirements
that will be applicable to dealers and major
participants, including capital, margin and business
conduct requirements, which are the subject of
separate rulemakings. For example, whether the
definition of a major participant is too broad or too
narrow may well depend in part on the substantive
requirements applicable to such entities, and
whether those substantive requirements are
themselves appropriate may in turn depend in part
on the scope of the major participant definition. We
therefore encourage comments that take into
account the interplay between the proposed
definitions and these substantive requirements.
9 See Section 721 of the Dodd-Frank Act (defining
‘‘swap dealer’’ in new Section 1a(49) of the CEA, 7
U.S.C. 1a(49)) and Section 761 of the Dodd-Frank
Act (defining ‘‘security-based swap dealer’’ in new
Section 3(a)(71) of the Exchange Act, 15 U.S.C.
78c(a)(71)).
10 The Dodd-Frank Act excludes from the
Exchange Act definition of ‘‘dealer’’ persons who
engage in security-based swap transactions with
eligible contract participants. See Section 3(a)(5) of
the Exchange Act, 15 U.S.C. 78c(a)(5), as amended
by Section 761(a)(1) of the Dodd-Frank Act.
The Dodd-Frank Act does not include comparable
amendments for persons who act as brokers in
swaps and security-based swaps. Because securitybased swaps are a type of security, persons who act
as brokers in connection with security-based swaps
must, absent an exemption, register with the SEC
as a broker pursuant to Exchange Act section 15(a),
and comply with the Exchange Act’s requirements
applicable to brokers.
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(i) Holding oneself out as a dealer in
swaps or security-based swaps,
(ii) Making a market in swaps or
security-based swaps,
(iii) Regularly entering into swaps or
security-based swaps with
counterparties as an ordinary course of
business for one’s own account, or
(iv) Engaging in activity causing
oneself to be commonly known in the
trade as a dealer or market maker in
swaps or security-based swaps.11
The definitions are disjunctive, in that
a person that engages in any of the
enumerated dealing activities is a swap
dealer or security-based swap dealer
even if the person does not engage in
any of the other enumerated activities.
The definitions, in contrast, do not
include a person that enters into swaps
or security-based swaps ‘‘for such
person’s own account, either
individually or in a fiduciary capacity,
but not as a part of a regular
business.’’ 12 The Dodd-Frank Act also
instructs the Commissions to exempt
from designation as a dealer an entity
that ‘‘engages in a de minimis quantity
of [swap or security-based swap] dealing
in connection with transactions with or
on behalf of its customers.’’ 13 Moreover,
the definition of ‘‘swap dealer’’ (but not
the definition of ‘‘security-based swap
dealer’’) provides that an insured
depository institution is not to be
considered a swap dealer ‘‘to the extent
it offers to enter into a swap with a
customer in connection with originating
a loan with that customer.’’ 14
The definitions also provide that a
person may be designated as a dealer for
one or more types, classes or categories
of swaps, security-based swaps, or
activities without being designated a
dealer for other types, classes or
categories or activities.15
The Commissions are proposing rules
to further define certain aspects of the
meaning of ‘‘swap dealer’’ and ‘‘securitybased swap dealer,’’ and are providing
guidance on how the Commissions
propose to interpret these terms. This
release specifically addresses: (A) The
types of activities that would cause a
person to be a swap dealer or securitybased swap dealer, including
differences in how those two definitions
should be applied; (B) the statutory
provisions requiring the Commissions to
exempt persons from the dealer
11 See CEA section 1a(49)(A); Exchange Act
section 3(a)(71)(A).
12 See CEA section 1a(49)(C); Exchange Act
section 3(a)(71)(C).
13 See CEA section 1a(49)(D); Exchange Act
section 3(a)(71)(D).
14 CEA section 1a(49)(A).
15 See CEA section 1a(49)(B); Exchange Act
section 3(a)(71)(B).
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definitions in connection with de
minimis activity; (C) the exception from
the ‘‘swap dealer’’ definition in
connection with loans by insured
depository institutions; (D) the
possibility that a person may be
considered a dealer for some types,
classes or categories of swaps, securitybased swaps, or activities but not others;
and (E) certain interpretative issues that
arise in particular situations. The
Commissions request comment on all
aspects of the proposals, including the
particular points noted in the discussion
below.
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A. Swap and Security-Based Swap
Dealing Activity
1. Comments Regarding Dealing
Activities
Commenters provided numerous
examples of conduct they viewed as
dealing activities—as well as conduct
they did not view as dealing activities.
For example, many of the commenters
stated that dealers provide ‘‘bid/ask’’ or
‘‘two-way’’ prices for swaps on a regular
basis, or regularly participate in both
sides of the swap market. Some
commenters indicated that dealers
perform an intermediary function. Other
commenters stated that a person holds
itself out as a dealer if it consistently
and systematically markets itself as a
swap dealer to third parties. Some
commenters described market makers in
the swap markets as persons that stand
ready to buy or sell swaps at all times,
are open to doing swaps business on
both sides of a market, or make bids to
buy and offers to sell swaps or a type
of swap at all times. Commenters stated
that a person should be included in the
definition of dealer if its sole or
dominant line of business is swaps
activity. One commenter urged the
Commissions to adopt a swap
association’s definition of a primary
member as the definition of dealer.
Some commenters stated that the
definition of dealer should be read
narrowly. For example, some
commenters suggested that the market
maker concept should not encompass
persons that provide occasional quotes
or that do not make bids or offers
consistently or at all times. Another
commenter stated that a willingness to
buy or sell a swap or security-based
swap at a particular time does not
constitute market making absent the
creating of a two-way market. One
commenter suggested that solely acting
as a market maker should not cause a
person to be a dealer, since firms may
have commercial purposes for offering
two-way trades. Another commenter
stated that an entity that ‘‘holds itself
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out’’ as a dealer should qualify as a swap
dealer only if it ‘‘consistently and
systematically markets itself as a dealer
to third-parties.’’ 16
Many commenters called for the
exclusion of particular types of persons
from the definition of swap dealer or
security-based swap dealer. Several
commenters maintained that
commercial end-users of swaps or
security-based swaps that enter into
swaps or security-based swaps to hedge
or mitigate commercial risk should be
excluded from the definitions. Another
commenter stated the definitions should
exclude persons who use swaps or
security-based swaps for bona fide
hedging. Other commenters indicated
that cooperatives that enter into swaps
in connection with the business of their
members should be excluded.
Commenters also stated that if all of a
person’s swaps are cleared on an
exchange or derivatives clearing
organization, the person should not be
deemed to be a dealer. One commenter
stated competitive power suppliers
should be excluded, and another stated
that the dealer definition should not
apply to futures commission merchants
that act economically like brokers.
Commenters, particularly those in the
securities industry, urged the
Commissions to interpret the definitions
of swap dealer and security-based swap
dealer consistently with precedent that
distinguishes between dealers in
securities and traders in securities.
However, one commenter also noted
that some concepts from the securities
and commodities laws may not easily be
applied to these markets.
2. Application of the Core Tests to
‘‘Swap Dealers’’ and ‘‘Security-Based
Swap Dealers’’
The Dodd-Frank Act defines the terms
‘‘swap dealer’’ and ‘‘security-based swap
dealer’’ in a functional manner,
encompassing how a person holds itself
out in the market, the nature of the
conduct engaged in by the person, and
how the market perceives the person’s
activities. This suggests that the
definitions should not be interpreted in
a constrained or overly technical
manner. Rigid standards would not
provide the necessary flexibility to
respond to evolution in the ways that
dealers enter into swaps and securitybased swaps. The different types of
swap and security-based swap markets
16 See letter from Eric Dennison, Sr. Vice
President and General Counsel, Stephanie Miller,
Assistant General Counsel—Commodities, and Bill
Hellinghausen, Director of Regulatory Affairs, EDF
Trading, dated September 20, 2010 (distinguishing
transactions that the commenter enters into as part
of energy management services).
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are diverse, and there does not appear
to be a single set of criteria that can be
determinative in all markets.
At the same time, we note that there
may be certain distinguishing
characteristics of swap dealers and
security-based swap dealers, including
that:
• Dealers tend to accommodate
demand for swaps and security-based
swaps from other parties;
• Dealers are generally available to
enter into swaps or security-based
swaps to facilitate other parties’ interest
in entering into those instruments;
• Dealers tend not to request that
other parties propose the terms of swaps
or security-based swaps; rather, dealers
tend to enter into those instruments on
their own standard terms or on terms
they arrange in response to other
parties’ interest; and
• Dealers tend to be able to arrange
customized terms for swaps or securitybased swaps upon request, or to create
new types of swaps or security-based
swaps at the dealer’s own initiative.
We also recognize that the principles
relevant to identifying dealing activity
involving swaps can differ from
comparable principles associated with
security-based swaps. These differences
are due, in part, to differences in how
those instruments are used. For
example, because security-based swaps
may be used to hedge or gain economic
exposure to underlying securities (while
recognizing distinctions between
securities-based swaps and other types
of securities, as discussed below), there
is a basis to build upon the same
principles that are presently used to
identify dealers for other types of
securities. Accordingly, we separately
address how the core tests would apply
to swap dealers and to security-based
swap dealers.
a. Application to Swap Dealers
The definition of swap dealer should
be informed by the differences between
swaps, on the one hand, and securities
and commodities, on the other.
Transactions in cash market securities
and commodities generally involve
purchases and sales of tangible or
intangible property. Swaps, in contrast,
are notional contracts requiring the
performance of agreed terms by each
party.17 Thus, many of the concepts
cited by commenters, such as whether a
person buys and sells swaps or makes
a two-sided market in swaps or trades
within a bid/offer spread, cannot
17 As discussed below, however (see note 42,
infra), the Dodd-Frank Act amended the Exchange
Act definitions of ‘‘buy,’’ ‘‘purchase,’’ ‘‘sale’’ and
‘‘sell’’ to apply to particular actions involving
security-based swaps.
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necessarily be applied to all types of
swaps to determine if the person is a
swap dealer. We understand that market
participants do use this terminology
colloquially to describe the process of
entering into a swap. For example, a
person seeking a fixed/floating interest
rate swap may inquire as to the fixed
rates, spread above the floating rate and
other payments that another person
would require in order to enter into a
swap. But, while these persons may
discuss bids, offers, prices and so forth,
the parties are negotiating the terms of
a contract, they are not negotiating the
price at which they will transfer
ownership of tangible or intangible
property. Accordingly, these concepts
are not determinative of whether a
person is a ‘‘swap dealer.’’
Instead, persons who are swap dealers
may be identified by the functional role
they fulfill in the swap markets. As
noted above, swap dealers tend to
accommodate demand and to be
available to enter into swaps to facilitate
other parties’ interest in swaps
(although swap dealers may also
advance their own investment and
liquidity objectives by entering into
such swaps). In addition, swap dealers
can often be identified by their
relationships with counterparties. Swap
dealers tend to enter into swaps with
more counterparties than do nondealers, and in some markets, nondealers tend to constitute a large portion
of swap dealers’ counterparties. In
contrast, non-dealers tend to enter into
swaps with swap dealers more often
than with other non-dealers.18 The
Commissions can most efficiently
achieve the purposes underlying Title
VII of the Dodd-Frank Act—to reduce
risk and to enhance operational
standards and fair dealing in the swap
markets—by focusing their attention on
those persons whose function is to serve
as the points of connection in those
markets. The definition of swap dealer,
construed functionally in the manner
set forth above, will help to identify
those persons.
Clause (A)(iii) of the statutory
definition of swap dealer, which
includes any person that ‘‘regularly
enters into swaps with counterparties as
an ordinary course of business for its
own account,’’ 19 has been the subject of
18 Some of the commenters appeared to suggest
that significant parts of the swap markets operate
without the involvement of swap dealers. We
believe that this analysis is likely incorrect, and that
the parties that fulfill the function of dealers should
be identified and are likely to be swap dealers.
19 We interpret this reference to a person entering
into swaps ‘‘with counterparties * * * for its own
account’’ to refer to a person entering into a swap
as a principal, and not as an agent. A person who
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significant uncertainty among
commenters. The commenters point out
that its literal terms could encompass
many parties who regularly enter into
swaps without engaging in any form of
swap dealing activity. In this regard,
clause (A)(iii) of the definition should
be read in combination with the express
exception in subparagraph (C) of the
swap dealer definition, which excludes
‘‘a person that enters into swaps for such
person’s own account, either
individually or in a fiduciary capacity,
but not as a part of a regular business.’’
Thus, the difference between the
inclusion in clause (A)(iii) and the
exclusion in subparagraph (C) is
whether or not the person enters into
swaps as a part of, or as an ordinary
course of, a ‘‘regular business.’’ 20 We
believe that persons who enter into
swaps as a part of a ‘‘regular business’’
are those persons whose function is to
accommodate demand for swaps from
other parties and enter into swaps in
response to interest expressed by other
parties. Conversely, persons who do not
fulfill this function should not be
deemed to enter into swaps as part of a
‘‘regular business’’ and are not likely to
be swap dealers.
In sum, to determine if a person is a
swap dealer, we would consider that
person’s activities in relation to the
other parties with which it interacts in
the swap markets. If the person is
available to accommodate demand for
swaps from other parties, tends to
propose terms, or tends to engage in the
other activities discussed above, then
the person is likely to be a swap dealer.
Persons that rarely engage in such
activities are less likely to be deemed
swap dealers.
We request comment on this
interpretive approach for identifying
whether a person is a swap dealer.
b. Application to Security-Based Swap
Dealers
The definition of ‘‘security-based
swap dealer’’ has parallels to the
definition of ‘‘dealer’’ under the
Exchange Act.21 In addition, securityentered into swaps as an agent for customers (i.e.,
for the customers’ accounts) would be required to
register as either a Futures Commission Merchant,
Introducing Broker, Commodity Pool Operator or
Commodity Trading Advisor, depending on the
nature of the person’s activity.
20 The definition of ‘‘security-based swap dealer’’
is structured similarly, and should be interpreted
similarly.
21 The Exchange Act in relevant part defines
‘‘dealer’’ to mean ‘‘any person engaged in the
business of buying and selling securities (not
including security-based swaps, other than securitybased swaps with or for persons that are not eligible
contract participants) for such person’s own
account through a broker or otherwise,’’ but with an
exception for ‘‘a person that buys or sells securities
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80177
based swaps may be used to hedge risks
associated with the ownership of certain
other types of securities,22 and securitybased swaps may be used to gain
economic exposure akin to ownership of
certain other types of securities.23 As a
result, the SEC would consider the same
factors that are relevant to determining
whether a person is a ‘‘dealer’’ under the
Exchange Act as also generally relevant
to the analysis of whether a person is a
security-based swap dealer.
The Exchange Act has been
interpreted to distinguish between
‘‘dealers’’ and ‘‘traders.’’ In this context,
the SEC previously has noted that the
dealer-trader distinction:
Recognizes that dealers normally have a
regular clientele, hold themselves out as
buying or selling securities at a regular place
of business, have a regular turnover of
inventory (or participate in the sale or
distribution of new issues, such as by acting
as an underwriter), and generally provide
liquidity services in transactions with
investors (or, in the case of dealers who are
market makers, for other professionals).24
Other non-exclusive factors that are
relevant for distinguishing between
dealers and non-dealers can include the
receipt of customer property and the
furnishing of incidental advice in
connection with transactions.
The markets involving security-based
swaps are distinguishable in certain
respects from markets involving cash
market securities—particularly with
regard to the concepts of ‘‘inventory’’
(which generally appears inapplicable
in this context) 25 and ‘‘regular place of
business.’’ For example, the suggestion
that dealers are more likely to operate at
a ‘‘regular place of business’’ than traders
should not be construed in a way that
ignores the reality of how the securitybased swap markets operate (or that
(not including security-based swaps, other than
security-based swaps with or for persons that are
not eligible contract participants) for such person’s
own account, either individually or in a fiduciary
capacity, but not as a part of a regular business.’’
Exchange Act sections 3(a)(5)(A) and (B), 15 U.S.C.
78c(a)(5)(A) and (B), as amended by Section
761(a)(1) of the Dodd-Frank Act.
22 For example, an entity that owns a particular
security may use a security-based swap to hedge the
risks of that security. Conversely, an entity may
seek to offset exposure involving a security-based
swap by using another security as a hedge.
23 For example, an entity may enter into a
security-based swap to gain economic exposure
akin to a long or short position in a stock or bond,
without having to engage in a cash market
transaction for that instrument.
24 Securities Exchange Act Release No. 47364
(Feb. 13, 2003) (footnotes omitted).
25 In particular, an analysis that considers dealers
to differ from traders in part because dealers have
regular turnover in ‘‘inventory’’ appears not to apply
in the context of security-based swaps, given that
those instruments are created by contract between
two market counterparties, rather than reflecting
financial rights issued by third-parties.
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ignores evolution in dealing practices
involving other types of securities).
Dealers may use a variety of methods to
communicate their availability to enter
into security-based swaps with other
market participants. The dealer-trader
distinction should not be applied to the
security-based swap markets without
taking those distinctions into account.26
Even in light of those differences,
however, we believe that the dealertrader distinction provides an important
analytical tool to assist in determining
whether a person is a ‘‘security-based
swap dealer.’’
Commenters have raised concerns
that the ambit of the security-based
swap dealer definition could encompass
end-users that use security-based swaps
for hedging their business risks.
Deeming those entities to be securitybased swap dealers due to their hedging
activities could discourage their use of
hedging transactions or subject them to
a regulatory framework that was not
intended to address their businesses and
could subject them to unnecessary costs.
Under the dealer-trader distinction,
however, we would expect entities that
use security-based swaps to hedge their
business risks, absent other activity,
likely would not be dealers.27 Also, as
discussed below, both the ‘‘securitybased swap dealer’’ definition and the
dealer-trader distinction in part turn on
whether a person holds itself out as a
dealer.
We request comment on the
application of the dealer-trader
distinction as part of the analysis of
whether a person is a security-based
swap dealer.
26 The definition of ‘‘security-based swap dealer,’’
unlike the Exchange Act’s definition of ‘‘dealer,’’
does not specifically refer to ‘‘buying’’ and ‘‘selling.’’
We do not believe that this language difference is
significant, however, as the Dodd-Frank Act
amended the Exchange Act definitions of ‘‘buy’’ and
‘‘purchase,’’ and the Exchange Act definitions of
‘‘sale’’ and ‘‘sell,’’ to encompass the execution,
termination (prior to its scheduled maturity date),
assignment, exchange or similar transfer or
conveyance of, or extinguishing of rights or
obligations under, a security-based swap. See DoddFrank Act sections 761(a)(3), (4) (amending
Exchange Act sections 3(a)(13), (14)).
27 Of course, if a person’s other activities satisfy
the definition of security-based swap dealer, it must
comply with the applicable requirements with
regard to all of its security-based swap activities,
absent an order to the contrary, as discussed below.
Also, as discussed below, we would expect endusers to use security-based swaps for hedging
purposes less commonly than they use swaps for
hedging purposes.
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c. Issues Common to Both Definitions
i. Holding Oneself Out as, and Being
Commonly Known in the Trade as, a
Swap Dealer or Security-Based Swap
Dealer
As noted above, the application of
these definitions to persons that ‘‘hold
themselves out’’ as dealers or that are
‘‘commonly known in the trade’’ as
dealers highlights the need for a
functional interpretation of the dealer
definitions. We believe that factors that
may reasonably indicate that a person is
holding itself out as a dealer or is
commonly known in the trade as a
dealer may include (but are not limited
to) the following:
• Contacting potential counterparties
to solicit interest in swaps or securitybased swaps,
• Developing new types of swaps or
security-based swaps (which may
include financial products that contain
swaps or security-based swaps) and
informing potential counterparties of
the availability of such swaps or
security-based swaps and a willingness
to enter into such swaps or securitybased swaps with the potential
counterparties,
• Membership in a swap association
in a category reserved for dealers,
• Providing marketing materials (such
as a Web site) that describe the types of
swaps or security-based swaps that one
is willing to enter into with other
parties, or
• Generally expressing a willingness
to offer or provide a range of financial
products that would include swaps or
security-based swaps.
Notably, holding oneself out as a
security-based swap dealer would likely
encompass a situation in which a
person that is a ‘‘dealer’’ in another type
of security enters into a security-based
swap with a customer.28 Another
example of holding oneself out as a
security-based swap dealer would likely
be an entity expressing its availability to
provide liquidity to counterparties that
seek to enter into security-based swaps,
regardless of the ‘‘direction’’ of the
transaction or across a broad spectrum
of risks (e.g., credit default swaps
related to a variety of issuers).
The determination of who is
commonly known in the trade as a swap
28 For example, if a person that is a dealer in
securities that are not security-based swaps enters
into a security-based swap transaction with one of
its cash market customers, the person would appear
to be engaged in security-based swap dealing
activity with that customer. In that circumstance,
the customer reasonably would be expected to view
the person as a dealer for purposes of the securitybased swap, making the applicable business
conduct requirements particularly important.
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dealer or security-based swap dealer
may appropriately reflect, among other
factors, the perspective of persons with
substantial experience with and
knowledge of the swap and securitybased swap markets, regardless of
whether an entity is known as a dealer
by persons without that experience and
knowledge.
ii. Making a Market in Swaps or
Security-Based Swaps
A number of commenters suggested
that the market making component of
the definitions should apply only to
persons that quote a two-sided market
consistently or at all times. Some
commenters also suggested that a
person’s willingness to buy or to sell a
swap or security-based swap at any
particular time should not be deemed to
be market making activity. While
continuous two-sided quotations and a
willingness to stand ready to buy and
sell a security are important indicators
of market making in the equities
markets,29 these indicia may not be
appropriate in the context of the swap
or security-based swap markets, given
that parties do not enter into many types
of swaps or security-based swaps on a
continuous basis, and that parties may
use a variety of methods for
communicating their willingness to
enter into swaps or security-based
swaps. Any analysis that would impute
to the definitions a ‘‘continuous’’ activity
requirement may cause certain persons
that engage in non-continuous dealing
activities not to be regulated as swap
dealers or security-based swap dealers.
We have not identified anything in the
statutory text or legislative history of the
Dodd-Frank Act to suggest that Congress
intended such a result.
iii. No Predominance Test
Although some commenters suggested
that a person should be a swap dealer
or security-based swap dealer only if
such activity is the person’s sole or
predominant business, the statutory
definition does not contain a
predominance test or otherwise depend
upon the level of the person’s dealing
activity, other than the de minimis
exception discussed below. A
predominance standard would not
29 See Exchange Act Release No. 58875 (Oct. 14,
2008), 73 FR 61690 (Oct. 17, 2008) (‘‘Although
determining whether or not a market maker is
engaged in bona-fide market making would depend
on the facts and circumstances of the particular
activity, factors that indicate a market maker is
engaged in bona-fide market making activities may
include, for example, whether the market maker
incurs any economic or market risk with respect to
the securities (e.g., by putting their own capital at
risk to provide continuous two-sided quotes in
markets).’’).
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provide a workable test of dealer status
because many of the parties that are
commonly acknowledged as swap or
security-based swap dealers also engage
in other businesses that often outweigh
their swap or security-based swap
dealing business in terms of transaction
volume or other measures. Based on the
plain meaning of the statutory
definition, so long as a person engages
in dealing activity that is not de
minimis, as discussed below, the person
is a swap dealer or security-based swap
dealer.30
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iv. Application of the Definition to New
Types of Swaps and New Activities
The Commissions intend to apply the
definitions of swap dealer and securitybased swap dealer flexibly when the
development of innovative business
models is accompanied by new types of
dealer activity. As discussed above, the
Commissions generally intend to follow
a ‘‘facts-and-circumstances’’ approach
with respect to identifying dealing
activities. The dealer definitions must
be flexible enough to cover appropriate
persons as the swap markets evolve.
v. Request for Comment
The Commissions request comment
on these interpretations of holding
oneself out as a dealer and being
commonly known in the trade as a
dealer, as well as the lack of a
predominance test, and the application
of the definitions to new types of swaps
and new activities. Commenters
particularly are requested to address the
relevance, to the dealer analysis, of
activities such as an entity’s
membership in a swap execution facility
(‘‘SEF’’) or a security-based SEF, or use
of facilities that may not be SEFs or
security-based SEFs. Are there factors
that would lead entities to become
members of SEFs that would not make
membership relevant to the dealer
analysis? Commenters also are
requested to generally address how the
dealer analysis should appropriately
apply the requirements applicable to
dealers (e.g., capital, margin and
business conduct requirements) to the
entities that should be subject to those
requirements. In addition, commenters
are requested to address how the dealer
definitions should be applied to entities
such as, for example, Federal home loan
banks subject to restrictions limiting
their dealing activities to particular
types of counterparties. Finally,
30 As one example, a non-financial company that
engages in both swap dealing and other commercial
activities would fall within the definition of swap
dealer because of its swap dealing activities,
notwithstanding that it also engages in other
commercial activities.
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commenters are requested to address
whether additional guidance is
advisable to help identify dealer activity
and to promote effective enforcement of
the requirements applicable to swap
dealers and security-based swap dealers.
3. Designation of a Person as a Swap
Dealer
The Dodd-Frank Act has amended the
CEA and the Exchange Act to require a
person that meets either of the
definitions to register as a swap dealer
and/or security-based swap dealer,31
and the Commissions are proposing
separate rules regarding this registration
requirement. In connection with the
registration requirement, market
participants are in a position to assess
their activities to determine whether
they function in the manner described
in the definitions. In addition, the
Commissions have the authority to take
enforcement actions in response to a
dealer’s failure to register. In
determining whether a person meets the
applicable definitions, the Commissions
may use information from other
regulators, swap data repositories,
registered clearing agencies, derivatives
clearing organizations and other
sources.
4. Application of the Swap Dealer
Definition to Agricultural Commodities
Section 723(c)(3)(B) of the DoddFrank Act provides that swaps in
agricultural commodities shall be
subject to such terms and conditions as
the CFTC may prescribe. In a separate
rulemaking, the CFTC has proposed a
definition of the term ‘‘agricultural
commodity.’’ 32 Acting under the
authority in Section 723(c)(3)(B), the
CFTC may develop particular terms and
conditions for the interpretation of the
swap dealer definition when it is
applied to dealing in swaps in
agricultural commodities. Any such
terms and conditions would not be
applicable to the definition of securitybased swap dealer. The CFTC requests
comment on the application of the swap
dealer definition to dealers, including
potentially agricultural cooperatives,
that limit their dealing activity
primarily to swaps in agricultural
commodities. The CFTC may consider
any comments on this topic for both the
definition of swap dealer and also for
any rulemaking regarding swaps in
agricultural commodities.
31 See CEA section 4s(a)–(b); Exchange Act
section 15F(a)–(b).
32 See 75 FR 65586 (Oct. 26, 2010).
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80179
B. De Minimis Exemption to the
Definitions
The Dodd-Frank Act requires that the
Commissions exempt, from designation
as a ‘‘swap dealer’’ or ‘‘security-based
swap dealer,’’ a person who ‘‘engages in
a de minimis quantity of [swap or
security-based swap] dealing in
connection with transactions with or on
behalf of its customers.’’ 33 The statutory
definitions do not require that the
Commissions fix a specific level of swap
activity that will be considered de
minimis, but instead require that the
Commissions ‘‘promulgate regulations to
establish factors with respect to the
making of this determination to
exempt.’’
1. Comments Regarding the De Minimis
Exemption
Some commenters asserted that the de
minimis exemption should be linked to
systemic risk concerns, stating that
persons engaged in dealing activities
that do not pose systemic risk should be
able to take advantage of the exemption.
Other commenters suggested that a
person’s dealing activities should be
considered de minimis if they do not
pose undue risks to the person.
Commenters also expressed the view
that the application of the exemption
should be based on quantitative criteria.
2. Proposed Rule Regarding the De
Minimis Exemption
The Commissions preliminarily
believe that the ‘‘de minimis’’ exemption
should be interpreted to address
amounts of dealing activity that are
sufficiently small that they do not
warrant registration to address concerns
implicated by the regulations governing
swap dealers and security-based swap
dealers.34 In other words, the exemption
should apply only when an entity’s
dealing activity is so minimal that
applying dealer regulations to the entity
would not be warranted.
We thus preliminarily do not agree
with those commenters that argued that
33 See CEA section 1a(49)(D); Exchange Act
section 3(a)(71)(D).
34 The Title VII requirements applicable to swap
and security-based swap dealers include, for
example: requirements that dealers conform to
regulatory standards relating to the confirmation,
processing, netting, documentation and valuation of
swaps and security-based swaps (CEA section 4s(i),
Exchange Act section 15F(i)); requirements that
dealers disclose, to regulators, information
concerning terms and conditions of swaps or
security-based swaps, as well as information
concerning trading practices, financial integrity
protections and other trading information (CEA
section 4s(j)(3), Exchange Act section 15F(j)(3));
conflicts of interest provisions (CEA section 4s(j)(5),
Exchange Act section 15F(j)(5)); and chief
compliance officer requirements (CEA section 4s(k),
Exchange Act section 15F(k)).
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a de minimis quantity of dealing should
be measured in relation to the level of
the person’s other activities (or other
swap or security-based swap activities).
Aside from the fact that the statute does
not explicitly call for a relative test,
such an approach would lead to the
result that larger and more active
companies, which presumably would be
more able to influence the swap
markets, would be more likely to qualify
for the exemption than smaller and less
active companies. Also, a relative test
not only would require a means of
measuring the person’s dealing
activities, but also would require a
means of measuring the larger scope of
activities to which its swap dealing or
security-based swap dealing activities
are to be compared, thus introducing
unnecessary complexity to the
exemption’s application.
Our proposed factors for the de
minimis exemption seek to focus the
availability of the exemption toward
entities for which registration would not
be warranted from a regulatory point of
view in light of the limited nature of
their dealing activities. At the same
time, we recognize that this focus does
not appear to readily translate into
objective criteria. Thus, while the
proposed factors discussed below reflect
our attempt to delimit the de minimis
exemption appropriately, we recognize
that a range of alternative approaches
may be reasonable, and we are
particularly interested in commenters’
suggestions as to the appropriate factors.
The first proposed factor is that the
aggregate effective notional amount,
measured on a gross basis, of swaps or
security-based swaps that an entity
enters into over the prior 12 months in
connection with its dealing activities 35
could not exceed $100 million.36 We
understand that in general the notional
size of a small swap or security-based
swap is $5 million or less, and this
35 The de minimis exemption specifically places
limits on a person’s dealing activity involving
swaps or security-based swaps. Thus, these limits
would not apply to swap or security-based swap
activity that does not itself constitute dealing
activity, such as activity in which a person hedges
or mitigates a commercial risk of its business that
is unrelated to a dealing business (i.e., as discussed
above, when the person did not accommodate
demand from the other party, respond to the other
party’s interest in swaps or security-based swaps,
solicit the other party, propose economic terms,
intermediate between parties, provide liquidity, or
engage in other dealing activities). See part II.A.2,
supra.
36 See proposed CEA rule 1.3(ppp)(4)(ii);
proposed Exchange Act rule 3a71–2(a). To the
extent that the stated notional amount of a swap or
security-based swap is leveraged or enhanced by its
structure, the calculation shall be based on the
effective notional amount of the swap or securitybased swap rather than on its stated notional
amount.
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proposed threshold would reflect 20
instruments of that size. Given the
customer protection issues raised by
swaps and security-based swaps—
including the risks that counterparties
may not fully appreciate when entering
into swaps or security-based swaps—we
believe that this notional amount
reflects a reasonable limit for identifying
those entities that engage in a de
minimis level of dealing activity.37 This
standard would measure an entity’s
quantity of dealing on a gross basis
(without consideration of the market
risk offsets associated with combining
long and short positions) to reflect the
entity’s overall amount of dealing
activity. Similarly, the proposed
notional threshold would not account
for the amount of collateral held by or
provided by the entity, nor other risk
mitigating factors, in determining
whether it engages in a de minimis
quantity of dealing, given that dealer
status focuses on an entity’s absolute
level of activity, and is not directly
based on the risks that an entity poses
or faces.38
In addition, the aggregate effective
notional amount of such swaps or
security-based swaps, in which the
person’s counterparty is a ‘‘special
entity’’ (as that term is defined in CEA
Section 4s(h)(2)(C) and Exchange Act
Section 15F(h)(2)(C)),39 that an entity
enters into over the prior 12 months
could not exceed $25 million.40 The
Dodd-Frank Act provided special
protections to special entities in
connection with swaps and securitybased swaps, and we preliminarily
believe that this lower proposed
threshold reasonably reflects the special
protections afforded to those entities.
In addition, to take advantage of the
de minimis exemption, the proposed
rule would provide that the entity could
not have entered into swaps or securitybased swaps (as applicable) as a dealer
with more than 15 counterparties, other
than security-based swap dealers, over
the prior 12 months.41 The
37 We preliminarily believe that activity above
this amount would be sufficient to warrant dealer
registration to bring about the benefits of such
registration.
38 Also, allowing offsets for collateral would
result in a de minimis standard that could
encompass positions of virtually unlimited size.
39 The term ‘‘special entity’’ encompasses: Federal
agencies; States, State agencies and political
subdivisions (including cities, counties and
municipalities); ‘‘employee benefit plans’’ as
defined under the Employee Retirement Income
Security Act of 1974 (‘‘ERISA’’); ‘‘governmental
plans’’ as defined under ERISA; and endowments.
40 See proposed CEA rule 1.3(ppp)(4)(ii);
proposed Exchange Act rule 3a71–2(b).
41 See proposed CEA rule 1.3(ppp)(4)(iii);
proposed Exchange Act rule 3a71–2(c). That these
tests measure the entity’s activities over the prior
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Commissions preliminarily believe that
an entity that enters into swaps or
security-based swaps, in a dealer
capacity, with a larger number of
counterparties should be registered to
help achieve Title VII’s orderly market
goals, and thus cannot be said to engage
in a de minimis quantity of dealing
(even if the aggregate effective notional
amount of the swaps or security-based
swaps is less than the thresholds noted
above).42 For purposes of determining
the number of counterparties, we
preliminarily believe that counterparties
who are members of an affiliated group
would generally count as one
counterparty, given that the purpose of
the limit is to measure the scope of
dealer’s interaction with separate
counterparties.43
Finally, the proposed rule would
provide that, to take advantage of the de
minimis exemption, the entity could not
have entered into more than 20 swaps
or security-based swaps (as applicable)
as a dealer during the prior 12 months.44
As is the case for the limitation on the
number of counterparties, the
Commissions preliminarily believe that
an entity that enters into a larger
number of swaps or security-based
swaps, in a dealer capacity, would, if
registered, help achieve Title VII’s
orderly market goals, and thus cannot be
said to engage in a de minimis quantity
of dealing. For these purposes, we
would expect that each separate
transaction the entity enters into under
a swap or security-based swap master
agreement in general would count as
entering into a swap or security-based
swap, but that an amendment of an
existing swap or security-based swap in
which the counterparty remained the
same and the underlying item remained
substantially the same would not count
as a new swap or security based swap.45
12 months provides certainty. As of the end of each
month, the entity will know whether it may qualify
for the exemption during the following month.
42 Similarly, because all the de minimis factors
must be satisfied, a person who enters into only a
single swap or security-based swap, as a swap
dealer, with a single counterparty could not qualify
for the de minimis exemption if that swap or
security-based swap exceeds the effective notional
amount threshold.
43 For this purpose, an affiliated group would be
defined as any group of entities that is under
common control and that reports information or
prepares its financial statements on a consolidated
basis.
44 See proposed CEA rule 1.3(ppp)(4)(iv);
proposed Exchange Act rule 3a71–2(d).
45 For these purposes only, an amendment to an
existing swap or security-based swap would not
need to be counted as a new swap or security-based
swap if the underlying item is substantially the
same as the original item. This may occur, for
example, to reflect the effect of a corporate action
such as a merger. An amendment would be counted
as a new swap or security-based swap, however, to
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The proposed rule would not
distinguish between different types of
swaps or security-based swaps into
which entities may enter (e.g., rate
swaps versus other commodity swaps,
or credit default swaps versus equity
swaps). The Commissions preliminarily
do not believe that the ceiling for
distinguishing de minimis dealing
activities from other dealing activities
appropriately turns upon the particular
type of swap or security-based swap.46
The Commissions request comment
on the proposed rule regarding the de
minimis exemption. Commenters
particularly are requested to address
whether certain of the proposed factors
should be modified or eliminated; for
example, should the proposed $100
million limit on annual notional swaps
or security-based swaps entered into in
a dealer capacity be raised or lowered to
better implement the intended scope of
the de minimis exemption—i.e., to
exclude entities for which dealer
regulation would not be warranted?
Should we adopt different thresholds
that would appropriately limit the
exemption so it encompasses only those
entities whose dealing activities are
such that dealer regulation is not
warranted? To what extent would
certain entities be expected to reduce or
otherwise adjust their dealing activity to
fall within the scope of the de minimis
exemption? Would there be any adverse
implications for market participants if
this happens? To what extent could the
proposed factors potentially reduce
dealing activity, and in doing so reduce
the liquidity available in the swap or
security-based swap market?
Commenters also are requested to
address whether the rule should seek to
identify only certain types of
counterparties with which a person
could engage in dealing activities under
the exemption. We also particularly
request comment on the proposed $25
million notional threshold for dealer
transactions with ‘‘special entities,’’
including whether that proposed
threshold should be raised or lowered,
and whether an entity that enters into
dealing transactions with ‘‘special
entities’’ should be able to take
advantage of the exemption at all. In
addition, we request comment on
the extent that the change in the underlying item
modifies the economic risk reflected by the swap
or security-based swap.
46 The Exchange Act’s definition of ‘‘dealer’’ does
not include a de minimis exemption. Thus, an
entity that engages in dealing activity involving
securities (other than security-based swaps with
eligible contract participants) would be required to
register as a ‘‘dealer’’ under the Exchange Act, and
comply with the Exchange Act’s requirements
applicable to dealers, absent some other exception
or exemption from registration.
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whether the proposed threshold for
transactions with ‘‘special entities’’
would provide a disincentive to dealers
entering into transactions with such
entities.
Commenters further are requested to
address whether the factors may
appropriately account for the size of the
swap or security-based swap activities
compared to the size of the entity; how
an entity’s swaps or security-based
swaps with affiliated counterparties
should be treated for purposes of the
test; and whether the exemption’s
factors should vary depending on the
type of swap or security-based swap at
issue.
In addition, commenters are requested
to address the significance of the fact
that the statutory de minimis exemption
specifically references transactions with
or on behalf of a customer. Does that
mean the exemption was intended to
specifically address dealing activity as
an accommodation to an entity’s
customers? If so, should the exemption
be conditioned on the presence of an
existing relationship between the entity
and the counterparty that does not
entail swap or security-based swap
dealing activity, and if so, which types
of relationships should be treated as
creating a ‘‘customer’’ relationship?
Commenters also are requested to
address whether the de minimis
exemption should excuse an entity from
having to comply with certain
regulatory requirements imposed on
swap dealers or security-based swap
dealers, while also mandating
compliance with other dealer
requirements. In addition, commenters
are requested to address whether, in lieu
of the self-executing approach proposed
here, the Commissions instead should
require that entities which seek relief
under this de minimis exemption must
submit exemptive requests to the
relevant agency for the agency’s
consideration and action. Commenters
further are requested to address whether
the proposed notional threshold for the
de minimis exception should be subject
to a formula that permits automatic
periodic adjustments to the threshold,
such as to reflect changes in market size
or in the size of typical contracts.
C. Statutory Exclusion for Swaps in
Connection With Originating a Loan
The ‘‘swap dealer’’ definition excludes
an insured depository institution (‘‘IDI’’)
‘‘to the extent it offers to enter into a
swap with a customer in connection
with originating a loan with that
customer.’’ 47 This exclusion does not
47 See
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80181
appear in the definition of ‘‘securitybased swap dealer.’’
1. Comments Regarding the Exclusion
for Swaps in Connection With Loans
Three IDIs commented on this aspect
of the definition, stating that the
exclusion should encompass any swap
entered into contemporaneously with a
loan that is related to any of the
borrower’s activities that affect the
ability to repay the loan and can be
hedged. Thus, in their view, the
exclusion should cover exchange rate
and physical commodity swaps in
addition to interest rate swaps. The IDIs
also said the exclusion should apply to
amendments, restructurings and
workouts of loans, and to lenders that
act through a syndicate.
Another commenter expressed similar
views, and also asked for clarification
whether the exclusion applies to all
aspects of the definition, or if it applies
only to whether a person is commonly
known in the trade as a swap dealer.
The CFTC preliminarily believes the
exclusion applies to all aspects of the
swap dealer definition.
2. Proposed Rule Regarding the
Exclusion for Swaps in Connection
With Loans
The CFTC preliminarily interprets the
word ‘‘offer’’ in this exclusion to include
scenarios where the IDI requires the
customer to enter into a swap, or the
customer asks the IDI to enter into a
swap, specifically in connection with a
loan made by that IDI. Also, the
proposed rule provides that, in order to
prevent evasion, the statutory exclusion
does not apply where (i) The purpose of
the swap is not linked to the financial
terms of the loan; (ii) the IDI enters into
a ‘‘sham’’ loan; or (iii) the purported
‘‘loan’’ is actually a synthetic loan such
as a loan credit default swap or loan
total return swap.
The proposed rule would apply the
statutory exclusion only to swaps that
are connected to the financial terms of
the loan, such as, for example, its
duration, interest rate, currency or
principal amount. Although
commenters urged that this exclusion be
extended to other aspects of the lending
relationship, we preliminarily believe
that it would not be appropriate that
this exclusion from the swap dealer
definition encompass swaps that are
connected to the borrower’s other
business activities, even if the loan
agreement requires that the borrower
enter into such swaps or otherwise
refers to them. We preliminarily believe
that a broader reading of the exclusion
could encompass all swap activity
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between an IDI and its borrowers, which
we do not think is intended.
The origination of commercial loans
is a complex process, and the CFTC
preliminarily believes that this
exclusion should be available to all IDIs
that are a source of funds to a borrower.
For example, all IDIs that are part of a
loan syndicate providing a loan to a
borrower could claim this exclusion
with respect to swaps entered into with
the borrower that are connected to the
financial terms of the loan. Similarly,
the proposed exclusion could be
claimed with respect to such swaps
entered into by any IDI that participates
in or obtains a participation in such
loan by means of a transfer or
otherwise.48 Also, an IDI that is a source
of funds for the refinancing of a loan
(whether directly or through a
syndicate, participation or otherwise)
could claim the exclusion if it enters
into a swap with the refinancing
borrower.
We emphasize that this proposed
exclusion, by its statutory terms, is
available only to IDIs. If an IDI were to
transfer its participation in a loan to a
non-IDI, then the non-IDI would not be
able to claim this exclusion, regardless
of the terms of the loan or the manner
of the transfer. Similarly, a non-IDI that
is part of a loan syndicate with IDIs
would not be able to claim the
exclusion.
In sum, the proposed exclusion may
be claimed by a person that meets the
following three conditions: (i) The
person is an IDI; (ii) the person is the
source of funds to a borrower in
connection with a loan (either directly
or through syndication, participation,
refinancing or otherwise); and (iii) the
person enters into a swap with the
borrower that is connected to the
financial terms of the loan (so long as
the loan is not a sham or a synthetic
loan).
The CFTC requests comment on the
proposed rule relating to the statutory
exclusion for swaps in connection with
originating a loan, and in particular on
whether this statutory exclusion should
be extended beyond swaps that are
connected to the financial terms of the
loan, and if so, why. The CFTC also
requests comment on whether this
exclusion should apply only to swaps
that are entered into contemporaneously
with the IDI’s origination of the loan
(and if so, how ‘‘contemporaneously’’
should be defined for this purpose), or
48 The
CFTC preliminarily believes that the
proposed exclusion could be claimed by any IDI
that participates in a loan through any means that
involves a payment to a lender to take the place of
that lender, including an ‘‘English style’’
participation.
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whether this exclusion should also
apply to swaps entered into during part
or all of the duration of the loan.
D. Designation as a Dealer for Certain
Types, Classes, or Categories of Swaps,
Security-Based Swaps, or Activities
The statutory definitions include a
provision stating that a person may be
designated as a dealer for one or more
types, classes or categories of swaps,
security-based swaps, or activities
without being considered a swap dealer
or security-based swap dealer for other
types, classes or categories of swaps,
security-based swaps, or activities. This
provision is permissive and does not
require the Commissions to designate
persons as dealers for only a limited set
of types, classes or categories of swaps,
security-based swaps, or activities.
1. Comments Regarding Limited
Designation as a Swap Dealer or
Security-Based Swap Dealer
One commenter stated that the
Commissions should allow a person to
register as a swap dealer or securitybased swap dealer for only a limited set
of types, classes or categories of swaps
or security-based swaps. Another
commenter expressed the view that a
person designated as a swap dealer or
security-based swap dealer should be
designated as such for all types of swaps
or security-based swaps, respectively.
2. Proposed Rule Regarding Limited
Designation as a Swap Dealer or
Security-Based Swap Dealer
In general, the Commissions propose
that a person that satisfies the definition
of swap dealer or security-based swap
dealer would be a dealer for all types,
classes or categories of swaps or
security-based swaps, or activities
involving swaps or security-based
swaps, in which the person engages.49
Thus, the person would be subject to all
regulatory requirements applicable to
dealers for all swaps or security-based
swaps into which it enters. We propose
this approach because it may be difficult
for swap dealers and security-based
swap dealers to separate their dealing
activities from their other activities
involving swaps or security-based
swaps.50
The proposed rule also states,
however, that the Commissions may
provide for a person to be designated as
a swap dealer or security-based swap
49 See proposed CEA rule 1.3(ppp)(3); proposed
Exchange Act rule 3a71–1(c).
50 For example, in order to efficiently impose the
dealer requirements on only the person’s dealing
activities, it may be necessary for the person to have
separate books and records and a separate
compliance regime for its dealing activities.
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dealer for only specified categories of
swaps, security-based swaps, or
activities, without being classified as a
dealer for all categories.51 This proposed
rule would afford persons an
opportunity to seek, on an appropriate
showing, a limited designation based on
facts and circumstances applicable to
their particular activities. The
Commissions anticipate that a swap
dealer could seek a limited designation
at the same time as, or at a later time
subsequent to, the person’s initial
registration as a swap dealer.
The CFTC understands that there may
potentially be non-financial entities,
such as physical commodity firms, that
conduct swap dealing activity through a
division of the entity, and not a
separately-incorporated subsidiary. In
these instances, the entity’s swap
dealing activity would not be a core
component of the entity’s overall
business. If this type of entity registered
as a swap dealer, the CFTC anticipates
that certain swap dealer requirements
would apply to the swap dealing
activities of the division, but not
necessarily to the swap activities of
other parts of the entity.
The Commissions request comment
on the proposed rules regarding limited
designation as a swap dealer or securitybased swap dealer. Commenters
particularly are requested to address the
circumstances in which such limited
purpose designations would be
appropriate, the factors that the
Commissions should consider when
addressing such requests, and the type
of information requestors should
provide in support of their request. For
example, would it be appropriate to
grant such limited purpose designations
only to entities that do not otherwise
fall within the definition of a financial
entity, and whose dealing activity is
below a defined threshold of the entity’s
overall activity? At what level should
the Commissions set such a threshold?
Which of the requirements applicable to
dealers should or should not apply to
such entity’s non-dealing activities in
swaps and security-based swaps?
In addition, commenters are requested
to address whether the Commissions
should provide for limited purpose
designations of swap dealers or securitybased swap dealers through some other
mechanism as an alternative to, or in
51 CEA section 1a(49)(B); Exchange Act section
3(a)(71)(B). As discussed below, the Commissions
preliminarily believe that there are four major
categories of swaps and two major categories of
security-based swaps. See part IV.A, infra. The
designation as a swap dealer or security-based swap
dealer may, for example, be limited in terms of
these categories or in terms of particular activities
of the person.
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addition to, case-by-case evaluations of
individual applications. If so, what
criteria and procedures would be
appropriate for making limited purpose
designations through this type of
approach? Also, should the limited
purpose designation apply on a
provisional basis starting at the time
that the entity makes an application for
a limited purpose designation?
Finally, commenters also are asked to
address whether such limited purpose
designations should be conditioned in
any way, such as by the provision of
information of the type that would be
required with respect to an entity’s
swaps or security-based swaps
involving the particular category or
activity for which they are not
designated as a dealer.
emcdonald on DSK2BSOYB1PROD with PROPOSALS2
E. Certain Interpretative Issues
1. Affiliate Issues
We preliminarily believe that the
word ‘‘person’’ in the swap dealer and
security-based swap dealer definitions
should be interpreted to mean that the
designation applies with respect to a
particular legal person. That is, for
example, we would not view a trading
desk or other discrete business unit that
is not a separately organized legal
person as a swap dealer; rather, the legal
person of which it is a part would be the
swap dealer. Also, an affiliated group of
legal persons under common control
could include more than one dealer.
Within such a group, any legal person
that engages in swap or security-based
swap dealing activities would be a swap
dealer or security-based swap dealer, as
applicable.
In determining whether a particular
legal person is a swap dealer or securitybased swap dealer, we preliminarily
believe it would be appropriate for the
person to consider the economic reality
of any swaps and security-based swaps
it enters into with affiliates (i.e., legal
persons under common control with the
person at issue), including whether
those swaps and security-based swaps
simply represent an allocation of risk
within a corporate group.52 Swaps and
security-based swaps between persons
under common control may not involve
the interaction with unaffiliated persons
that we believe is a hallmark of the
elements of the definitions that refer to
holding oneself out as a dealer or being
52 Such swaps and security-based swaps should
be considered in this way only for purposes of
determining whether a particular person is a swap
dealer or security-based swap dealer and does not
necessarily apply in the context of the Exchange
Act’s general definition of ‘‘dealer.’’ The swaps and
security-based swaps, moreover, would continue to
be subject to all laws and requirements applicable
to such swaps and security-based swaps.
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commonly known as a dealer. To the
extent, however, that an entity seeks to
use transactions between persons under
common control to avoid one of the
dealer definitions, the Commissions
have the authority to prohibit practices
designed to evade the requirements
applicable to swap dealers and securitybased swap dealers.53
The Commissions invite comment as
to how the swap dealer and securitybased swap dealer definitions should be
applied to members of an affiliated
group. Commenters particularly are
invited to address how the Commissions
should interpret common control for
these purposes, and whether this
interpretation should be limited to
wholly-owned affiliates.
2. Application to Particular Swap
Markets
The swap markets are diverse and
encompass a variety of situations in
which parties enter into swaps with
each other. We believe it is helpful to
the understanding of the rule to discuss
some of these situations, particularly
those that have been raised by
commenters, here. The situations
discussed below include persons who
enter into swaps as aggregators, as part
of their participation in physical
markets, or in connection with the
generation and transmission of
electricity. We invite comment as to
what aspects of the parties’ conduct in
these situations should, or should not,
be considered swap dealing activities,
and whether the parties involved in
these situations are swap dealers.
a. Aggregators
Commenters explained that some
persons enter into swaps with other
parties in order to aggregate the swap
positions of the other parties into a size
that would be more amenable to
entering into swaps in the larger swap
market, or otherwise to make entering
into such swaps more efficient. For
example, certain cooperatives enter into
swaps with smaller cooperatives,
smaller businesses or their members in
order to establish a position in a
commodity that is large enough to be
traded on a swap or futures market.
Similarly, one smaller financial
institution explained that it enters into
swaps with counterparties whose swap
positions would not be large enough to
be of interest to larger financial
53 See Dodd-Frank Act sections 721(b)(2),
761(b)(3). For example, it would not be permissible
for an entity that provides liquidity on one side of
the market to use affiliated entities to provide
liquidity on the other side in an attempt to avoid
having to register as a swap or security-based swap
dealer.
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80183
institutions. This institution stated that
it enters into offsetting swaps with
larger financial institutions so that it is
in a neutral position between the
counterparties and the larger financial
institutions.
The result of these arrangements is
that such persons engage in activities
that are similar in many respects to
those of a swap dealer as set out in the
definition—the person enters into swaps
to accommodate demand from other
parties, it enters into swaps with a
relatively large number of non-dealers,
and it holds itself out as willing to enter
into swaps. It may be that the swap
dealing activities of these aggregators
would not exceed the de minimis
threshold, and therefore they would not
be swap dealers. The CFTC, in
particular, requests comment as to how
the de minimis threshold would apply
to such persons. If their activity would
exceed the de minimis threshold set
forth in the proposed rule, the
Commissions request comment on the
application of the swap dealer
definition to their activity.
b. Physical Market Participants
The markets in physical commodities
such as oil, natural gas, chemicals and
metals are complex and varied. They
involve a large number of market
participants that, over time, have
developed highly customized
transactions and market practices that
facilitate efficiencies in their market in
unique ways. Some of these transactions
would be encompassed by the statutory
definition of ‘‘swap,’’ and some
participants in these markets engage in
swap dealing activities that are above
the proposed de minimis threshold. The
Commissions invite comment as to any
different or additional factors that
should be considered in applying the
swap dealer definition to participants in
these markets.
c. Electricity Generation and
Transmission
The use of swaps in the generation
and transmission of electricity is highly
complex because electricity cannot be
stored and therefore is generated,
transmitted and used on a continuous,
real-time basis. Also, the number and
variety of participants in the electricity
market is very large and some electricity
services are provided as a public good
rather than for profit. Nevertheless,
some participants engage in swap
dealing activities as described above
that are above the de minimis threshold
set forth in the proposed rule. The
Commissions invite comment as to any
different or additional factors that
should be considered in applying the
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swap dealer definition to participants in
the generation and transmission of
electricity. Specifically, the
Commissions invite comment on
whether there are special
considerations, including without
limitation special considerations arising
from section 201(f) of the Federal Power
Act, related to non-profit, public power
systems such as rural electric
cooperatives and entities operating as
political subdivisions of a State, and the
applicability of the exemptive authority
in section 722(f) of the Dodd-Frank Act
to address those considerations.
III. Amendments to Definition of
Eligible Contract Participant
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A. Overview
The Commodity Futures
Modernization Act of 2000 (‘‘CFMA’’) 54
generally excluded or exempted
transactions between eligible contract
participants (‘‘ECPs’’) from most
provisions of the CEA.55 Section
723(a)(1)(A) of the Dodd-Frank Act
repeals those exclusions and
exemptions. ECP status remains
important, however, because Section
723(a)(2) of the Dodd-Frank Act renders
it unlawful for a non-ECP to enter into
a swap other than on, or subject to the
rules of, a designated contract market
(‘‘DCM’’).56 Section 763(e) of the DoddFrank Act also renders it unlawful for a
non-ECP to enter into a security-based
swap unless such transaction is effected
on a national securities exchange
registered pursuant to Section 6(b) of
the Exchange Act.57 In addition, Section
768(b) of the Dodd-Frank Act makes it
54 Public Law 106–554, 114 Stat. 2763 (Dec. 21,
2000).
55 See CEA sections 2(d) (Excluded Derivative
Transactions), 2(e) (Excluded Electronic Trading
Facilities), 2(g) (Excluded Swap Transactions) and
2(h) (Legal Certainty for Certain Transactions in
Exempt Commodities) (7 U.S.C. 2(d), (e), (g), (h)).
The CFMA also excluded swap agreements from the
definitions of ‘‘security’’ in Section 3(a)(10) of the
Exchange Act and Section 2(a)(1) of the Securities
Act. See Section 3A of the Exchange Act, 15 U.S.C.
78c–1, and Section 2A of the Securities Act, 15
U.S.C. 77b–1 (both of which have been modified by
the Dodd-Frank Act). The CFMA, however,
provided that the SEC had antifraud authority over
security-based swap agreements.
56 Section 723(a)(2) of the Dodd-Frank Act adds
new subsection (e) to CEA section 2 (7 U.S.C. 2(e)).
New CEA section 2(e) provides that ‘‘[i]t shall be
unlawful for any person, other than an eligible
contract participant, to enter into a swap unless the
swap is entered into on, or subject to the rules of,
a board of trade designated as a contract market
under section 5.’’
57 Section 763(e) of the Dodd-Frank Act adds
paragraph (l) to Exchange Act section 6. New
Exchange section 6(l) provides that ‘‘[i]t shall be
unlawful for any person to effect a transaction in
a security-based swap with or for a person that is
not an eligible contract participant, unless such
transaction is effected on a national securities
exchange registered pursuant to subsection (b).’’
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unlawful for a non-ECP to enter into a
security-based swap unless a
registration statement is in effect. While
this means that non-ECPs cannot enter
into swaps on SEFs or on a bilateral, offexchange basis, it also opens swaps to
non-ECPs, so long as the swaps are
entered into on, or subject to the rules
of, a DCM. Similarly, while non-ECPs
cannot enter into security-based swaps
unless the transaction is effected on a
national securities exchange and the
security-based swap has an effective
registration statement, it also opens
security-based swaps to non-ECPs.
Congress also amended 58 the ECP
definition in Section 721(a)(9) of the
Dodd-Frank Act by: (1) Raising a
threshold that governmental entities
may use to qualify as ECPs, in certain
situations, from $25 million in
discretionary investments to $50 million
in such investments; and (2) replacing
the ‘‘total asset’’ standard for individuals
to qualify as ECPs with a discretionary
investment standard.59
B. Commenters’ Views
The ECP definition elicited comment
from nine commenters. The comments
ranged from requests not to increase the
monetary thresholds for governmental
employee benefit plans in certain
instances to suggestions to dramatically
raise them across the board, and from
requests not to change the definition in
a way that would limit the commenter’s
access to swaps to specific proposals to
address such otherwise limited access.
In the Dodd-Frank Act, Congress
addressed aspects of the ECP definition
that it found to be of particular concern
regarding governmental entities and
individuals. Otherwise, though, persons
who qualified for exclusions or
exemptions to enter into bilateral, offexchange swaps prior to the Dodd-Frank
Act will still qualify to do so with
respect to non-standardized swaps
under the Dodd-Frank Act, with the
exceptions discussed below. We have
not identified any legislative history
58 The changes to the ECP definition made by the
Dodd-Frank Act originated in the Administration’s
‘‘White Paper’’ on financial regulatory reform. See
Financial Regulatory Reform, A New Foundation:
Rebuilding Financial Supervision and Regulation,
available at https://www.financialstability.gov/docs/
regs/FinalReprot_web.pdf, at 48–49 (June 17, 2009)
(‘‘Current law seeks to protect unsophisticated
parties from entering into inappropriate derivatives
transactions by limiting the types of counterparties
that could participate in those markets. But the
limits are not sufficiently stringent.’’).
59 The monetary component of ECP status for
individuals remains the same under the amended
ECP definition: More than $10 million (but now in
discretionary investments, not in total assets), or $5
million if the transactions for which ECP status is
necessary are for risk management of an asset or
liability the individual owns or incurs, or is
reasonably likely to own or incur.
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suggesting that Congress intended the
Commissions to undertake a wholesale
revision of the ECP definition.
Accordingly, the Commissions are
limiting the further definition of the
term ECP to the discrete issues
discussed below.
C. New ECP categories
The CEA definition of ECP generally
is comprised of regulated persons; 60
entities defined as ECPs based on a total
asset test (e.g., a corporation,
partnership, proprietorship,
organization, trust, or other entity with
total assets exceeding $10 million) 61 or
an alternative monetary test coupled
with a non-monetary component (e.g.,
an entity with a net worth in excess of
$1 million and engaging in businessrelated hedging; 62 or certain employee
benefit plans, the investment decisions
of which are made by one of four
enumerated types of regulated
entities 63); and certain governmental
entities and individuals that meet
defined thresholds.64
Persons in the new major swap
participant, major security-based swap
participant, swap dealer and securitybased swap dealer categories are likely
to be among the most active and largest
users of swaps and security-based
swaps. Accordingly, the Commissions
propose to further define the term ECP
to include these new categories, which
will permit such persons to enter into
swaps and security-based swaps on
SEFs and on a bilateral basis (where
otherwise permitted under the DoddFrank Act and regulations thereunder).
We seek comment on this proposed
expansion of the ECP definition.
D. Relationship Between Retail Foreign
Currency and ECP Status in the Context
of a Commodity Pool
Prior to the Dodd-Frank Act, clause
(A)(iv) of the ECP definition provided
that a commodity pool was an ECP if the
pool and its operator met certain
requirements (i.e., the commodity pool
has $5 million in total assets and is
operated by a commodity pool operator
regulated under the CEA or subject to
60 CEA section 1a(18)(A)(i), (ii), (iii), (iv), (viii),
(ix), (x) (7 U.S.C. 1a(18)(A)(i), (ii), (iii), (iv), (viii),
(ix), (x)), as redesignated by Section 721(a)(9) of the
Dodd-Frank Act.
61 CEA section 1a(18)(A)(v)(I) (7 U.S.C.
1a(18)(A)(v)(I)), as redesignated by Section 721(a)(9)
of the Dodd-Frank Act.
62 CEA section 1a(18)(A)(v)(III) (7 U.S.C.
1a(18)(A)(v)(III)), as redesignated by Section
721(a)(9) of the Dodd-Frank Act.
63 CEA section 1a(18)(A)(vi) (7 U.S.C.
1a(18)(A)(vi)), as redesignated by Section 721(a)(9)
of the Dodd-Frank Act.
64 CEA sections 1a(18)(A)(vii) and (xi) (7 U.S.C.
1a(18)(A)(vii) and (xi), as redesignated by Section
721(a)(9) of the Dodd-Frank Act.
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emcdonald on DSK2BSOYB1PROD with PROPOSALS2
foreign regulation), regardless of
whether each pool participant was itself
an ECP.65 Section 741(b)(10) of the
Dodd-Frank Act amended clause (A)(iv)
of the ECP definition to provide that a
commodity pool engaging in retail
foreign currency transactions of the type
described in CEA sections 2(c)(2)(B) or
2(c)(2)(C) ; 66 (‘‘retail forex’’ and such
pools, ‘‘Retail Forex Pools’’) no longer
qualifies as an ECP for those purposes
if any participant in the pool is not
independently an ECP. The
Commissions believe that in some cases
commodity pools unable to satisfy the
conditions of clause (A)(iv) of the ECP
definition may rely on clause (A)(v) to
qualify as ECPs instead for purposes of
retail forex. Clause (A)(v) of the ECP
definition applies to business entities
irrespective of their form of organization
(i.e., corporations, partnerships,
proprietorships, organizations, trusts
and other entities), and contains a $1
million net worth test where such an
entity ‘‘enters into an agreement,
contract, or transaction in connection
with the conduct of the entity’s business
or to manage the risk associated with an
asset or liability owned or incurred or
reasonably likely to be owned or
incurred by the entity in the conduct of
the entity’s business.’’ 67
The Commissions believe that
permitting Retail Forex Pools with one
or more non-ECP participants to achieve
ECP status by relying on clause (A)(v) of
the ECP definition would frustrate the
intent of Congress in denying ECP status
to Retail Forex Pools under clause
(A)(iv). Consequently, the Commissions
propose to further define the term ECP
to preclude a Retail Forex Pool with one
or more non-ECP participants from
qualifying as an ECP by relying on
clause (A)(v) of the ECP definition if
such Retail Forex Pool is not an ECP
due to the language added to clause
(A)(iv) of the ECP definition by section
741(b)(10) of the Dodd-Frank Act (i.e.,
because the pool contains one or more
non-ECP participants). Because
commodity pools can be structured in
various ways and can have one or more
feeder funds and/or pools, many with
65 CEA section 1a(12)(A)(iv) (7 U.S.C.
1a(12)(A)(iv)).
66 7 U.S.C. 2(c)(2)(B) and (C). See generally
‘‘Regulation of Off-Exchange Retail Foreign
Exchange Transactions and Intermediaries,’’ 75 FR
55410 (Final Rule; Sept. 10, 2010) (discussing the
new CFTC retail forex regulatory regime);
‘‘Regulation of Off-Exchange Retail Foreign
Exchange Transactions and Intermediaries,’’ 75 FR
3282 (Proposed Rule; Jan. 20, 2010) (providing
historical background on the regulation of retail
forex transactions).
67 CEA section 1a(18)(A)(v) (7 U.S.C. 1a(18)(A)(v),
as redesignated by Section 721(a)(9) of the DoddFrank Act.
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their own participants, the Commissions
propose to preclude a Retail Forex Pool
from being an ECP pursuant to clause
(A)(iv) of the ECP definition if there is
a non-ECP participant at any investment
level (e.g., a participant in the pool itself
(a direct participant), an investor or
participant in a fund or pool that invests
in the pool in question (an indirect
participant), an investor or participant
in a fund or pool that invests in that
investor fund or pool (also an indirect
participant), etc.).
Similarly, the Commissions believe
that some commodity pools unable to
satisfy the total asset or regulated status
components of clause (A)(iv) of the ECP
definition may rely on clause (A)(v) to
qualify as ECPs instead. The
Commissions are of the view that a
commodity pool that cannot satisfy the
monetary and regulatory status
conditions prescribed in clause (A)(iv)
should not qualify as an ECP in reliance
on clause (A)(v) of the ECP definition.
Therefore, the Commissions propose to
further define the term ECP to prevent
such an entity from qualifying as an ECP
pursuant to clause (A)(v) of the ECP
definition.
E. Request for comment
The Commissions request comment
on all aspects of the proposed
amendments to the definition of
‘‘eligible contract participant.’’ Are the
proposed interpretations with respect to
Retail Forex Pools and other commodity
pools appropriate? Do entities described
in the various enumerated ECP
categories (other than commodity pools)
rely on clause (A)(v) to qualify as ECPs?
If so, should an entity that would be
described in one of the clauses of
paragraph (A) of the ECP definition, but
cannot satisfy the conditions prescribed
in that clause, be prohibited from
relying on clause (A)(v) of the ECP
definition?
In addition, should the Commissions
further narrow any or all of the ECP
categories? Why or why not? If so, what
additional conditions would be
appropriate? Should the Commissions
define the term ‘‘discretionary basis,’’ as
requested by one commenter, either
solely for purposes of clause (A)(vii) or
clause (A)(xi), or for both clauses?
Alternatively, should the Commissions
add any additional categories of ECPs,
such as the following categories
suggested by commenters: Commercial
real estate developers; energy or
agricultural cooperatives or their
members; or firms using swaps as
hedges pursuant to the terms of the
CFTC’s Swap Policy Statement? If so,
which ones and why?
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80185
IV. Definitions of ‘‘Major Swap
Participant’’ and ‘‘Major Security-Based
Swap Participant’’
The definitions of ‘‘major swap
participant’’ and ‘‘major security-based
swap participant’’ (also jointly referred
to as the ‘‘major participant’’ definitions)
respectively focus on the market
impacts and risks associated with an
entity’s swap and security-based swap
positions. In this respect, the major
participant definitions differ from the
definitions of ‘‘swap dealer’’ and
‘‘security-based swap dealer,’’ which
focus on an entity’s activities and
account for the amount or significance
of those activities only in the context of
the de minimis exception.
Despite those differences in focus,
persons that meet the major participant
definitions in large part must follow the
same statutory requirements that apply
to swap dealers and security-based swap
dealers.68 In this way, the statute
applies comprehensive regulation to
entities whose swap or security-based
swap activities do not cause them to be
dealers, but nonetheless could pose a
high degree of risk to the U.S. financial
system generally.69
The major participant definitions are
similar in their key provisions, although
one exception, as discussed below, is
available only in connection with the
‘‘major swap participant’’ definition.
Both major participant definitions
encompass persons that satisfy any of
three alternative tests: 70
• The first test encompasses persons
that maintain a ‘‘substantial position’’ in
any of the ‘‘major’’ categories of swaps or
security-based swaps, as those
categories are determined by the CFTC
68 In particular, under CEA section 4s and
Exchange Act section 15F, dealers and major
participants in swaps or security-based swaps
generally are subject to the same types of margin,
capital, business conduct and certain other
requirements, unless an exclusion applies. See CEA
section 4s(h)(4), (5); Exchange Act section 15F(h)(4),
(5).
69 As discussed below, the tests of the major
participant definitions use terms—particularly
‘‘systemically important,’’ ‘‘significantly impact the
financial system’’ or ‘‘create substantial counterparty
exposure’’—that denote a focus on entities that pose
a high degree of risk through their swap and
security-based swap activities. In addition, the link
between the major participant definition and risk
was highlighted during the Congressional debate on
the statute. See 156 Cong. Rec. S5907 (daily ed. July
15, 2010) (dialogue between Senators Hagen and
Lincoln, discussing how the goal of the major
participant definition was to ‘‘focus on risk factors
that contributed to the recent financial crisis, such
as excessive leverage, under-collateralization of
swap positions, and a lack of information about the
aggregate size of positions’’).
70 Also, neither major participant definition
encompasses an entity that meets the respective
swap dealer or security-based swap dealer
definition. See CEA section 1a(33)(A); Exchange Act
section 3(a)(67)(A)(i).
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or SEC as applicable. This test excludes
both ‘‘positions held for hedging or
mitigating commercial risk,’’ and
positions maintained by or contracts
held by any employee benefit plan (as
defined in paragraphs (3) and (32) of
section 3 of ERISA (29 U.S.C. 1002)) for
the primary purpose of hedging or
mitigating risks directly associated with
the operation of the plan.71
• The second test encompasses
persons whose outstanding swaps or
security-based swaps create ‘‘substantial
counterparty exposure that could have
serious adverse effects on the financial
stability of the United States banking
system or financial markets.’’ 72
• The third test encompasses any
‘‘financial entity’’ that is ‘‘highly
leveraged relative to the amount of
capital such entity holds and that is not
subject to capital requirements
established by an appropriate Federal
banking agency’’ and that maintains a
‘‘substantial position’’ in swaps or
security-based swaps for any of the
‘‘major’’ categories of swaps or securitybased swaps.73
The statute directs the CFTC or the
SEC to define ‘‘substantial position’’ for
the respective definition at the
threshold that it determines to be
‘‘prudent for the effective monitoring,
management, and oversight of entities
that are systemically important or can
significantly impact the financial system
of the United States.’’ The definitions
further provide that when defining
‘‘substantial position,’’ the CFTC or SEC
‘‘shall consider the person’s relative
position in uncleared as opposed to
cleared [swaps or security-based swaps]
and may take into consideration the
value and quality of collateral held
against counterparty exposures.’’ 74
Both major participant definitions
provide that a person may be designated
as a major participant for one or more
categories of swaps or security-based
swaps without being classified as a
major participant for all classes of swaps
or security-based swaps.75
Finally, the definition of ‘‘major swap
participant’’—but not the definition of
‘‘major security-based swap
participant’’—includes an exception for
any ‘‘entity whose primary business is
providing financing, and uses
derivatives for the purpose of hedging
71 See CEA section 1a(33)(A)(i); Exchange Act
section 3(a)(67)(A)(ii)(I).
72 See CEA section 1a(33)(A)(ii); Exchange Act
section 3(a)(67)(A)(ii)(II).
73 See CEA section 1a(33)(A)(iii); Exchange Act
section 3(a)(67)(A)(ii)(III).
74 See CEA Section 1a(33)(B); Exchange Act
section 3(a)(67)(B).
75 See CEA section 1a(33)(C); Exchange Act
section 3(a)(67)(C).
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underlying commercial risks related to
interest rate and foreign currency
exposures, 90 percent or more of which
arise from financing that facilitates the
purchase or lease of products, 90
percent or more of which are
manufactured by the parent company or
another subsidiary of the parent
company.’’ 76
Although the two major participant
definitions are similar, they address
instruments that reflect different types
of risks and that can be used by endusers and other market participants for
different purposes. Interpretation of the
definitions must appropriately account
for those differences.
The Commissions are proposing rules
to further define the ‘‘major swap
participant’’ and ‘‘major security-based
swap participant’’ definitions, by
specifically addressing: (a) The ‘‘major’’
categories of swaps or securities-based
swaps; (b) the meaning of ‘‘substantial
position’’; (c) the meaning of ‘‘hedging or
mitigating commercial risk’’; (d) the
meaning of ‘‘substantial counterparty
exposure that could have serious
adverse effects on the financial stability
of the United States banking system or
financial markets’’; and (e) the meanings
of ‘‘financial entity’’ and ‘‘highly
leveraged.’’ We also are proposing rules
to specify the use of a daily average
methodology for identifying whether a
person meets one of the major
participant definitions, provide for a
reevaluation period for certain entities
that exceed the relevant daily average by
a small amount, and provide for a
minimum length of time before a person
may no longer be deemed a major
participant.
We further propose that the CFTC or
SEC may limit an entity’s designation as
a major participant to only certain types,
classes or categories of swaps or
security-based swaps. We also address
certain additional interpretive issues
that commenters have raised. Finally,
while the Commissions also are not
proposing any exclusions from the
major participant definitions, we are
soliciting comment as to whether
certain types of entities should be
excluded from the definitions’
application.77
76 See
CEA section 1a(33)(D).
light of the significant and novel issues
raised by the major participant definitions, the
Commissions recognize the importance of
monitoring the swap and security-based swap
markets following adoption of major participant
rules. This will help us evaluate whether the rules
appropriately reflect how market participants use
these instruments, and will help us consider the
impact of market evolution and the ways in which
market participants may change their practices in
response to the rules, so we may identify potential
improvements to the rules or other actions to
77 In
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A. ‘‘Major’’ Categories of Swaps and
Securities-Based Swaps
The first and third tests of the
statutory major participant definitions
encompass entities that have a
substantial position in a ‘‘major’’
category of swaps or security-based
swaps. The Commissions are
responsible for designating these
‘‘major’’ categories.78
The Commissions propose to
designate ‘‘major’’ categories of swaps
and security-based swaps in a manner
that reflects the risk profiles of these
various instruments and the different
purposes for which end-users make use
of the various instruments. We
preliminarily believe that it is important
not to parse these ‘‘major’’ categories so
finely as to base the ‘‘substantial
position’’ thresholds on unduly narrow
risks that would reduce those
thresholds’ effectiveness as risk
measures. The ‘‘major’’ categories will
apply only for purposes of the major
participant definitions and are not
necessarily determinative with respect
to any other provision of the DoddFrank Act or the regulations adopted
thereunder.
1. Major Categories of Swaps
We propose to designate four ‘‘major’’
categories of swaps for purposes of the
‘‘major swap participant’’ definition. The
four categories are rate swaps, credit
swaps, equity swaps and other
commodity swaps.79 The first category
would encompass any swap which is
primarily based on one or more
reference rates, such as swaps of
payments determined by fixed and
floating interest rates, currency
exchange rates, inflation rates or other
monetary rates. The second category
would encompass any swap that is
primarily based on instruments of
indebtedness, including but not limited
to any swap primarily based on one or
more indices related to debt
instruments, or any swap that is an
index credit default swap or total return
enhance enforcement of major participant
regulation.
78 See CEA section 1a(33)(A)(i), (iii); Exchange
Act section 3(a)(67)(a)(2)(i), (iii). One commenter
suggested that we determine these categories by
reference to the types of instruments specifically
listed in the statutory definition of ‘‘swap.’’ See
Northwestern Mutual letter (suggesting that, for
regulatory consistency, each type of swap listed in
the definition and options on each of those swaps
should be considered to be an individual major
category). The statutory definition of ‘‘swap’’ lists 22
different types of swaps.
79 See proposed CEA rule 1.3(rrr). For the
avoidance of doubt, the term ‘‘swap’’ as it is used
in the definitions of the major swap categories in
rule 1.3(rrr) has the meaning set forth in section
1a(47) of the CEA and the rules promulgated
thereunder.
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swap on one or more indices of debt
instruments. The third category would
encompass any swap that is primarily
based on equity securities, such as any
swap primarily based on one or more
indices of equity securities, or any total
return swap on one or more equity
indices. The fourth category would
encompass any swap not included in
any of the first three categories. This
fourth category would generally
include, for example and not by way of
limitation, any swap for which the
primary underlying item is a physical
commodity or the price or any other
aspect of a physical commodity.80
The four major categories of swaps are
intended to cover all swaps. Each swap
would be in the category that most
closely describes the primary item
underlying the swap. If a swap is based
on more than one underlying item of
different types, the swap would be in
the category that describes the
underlying item that is likely to have
the most significant effect on the
economic return of the swap. The
proposed categories are consistent with
market statistics that distinguish
between these general types of swaps, as
well as market infrastructures that have
been established for these types of
swaps.
We request comment on this proposed
method of allocating swaps among
‘‘major’’ categories. Commenters
particularly are asked to address
whether there are any types of swaps
that would have unclear status under
this proposal, as well as whether all
swaps instead should be placed into a
single ‘‘major’’ category for purposes of
the ‘‘major swap participant’’ definition,
or whether there should be additional
‘‘major’’ categories of swaps.
Commenters are also asked to address
whether the rate swap category should
be divided into two separate
categories—one for swaps based on rates
of exchange between different
currencies, and another for swaps based
on interest rates, inflation rates and
other monetary rates—and if so, in
which category cross-currency rate
swaps should be included. Also, should
the major swap category for other
commodity swaps be divided into two
separate categories—one for swaps
based on agricultural commodities, and
another for swaps based on all other
80 The term ‘‘commodity’’ as defined in Section
1a(9) of the CEA, 7 U.S.C. 1a(9), and CFTC Rule
§ 1.3(e), 17 CFR 1.3(e) includes interest rates,
foreign exchange rates, and equity and debt indices
as well as physical commodities. Thus, the fourth
category of swaps is entitled ‘‘other commodity
swaps’’ because it includes any swap not included
in the other three categories.
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commodities not included in the other
categories?
additional ‘‘major’’ categories of
security-based swaps.
2. Major Categories of Security-Based
Swaps
We propose to designate two ‘‘major’’
categories of security-based swaps for
purposes of the ‘‘major security-based
swap definition.’’ The first category
would encompass any security-based
swap that is based, in whole or in part,
on one or more instruments of
indebtedness (including loans), or a
credit event relating to one or more
issuers or securities, including but not
limited to any security-based swap that
is a credit default swap, total return
swap on one or more debt instruments,
debt swap, debt index swap, or credit
spread.81 The second category would
encompass any other security-based
swaps not included in the first category;
this category would include, for
example, equity swaps.82
The proposed categories reflect the
fact that entities that transact in
security-based swaps for nonspeculative purposes would be expected
to use the respective instruments for
different purposes. For example, swaps
based on instruments of indebtedness,
such as credit derivatives, can be used
to hedge the risks associated with the
default of a counterparty or debt
obligation. Equity swaps can be used,
among other ways, to hedge the risks
associated with equity ownership or
gain synthetic exposure to equities.83
The proposed categories also are
consistent with market statistics that
currently distinguish between those
general types of security-based swaps,
as well as market infrastructures,
including separate trade warehouses,
that have been established for credit
default swaps and equity swaps.
We request comment on this proposed
method of allocating security-based
swaps between two ‘‘major’’ categories.
In particular, we request comment on
whether there are any types of securitybased swaps that would have unclear
status under this proposal, as well as
whether all security-based swaps
instead should be placed into a single
‘‘major’’ category for purposes of the
‘‘major security-based swap participant’’
definition, or whether there should be
80187
B. ‘‘Substantial Position’’
81 This category does not encompass a securitybased swap that is based on an instrument of
indebtedness solely in connection with the swap’s
financing leg.
82 See proposed Exchange Act rule 3a67–2.
83 At the same time, we note that the distinctions
between these proposed ‘‘major’’ categories of
‘‘security-based swaps’’ arguably are less significant
than the distinctions among the proposed major
categories of ‘‘swaps’’ (such as, for example, the
distinction between other commodity swaps and
rate swaps).
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As noted above, the Commissions are
required to define the term ‘‘substantial
position’’ as a threshold that is ‘‘prudent
for the effective monitoring,
management, and oversight of entities
that are systemically important or can
significantly impact the financial system
of the United States.’’ 84 This raises two
fundamental issues: (i) What types of
measures should be used to identify the
risks posed by an entity’s swap or
security-based swap positions; and (ii)
for each of those measures, how much
risk should be required to evidence a
‘‘substantial position’’?
1. Commenters’ Views
Commenters have expressed diverse
views as to what should constitute a
substantial position. A number of
commenters suggested the use of a test
based on the current uncollateralized
mark-to-market exposure posed by an
entity’s swap or security-based swap
positions, after taking bilateral netting
agreements into account. Two
commenters suggested specific dollar
amounts of uncollateralized exposure to
use as the substantial position
threshold.85 Several commenters
expressed the view that positions
subject to central clearing should be
entirely excluded from the analysis, or
at least should be discounted for
purposes of the analysis.86
Some commenters opposed using the
notional amount of swap or securitybased swap positions to set the
threshold, stating that the notional
amount is not indicative of the risks
associated with a position. Some
commenters similarly opposed using
measures of swap or security-based
swap volume to set the threshold,
84 See CEA section 1a(33)(B); Exchange Act
section 3(a)(67)(B).
85 See letter from Timothy W. Cameron, Esq.,
Managing Director, SIFMA Asset Management
Group, dated September 20, 2010 (‘‘SIFMA AMG
letter’’) (suggesting a standard of $2.5 billion average
exposure in any calendar quarter based on the
entity’s entire portfolio of swaps and security-based
swaps, other than foreign exchange swaps and
forwards); letter from Gus Sauter, Chief Investment
Officer, Vanguard, dated September 20, 2010
(‘‘Vanguard letter’’) (suggesting that the applicable
threshold be $500 million in uncollateralized
exposure for any single major swap category or $1
billion aggregate exposure across all major
categories).
86 See letter from Jennifer J. Kalb, Associate
General Counsel, Metropolitan Life Insurance
Company, dated September 20, 2010 (‘‘MetLife
letter’’) (suggesting that cleared trades be subject to
a lesser ‘‘charge’’ for purposes of the substantial
position calculation, or be excluded entirely).
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contending that the number of trades
does not reflect risk.87
A few commenters addressed the
possibility that the threshold could take
into account the potential future risks
associated with a position, in addition
to the risks associated with
uncollateralized current exposure.88
Some commenters suggested that the
threshold take into account the potential
riskiness of the particular type of
instrument at issue. Some commenters
maintained that the threshold should
take into account the number of
counterparties an entity has, the size of
an entity’s positions compared to the
size of the market, the size of an entity’s
swap or security-based swap positions
compared to the entity’s ability to
absorb losses of that magnitude, or the
financial strength of an entity’s
counterparties. Several commenters
stated that the threshold should be
based on an average measure over time,
so that short-term spikes in measures
such as exposure would not by
themselves cause an entity to meet the
major participant definitions. Some
commenters suggested that the
substantial position threshold should
reflect an amount of ‘‘systemic risk.’’ 89
87 But see letter from Christopher A. Klem, Ropes
& Gray, dated September 2, 2010 (test should
account for frequency of trading and frequency of
trading with non-dealers).
88 See letter from Andrew Baker, Chief Executive
Officer, Alternative Investment Management
Association, dated September 24, 2010 (‘‘AIMA
letter’’) (discussing possible methods of estimating
the maximum risk of loss related to positions); letter
from Warren Davis, Of Counsel, Sutherland Asbill
& Brennan LLP on behalf of the Federal Home Loan
Banks, dated September 20, 2010 (in addressing
‘‘substantial counterparty exposure’’ test, noting the
possibility of accounting for the potential exposure
of a portfolio).
89 See letter from Edward J. Rosen, Cleary Gottlieb
Steen & Hamilton LLP, dated September 21, 2010
(‘‘Cleary letter’’) (suggesting that the threshold
should be akin to the amount that is required for
a non-financial entity to be designated as
systemically important under Title I of the DoddFrank Act).
Section 113 of the Dodd-Frank Act provides that
the Financial Stability Oversight Council (‘‘FSOC’’)
may determine that a non-bank financial company
shall be supervised by the Federal Reserve Board,
subject to prudential standards, if the FSOC
‘‘determines that material financial distress at the
U.S. nonbank financial company, or the nature,
scope, size, scale, concentration,
interconnectedness, or mix of the activities of the
U.S. nonbank financial company, could pose a
threat to the financial stability of the United States.’’
In making that determination, the FSOC is to
consider: Leverage; off-balance sheet exposures;
transactions and relationships with other significant
non-bank financial companies and bank holding
companies; importance as a source of credit and
liquidity; extent to which assets are managed rather
than owned; the nature, scope, size, scale,
concentration, interconnectedness and mix of
activities; presence of a primary financial regulator;
assets and liabilities; and any other appropriate
risk-related factors.
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2. Proposed Substantial Position
Thresholds
The Commissions recognize that it is
important for the substantial position
thresholds to be set using objective
numerical criteria. Objective criteria
should permit regulators, market
participants and entities that may be
subject to the regulations to readily
evaluate whether swap or security-based
swap positions meet the thresholds, and
should promote the predictable
application and enforcement of the
requirements governing major
participants.
In determining the substantial
position thresholds—in light of what is
‘‘prudent for the effective monitoring,
management, and oversight’’ of entities
that are systemically important or can
significantly impact the U.S. financial
system—the Commissions are mindful
that tests based on current
uncollateralized exposure and tests
based on potential future exposure both
have respective advantages and
disadvantages. We thus are proposing
tests that would account for both types
of exposure.
A test that focuses solely on the
current uncollateralized exposure
associated with an entity’s swap and
security-based swap positions should
provide a reasonable measure of the
theoretical amount of potential risk that
an entity would pose to its
counterparties if the entity currently
were to default.90 Such a test also
should be relatively clear-cut for market
entities to implement, and would be
based on calculations that we expect
that market entities would perform as a
matter of course.
At the same time, a focus solely on
current uncollateralized exposure could
be overly narrow by failing to identify
risky entities until some time after they
begin to pose the level of risk that
should subject them to regulation as
major participants. Because exposure
can change significantly over short
periods of time, and a swap or securitybased swap position that may pose large
potential exposures nonetheless would
often have a mark-to-market exposure of
zero at inception, an entity’s positions
may already pose significant risk to
counterparties and to the market even
before its uncollateralized mark-tomarket exposure increases up to the
applicable threshold. A test that focuses
solely on current uncollateralized
90 In practice, however, this measure may
underestimate the amount of risk that an entity
poses to its counterparties, given that it may take
multiple days to liquidate a defaulting entity’s swap
or security-based swap positions, during which
time prices may move against the defaulting entity.
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exposure thus would not appear to be
sufficient to satisfy the systemic
importance standard required by the
statute.
Tests based on measures of potential
future exposure—which would address
an estimate of how much the value of
a swap or security-based swap might
change against an entity over the
remaining life of the contract—could
address the gap left by a current
uncollateralized exposure test. Potential
future exposure tests, however, would
reflect only an estimate of that type of
risk, and would only be as effective as
the factors used by the test.
While we have considered several
other types of tests that could be used
to determine the substantial position
threshold, we preliminarily do not
believe that the advantages of those tests
justify their disadvantages. For example,
while a threshold based on the number
of an entity’s counterparties could help
identify highly interconnected entities
(a factor that some have argued is
important for identifying an entity’s
systemic risk), it also has been argued
that a large number of counterparties
could mean that the losses associated
with that entity’s default would be
divided and absorbed by many
counterparties without broader market
effects.91 While a threshold that is based
on an entity’s financial strength would
help account for the possibility of an
entity’s default as well as the effects of
such a default, it would not address
swap-related risks to the market that are
not directly linked to the entity’s
default. In other words, an entity that
has large out-of-the-money swap or
security-based swap positions and faces
a margin call may cause significant
price movements in the swaps or
security-based swaps and in the related
reference entities or assets if the entity
chooses to unwind its positions, even if
the entity itself does not appear to
present a large threat of default. These
movements may be exacerbated if other
entities have similar positions.
Moreover, although substantial
position thresholds based on the
financial strength of an entity’s
counterparties would help measure the
potential that an entity’s default would
have a broader impact, such thresholds
could result in disparate results between
two entities with identical positions,
91 See AIMA letter (‘‘An entity that has only a
small number of counterparties may only affect a
small number of entities directly, should it fail, but
the impact could be significant if the position is
large and the counterparty is a systemically
important entity. A diversified exposure to multiple
entities could affect more entities but is likely to be
smaller and thus shares the losses in the industry
and having less systemic impact.’’).
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and also could encourage concentration
of exposure or potential future exposure
within a few counterparties. While tests
that are based on the volume of an
entity’s swaps or security-based swaps
may be helpful in identifying significant
swap or security-based swap activity,
such tests would not directly be
germane to the current or potential
future exposure posed by an entity’s
swap and security-based swap
positions. Finally, while we have
considered the feasibility of tests that
take specific contract features into
account (e.g., triggers that require the
payment of mark-to-market margin if an
entity’s credit rating is lowered), we
preliminarily believe that simpler tests
of exposure can more efficiently identify
the risks associated with particular
swap or security-based swap positions.
After considering these alternatives,
the Commissions are proposing two
tests to define ‘‘substantial position.’’
One test would focus exclusively on an
entity’s current uncollateralized
exposure; the other would supplement a
current uncollateralized exposure
measure with an additional measure
that estimates potential future exposure.
A position that satisfies either test
would be a ‘‘substantial position.’’
The Commissions, however, request
comment on whether it would be
appropriate to use other types of
approaches for determining whether an
entity has a substantial position—as an
alternative to, or in addition to, the two
proposed tests.
emcdonald on DSK2BSOYB1PROD with PROPOSALS2
a. Proposed Current Exposure Test
The proposed first substantial
position test, which would focus solely
on current uncollateralized exposure, in
general would set the substantial
position threshold by reference to the
sum of the uncollateralized current
exposure, obtained by marking-tomarket using industry standard
practices, arising from each of the
person’s positions with negative value
in each of the applicable ‘‘major’’
category of swaps or security-based
swaps (other than positions excluded
from consideration, such as positions
for the purpose of ‘‘hedging or mitigating
commercial risk’’).92
92 See proposed CEA rule 1.3(sss)(2); proposed
Exchange Act rule 3a67–3(b)(1). In other words, the
test would measure the portion of the exposure that
is not offset by the posting of collateral. If a position
was collateralized only partially, the value of the
collateral posted would be offset against the total
exposure, and the test would measure the residual
part of the exposure. We recognize that there may
be operational delays between changes in exposure
and the resulting exchanges of collateral, and in
general we would not expect that operational delays
associated with the daily exchange of collateral
would be considered to lead to uncollateralized
exposure for these purposes.
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A person would apply this proposed
substantial position test on a major
category-by-major category basis,
examining its positions with each
counterparty with which the person has
swaps or security-based swaps in the
particular category. For each
counterparty, the person would
determine the dollar value of the
aggregate current exposure arising from
each of its swap or security-based swap
positions with negative value (subject to
the netting provisions described below)
in that major category by marking-tomarket using industry standard
practices, and deduct from that amount
the aggregate value of the collateral the
person has posted with respect to the
swap or security-based swap positions.
The aggregate uncollateralized outward
exposure would be the sum of those
uncollateralized amounts over all
counterparties with which the person
has entered into swaps or security-based
swaps in the applicable major
category.93
The proposed test would not
prescribe any particular methodology
for measuring current exposure or the
value of collateral posted,94 and instead
would provide that the method should
be consistent with counterparty
practices and industry practices
generally.95
As noted above, the statutory definitions require
us to consider the presence of central clearing in
setting the substantial position threshold. This test
would account for the risk-mitigating effects of
central clearing in that centrally cleared swaps and
security-based swaps are subject to mark-to-market
margining that would largely eliminate the
uncollateralized exposure associated with a
position, effectively resulting in cleared positions
being excluded from the analysis.
93 See proposed CEA rule 1.3(sss)(2); proposed
Exchange Act rule 3a67–3(b)(2).
94 Depending on the particular circumstances of
the swap or security-based swap, such collateral
may be posted to a third-party custodian, directly
to the counterparty, or in accordance with the rules
of a derivatives clearing organization or clearing
agency.
95 Consistent with industry practices, we would
expect that entities may value exposure based on
measures that take into account the amounts that
would be payable if the transaction were
terminated. Also, to the extent the valuation of
collateral posted in connection with swaps or
security-based swaps is subject to other rules or
regulations, we would expect that the valuation of
collateral for purposes of the major participant
calculations would be consistent with those
applicable rules.
At the same time, we recognize that there can be
disputes or uncertainty as to an entity’s exposure
in connection with swap and security-based swap
positions, and as to the valuation of the collateral
it has posted in connection with those positions. In
some circumstances this could lead to uncertainty
as to whether the entity is a major participant. As
addressed below, we are requesting comment as to
the potential significance of these issues, and as to
whether we should set forth additional guidance or
mandate the use of specific standards with respect
to these valuations.
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This proposed test would account for
the risk mitigating effects of netting
agreements 96 by permitting an entity to
calculate its exposure on a net basis, by
applying the terms of master netting
agreements entered into between the
entity and a single counterparty.97
When calculating the net exposure the
entity may take into account offsetting
positions with that particular
counterparty involving swaps, securitybased swaps and securities financing
transactions (consisting of securities
lending and borrowing, securities
margin lending and repurchase and
reverse repurchase agreements) to the
extent that is consistent with the offsets
provided by the master netting
agreement.98
The Commissions preliminarily
believe that this approach is appropriate
because it avoids identifying a
position’s exposure as being
‘‘uncollateralized’’ when there is no
current counterparty risk associated
with it due to offsets under a netting
agreement with the counterparty.99 In
Also, it is important to recognize that while we
expect that other regulatory requirements
applicable to the valuation of swap or securitybased swap positions and collateral would be
relevant to certain calculations relating to major
participant status, our proposed rules would not be
relevant for other purposes, such as in the context
of capital and margin requirements.
96 Section 362(b)(17) of the United States
Bankruptcy Code generally provides derivatives
contracts with a safe harbor from the Bankruptcy
Code’s automatic stay, thus allowing parties to
these contracts to enforce their contractual rights,
including those associated with netting and offsets,
even after a counterparty has filed for bankruptcy.
In addition, Section 210(c)(8)(A) of the DoddFrank Act reaffirms the enforceability of netting and
offset provisions in certain derivatives contracts
with insolvent counterparties that have been placed
under the receivership of the Federal Deposit
Insurance Corporation (‘‘FDIC’’). However, the
Dodd-Frank Act also places certain limitations on
the timing by which netting rights may be exercised
when the FDIC has been appointed as the receiver
of an insolvent counterparty. See Dodd-Frank Act
section 210(c)(10)(B).
97 To the extent that the two counterparties
maintain multiple netting agreements (e.g., separate
agreements for dollar-denominated and eurodenominated instruments), the calculation would
account only for the netting permitted under the
netting agreement that is relevant to the swap or
security-based swap at issue.
98 See proposed CEA rule 1.3(sss)(2)(iii)(A);
proposed Exchange Act rule 3a67–3(b)(3)(A). As is
the case for the proposed rules on valuation, the
proposed rules regarding possible offsets of various
positions are for purposes of determining major
participant status only. Other rules proposed by the
Commissions may address the extent to which, if
any, persons such as dealers and major participants
may offset positions for other purposes.
99 If, for example, an entity was $X out of the
money in connection with a security-based swap,
but was $X in the money with the same
counterparty in connection with a swap, there
would be no economic need for the entities to
exchange collateral in connection with those
offsetting positions. A test that fails to account for
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calculating current uncollateralized
exposure, however, the entity may not
take into account the market risk offsets
associated with holding positions with
multiple counterparties.100 Also, the
entity may not ‘‘double count’’ any offset
or collateral—once any item of collateral
or any position with positive value has
been applied against current exposure,
the same item cannot be applied for
purposes of this test against any other
exposure.
The proposal to permit this type of
netting, however, raises questions as to
how an entity’s net out-of-the-money
exposure with a counterparty, and the
collateral posted with respect to its
positions with the counterparty, should
be allocated among swap positions,
security-based swap positions and other
positions specified in the rule.101 In
particular, when an entity has not fully
collateralized its net current exposure to
a particular counterparty with which it
has a netting agreement, there may be
questions regarding how to attribute the
net out-of-the-money positions and
associated collateral to its swap or
security-based swap positions. We
preliminarily believe that an entity that
has net uncollateralized exposure to a
counterparty should, for purposes of the
test, allocate that net uncollateralized
exposure pro rata in a manner that
reflects the exposure associated with
each of its out-of-the-money swap
positions, security-based swap positions
and non-swap positions.102 This
allocation would be intended to cause
the measure of uncollateralized
exposure connected with swaps or
security-based swaps for purposes of the
test to reasonably reflect the relative
contribution of those instruments to an
this netting of exposure could lead the entities to
engage in needless offsetting exchanges of
collateral.
100 See proposed CEA rule 1.3(sss)(2)(iii)(C);
proposed Exchange Act rule 3a67–3(b)(2)(iii). While
recognizing that offsetting positions of that type
would reduce the market risk facing the entity, the
offsets would not be expected to directly mitigate
the risks that the entity’s counterparties would face
if the entity were to default.
101 This issue does not arise to the extent that an
entity’s net positions with a counterparty are fully
collateralized.
102 In other words, if an entity’s out-of-the-money
rate swap positions have $W exposure, its out-ofthe-money other commodity swap positions have
$X exposure, its out-of-the-money security-based
swap positions have $Y exposure, and its other outof-the money positions covered by that netting
agreement have $Z exposure, fractions of the
collateral equal to W/(W+X+Y+Z) should be
allocated to the rate swap positions, X/(W+X+Y+Z)
to the other commodity swap positions and Y/
(W+X+Y+Z) to the security-based swap positions. A
similar process should be used for allocating net
out-of-the-money exposure across the categories of
swaps and security-based swaps that have out-ofthe-money exposure when one or more categories
are in-the-money.
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entity’s total overall uncollateralized
exposure.
For purposes of the definition of
‘‘major swap participant,’’ the
Commissions are proposing to set the
current uncollateralized exposure
threshold at a daily average of $1 billion
in the applicable major category of
swaps, except that the threshold for the
rate swap category would be a daily
average of $3 billion. For purposes of
the definition of ‘‘major security-based
swap participant,’’ this threshold would
be based on a daily average of $1 billion
in the applicable major category of
security-based swaps.103 We
preliminarily believe that these
proposed thresholds are appropriate for
identifying entities that, through their
swap and security-based swap activities,
have a significant potential to pose the
systemic importance or risks to the U.S.
financial system that the major
participant definition and associated
statutory requirements were intended to
address, but we also recognize that it is
possible that the appropriate threshold
should be higher or lower. In proposing
these specific thresholds, we have
sought to take into account several
factors: (i) The ability of the financial
system to absorb losses of a particular
size; 104 (ii) the appropriateness of
setting ‘‘prudent’’ thresholds that are
materially below the level that could
cause significant losses to the financial
system as it would not be appropriate
for the substantial position test to
encompass entities only after they pose
significant risks to the market through
their swap or security-based swap
activity; 105 and (iii) the need to account
for the possibility that multiple market
participants may fail close in time,
rather than focusing narrowly on the
potential impact of a single participant’s
default.106 Based on these factors, we
103 See proposed CEA rule 1.3(sss)(1); proposed
Exchange Act rule 3a67–3(a)(1).
104 In this regard, the Commissions preliminarily
believe that the ‘‘Tier 1’’ capital of major dealer
banks provides relevant information about the
ability of the financial system to absorb losses of a
particular size. We note that, among U.S. banks that
are dealers in credit derivatives, the six largest
banks account for the vast majority of dealing
activities. We understand that the most liquid ‘‘Tier
1’’ regulatory capital for those six banks ranges from
$14 billion to $113 billion.
105 In other words, the proposed thresholds are
intended to be low enough to provide for the
appropriately early regulation of an entity whose
swap or security-based swap positions have a
reasonable potential of posing significant
counterparty risks and risks to the market that stress
the financial system, while being high enough that
it would not unduly burden entities that are
materially less likely to pose these types of risks.
106 For example, the proposed $1 billion
threshold for swaps and security-based swaps
would reflect a potential loss of $3 billion if three
large swap or security-based swap entities were to
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preliminarily believe that the proposed
substantial position thresholds would
reasonably be expected to apply to
entities that have the potential of
satisfying the statutory criteria of
systemic importance or significant
impact to the U.S. financial system. As
discussed below, however, we welcome
comments on the appropriateness of the
proposed threshold.
These proposed thresholds would be
evaluated by reference to a calculation
of the mean of an entity’s
uncollateralized exposure measured at
the close of each business day,
beginning on the first business day of
each calendar quarter and continuing
through the last business day of that
quarter.107 In this regard, the
Commissions have taken into account
commenters’ concerns that an entity’s
exposure should not be evaluated based
on a single point in time, as short-term
market fluctuations may not fairly
reflect the risks of the entity’s positions.
The use of a daily average approach
should help address commenters’
concerns about the impact of short-term
price fluctuations, and also help
preclude the possibility that an entity
may seek to use short-term transactions
to distort the measure of exposure.
The Commissions request comment
on the proposed current
uncollateralized exposure test.
Commenters particularly are requested
to address whether the proposed
threshold amounts of current
uncollateralized exposure are
appropriate, and, if not, what alternative
higher or lower threshold amounts
would appropriately identify entities
that pose the types of risks that the
definition was intended to address. In
this regard, commenters specifically are
requested to address whether bank Tier
1 capital provides a good indicative
reference of the ability of major dealers
to absorb losses of a particular size, or
whether alternative reference points for
the analysis (e.g., the size of the swap
market or security-based swap market)
would also be applied. Commenters are
requested to address whether
uncollateralized mark-to-market
exposure is the appropriate way to
measure current exposure, and if not,
what alternative approach is more
appropriate, and why. Commenters also
are requested to address whether the
fail close in time. That $3 billion could represent
a significant impairment of the ability of some
major dealers to absorb losses, as reflected by their
Tier 1 capital.
We also are mindful of the views expressed by
the two commenters that suggested particular dollar
values for the threshold. See note 85, supra.
107 See proposed CEA rule 1.3(sss)(4); proposed
Exchange Act rule 3a67–3(d).
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Federal Register / Vol. 75, No. 244 / Tuesday, December 21, 2010 / Proposed Rules
proposed thresholds reasonably address
the need to set the threshold at a
prudent level so as to avoid the
possibility that the substantial position
test would encompass entities only after
they pose significant risks to the market,
whether the proposed thresholds
reasonably address the possibility that
multiple market entities could fail close
in time, and whether the proposed
thresholds reasonably address the fact
that swap or security-based swap
activities would comprise only part of
the risks to the market posed by an
entity. To what extent would this
proposed definition of ‘‘substantial
position’’ have an effect on the activities
of entities that potentially may be
deemed to be major participants? What
impact could these types of effects have
on liquidity, on risk-taking or riskreducing activities, or on other aspects
of the relevant markets?
Also, more fundamentally, we request
comment on whether the substantial
position analysis also should encompass
a test that does not account for the
collateral posted in connection with an
entity’s exposure, given that tests that
account for the posting of collateral
would not encompass entities that have
very large swap or security-based swap
positions that are fully collateralized
(either by the posting of bilateral
collateral or by virtue of central
clearing). In that light, should the
analysis seek to capture entities that
have very large positions in light of
potential market disruptions such
entities could cause, regardless of
whether the positions are collateralized?
Commenters further are requested to
address whether such thresholds should
also account for entities that have large
in-the-money positions that may
indicate their potential significance to
the market. In this regard, commenters
also are asked to address whether the
thresholds should specifically address
entities with large in-the-money
positions that lead them to receive large
amounts of collateral posted by their
counterparties, particularly to the extent
that such collateralized in-the-money
positions could later turn and lead the
entity to incur losses.
In addition, commenters are requested
to address whether and how it would be
appropriate to adjust the threshold
amounts over time, including whether
these proposed current uncollateralized
exposure thresholds should periodically
be adjusted by formula to reflect
changes in the ability of the market to
absorb losses over time, or changes in
other criteria over time. Commenters
further are requested to address whether
the test will be practical for potential
major participants to use. Moreover,
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commenters are requested to address
whether the proposed current exposure
test should be modified to account for
the risks associated with the expected
time lag between an entity’s default and
the liquidation of its swap or securitybased swap positions.
Commenters also are requested to
address whether we should set forth
additional guidance or mandate the use
of specific standards with respect to the
measure of exposure or valuing
collateral posted, or should specify
particular procedures in the event of
valuation disputes. What particular
industry standard documentation and
other methodologies could be used to
measure exposure and value collateral?
Also, how could regulatory
requirements applicable to the valuation
of collateral be relevant to the valuation
of collateral for purposes of the major
participant definitions?
Commenters are invited to address
whether the rule should provide that, in
measuring their current uncollateralized
exposure, entities must value collateral
in a way that is at least as conservative
as such collateral would be valued
according to applicable haircuts or other
adjustments dictated by applicable
regulations. Commenters further are
requested to address whether the test
should exclude certain types of
collateral that cannot readily be valued.
Also, commenters are requested to
address whether the proposed method
of evaluation—the mean of an entity’s
uncollateralized exposure measures at
the close of each business day,
beginning on the first business day of
each calendar quarter and continuing
through the last business day of that
quarter—would be unduly burdensome
or potentially subject to gaming or
evasion.
Should the proposed approach for
measuring uncollateralized current
exposure be amended or supplemented,
such as by establishing requirements for
how exposure should be measured or
collateral should be valued in certain
circumstances (e.g., requiring the
valuation of certain types of collateral to
be conservative during times of rapid
price changes in the relevant asset
class)? Should current exposure and
collateral be required to be valued in
accordance with US generally accepted
accounting principles? Would
measurement according to such
principles differ in any respects from
measurement under the proposal, and, if
so, how?
In addition, commenters are requested
to address the proposed netting
provisions of this test, including:
whether the proposed test would
reasonably permit the measure of
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uncollateralized exposure to account for
bilateral netting agreements; whether
additional types of positions should be
included within the netting provisions;
whether the proposal appropriately
takes into account the netting of
exposures and collateral involving
positions in financial instruments other
than swaps, security-based swaps and
securities financing transactions and if
so, whether any limitations to such
offsetting would be necessary or
appropriate; whether the netting
provisions should accommodate
offsetting positions involving the net
equity balance in an entity’s securities
account (e.g., free credit balances, other
credit balances, and fully paid
securities), and if so, whether any
limitations to such offsetting would be
necessary or appropriate; whether the
netting provisions should accommodate
offsets for exposures, or collateral
connected with the positions that an
entity has with the affiliate of a
counterparty; and whether the proposed
method of allocating the
uncollateralized portion of exposures
among the different types of financial
instruments that are all subject to a
single netting agreement is appropriate.
Commenters also are requested to
address whether the proposed current
uncollateralized exposure test would
pose significant monitoring burdens
upon entities that have swap or
security-based swap positions that are
significant enough to potentially meet
the current uncollateralized exposure
threshold. Should we provide guidance
as to policies and procedures that such
an entity should be able to follow to
demonstrate that it does not meet the
applicable thresholds?
b. Proposed Current Exposure Plus
Potential Future Exposure test
The second proposed test would
account both for current
uncollateralized exposure (as discussed
above) and for the potential future
exposure associated with swap or
security-based swap positions in the
applicable ‘‘major’’ category of swaps or
security-based swaps. This additional
test would allow the major participant
analysis to take into account estimates
of how the value of an entity’s swap or
security-based swap positions may
move against the entity over time.
The potential future exposure portion
of this proposed test would be based on
an entity’s ‘‘aggregate potential outward
exposure,’’ which would reflect the
potential exposure of the entity’s swap
or security-based swap positions in the
applicable ‘‘major’’ category of swap or
security-based swaps, subject to certain
adjustments. Bank capital standards also
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make use of this type of test,108 and this
proposal builds upon those standards
but modifies them to focus on the risk
that an entity poses to its counterparties
(rather than on the risk that
counterparties pose to an entity). In
doing so, this proposal seeks to use a
test that can be implemented by a range
of market participants, and that can be
expected to lead to reproducible results
across market participants with
identical swap or security-based swap
portfolios, rather than relying on
alternative tests (e.g., value at risk
measures or stress testing
methodologies) that may be costly for
market participants to implement and
that would not be expected to lead to
reproducible results across participants.
The exposure measures in general
would be based on the total notional
principal amount of those positions,
adjusted by certain risk factors that
reflect the type of swap or securitybased swap at issue and the duration of
the position.109 For positions in which
108 See 12 CFR part 3, app. C, section 32 (Office
of the Comptroller of the Currency bank capital
standards).
109 For example, consistent with the bank
standards, the multiplier for equity swaps would
range from 0.06 for equity swaps of one year or less
to 0.10 for equity swaps with a maturity of more
than five years. See proposed Exchange Act rule
3a67–3(c)(2)(i)(A). For security-based swaps based
on the credit of a reference entity, the multiplier
would be 0.1.
The current bank capital standards contain a
distinction based on whether the credit derivative
is on ‘‘investment grade’’ or ‘‘non-investment grade’’
reference entities, providing a 0.1 multiplier for the
former and a lower 0.05 multiplier for the latter. We
preliminarily do not believe that a test that
distinguishes among reference entities by reference
to their credit ratings would be appropriate for
purposes of these definitions, particularly in light
of the fact that the Dodd-Frank Act mandates the
substitution of credit ratings with other standards
of creditworthiness in U.S. regulations. See DoddFrank Act section 939A.
The multipliers in part will be a function of the
remaining maturity of the swap or security-based
swap. If the swap or security-based swap, however,
is structured such that on specified dates the
outstanding exposure is settled and the terms are
reset so the market value is zero, the remaining
maturity would equal the time until the next reset
date.
Although we recognize that these risk multipliers
may suggest a lower than expected volatility of
credit or equity derivatives of that duration, this
may be offset by the fact that the proposed
calculations of potential future exposure do not
directly account for portfolio netting or collateral
updates that could mitigate future exposure. We
preliminarily believe that the use of these
thresholds (and proposed related calculations) for
purposes of identifying major participants are
consistent with similar bank capital standards and
are therefore suitable for use as an estimate of
potential future exposure. We are also cognizant
that requiring a more complete calculation of
potential future exposure may be costly and
burdensome for participants, especially those who
would otherwise not meet the thresholds for major
swap or security-based swap participant and would
not have systems in place to perform a more
complete calculation.
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the stated notional amount is leveraged
or enhanced by the particular structure,
this calculation would be based on the
position’s effective notional amount.110
At the same time, the proposed
measures would contain adjustments for
certain types of positions that pose
relatively lower potential risks.111 In
addition, the general risk-adjusted
notional measures of potential future
exposure would be reduced to reflect
the risk mitigation effects of master
netting agreements, in a manner
consistent with bank capital
standards.112
The proposed measures of potential
future exposure would contain further
downward adjustments to account for
110 See proposed CEA rule 1.3(sss)(3)(ii);
proposed Exchange Act rule 3a67–3(c)(2)(i)(B). For
purposes of this rule, in the case of positions that
represent the sale of an option on a swap or
security-based swap (other than the sale of an
option permitting the person exercising the option
to purchase a credit default swap), we would view
the effective notional amount of the option as being
equal to the effective notional amount of the
underlying swap or security-based swap, and we
would view the duration used for purposes of the
formula as being equal to the sum of the duration
of the option and the duration of the underlying
swap or security-based swap.
111 The analysis would exclude swap or securitybased swap positions that constitute the purchase
of an option, such that the person has no additional
payment obligations under the position, as well as
other positions on which the person has prepaid or
otherwise satisfied all of its payment obligations.
See proposed Exchange Act rule 3a67–3(c)(2)(i)(C).
For similar reasons, the potential outward
exposure associated with a position by which a
person buys credit protection using a credit default
swap would be capped at the net present value of
the unpaid premiums. See proposed CEA rule
1.3(sss)(3)(ii)(A)(4); proposed Exchange Act rule
3a67–3(c)(2)(i)(D).
112 In particular, for swaps or security-based
swaps subject to master netting agreements the
potential exposure associated with the person’s
swap or security-based swaps with each
counterparty would equal a weighted average of the
potential exposure in the applicable ‘‘major’’
category of swaps or security-based swaps with a
particular counterparty as calculated without
reference to netting, and that amount reduced by
the ratio of net current replacement cost to gross
current replacement cost of all swap and securitybased swap positions with that counterparty,
consistent with the following equation: PNet = 0.4
x PGross + 0.6 x NGR x PGross.
Under this formula, PNet is the potential exposure
in the applicable ‘‘major’’ category of swaps or
security-based swaps adjusted for bilateral netting;
PGross is the potential exposure in that category
without adjustment for bilateral netting; and NGR
is the ratio of net current replacement cost to gross
current replacement cost. See proposed CEA rule
1.3(sss)(3)(ii)(B); proposed Exchange Act rule 3a67–
3(c)(2)(ii).
The ‘‘NGR’’ ratio is intended to serve as a type of
proxy for the impact of netting on potential future
exposure, but does not serve as a precise indicator
of future changes in net exposure relative to gross
exposure, as the ratio and potential exposure can
be influenced by many idiosyncratic properties of
individual portfolios. See Basle Committee on
Banking Supervision, ‘‘The Treatment of the Credit
Risk Associated with Certain Off-Balance-Sheet
Items’’ (July 1994).
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the risk mitigation effects of central
clearing and mark-to-market margining.
In particular, if the swap or securitybased swap positions are cleared by a
registered clearing agency or subject to
daily mark-to-market margining,113 the
measures of potential future exposure
would further be adjusted to equal
twenty percent of the potential future
exposure calculated using the
methodology described above.114 The
Commissions preliminarily believe that
a significant downward adjustment
would be appropriate because clearing
and daily mark-to-market margining
would be expected to reduce the
potential future risks posed by an
entity’s swap or security-based swap
positions. Also, it is appropriate to
incentivize the use of central clearing
and daily mark-to-market margining as
practices for helping to control risks. We
are not proposing to entirely eliminate
such cleared and margined positions
from the analysis of potential future
exposure, however, because clearing
may not entirely eliminate the risks
posed by an entity’s potential default,115
and daily mark-to-market margining
would not eliminate the risks associated
with large intra-day price movements.
While the proposed amount of the
adjustment seeks to balance these
113 For these purposes, a swap or security-based
swap would be considered to be subject to daily
mark-to-market margining if, and for as long as, the
counterparties follow the daily practice of
exchanging collateral to reflect changes in exposure
(after taking into account any other positions
addressed by a netting agreement between the
parties). If a person is permitted to maintain an
uncollateralized ‘‘threshold’’ amount under the
agreement, that amount (regardless of actual
exposure) would be considered current
uncollateralized exposure for purposes of the test.
Also, if the agreement provides for a minimum
transfer amount in excess of $1 million, the entirety
of that amount would be considered current
uncollateralized exposure. See proposed CEA rule
1.3(sss)(3)(iii)(B); proposed Exchange Act rule
3a67–3(c)(3)(ii).
In this way, the measure of potential future
exposure would reflect for the risk mitigating
benefits of daily margining, while specifically
accounting for industry practices that limit those
benefits. Of course, to take advantage of this
adjustment it is not enough to the agreement to
provide for daily mark-to-market margining—the
parties must actually follow that practice.
114 See proposed CEA rule 1.3(sss)(3)(iii)(A);
proposed Exchange Act rule 3a67–3(c)(3).
115 For example, the central counterparties that
clear credit default swaps do not necessarily
become the counterparties of their members’
customers (although even absent direct privity
those central counterparties benefit customers by
providing for protection of collateral they post as
margin, and by providing procedures for the
portability of the customer’s positions in the event
of a dealer’s default). As a result, central clearing
may not eliminate the counterparty risk that the
customer poses to the dealer. Even then, however,
required mark-to-market margining should help
control that risk, and central clearing thus would
be expected to reduce the likelihood that an entity’s
default would lead to broader market impacts.
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competing factors, we recognize that
alternative higher or lower downward
adjustments may also be appropriate.
For purposes of the ‘‘major swap
participant’’ definition, the substantial
position threshold would be $2 billion
in daily average current uncollateralized
exposure plus aggregate potential
outward exposure in the applicable
major swap category, except that the
threshold for the rate swap category
would be a daily average of $6 billion.
For purposes of the ‘‘major securitybased swap participant’’ definition, the
substantial position threshold would be
$2 billion in daily average current
uncollateralized exposure plus aggregate
potential outward exposure in any
major security-based swap category.116
These proposed amounts reflect the
same factors discussed above in the
context of the current uncollateralized
exposure test,117 but are raised to reflect
the fact that potential future exposure is
a measure of potential risk over time,
and hence is less likely to pose a direct,
immediate impact on the markets than
current measures of uncollateralized
exposure. We recognize that alternative
risk thresholds may also be appropriate,
and we welcome comment on potential
alternatives.
In light of the amount of this
threshold and the underlying risk
adjustments, we preliminarily do not
believe that an entity would need to
calculate its potential future exposure
for purposes of the test unless the entity
has large notional positions. For
example, in light of the proposed risk
adjustment of 0.10 for credit derivatives,
an entity that does not have any
uncollateralized current exposure
would have to have notional positions
of at least $20 billion to potentially meet
the $2 billion threshold, even before
accounting for the discounts associated
with netting agreements. If those swaps
or security-based swaps are cleared or
subject to mark-to-market margining, the
additional 20 percent risk adjustment
would mean that the entity without
current uncollateralized exposure
would have to have cleared notional
positions of at least $100 billion to
possibly meet that threshold.118
The Commissions request comment
on this proposed use of a current
exposure plus potential future exposure
test to determine the substantial
116 See
proposed Exchange Act rule 3a67–3(a)(2).
notes 103 to 106, supra, and
accompanying text.
118 Based on these thresholds, we preliminarily
believe that only relatively few entities would
regularly have to perform these potential future
exposure calculations with regard to their securitybased swaps. See notes 181 and 182, infra, and
accompanying text.
117 See
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position threshold. Commenters
particularly are requested to address the
appropriateness of using potential
exposure risk adjustments derived from
bank capital rules; and the
appropriateness of using bank capital
methodologies for addressing positions
subject to netting agreements. Also,
should this test be supplemented by a
test that accounts for the notional
amount of an entity’s swap or securitybased swap positions without riskadjustments, to focus on entities that
have very large swap or security-based
swap positions?
Commenters are requested to address
whether the proposed threshold
amounts for the proposed current
exposure plus potential future exposure
test are appropriate, and if not, what
alternative threshold amounts would be
more appropriate, and why. In addition,
commenters are requested to address the
proposed method of discounting the
potential future exposure associated
with cleared positions or positions
subject to daily mark-to-market
margining to equal 20 percent of what
the measure of potential future exposure
would be otherwise. Would a larger or
smaller discount be appropriate? Is
there data available that may assist with
reaching the appropriate discount
factor? Also, in that regard, should both
sets of discounts be equal, or should
cleared positions be subject to more of
a discount than uncleared positions
subject to daily mark-to-market
margining? Commenters also are invited
to address whether the proposed
discounts for cleared positions or
positions that are marked-to-market
would make it unnecessary or
duplicative for this test separately to
account for netting agreements. Also, if
an entity currently has posted excess
collateral in connection with a position,
should the amount of that current
overcollateralization be deducted from
its measure of potential future
exposure?
Commenters also are requested to
address whether the proposed test in
connection with purchases of credit
protection—which would cap the
measure of exposure at the net present
value of unpaid premiums—would raise
problems in implementation, and
whether we should propose any
particular discount rate to be used in
conducting the calculation (and, if so,
what discount rate should be
appropriate). Also, should the measure
of potential future exposure in
connection with purchases of credit
protection and options also account for
collateral that a counterparty has posted
in connection with an entity’s in-themoney positions, given that such
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80193
collateralized in-the-money positions
could later turn and cause losses to an
entity? In addition, for positions that
represent the sale of options on swaps
or security-based swaps, would the
effective notional amount of the option
for purposes of the calculation properly
be deemed to be the notional amount of
the underlying instrument (or should
the notional amount of the option vary
based on the link between the changes
in the value of the option and changes
in the value of the underlying), and
would the duration of the option
properly be deemed to be the sum of the
duration of the option and the duration
of the underlying swap or securitybased swap?
Commenters also are requested to
address whether the risk adjustment for
credit derivatives should reflect the
riskiness of the underlying reference
entity, and, if so, how should that be
accomplished in a way that does not
rely on the use of credit ratings.
The proposed test of potential future
exposure is based in part on the
application of fixed multipliers to the
notional amounts, or effective notional
amounts, of swaps and security-based
swaps. In this regard, commenters are
invited to discuss whether there are
alternative tests that would be more
effective to determine potential future
exposure or otherwise to supplement an
uncollateralized current exposure test,
and whether such alternative tests may
be more effectively developed in the
near future, when additional data
regarding swap and security-based swap
positions are likely to be available. In
particular, commenters are requested to
identify any tests based on nonproprietary risk models that could be
uniformly applied by all potential major
participants to measure potential future
exposure. Commenters who propose
alternative tests are asked to address
how the tests would provide consistent
results across different types of swaps
and security-based swaps, including
customized instruments, in the different
major categories. Commenters are also
invited to address, on the other hand,
whether a single test based on
uncollateralized current exposure (i.e.,
without any test of potential future
exposure) would be adequate for
identifying entities whose swap or
security-based swap positions pose a
relatively high degree of risk to
counterparties and to the markets. In
addition, commenters are invited to
identify any tests or thresholds below
which a party would be deemed not to
be a major swap participant, without
needing to calculate the exposure tests
set forth in the proposed rule.
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Commenters further are requested to
address whether and how it would be
appropriate to adjust the threshold
amounts over time, including whether
these proposed thresholds should
periodically be adjusted by formula to
reflect changes in the ability of the
market to absorb losses over time, or
changes in other criteria over time. In
addition, commenters are requested to
address whether the proposed use of a
daily average measure for purposes of
this test would be burdensome for
potential major participants to
implement, and, if so, how often should
potential participants have to measure
these amounts. Commenters also are
requested to address whether any such
tests should seek to reflect the
maximum level of exposure associated
with a position, rather than riskadjusted estimates of exposure proposed
here.
In addition, commenters are requested
to address whether this proposed test
would pose significant monitoring
burdens upon entities that have swap or
security-based swap positions that are
significant enough to potentially meet
the combined current uncollateralized
exposure and potential future exposure
test. Should we provide guidance as to
policies and procedures that such an
entity should be able to follow to be able
to demonstrate that it does not meet the
applicable thresholds?
C. ‘‘Hedging or Mitigating Commercial
Risk’’
The first test of the major participant
definitions excludes positions held for
‘‘hedging or mitigating commercial risk’’
from the substantial position
analysis.119
Commenters took the position that
this exclusion from the major
participant definitions should
encompass a variety of uses of swaps
and security-based swaps to hedge risks
faced by non-financial entities.120 Some
commenters also suggested that the
exclusion should be interpreted to
address risks such as ‘‘balance sheet
risk,’’ the ‘‘risk of under-diversification,’’
and hedges undertaken on a portfolio
basis. Some commenters favored
interpreting this exclusion to permit its
use by insurers and banks. One
commenter emphasized the need to
avoid taking interpretations that would
encourage commercial entities not to
119 See CEA section 1a(33)(A)(i)(I); Exchange Act
section 3(a)(67)(A)(i)(I).
120 See, e.g., letter from Coalition for Derivatives
End-Users, dated September 20, 2010 (discussing,
inter alia, a supplier’s use of credit derivatives in
connection with a cash receivable, and a company’s
use of equity derivatives in connection with a stock
repurchase program).
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manage risks that they otherwise would
manage.121 Commenters also took the
position that the addition of the word
‘‘mitigating’’ was intended to expand the
exclusion beyond what would have
been encompassed had only the term
‘‘hedging’’ been used.122
1. Proposed Interpretation
In interpreting the meaning of
‘‘hedging or mitigating commercial risk’’
for purposes of the first test of the major
participant definitions, the
Commissions first note that virtually
identical language is found in the DoddFrank provisions granting an exception
from the mandatory clearing
requirement to non-financial entities
that are using swaps or security-based
swaps to hedge or mitigate commercial
risk.123 Because Congress used virtually
identical language in both instances, the
Commissions intend to interpret the
phrase ‘‘hedging or mitigating
commercial risk’’ with respect to the
participant definitions in the same
manner as the phrase ‘‘hedge or mitigate
commercial risk’’ in the exception from
the mandatory clearing requirement.124
The Commissions also note that
although only non-financial entities that
121 See Cleary letter (also urging inclusion of ‘‘all
risks’’ arising in connection with a company’s
business activities, including risks incidental to a
company’s ordinary course of business).
122 See MetLife letter (addition of mitigation
‘‘plainly indicates that this exclusion intends an
expansive definition of hedging and can also
encompass non-speculative derivatives positions
used to manage economic risk, including
potentially diversification and synthetic asset
strategies, such as the conservative ‘replication’
strategy permitted under State insurance laws’’);
letter from Joanne R. Medero, Managing Director,
BlackRock, dated September 20, 2010 (addressing
the parallel context of the exclusion for ERISA plan
positions).
123 See CEA section 2(h)(7)(A); Exchange Act
section 3C(g)(1)(B) (exception from mandatory
clearing requirements when one or more
counterparties are not ‘‘financial entities’’ and are
using swaps or security-based swaps ‘‘to hedge or
mitigate commercial risk’’). The definition of
commercial risk here is for purposes of only the
major participant definitions and, to the extent the
interpretation is similar, for purposes of the enduser exception from the mandatory clearing
requirement. The concept of commercial risk may
be interpreted differently for other purposes under
the CEA and the Exchange Act.
124 There is a technical difference in the way
those provisions use the concept of hedging and
mitigating commercial risk—in that the major
participant definitions specifically refer to
‘‘positions held for hedging and mitigating
commercial risk’’ while the end-user exception
refers to a counterparty that ‘‘is using [swaps or
security-based swaps] to hedge or mitigate
commercial risk.’’ That difference is consistent with
the different language used in the two places
(particularly the use of ‘‘substantial position’’ in the
major participant definitions) and we do not see a
reason why the use of the term in the context of
the major participant definitions should be
construed differently than its use in the comparable
clearing exception.
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are using swaps or security-based swaps
to hedge or mitigate commercial risk
generally may qualify for the clearing
exemption, no such statutory restriction
applies with respect to the exclusion for
hedging positions in the first major
participant test. Accordingly, with
respect to the first major participant test,
it appears that positions established to
hedge or mitigate commercial risk may
qualify for the exclusion, regardless of
the nature of the entity—i.e., whether a
financial entity (including a bank) or a
non-financial entity.125
In general, we are premising the
proposed exclusion on the principle
that swaps or security-based swaps
necessary to the conduct or management
of a person’s commercial activities
should not be included in the
calculation of a person’s substantial
position.126 In this regard, the
Commissions preliminarily believe that
whether an activity is commercial
should not be determined solely by the
person’s organizational status as a forprofit company, a non-profit
organization or a governmental entity.
Rather, the determinative factor should
be whether the underlying activity to
which the swap relates is commercial in
nature.127
125 The presence of the third major participant
test suggests that financial entities generally may
not be precluded from taking advantage of the
hedging exclusion in the first test. The third test,
which does not account for hedging, specifically
applies to non-bank financial entities that are
highly leveraged and have a substantial position in
a major category of swaps or security-based swaps.
That test would be redundant if the hedging
exclusion in the first major participant test were
entirely unavailable to financial entities.
Also, had the statute intended the phrase ‘‘hedge
or mitigate commercial risk’’ to apply only to
activities of or positions held by non-financial
entities, it would not have been necessary to
include an additional provision in the statute
generally restricting the availability of the clearing
exception to non-financial entities.
126 The scope of the proposed exclusion is based
on our understanding that when a swap or securitybased swap is used to hedge an entity’s commercial
activities, the gains or losses associated with the
swap or security-based swap itself will be offset by
losses or gains in the entity’s commercial activities,
and hence the risks posed by the swap or securitybased swap to counterparties or the industry
generally will be mitigated.
127 We do not concur with the suggestion that the
use of the word ‘‘mitigating’’ within the major
participant definitions was intended to mean
something significantly more than hedging. Other
provisions of the Dodd-Frank Act appear to use the
terms ‘‘hedging’’ and ‘‘mitigating’’ interchangeably;
for example, certain provisions of the Dodd-Frank
Act refer to ‘‘risk-mitigating hedging activities.’’ See
Dodd-Frank Act section 619 (adding Section 13 to
the Bank Holding Company Act of 1956); DoddFrank Act section 619 (adding Section 27B to the
Securities Act of 1933). Title VII also refers to
‘‘[h]edging and other similar risk mitigating
activities.’’ Dodd-Frank Act section 716(d)(1).
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a. Proposed Exclusion in the ‘‘Major
Swap Participant’’ Definition
As a general matter, the CFTC
preliminarily believes that whether a
position hedges or mitigates commercial
risk should be determined by the facts
and circumstances at the time the swap
is entered into, and should take into
account the person’s overall hedging
and risk mitigation strategies. At the
same time, the swap position could not
be held for a purpose that is in the
nature of speculation, investing or
trading. Although the line between
speculation, investing or trading, on the
one hand, and hedging, on the other,
can at times be difficult to discern, the
statute nonetheless requires such
determinations.128 The CFTC expects
that a person’s overall hedging and risk
management strategies will help inform
whether or not a particular position is
properly considered to hedge or mitigate
commercial risk. Although the
definition includes swaps that are
recognized as hedges for accounting
purposes or as bona fide hedging for
purposes of an exemption from position
limits under the CEA, the swaps
included within the proposed exclusion
are not limited to those categories.
Rather, the proposal covers swaps
hedging or mitigating any of a person’s
business risks, regardless of their status
under accounting guidelines or the bona
fide hedging exemption.
The CFTC invites comment on
whether swaps qualifying for the
hedging or risk mitigation exclusion
should be limited to swaps where the
underlying hedged item is a nonfinancial commodity. Commenters may
also address whether swaps subject to
this exception should hedge or mitigate
commercial risk on a single risk or an
aggregate risk basis, and on a single
entity or a consolidated basis. The CFTC
also invites comment on whether risks
such as the foreign exchange, currency,
or interest rate risk relating to offshore
128 We preliminarily believe that swap positions
that are held for the purpose of speculation or
trading are, for example, those positions that are
held primarily to take an outright view on the
direction of the market, including positions held for
short term resale, or to obtain arbitrage profits.
Swap positions that hedge other positions that
themselves are held for the purpose of speculation
or trading are also speculative or trading positions.
We preliminarily believe that swap positions that
are held for the purpose of investing are, for
example, those positions that are held primarily to
obtain an appreciation in value of the swap position
itself, without regard to using the swap to hedge an
underlying risk. In contrast, a swap position related
to a non-swap investment (such as the purchase of
an asset that a commercial enterprise will use to
produce income or otherwise advance its
commercial interests) may be a hedging position if
it otherwise qualifies for the definition of hedging
or mitigating commercial risk.
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affiliates, should be covered; whether
industry-specific rules on hedging, or
rules that apply only to certain
categories of commodity or asset classes
are appropriate at this time; whether
swaps facilitating asset optimization or
dynamic hedging should be included;
and whether hedge effectiveness should
be addressed. Commenters are requested
to discuss both the policy and legal
bases underlying their comments.
b. Proposed Exclusion in the ‘‘Major
Security-Based Swap Participant’’
Definition
The proposed meaning of ‘‘hedging or
mitigating commercial risk’’ for
purposes of the ‘‘major security-based
swap participant’’ definition would
require that a security-based swap
position be economically appropriate to
the reduction of risks in the conduct
and management of a commercial
enterprise, where they arise from the
potential change in the value of assets,
liabilities and services connected with
the ordinary course of business of the
enterprise.129 This standard is intended
to exclude from the first major
participant test security-based swaps
that pose limited risk to the market and
to counterparties because the positions
would be substantially related to
offsetting risks from an entity’s
commercial operations.130 The securitybased swaps included within the
proposed rule would not be limited to
those recognized as hedges for
accounting purposes; rather, the
proposal has been drafted to cover
security-based swaps used in the
broader range of transactions commonly
referred to as economic hedges,
129 See proposed Exchange Act rule 3a67–4(a).
The concept of ‘‘economically appropriate’’ already
is found in rules under the CEA pertaining to the
definition of ‘‘bona fide hedging’’ for purposes of an
exemption from position limits. See CEA rule
1.3(z). In the context of the definition of ‘‘major
security-based swap participant,’’ we may take into
account existing interpretations of that term under
the CEA, but only to the extent that such
interpretations would appropriately be applied to
the use of security-based swaps for hedging.
The SEC preliminarily plans to interpret the
concept of ‘‘economically appropriate’’ based on
whether a reasonably prudent person would
consider the security-based swap to be appropriate
for managing the identified commercial risk. The
SEC also preliminarily believes that for a securitybased swap to be deemed ‘‘economically
appropriate’’ in this context, it should not introduce
any new material quantum of risks (i.e., it cannot
reflect over-hedging that could reasonably have a
speculative effect) and it should not introduce any
basis risk or other new types of risk (other than the
counterparty risk that is attendant to all securitybased swaps) more than reasonably necessary to
manage the identified risk.
130 These hedging positions would include
activities, such as the management of receivables,
that arise out of the ordinary course of an entity’s
commercial operations, including activities that are
incidental to those operations.
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80195
regardless of their status under
accounting guidelines.
At the same time, the security-based
swap position could not be held for a
purpose that is in the nature of
speculation or trading.131 In addition,
the security-based swap position could
not be held to hedge or mitigate the risk
of another security-based swap position
or swap position unless that other
position itself is held for the purpose of
hedging or mitigating commercial risk
as defined by the rule or CEA rule
1.3(ttt).132
We look forward to commenters’
views on whether the proposed
standard strikes an appropriate balance
in determining which positions may be
excluded for purposes of the first major
participant test. We recognize that there
are other reasonable views as to what
positions may appropriately be
considered to be for the purposes of
hedging or mitigating commercial risk.
We also recognize the importance of
providing as clear guidance as possible
as to what is or is not a hedging position
for these purposes.
The proposal also would condition
the entity’s ability to exclude these
security-based swap positions on the
entity engaging in certain specified
activities related to documenting the
underlying risks and assessing the
effectiveness of the hedge in connection
with the positions.133 These activities
are intended to help ensure that
positions excluded for purposes of the
131 See proposed Exchange Act rule 3a67–4(b)(1).
For these purposes, we preliminarily believe that
security-based swap positions that are held for the
purpose of speculation or trading are those
positions that are held intentionally for short-term
resale and/or with the intent of benefiting from
actual or expected short-term price movements or
to lock in arbitrage profits, as well as security-based
swap positions that hedge other positions that
themselves are held for the purpose of speculation
or trading. Thus, for example, positions that would
be part of a ‘‘trading book’’ of an entity such as a
bank would not constitute hedging positions that
may be excluded for purposes of the first major
participant test.
132 See proposed Exchange Act rule 3a67–4(b)(2).
133 See proposed Exchange Act rule 3a67–4(a)(3).
The proposal particularly would require the person
to: Identify and document the risks that are being
reduced by the security-based swap position;
establish and document a method of assessing the
effectiveness of the security-based swap as a hedge;
and regularly assess the effectiveness of the
security-based swap as a hedge.
We expect that market participants that have
security-based swap activities significant enough
that they may be major participants would already
engage in risk assessment activities for their
hedging positions, either formally or informally,
and thus we do not believe that the proposed
requirements would disrupt existing business
practices. Instead, the proposal is intended to create
standards that will allow market participants to
confirm their compliance with the rule by
formalizing risk assessment activities that should
already be part of an effective hedging program.
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first major participant test would not
extend to positions that are not entered
into to reduce or hedge commercial
risks, or that at a later time no longer
substantially serve to reduce or mitigate
such risks.134
We preliminarily believe that this
proposed approach would facilitate the
following types of security-based swap
positions:
• Positions established to manage the
risk posed by a customer’s, supplier’s or
counterparty’s potential default in
connection with: financing provided to
a customer in connection with the sale
of real property or a good, product or
service; a customer’s lease of real
property or a good, product or service;
a customer’s agreement to purchase real
property or a good, product or service in
the future; or a supplier’s commitment
to provide or sell a good, product or
service in the future; 135
• Positions established to manage the
risk posed by a financial counterparty
(different from the counterparty to the
hedging position at issue) in connection
with a separate transaction (including a
position involving a credit derivative,
equity swap, other security-based swap,
interest rate swap, commodity swap,
foreign exchange swap or other swap,
option, or future that itself is for the
purpose of hedging or mitigating
commercial risk pursuant to the rule or
CEA rule 1.3(ttt));
• Positions established to manage
equity or market risk associated with
certain employee compensation plans,
including the risk associated with
market price variations in connection
with stock-based compensation plans,
such as deferred compensation plans
and stock appreciation rights;
• Positions established to manage
equity market price risks connected
with certain business combinations,
such as a corporate merger or
consolidation or similar plan or
acquisition in which securities of a
person are exchanged for securities of
any other person (unless the sole
purpose of the transaction is to change
an issuer’s domicile solely within the
United States), or a transfer of assets of
a person to another person in
consideration of the issuance of
134 This condition does not mandate that an entity
follow a particular set of procedures to take
advantage of the exclusion. We would expect that
an entity that already engages in these types of risk
assessment procedures in connection with its
existing business activities to be able to rely on
those procedures to satisfy the condition. These
conditions also could be satisfied by the entity’s use
of a third-party to assist with these risk assessment
activities.
135 The references here to customers and
counterparties do not include swap or securitybased swap counterparties.
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securities of such other person or any of
its affiliates;
• Positions established by a bank to
manage counterparty risks in
connection with loans the bank has
made; and
• Positions to close out or reduce any
of those positions.
2. Request for Comments
We request comment on the proposed
definition of ‘‘hedging or mitigating
commercial risk’’ for purposes of both
the ‘‘major swap participant’’ and the
‘‘major security-based swap participant’’
definitions. Commenters particularly are
requested to address whether the
proposed definitions would adequately
limit the types of swaps or securitybased swaps that are encompassed by
the definition, such that the definitions
do not encompass positions that serve
speculative, trading or other nonhedging purposes. In this regard, do the
proposed definitions appropriately
exclude from the scope of the definition
swaps and security-based swaps that
would be less likely to pose risks to
counterparties and the market, by virtue
of gains or losses on those swaps being
offset by losses or gains associated with
an entity’s commercial operations?
Commenters further are requested to
address whether the proposed
‘‘economically appropriate’’ standard
would effectively limit the positions
encompassed by the definition. If not,
what alternative standards (e.g.,
standards derived from accounting
principles) would more effectively
identify hedging positions and
distinguish those from positions held
for other purposes? In that regard, is the
concept of ‘‘economically appropriate’’
well-understood, and, if not, is there
another concept that would more
effectively delimit the nature of the
relationship between the swap or
security-based swap position and the
risk being hedged or mitigated? Also, in
the context of the definition of this term
for purposes of security-based swaps,
should existing interpretive guidance
pertaining to the concept of
‘‘economically appropriate’’ with respect
to the CEA’s bona fide hedging
exemption for position limits be
considered, and, if so, to what extent?
We further request comment on possible
alternative approaches to the test
identifying positions entered into for the
purpose of hedging or mitigating
commercial risk. For example, should
the test require the entity excluding a
position to have a reasonable basis to
believe, and to actually believe, that the
excluded swap would be a ‘‘highly
effective,’’ ‘‘reasonably effective’’ or
‘‘economically appropriate’’ hedge of a
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specified commercial risk? Should the
test be generally identical to the
proposed test, but with the substitution
of the phrase ‘‘highly effective’’ or
‘‘reasonably effective’’ (or another
standard) for ‘‘economically
appropriate’’? Should the test be based
on accounting principles for hedging
treatment (i.e., a quantitative test
requiring the hedge to be within a
certain band of effectiveness)?
Commenters also are requested to
address the proposed restrictions on
positions in the nature of speculation or
trading. Is it appropriate not to permit
any speculative or trading positions
from being deemed for the purpose of
hedging or mitigating commercial risk?
What would be the impact of such an
interpretation on an entity’s risk
mitigation practices? Also, is the
dividing line between speculative and
trading positions on the one hand, and
positions eligible to be considered to be
hedging positions on the other hand,
sufficiently clear? Is such a line
appropriately based on whether the
position is intended to be held for the
short-term versus long-term intent?
Would some alternative criteria be
preferable in terms of setting forth
objective standards for identifying risk
reducing hedging positions and
distinguishing them from other
positions? Also, would additional
standards or other guidance be
appropriate to help ensure that
positions used in connection with
speculative or trading purposes do not
fall within the definition?
We further request comment on the
proposal that a swap or security-based
swap would not fall within the
definition of ‘‘hedging or mitigating
commercial risk’’ if it is held to hedge
or mitigate the risk of another swap or
security-based swap, unless that other
position itself is held for the purpose of
hedging or mitigating commercial risk.
One consequence of this approach
might be that a particular swap or
security-based swap hedging a
particular type of risk would be
included or excluded based solely on
whether that risk arises from another
swap or security-based swap or from a
different type of transaction.136 Is this
the appropriate approach? What would
be the consequences of this approach for
136 For example, under this proposal an entity
may exclude from the first major participant test a
security-based swap used to manage the credit risk
posed by a customer’s default in connection with
financing that an entity provides to that customer.
The entity may not exclude an identical securitybased swap, however, if that security-based swap is
used to hedge the credit risk associated with a
second swap or security-based swap that itself is
not for the purpose of hedging or mitigating
commercial risk.
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different types of entities? How would
the proposed approach affect the risk
management practices of entities that
are close to the proposed threshold? Is
it appropriate to include both positions
within the major participant
calculations? If this general approach in
the proposed rule were adopted, should
there be any exceptions to the
approach? What alternative approaches
might be considered? For example,
would it be appropriate to exclude a
swap or security-based swap that hedges
another swap or security-based swap
from the calculation? What would be
the advantages and disadvantages of this
approach?
Moreover, commenters are requested
to address whether the definition
should encompass a quantitative test
that would limit the total value of swaps
and security-based swaps that an entity
may include under this rule to be no
more than the total value of underlying
risk identified by such entity. If so, what
measurement should be used for
determining an entity’s total value of
swaps and security-based swaps and
total value of underlying risk, and what
methods or procedures should entities
be required to follow when calculating
and comparing the two values?
In addition, commenters are requested
to address whether the proposed
procedural requirements, in the context
of this definition for purposes of the
‘‘major security-based swap participant’’
analysis, are appropriate. In this regard,
commenters are requested to discuss
whether there are any advantages or
disadvantages to providing more
specific procedural requirements;
whether the proposed procedural
requirements will alter business
practices to the extent that a transition
period is necessary before they are
implemented; and whether specific
guidance is required to address how the
proposed procedural requirements will
affect existing positions. In addition,
commenters are requested to address
whether the proposed procedural
requirements should include a
requirement to quantify the underlying
risk and the effectiveness of the hedge,
and whether such quantitative
assessments would impose significant
systems costs or other costs. Also,
should an assessment of hedging
effectiveness be required at all, in light
of the costs that may be associated with
such a requirement?
More generally, would the proposed
standards for identifying positions for
the purpose of hedging or mitigating
commercial risk suffice to allow a
person holding a security-based swap
position to identify and document the
commercial risks that are being hedged
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or mitigated by that position, and if not,
what additional requirements are
needed? Should additional guidance be
provided regarding whether
components of risks (in assets, liabilities
or services) or whether risks in
portfolios (of assets, liabilities or
services) may be identified as the
commercial risks that are being hedged
or mitigated by the position, and, if so,
which components? Also, should
additional guidance be provided with
respect to the form of documentation or
the elements of the hedging relationship
that should be documented, and, if so,
which elements? Moreover, if a swap or
security-based swap that was hedging at
inception were no longer to serve a
hedging purpose over time, should it no
longer fall within the definition of
hedging or mitigating commercial risk?
In addition, should the rule specify
the frequency with which an entity
should assess the effectiveness of the
hedge? Also, should we provide
additional guidance on the acceptable
methods of assessing effectiveness? Is a
qualitative assessment adequate to
assess effectiveness or should a
quantitative assessment also be
required? Should the rule establish a
level of offset between the position and
the hedged risk, below which the
position would not be considered to be
effective at reducing risk, and, if so,
what is the level of offset (or range of
levels) below which the position should
not be considered to be effective? Are
there methods for assessing
effectiveness that should not be
permitted for these purposes?
Commenters also are requested to
address whether the proposal also
should encompass certain activities in
which an entity hedges an affiliate’s
risks.
We further request comment on how
the definition should apply to hedging
activities by financial entities.
Commenters particularly are invited to
address whether financial entities
should be able to rely on this exclusion,
or whether financial entities should face
special limits in the context of this
exclusion. Commenters further are
requested to address how the proposed
provisions excluding positions in the
nature of speculation or trading from the
definition would apply to activities by
banks, including permissible trading
activities by banks, and, in particular,
whether it is appropriate to exclude
positions that are part of an entity’s
‘‘trading book.’’
Commenters also are requested to
address the application of the proposal
to registered investment companies,
including whether additional guidance
would be appropriate with respect to
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80197
which uses of security-based swaps by
registered investment companies would
fall within the exclusion.
D. ‘‘Substantial Counterparty Exposure’’
The second test of the major
participant definitions addresses
entities whose swaps and security-based
swaps ‘‘create substantial counterparty
exposure that could have serious
adverse effects on the financial stability
of the United States banking system or
financial markets.’’ 137 Unlike the first
test of the major participant definitions,
this test does not focus on positions in
a ‘‘major’’ category of swaps or securitybased swaps. Also, unlike the first test,
this test does not explicitly exclude
hedging positions or certain ERISA plan
positions from the analysis.
Some commenters suggested that the
second major participant definition test
should be interpreted in a manner
similar to the first test. Many
commenters stated that the analysis
should also reflect netting agreements
and the posting of collateral. Some
commenters stated that the test should
exclude hedging positions, and cleared
positions.
We preliminarily believe that the
second major participant definition
test’s focus on the counterparty risk
associated with an entity’s swap or
security-based swap positions is similar
enough to the ‘‘substantial position’’
risks embedded in the first test that the
second test appropriately takes into
account the same measures of current
uncollateralized exposure and potential
future exposure that are used in our
proposal for the first test. For the second
test, however, the thresholds must focus
on the entirety of an entity’s swap
positions or security-based swap
positions, rather than on positions in
any specific ‘‘major’’ category. In
addition, this second test does not
explicitly account for positions for
hedging commercial risk or ERISA
positions.
Accordingly, these proposed
calculations of substantial counterparty
exposure would be performed in largely
the same way as the calculation of
substantial position in the first major
participant definition tests, except that
the amounts would be calculated by
reference to all of the person’s swap or
security-based swap positions, rather
than by reference to a specific ‘‘major’’
category of such positions.138
For purposes of the ‘‘major swap
participant’’ definition, the CFTC
137 See CEA section 1a(33)(A)(ii); Exchange Act
section 3(a)(67)(A)(ii)(II).
138 See proposed CEA rule 1.3(uuu)(2); proposed
Exchange Act rule 3a67–5(b)(1).
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proposes that the second major
participant definition test be satisfied by
a current uncollateralized exposure of
$5 billion, or a combined current
uncollateralized exposure and potential
future exposure of $8 billion, across the
entirety of an entity’s swap positions.139
For purposes of the ‘‘major securitybased swap participant’’ definition, the
SEC proposes that the second test be
satisfied by a current uncollateralized
exposure of $2 billion, or a combined
current uncollateralized exposure and
potential future exposure of $4 billion,
across the entirety of an entity’s
security-based swap positions.140 We
look forward to commenters’ views as to
whether alternative thresholds would be
more appropriate to achieve the
statutory goals.
These proposed thresholds in part are
based on the same factors that underpin
the proposed ‘‘substantial position’’
thresholds.141 The proposed thresholds,
however, also reflect the fact that this
test must account for an entity’s
positions across four major swap
categories or two major security-based
swap categories.142 These proposed
thresholds, moreover, have further been
raised to reflect the fact that this second
test (unlike the first major participant
test) encompasses certain hedging
positions that, in general, we would
expect to pose fewer risks to
counterparties and to the markets as a
whole than positions that are not for
purposes of hedging.
We request comment on this proposal.
Commenters particularly are requested
to address whether the proposed use of
current uncollateralized exposure and
potential future exposure tests
(including the parts of those tests that
account for positions that are cleared or
subject to mark-to-market margining) are
appropriate, and whether the proposed
thresholds are set at an appropriate
level. Should the thresholds be higher
or lower? If so, what alternative
threshold amounts would be more
appropriate, and why? Commenters also
are requested to address whether the
test should exclude commercial risk and
ERISA hedging positions, on the
grounds that those hedging positions
may not raise the same degree of risk to
counterparties as other swap or securitybased swap positions. Comments are
also requested on whether the test of
139 See
proposed CEA rule 1.3(uuu)(1).
proposed Exchange Act rule 3a67–5(a).
141 See notes 103 to 106 and 117, supra, and
accompanying text.
142 Thus, these proposed thresholds in part would
account for an entity that has large positions in
more than one major category of swaps or securitybased swaps, but that does not meet the substantial
position threshold for either.
140 See
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substantial counterparty exposure, given
its focus on the systemic risks arising
from the entirety of a person’s portfolio,
should include a measure to take into
account the person’s combined swap
positions and security-based swap
positions.
E. ‘‘Financial Entity’’ and ‘‘Highly
Leveraged’’
The third test of the major participant
definitions addresses any ‘‘financial
entity,’’ other than one subject to capital
requirements established by an
appropriate Federal banking agency,143
that is ‘‘highly leveraged relative to the
amount of capital’’ the entity holds, and
that maintains a substantial position in
a ‘‘major’’ category of swaps or securitybased swaps. This test does not permit
an exclusion for positions held for
hedging.
As discussed below, we are proposing
specific definitions of the terms
‘‘financial entity’’ and ‘‘highly
leveraged.’’ In addition, we request
comment on whether we should include
additional regulators within the
proposed interpretation of what is an
appropriate Federal banking agency.
1. Meaning of ‘‘financial entity’’
While the third major participant
definition test does not explicitly define
‘‘financial entity,’’ Title VII of the DoddFrank Act defines ‘‘financial entity’’ in
the context of the end-user exception
from mandatory clearing (an exception
that generally is not available to those
entities).144 Some commenters have
pointed out that using that definition
here would produce circular results.145
We preliminarily do not believe there
is a basis to define ‘‘financial entity’’ for
purposes of the major participant
definitions in a way that materially
differs from the definition used in the
end-user exception from mandatory
clearing. Using the same basic definition
also would appear to be consistent with
the statute’s intent to treat non-financial
end-users differently than financial
entities. Accordingly, other than
143 Sections 721 and 761 of the Dodd-Frank Act
add a definition of the term ‘‘appropriate Federal
banking agency’’ in sections 1a and 3(a) of the CEA
and the Exchange Act, respectively, 7 U.S.C. 1a(2),
15 U.S.C. 78c(a)(72). The Commissions propose to
refer to those statutory definitions for purposes of
the rules.
144 See CEA section 2(h)(7)(C)(i); Exchange Act
section 3C(g)(3)(A).
145 See Cleary letter (also addressing status of
broker-dealers and futures commission merchants
as part of the analysis).
The circularity would result because, for
purposes of the end-user clearing exception,
‘‘financial entity’’ is defined to include swap
dealers, security-based swap dealers, major swap
participants, and major security-based swap
participants.
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technical changes to avoid circularity,
we propose to use the same definition
in the major participant definitions.146
Commenters are requested to address
our proposed definition of ‘‘financial
entity.’’
2. Meaning of ‘‘Highly Leveraged’’
Some commenters have stated that the
term ‘‘highly leveraged’’ should be
interpreted by looking at the leverage
associated with other firms in an
entity’s line of business, rather than by
applying an across-the-board measure of
leverage.147 One commenter suggested
that higher leverage may be warranted
for entities with a smaller capital base,
and another commenter suggested that
we look at analogous banking
regulations rather than creating a new
regime for measuring leverage. Some
commenters suggested ways of
addressing specific items for purposes
of determining leverage.148
The Commissions recognize that
traditional balance sheet measures of
leverage have limitations as tools for
146 See proposed CEA rule 1.3(vvv)(1); proposed
Exchange Act rule 3a67–6(a). To avoid circularity,
the meaning of ‘‘financial entity’’ for purposes of the
‘‘major swap participant’’ definition would not
encompass any ‘‘swap dealer’’ or ‘‘major swap
participant’’ (but would encompass ‘‘security-based
swaps dealers’’ and ‘‘major security-based swap
participants’’). The meaning of ‘‘financial entity’’ for
purposes of the ‘‘major security-based swap
participant’’ definition would not encompass any
‘‘security-based swap dealer’’ or ‘‘major securitybased swap participant (but would encompass
‘‘swap dealers’’ and ‘‘major swap participants’’). For
both definitions, ‘‘financial entity’’ would include
any: commodity pool (as defined in section 1a(10)
of the CEA); private fund (as defined in section
202(a) of the Investment Advisers Act of 1940);
employee benefit plan as defined in paragraphs (3)
and (32) of section 3 of the Employee Retirement
Income Security Act of 1974; and person
predominantly engaged in activities that are in the
business of banking or financial in nature (as
defined in section 4(k) of the Bank Holding
Company Act of 1956).
147 See letter from Robert Pickel, Executive Vice
Chairman, International Swaps and Derivatives
Association, Inc., dated September 20, 2010
(suggesting that ‘‘leverage ratio limits to which
banks and other regulated entities are subject would
be unsuitably low for other enterprises’’); letter from
Steve Martinie, Assistant General Counsel and
Assistant Secretary, The Northwestern Mutual Life
Insurance Company, dated September 20, 2010
(‘‘Northwestern Mutual letter’’) (suggesting that
financial firms require less cushion than other
entities because financial firms are able to match
their assets and liabilities more closely).
148 See Northwestern Mutual letter (suggesting
that the Commissions recognize that liabilities such
as bank deposits and insurance policy reserves are
not leverage); Vanguard letter (suggesting that
leverage should relate to debt financing and should
not encompass potential leveraging effects posed by
derivatives); SIFMA AMG letter (suggesting that the
Commissions take into account the difference
between non-recourse and recourse obligations, the
difference between notional amounts payable and
actual payable obligations, and the difference
between actual financial obligations and leverage
embedded in a derivative that affects returns but
does not result in a payment obligation).
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evaluating an entity’s ability to meet its
obligations. In part this is because such
measures of leverage do not directly
account for the potential risks posed by
specific instruments on the balance
sheet, or financial instruments that are
held off of an entity’s balance sheet (as
may be the case with an entity’s swap
and security-based swap positions). At
the same time, we preliminarily do not
believe that it is necessary to use more
complex measures of risk-adjusted
leverage here, particularly given that the
third test in the major participant
definitions already addresses those
types of risks by considering whether an
entity has a substantial position in a
major category of swaps or securitybased swaps. We are also mindful of the
costs that entities would face if forced
to undertake a complex risk-adjusted
leverage calculation, especially for
entities that would not already be
performing this type of analysis.149
Additionally, we preliminarily do not
believe that it is necessary for the
leverage standard to account for the
degree of leverage associated with
different types of financial entities.
Although the third test of the major
participant definitions does not define
‘‘highly leveraged,’’ we note that
Congress addressed the issue of leverage
in Title I of the Dodd-Frank Act. There,
Congress provided that the Board of
Governors of the Federal Reserve
System must require a bank holding
company with total consolidated assets
equal to or greater than $50 billion, or
a nonbank financial company
supervised by the Board of Governors,
to maintain a debt to equity ratio of no
more than 15 to 1 if the FSOC
determines ‘‘that such company poses a
grave threat to the financial stability of
the United States and that the
imposition of such requirement is
necessary to mitigate the risk that such
149 The Basel Committee on Banking Supervision
recently proposed one method for calculating riskadjusted leverage in its Consultative Document
entitled: ‘‘Strengthening the resilience of the
banking sector’’ (Dec. 2009). This proposal would
create a new leverage ratio based on a comparison
of capital to total exposure. Total exposure for these
purposes would be measured by, among other
things, including the notional value of all written
credit protection, severely limiting the recognition
given to netting, and calculating the risks associated
with off-balance sheet derivatives transactions, as
measured by the current exposure method for
calculating future risks outlined in Basel II. The
Consultative Document drew over 150 comments
from the international financial community, which
included both those in support of, and those that
questioned the inclusion of a risk-adjusted leverage
ratio within the Basel framework. The Basel
Committee on Banking Supervision expects to
deliver a full package of reforms by the end of 2010,
based on the Consultative Document released in
December 2009 and comments received thereon.
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company poses to the financial stability
of the United States.’’ 150
This requirement in Title I suggests
potential alternative approaches to the
definition of ‘‘highly leveraged’’ for
purposes of the major participant
definitions. On the one hand, the 15 to
1 limit may represent an upper limit of
acceptable leverage, indicating that the
limit for the major participant
definitions should be lower so as to
create a buffer between entities at that
upper limit and entities that are not
highly leveraged. On the other hand, the
Title 1 requirement, which applies only
when the entity in question poses a
‘‘grave threat’’ to financial stability, may
indicate that the 15 to 1 leverage ratio
is also the appropriate test of whether
an entity poses the systemic risk
concerns implicated by the major
participant definitions.
For these reasons, we propose two
possible definitions of the point at
which an entity would be ‘‘highly
leveraged’’—either an entity would be
‘‘highly leveraged’’ if the ratio of its total
liabilities to equity is in excess of 8 to
1, or an entity would be ‘‘highly
leveraged’’ if the ratio of its total
liabilities to equity is in excess of 15 to
1. In either case, the determination
would be measured at the close of
business on the last business day of the
applicable fiscal quarter. To promote
consistent application of this leverage
test, entities that file quarterly reports
on Form 10–Q and annual reports on
Form 10–K with the SEC would
determine their total liabilities and
equity based on the financial statements
included with such filings.151 All other
entities would calculate the value of
total liabilities and equity consistent
with the proper application of U.S.
generally accepted accounting
principles.
We believe that the 15 to 1 ratio could
be consistent with the use of that ratio
in Title I, which, as noted above,
provides that the 15 to 1 leverage ratio
would be applied to a bank holding
company or nonbank financial company
subject to Title I as a maximum only if
it is determined that the company poses
a ‘‘grave threat’’ to financial stability.
Commenters are requested to address
whether the proposed 15 to 1 standard
used in Title I suggests that a standard
higher than 15 to 1 should be used here,
given that the Title I standard is
applicable only to large entities that also
pose a ‘‘grave threat’’ to financial
150 See
Dodd-Frank Act section 165(j)(1).
entities would include those that
submit periodic reports on a voluntary basis to the
SEC, as well as those that are required to file
periodic reports with the SEC.
151 These
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stability and thus may suggest that a
higher standard is appropriate for
entities that do not pose the same degree
of threat. Alternatively, the 8 to 1 ratio
could be consistent with the exemption
in the third test of the major participant
definitions for financial institutions that
are subject to capital requirements set
by the Federal banking agencies, as it is
possible that financial institutions were
specifically excluded from the third test
based on the presumption that they
generally are highly leveraged, and
hence would have been covered by the
third test if they were not expressly
exempted. Based on our analysis of
financial statements it appears that
those institutions generally have
leverage ratios of approximately 10 to 1,
which may suggest that the ‘‘highly
leveraged’’ threshold would have to be
lower for those institutions to be
potentially subject to the third test.
Such an approach would help to ensure
that the third test of the major
participant definition applies to
financial entities that are not subject to
capital requirements set by the Federal
banking agencies, but that have leverage
ratios similar to institutions that are
subject to those requirements.
The Commissions request comment
on the proposed alternative definitions
of ‘‘highly leveraged.’’ Commenters
particularly are requested to specifically
address the relative merits of the
proposed alternative 8 to 1 and 15 to 1
standards, as well as other standards
that they believe would be appropriate
for these purposes.152
Commenters further are requested to
address whether a risk-adjusted leverage
ratio should be used, and, if so, how the
ratio should be calculated (including
whether particular items should be
included or excluded when making this
calculation), and whether a riskadjusted leverage ratio could be
developed relying on measures already
152 In this regard, we recognize that under
Exchange Act rule 15c3–1, a broker-dealer may
determine its required minimum net capital, among
other ways, by applying a financial ratio that
provides that its aggregate indebtedness shall not
exceed 1500% of its net capital (i.e., a 15 to 1
aggregate indebtedness to net capital ratio).
Exchange Act Rule 17a–11 further requires that
broker-dealers that use such method to establish
their required minimum net capital must provide
notice to regulators if their aggregate indebtedness
exceeds 1200% of their net capital (i.e., a 12 to 1
aggregate indebtedness to net capital ratio). We
recognize that these measures, however, reflect a
different ratio of total liabilities to equity; for
example, the calculation of aggregate indebtedness
in rule 15c3–1 excludes certain liabilities, and the
calculation of net capital includes certain
subordinated debt—meaning that these measures
would respectively be equivalent to ratios higher
than 15:1 or 12:1 when converted to a balance sheet
ratio of liabilities to equity such as that used under
the proposed rule.
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calculated by entities as a matter of
course.153 Commenters further are
requested to address whether the
leverage ratio should be revised to
require that the amount of potential
future exposure (as outlined in the
‘‘substantial position’’ discussion above)
be combined with total liabilities before
such number is compared to equity for
purposes of calculating the ratio, and, if
so, whether the proposed ratios would
still be appropriate; whether the rule
should more specifically address issues
as to how certain types of positions or
liabilities should be accounted for when
calculating leverage; whether the
proposed timing of the measurement—
the close of business on the last
business day of the applicable fiscal
quarter—would be potentially subject to
gaming or evasion; and whether the rule
text should particularly prescribe how
separate categories of entities calculate
leverage.
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F. Implementation Standard,
Reevaluation Period and Minimum
Duration of Status
While the analysis of whether an
entity is a major participant is backward
looking, an entity that meets the criteria
for being a major participant is required
to register with the CFTC and/or the
SEC, and comply with the requirements
applicable to major participants. We
recognize that these entities will need
time to complete their applications for
registration and to come into
compliance with the applicable
requirements. We thus propose that an
unregistered entity that meets the major
participant criteria as a result of its
swap or security-based swap activities
in a fiscal quarter would not be deemed
to be a major participant until the earlier
of the date on which it submits a
complete application for registration
pursuant to CEA Section 4s(b) or
Exchange Act Section 15F(b), or two
months after the end of that quarter.154
We preliminarily believe that this
would provide entities with an
appropriate amount of time to apply for
registration and, with the time between
the submission of an application and
the effectiveness of the registration, to
comply with the requirements
applicable to major participants,
without permitting undue delay.
153 For example, would adjustments akin to those
discussed above in the context of broker-dealer net
capital provide a more useful measure of leverage
for these purposes?
154 See proposed CEA rule 1.3(qqq)(4)(i);
proposed Exchange Act rule 3a67–7(a). The
Commissions are proposing separate rules regarding
the registration requirements and processes for
major participants.
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We also propose to provide a
reevaluation for entities that meet one or
more of the applicable major participant
thresholds, but only by a modest
amount.155 In particular, an
unregistered entity that has met these
criteria as a result of its swap or
security-based swap activities in a fiscal
quarter, but without exceeding any
applicable threshold by more than
twenty percent, would not immediately
be subject to the timing requirements
discussed above. Instead, that entity
would become subject to those
requirements if the entity exceeded any
of the applicable daily average
thresholds in the next fiscal quarter.156
We preliminarily believe this type of
reevaluation period would avoid
applying the major participant
requirements to entities that meet the
major participant criteria for only a
short time due to unusual activity.
In addition, we propose that any
entity that is deemed to be a major
participant would retain that status
until such time that it does not exceed
any of the applicable thresholds for four
consecutive quarters after the entity
becomes registered.157 Commentators
raised concerns about the possibility of
entities moving in and out of the status
on a rapid basis,158 and we believe that
this proposal appropriately addresses
that concern in a way that would help
promote the predictable application and
enforcement of the requirements
governing major participants.
The Commissions request comment
on these proposals. Commenters
particularly are requested to address:
Whether two months is an adequate
amount of time for entities that have
met the criteria to submit an application
for registration; whether there is an
adequate amount of time to make the
necessary internal changes to come into
compliance with the requirements
applicable to major participants before
being subject to those requirements as a
result of a registration becoming
effective; whether twenty percent is the
appropriate threshold for applicability
155 Commenters raised concerns over an entity
qualifying as a major participant due to an unusual
event. See, e.g., letter from American Benefits
Council and Committee on the Investment of
Employee Benefit Assets, dated September 20, 2010
(stating that quirky volatility may affect the
determinations).
156 See proposed CEA rule 1.3(qqq)(4)(ii);
proposed Exchange Act rules 3a67–7(b).
157 See proposed CEA rule 1.3(qqq)(5); proposed
Exchange Act rules 3a67–7(c)(1).
158 See Vanguard letter (suggesting that entities
should remain in the status after qualification for
an extended defined period such as one calendar
year); AIMA letter (noting that recategorization of
entities could be disruptive for entities’ business
models and could be administratively burdensome
for the Commissions).
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of the reevaluation period; whether
there would be any risks arising from
delaying registration as a major
participant for an entity that exceeds the
thresholds, but qualifies for the
reevaluation period; and whether four
consecutive quarters of not meeting the
criteria for major participant status after
registration is granted is the appropriate
amount of time that a major participant
should be required to stay in the status.
In addition, we request comment on
the appropriateness of the proposed
reevaluation period. Commenters
particularly are requested to address
whether it is likely that unusual market
conditions could cause an entity to
exceed the proposed thresholds over the
course of a quarter (based on a daily
average) without generally raising the
types of risks that the thresholds were
intended to identify. Also, should the
use of the reevaluation period be
conditioned on requiring any entity
relying on the reevaluation period to
make a representation, or otherwise
demonstrate, that it exceeded the
threshold due to a one-time
extraordinary event, and that it will be
below the threshold at the next time of
measurement?
G. Limited Purpose Designations
In general, a person that meets the
definition of major participant will be
considered to be a major participant
with respect to all categories of swaps
or security-based swaps, as applicable,
and with regard to all activities
involving those instruments.159 As
discussed above, however, the statutory
definitions provide that a person may be
designated as a major participant for one
or more categories of swaps or securitybased swaps without being classified as
a major participant for all categories.160
Thus, as with the definitions of ‘‘swap
dealer’’ and ‘‘security-based swap
dealer,’’ we propose to provide that
major participants who engage in
significant activity with respect to only
certain types, classes or categories of
swaps or security-based swaps may
apply for relief with respect to other
types of swaps or security-based swaps
from certain of the requirements that are
applicable to major participants. The
Commissions anticipate that a major
participant could seek a limited
designation at the same time as, or at a
later time subsequent to, the person’s
initial registration as a major
participant. Because of the variety of
situations in which major participants
159 See proposed CEA rule 1.3(qqq)(2); proposed
Exchange Act rule 3a67–1(c).
160 CEA section 1a(33)(C); Exchange Act section
3(a)(67)(C).
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may enter into swaps or security-based
swaps, it is difficult to set out at this
time the conditions, if any, which
would allow a person to be designated
as a major participant with respect to
only certain types, classes or categories
of swaps or security-based swaps.
The Commissions request comment
on the proposed rules regarding limited
designation as a major participant.
Commenters particularly are requested
to address the circumstances in which
such limited purpose designations
would be appropriate, and to address
the factors that the Commissions should
consider when addressing such
requests, and the type of information
requestors should provide in support of
their request. Commenters also are
asked to address whether such limited
purpose designations should be
conditioned in any way, such as by the
provision of information of the type that
would be required with respect to an
entity’s swaps or security-based swaps
involving the particular category or
activity for which they are not
designated as a major participant.
emcdonald on DSK2BSOYB1PROD with PROPOSALS2
H. Additional Interpretive Issues
Commenters have raised additional
issues related to the major participant
definitions.
1. Exclusion for ERISA Plan Positions
As discussed above, the first test of
the major participant definitions
excludes from the analysis ‘‘positions
maintained by any employee benefit
plan (or any contract held by such a
plan) as defined in paragraphs (3) and
(32) of section 3 of ERISA (29 U.S.C.
1002) for the primary purpose of
hedging or mitigating any risk directly
associated with the operation of the
plan.’’ Some commenters suggested that
the exclusion should encompass
activities such as portfolio rebalancing
and diversification, and gaining
exposure to alternative asset classes,
and that this type of exclusion also
should apply to certain other types of
entities.161
We preliminarily do not believe that
it is necessary to propose a rule to
further define the scope of this
exclusion. In this regard, we note that
this ERISA plan exclusion, unlike the
other exclusion in the first major
participant test, is not limited to
‘‘commercial’’ risk, which may be
construed to mean that hedging by
161 See Cleary letter (addressing welfare plans or
entities holding assets of such plans, such as
voluntary employee beneficiary associations,
employer group trusts or bank-maintained
collective trusts); see also letter from Jane Hamblen,
State of Wisconsin Investment Board, dated
September 20, 2010.
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ERISA plans should be broadly
excluded.
While the Commissions are not
proposing to make this type of exclusion
available to additional types of entities,
we request comment on whether we
should do so. If so, what type of entities
should receive this type of exclusion,
and why do the concerns that led to the
enactment of the major participant
requirements in the Dodd-Frank Act not
apply to such entities?
2. Application of Major Participant
Definitions to Managed Accounts
Some commenters have stated that
asset managers and investment advisers
should not be deemed to be major
participants by virtue of the swap and
security-based swap positions held by
the accounts they manage. These
commenters have emphasized that asset
managers and investment advisers are
separate legal entities from the accounts
that they administer, the accounts
themselves are the counterparties to the
swaps and security-based swaps, and
managers and advisers do not maintain
capital to support the trades of their
clients. One commenter also expressed
the view that the positions of individual
accounts under the advisement of a
single asset manager should not be
aggregated for the purpose of the major
participant definitions because different
accounts managed by an asset manager
may use the same positions for different
purposes.162
Preliminarily, we do not believe that
the major participant definitions should
be construed to aggregate the accounts
managed by asset managers or
investment advisers to determine if the
asset manager or investment adviser
itself is a major participant. The major
participant definitions apply to the
entities that actually ‘‘maintain’’
substantial positions in swaps and
security-based swaps or that have swaps
or security-based swaps that create
substantial counterparty exposure. The
Commissions have the authority to
adopt anti-evasion rules to address the
possibility that persons who enter into
swaps and security-based swaps may
attempt to allocate the swaps and
security-based swaps among different
accounts (thereby attempting to treat
162 In addition, a colloquy on the Senate floor
addressed the status of managed accounts for
purposes of the major participant definitions,
particularly focusing on whether the analysis
should ‘‘look at the aggregate positions of funds
managed by asset managers or at the individual
fund level?’’ In response, it was stated that, ‘‘[a]s a
general rule, the CFTC and the SEC should look at
each entity on an individual basis when
determining its status as a major swap participant.’’
See 156 Cong. Rec. S5907 (daily ed. July 15, 2010)
(colloquy between Senators Hagan and Lincoln).
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such other accounts as the entity that
has entered into the swaps or securitybased swaps) for the purpose of evading
the regulations applicable to major
participants.163 In addition, we note that
since the major participant definitions
focus on the entity that enters into
swaps or security-based swaps, all of the
managed positions of which a person is
the beneficial owner are to be aggregated
(along with such beneficial owner’s
other positions) for purposes of
determining whether such beneficial
owner is a major participant.164
The Commissions request comment
on the application of the major
participant definitions to managed
accounts. Commenters particularly are
requested to address: whether
additional guidance is necessary to
address issues relating to the
application of the major participant
definition to managed accounts;
whether there are areas of potential
abuse, and if so, what they may be.
Commenters further are requested to
address whether the Commissions
should adopt anti-evasion rules to
address areas of potential abuse, and if
so, how such rules should be crafted.
In addition, commenters are requested
to discuss any implementation concerns
that may arise if the beneficial owner of
a managed account meets one of the
major participant definitions; for
example, would the beneficial owner
face any impediments in terms of
identifying whether it falls within the
major participant definitions? Also,
what implementation issues would arise
with respect to applying the major
participant definitions to managed
accounts and/or their beneficial owners
if the accounts’ advisers or managers are
not subject to regulation as major
participants?
3. Application of Major Participant
Definitions to Positions of Affiliated
Entities
The issues discussed above with
regard to managed accounts also are
related to the separate issue of whether
the major participant tests should, in
some circumstances, aggregate the swap
and security-based swap positions of
entities that are affiliated. Absent that
type of aggregation, an entity could seek
to evade major participant status by
allocating swap or security-based swap
163 See Dodd-Frank Act sections 721(b)(2),
761(b)(3).
164 This guidance relates only to the application
of the major participant definitions to managed
accounts. It is not intended to apply to the
treatment of managed accounts with respect to any
other rules promulgated by the CFTC or SEC to
implement Title VII of the Dodd-Frank Act or to any
other applicable rules or requirements.
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positions among a number of affiliated
entities.
In situations in which a parent is the
majority owner of a subsidiary entity,
we preliminarily believe that the major
participant tests may appropriately
aggregate the subsidiary’s swaps or
security-based swaps at the parent for
purposes of the substantial position
analyses.165 Attributing those positions
to a parent appears consistent with the
concepts of ‘‘substantial position’’ and
‘‘substantial counterparty exposure,’’
given that the parent would effectively
be the beneficiary of the transaction. In
those circumstances, however, there
still may be questions as to whether the
requirements applicable to major
participants—e.g., capital, margin and
business conduct—should be placed
upon the parent or the subsidiary. We
recognize that it may be appropriate at
times to apply such requirements upon
the subsidiary to the extent that the
subsidiary is acting on behalf of the
parent.166
Commenters particularly are invited
to discuss when it would be appropriate
to apply the major participant
definitions to entities that are the
majority owner of subsidiaries that enter
into swaps or security-based swaps, or
whether attribution of a subsidiary’s
security-based swap positions is
generally inappropriate. Also, to the
extent this type of attribution is
appropriate, to what extent should the
subsidiary retain responsibilities for
complying with the capital, margin,
business conduct and other
requirements applicable to major
participants?
Commenters further are requested to
address whether the swaps or securitybased swaps of corporate subsidiaries in
some circumstances should be
attributed to an entity that itself is not
the majority owner of the direct
counterparty to a swap or security-based
swap. Moreover, should this type of
attribution apply when one entity
controls another entity, and, if so, how
should the concept of control be defined
for these purposes? In addition,
commenters are requested to address
whether, as an alternative approach, this
type of attribution would be appropriate
specifically when a parent provides
guarantees on behalf of its subsidiaries,
165 Arguably, the basis for this type of attribution
would be even stronger if the parent wholly owns
the subsidiary. An attribution rule that only
addresses 100 percent ownership situations,
however, may readily be susceptible to gaming if
the parent were to sell a very small interest in the
subsidiary to another party.
166 It may also be appropriate to address these
issues in connection with the rule proposals
addressing the substantive requirements applicable
to major participants.
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or third parties provide guarantees on
behalf of unaffiliated entities.
Commenters further are requested to
address any issues that would arise with
regard to the effective implementation
of the requirements applicable to major
participants in the context of this type
of attributions.
4. Application of Major Participant
Definitions to Inter-Affiliate Swaps and
Security-Based Swaps
Several commenters have suggested
that swaps and security-based swaps
between affiliated counterparties should
not be considered within the analysis of
whether an entity’s swap or securitybased swap positions cause it to be a
major participant. Such inter-affiliate
swaps and security-based swaps may be
used to achieve various operational and
internal efficiency objectives.
The Commissions preliminarily
believe that when a person analyzes its
swap or security-based swap positions
under the major participant definitions,
it would be appropriate for the person
to consider the economic reality of any
swaps or security-based swaps it enters
into with wholly owned affiliates,
including whether the swaps and
security-based swaps simply represent
an allocation of risk within a corporate
group.167 Such swaps and securitybased swaps among wholly-owned
affiliates may not pose the exceptional
risks to the U.S. financial system that
are the basis for the major participant
definitions. As discussed above in the
context of managed accounts, however,
an entity would not be able to evade the
requirements applicable to major
participants by allocating among
multiple affiliates swap or securitybased swap positions of which it is the
beneficial owner.
The Commissions request comment
on the treatment of inter-affiliate swaps
and security-based swaps between
wholly-owned affiliates of the same
corporate parent in connection with the
major participant definitions.
Commenters also are requested to
address whether similar interpretations
should apply to swaps and securitybased swaps between entities within a
consolidated group as determined in
accordance with U.S. generally accepted
accounting principles. Commenters
further are requested to discuss whether
the major participant definition should
be interpreted to encompass an entity
167 Such swaps and security-based swaps should
be considered in this way only for purposes of
determining whether a particular person is a major
participant. The swaps and security-based swaps
would continue to be subject to all laws and
requirements applicable to such swaps and
security-based swaps.
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(including an affiliate of the named
counterparty to the swap or securitybased swap) that provides a guarantee of
the named counterparty’s obligations,
either in the form of a guarantee or
through some other form of credit
support whereby the guarantor agrees to
satisfy margin obligations of the named
counterparty and/or periodic payment
obligations of the named counterparty.
5. Legacy Portfolios
Some commenters have stated that
certain entities that maintain legacy
portfolios of credit default swaps that
previously had been entered into in
connection with the activities of
monoline insurers and ‘‘credit derivative
product companies’’ should not be
considered major participants. The
commenters argued that these entities
would be unable to comply with the
capital and margin requirements
applicable to major participants, and
that regulation as major participants is
unnecessary given that the entities are
not writing any additional swaps or
security-based swaps.
We request comment on whether the
rules further defining major swap
participant and major security-based
swap participant should exclude such
entities from the major participant
definition if their swap and securitybased swap positions are limited to
those types of legacy positions. The
exclusion from the definition could be
conditional, and any such excluded
entity would be required to provide the
Commissions with position information
of the type that registered major
participants would be required to
provide. We invite comment on any
other conditions that might be
appropriate to an exclusion of such
legacy portfolios from the major
participant definitions.
6. Potential Exclusions
Some commenters stated that the
major participant definitions should not
be interpreted to apply to entities such
as investment companies,168 ERISA
plans, registered broker-dealers and/or
registered futures commission
168 See letter from Karrie McMillan, General
Counsel, Investment Company Institute, dated
September 20, 2010 (registered investment
companies should be excluded from the major
participant (and dealer) definitions, or else the
terms of the definitions should be interpreted to
clarify that mutual funds generally will not be
major participants).
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merchants,169 and long-term investors
such as sovereign wealth funds.170
These comments, and the rationale
behind the comments, raise the issue of
whether we should exclude,
conditionally or unconditionally,
certain types of entities from the major
participant definitions, on the grounds
that such entities do not present the
risks that underpin the major
participant definitions and/or to avoid
duplication of existing regulation. While
we are not proposing any such
exclusions, we request comment as to
whether we should exclude certain
types of entities, including those noted
above, as well as to entities subject to
bank capital rules, State-regulated
insurers, private and State pension
plans, and registered derivatives
clearing organizations or clearing
agencies.
Commenters particularly are
requested to address whether such
exclusions are necessary and
appropriate in light of the proposed
rules that would be applicable to major
participants, whether any conditions
would be appropriate for such
exclusions, and whether modifying
those proposed rules would more
effectively address these issues than
granting specific exclusions from the
major participant definitions for specific
types of entities. Commenters also are
particularly requested to discuss
whether banks should be excluded from
the major participant definitions
because of the regulation to which they
already are subject. Commenters also are
requested to discuss whether registered
investment companies should be
excluded from the major participant
definitions because of the regulations to
which they already are subject, and
whether registered investment
companies would be able to comply
with capital and margin requirements
applicable to major participants.
Commenters also particularly are
requested to address whether sovereign
wealth funds or other entities linked to
foreign governments should be excluded
169 See letter from The Swaps & Derivatives
Marketing Ass’n, dated September 20, 2010 (certain
hedged positions of broker-dealers and futures
commission merchants with customers should not
be considered as part of the substantial position
analysis); Cleary letter (registered and wellcapitalized broker-dealers and futures commission
merchants should not fall within the scope of the
third major participant test).
170 See letter from Lee Ming Chua, General
Counsel, Government of Singapore Investment
Corp., dated September 20, 2010 (stating that the
major participant definitions were not intended to
apply to long-term financial investors); see also
letter from Richard M. Whiting, The Financial
Services Roundtable, dated September 20, 2010
(major participant definitions should exclude firms
that solely act as investors).
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from the major participant definitions,
particularly in light of the provisions of
the Dodd-Frank Act governing its
territorial reach, and whether the
answer in part should be determined
based on whether the entity’s
obligations are backed by the full faith
and credit of the foreign government.
V. Administrative Law Matters—CEA
Revisions (Definitions of ‘‘Swap Dealer’’
and ‘‘Major Swap Participant,’’ and
Amendments to Definition of ‘‘Eligible
Contract Participant’’)
A. Regulatory Flexibility Act
The Regulatory Flexibility Act
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.171 The rules proposed by the
CFTC provide definitions that will
largely be used in future rulemakings
and which, by themselves, impose no
significant new regulatory requirements.
Accordingly, the Chairman, on behalf of
the CFTC, hereby certifies pursuant to 5
U.S.C. 605(b) that the proposed rules
will not have a significant economic
impact on a substantial number of small
entities.
B. Paperwork Reduction Act
The proposed rule will not impose
any new recordkeeping or information
collection requirements, or other
collections of information that require
approval of the Office of Management
and Budget under the Paperwork
Reduction Act.172 The CFTC invites
public comment on the accuracy of its
estimate that no additional
recordkeeping or information collection
requirements or changes to existing
collection requirements would result
from the rules proposed herein.
C. Cost-Benefit Analysis
Section 15(a) of the CEA 173 requires
the CFTC to consider the costs and
benefits of its actions before issuing a
rulemaking under the CEA. By its terms,
Section 15(a) does not require the CFTC
to quantify the costs and benefits of a
rule or to determine whether the
benefits of the rulemaking outweigh its
costs; rather, it requires that the CFTC
‘‘consider’’ the costs and benefits of its
actions. Section 15(a) further specifies
that the costs and benefits shall be
evaluated in light of five broad areas of
market and public concern: (1)
Protection of market participants and
171 5
U.S.C. 601 et seq.
U.S.C. 3501 et seq.
173 7 U.S.C. 19(a).
172 44
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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 CFTC may in its
discretion give greater weight to any one
of the five enumerated areas and could
in its discretion determine that,
notwithstanding its costs, a particular
rule is necessary or appropriate to
protect the public interest or to
effectuate any of the provisions or
accomplish any of the purposes of the
CEA.
1. Summary of Proposed Requirements
The proposed regulations would
further define the terms ‘‘swap dealer,’’
‘‘eligible contract participant,’’ ‘‘major
swap participant,’’ and related terms,
including ‘‘substantial position’’ and
‘‘substantial counterparty exposure.’’
The proposed regulations regarding
eligible contract participants are
clarifying changes that are not expected
to have substantive effects on market
participants. The proposed regulations
further defining swap dealer and major
swap participant are significant because
any entity determined to be a swap
dealer or major swap participant would
be subject to registration, margin,
capital, and business conduct
requirements set forth in the DoddFrank Act, as those requirements are
implemented in rules proposed or to be
proposed by the CFTC. Those
requirements will likely lead to
compliance costs, capital holding costs,
and margin posting costs, which have
been or will be addressed in the CFTC’s
proposals to implement those
requirements. On the other hand, those
requirements will likely lead to benefits
in the form of increased market
transparency, reduced counterparty risk
and a lower incidence of systemic crises
and other market failures. This
discussion concerns the costs and
benefits arising from the proposed
definitional tests themselves, in terms of
the burden on market participants to
determine how the proposed definitions
apply, and the benefits arising from the
specificity of the proposals.
2. Proposed Regulations Regarding
‘‘Eligible Contract Participant’’
The proposal regarding ‘‘eligible
contract participant’’ would provide that
swap dealers and major swap
participants would qualify as eligible
contract participants. The CFTC
believes this proposal is in line with the
expectations of market participants and
would impose virtually no costs while
providing the benefit of greater
certainty. The proposal would also
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provide that certain commodity pools
could not qualify as eligible contract
participants under certain provisions
specified in the proposal. The CFTC
believes that this proposal clarifies the
interpretation of this aspect of the
eligible contract participant definition
and would prevent the commodity
pools from using a provision of the
definition that was not intended to
apply to the commodity pools. Thus,
while the proposal would potentially
impose some costs on the commodity
pools that could no longer rely on
certain provisions of the definition,
benefits would arise from preventing the
misinterpretation of the definition.
emcdonald on DSK2BSOYB1PROD with PROPOSALS2
3. Proposed Regulations Regarding
‘‘Swap Dealer’’
The proposal regarding ‘‘swap dealer’’
would further define the term by
providing that any person that engages
in specified activities is a swap dealer.
The proposal describes these activities
qualitatively and in relatively general
terms that apply in the same way to all
parts of the swap markets. With regard
to the de minimis exemption from the
definition, the proposal sets out brightline quantitative tests to determine if a
person’s swap dealing activity is de
minimis. For the exclusion of swaps in
connection with originating a loan by an
insured depository institution, the
proposal describes the scope of the
exclusion qualitatively in terms that
depend primarily on the terms of the
swaps that would be eligible for the
exclusion and the identity of the parties
to the swap. Also, the proposal includes
a voluntary process by which a swap
dealer may request that the CFTC limit
the swap dealer designation to certain
aspects of the person’s activity.
a. Costs
The costs to a market participant from
the proposed regulations further
defining ‘‘swap dealer’’ would arise
primarily from its need to review its
activities and determine, as a qualitative
matter, whether its activities are of the
type described in the proposal. As its
activities change from time to time, it
would be necessary to repeat this
review, and ongoing compliance costs
may arise if the market participant
determines that it should adapt its
activities so as to not be encompassed
by the definition. Because the proposed
regulations are qualitative and on
relatively general terms, there may be
multiple interpretations of the general
criteria by market participants. A market
participant whose activities fall within
the realm of those described in the
proposal may have to incur the costs of
a more focused review to determine
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whether or not it is encompassed by the
definition.
The proposal regarding the de
minimis exemption, on the other hand,
would impose lower costs because of
the precise, quantitative nature of the
proposed exemption. A market
participant would incur only the cost of
determining the applicable quantities,
such as notional value, number of
swaps, number of counterparties, and so
forth set out in the proposal. The CFTC
believes that relatively few market
participants would have to determine
whether the de minimis exemption
applies to their activities, and there
would be only a low number of
instances where application of the
quantitative tests would be uncertain.
Similarly, the CFTC believes that
insured depository institutions would
incur relatively low costs to apply the
proposed exclusion of swaps in
connection with originating loans
because the proposed criteria relate to
matters in which the institution is
directly involved.
Last, the costs of the voluntary
process for a request for a limited
designation as a swap dealer are
difficult to predict because they would
depend on the complexity of the person
making the request and the particular
factors that are relevant to the limited
designation. The CFTC believes that the
person making the request would have
broad discretion in determining how to
do so and thereby could control the
costs of the request to some extent.
b. Benefits
The benefits of the proposed
regulations further defining ‘‘swap
dealer’’ include that they set out a single
set of criteria to be applied by all market
participants. Thus, the proposed
regulations create a level playing field
that permits all market participants to
determine, on an equal basis, which
activities would potentially lead to
designation as a swap dealer. The
proposed regulations are set out in plain
language terms that may be understood
and applied by all market participants
without relying on the technical
expertise that may be required to
implement more elaborate tests. The
CFTC believes that the proposal can be
fairly applied by substantially all market
participants who could potentially be
swap dealers.
Regarding the proposals regarding the
de minimis exemption and the
exclusion of swaps in connection with
the origination of loans, benefits arise
from the relatively specific, quantitative
nature of the proposals. Since these
proposals are expected to be applied by
relatively few market participants in
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limited situations, more detailed
regulations are appropriate. The CFTC
believes that these detailed criteria will
permit market participants to make a
relatively quick and low-cost
determination of whether the exemption
or exclusion apply. The proposal for
requests for a limited swap dealer
designation provides the benefit of
flexibility to allow each market
participant making this request to
determine how to do so.
4. Proposed Regulations Regarding
‘‘Major Swap Participant’’
The proposal regarding ‘‘major swap
participant’’ would further define the
term by setting out quantitative
thresholds against which a market
participant would compare its swap
activities to determine whether it is
encompassed by the definition. The
proposal would require that potential
major swap participants analyze their
swaps in detail to determine, for
example, which of their swaps are
subject to netting agreements or markto-market collateralization and the
amount of collateral posted with respect
to the swaps. The proposal includes a
general, qualitative definition of the
swaps that may be excluded from the
comparison because they are used to
‘‘hedge or mitigate commercial risk.’’
Like the swap dealer proposal, there is
a voluntary process by which a major
swap participant may request that the
CFTC limit the major swap participant
designation to certain aspects of the
person’s activity.
a. Costs
The costs to a market participant from
the proposed regulations further
defining ‘‘major swap participant’’
would arise primarily from its need to
analyze its swaps and determine
whether it has a ‘‘substantial position’’ or
‘‘substantial counterparty exposure’’ as
defined in the proposal. The proposed
rule defines potential future exposure
by a factor of the dollar notational value
of the swap. The Commission also
considered market-based tests of
potential future exposure such as
margin requirements or other valuations
of the outstanding position. The
Commission decided in favor of a more
easily implementable test rather than
market-based criteria for potential future
exposure, given that daily variation in
market prices is captured by the current
exposure calculation. The CFTC
believes that because the proposed
quantitative thresholds are high, only
very few market participants would
have to conduct a detailed analysis to
determine whether they are
encompassed by the proposed
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definition. The cost of the detailed
analysis would vary for each market
participant, depending on the particular
characteristics of its swaps. Similarly,
the costs to a market participant of
determining whether it uses swaps to
hedge or mitigate commercial risk
would depend on how the market
participant uses swaps. It is possible
that for some market participants with
complex positions in swaps, the costs of
the analysis could be relatively high.
As is the case for the similar proposal
regarding swap dealers, the costs of the
voluntary process for a request for a
limited designation as a major swap
participant are difficult to predict
because they would depend on the
complexity of the particular case. The
CFTC believes that the person making
the request would have broad discretion
in determining how to do so and
thereby could control the costs of the
request to some extent.
emcdonald on DSK2BSOYB1PROD with PROPOSALS2
b. Benefits
The benefits of the proposed
regulations further defining ‘‘major swap
participant’’ include that they set out a
quantitative, bright-line test that can be
applied at a relatively low cost. Also,
the definition of ‘‘hedging or mitigating
commercial risk’’ is stated in general
terms that may be flexibly applied by
potential major swap participants. In
preparing this proposal, the CFTC
considered other methods of defining
‘‘major swap participant,’’ including
multi-factor analyses, stress tests and
adversary processes. The CFTC believes
that these other methods would impose
significantly higher costs for both the
market participants that would have to
apply them and for the CFTC (and,
indirectly, the taxpayer), without
providing additional benefits. The costs
would result primarily from the need to
retain qualified experts who would
devote significant time and other
resources to a detailed analysis of
multiple aspects of the potential major
swap participant’s swap positions. The
benefits that could justify more costly
proposals include reductions in
arbitrary differences in results and
greater consistency and predictability.
However, other potential methods of
further defining ‘‘major swap
participant’’ do not appear likely to
provide such benefits to an extent that
would justify the higher costs.
5. Request for Comment
The CFTC invites public comment on
its cost-benefit considerations.
Commenters are also invited to submit
any data or other information that they
may have quantifying or qualifying the
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costs and benefits of the proposed rules
with their comments.
D. Consideration of Impact on the
Economy
For purposes of the Small Business
Regulatory Enforcement Fairness Act of
1996 (‘‘SBREFA’’) 174 the CFTC must
advise the Office of Management and
Budget as to whether the proposed rules
constitute a ‘‘major’’ rule. Under
SBREFA, a rule is considered ‘‘major’’
where, if adopted, it results or is likely
to result in: (1) An annual effect on the
economy of $100 million or more (either
in the form of an increase or a decrease);
(2) a major increase in costs or prices for
consumers or individual industries; or
(3) significant adverse effect on
competition, investment or innovation.
If a rule is ‘‘major,’’ its effectiveness will
generally be delayed for 60 days
pending Congressional review. We do
not believe that any of the proposed
rules, in their current form, would
constitute a major rule.
We request comment on the potential
impact of the proposed rules on the
economy on an annual basis, on the
costs or prices for consumers or
individual industries, and on
competition, investment or innovation.
Commenters are requested to provide
empirical data and other factual support
for their views to the extent possible.
VI. Administrative Law Matters—
Exchange Act Rules (Definitions of
‘‘Security-Based Swap Dealer’’ and
‘‘Major Security-Based Swap
Participant’’)
A. Paperwork Reduction Act Analysis
Certain provisions of the proposed
rules may impose new ‘‘collection of
information’’ requirements within the
meaning of the Paperwork Reduction
Act of 1995 (‘‘PRA’’).175 The SEC has
submitted them to the Office of
Management and Budget (‘‘OMB’’) for
review in accordance with 44 U.S.C.
3507 and 5 CFR 1320.11. The title of the
new collection of information is
‘‘Procedural Requirements Associated
with the Definition of ‘Hedging or
Mitigating Commercial Risk.’’’ An
agency may not conduct or sponsor, and
a person is not required to respond to,
a collection of information unless it
displays a currently valid OMB control
number. OMB has not yet assigned a
control number to the new collection of
information.
174 Public Law 104–121, Title II, 110 Stat. 857
(1996) (codified in various sections of 5 U.S.C., 15
U.S.C. and as a note to 5 U.S.C. 601).
175 44 U.S.C. 3501 et seq.
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1. Summary of Collection of Information
Proposed Exchange Act rule 3a67–4
would define the term ‘‘hedging or
mitigating commercial risk.’’ 176
Security-based swap positions that meet
this proposed definition would be
excluded from the ‘‘substantial position’’
analysis under the first test of the
proposed definition of major securitybased swap participant.
For a security-based swap position to
be held for the purpose of hedging or
mitigating commercial risk under
proposed rule 3a67–4, the person
holding the position must satisfy several
conditions, including the following:
(i) The person must identify and
document the risks that are being
reduced by the security-based swap
position;
(ii) The person must establish and
document a method of assessing the
effectiveness of the security-based
swaps as a hedge; and
(iii) The person must regularly assess
the effectiveness of the security-based
swap as a hedge.
2. Proposed Use of Information
The collections of information in
proposed rule 3a67–4 are designed to
help prevent abuse of the exclusion and
to help ensure that the exclusion is only
available to those entities that are
engaged in legitimate hedging or risk
mitigating activities.
3. Respondents
The collections of information in
proposed rule 3a67–4 would apply to
those entities seeking to exclude the
security-based swap positions held for
hedging or mitigating commercial risk
from the substantial position
calculation. As discussed below in
Section VI.B.4., based on the current
market, we estimate that approximately
10 entities have security-based swap
positions of a magnitude that they could
potentially reach the major securitybased swap participant thresholds.
Accordingly, we estimate that
approximately 10 entities would seek to
avail themselves of the exclusion from
176 As noted previously, the concept of ‘‘hedging
or mitigating commercial risk’’ also is found in the
statutory provisions granting an exception to endusers from the mandatory clearing requirement in
connection with swaps and security-based swaps.
See CEA section 2(h)(7)(A); Exchange Act section
3C(g)(1)(B) (exception from mandatory clearing
requirements when one or more counterparties are
not ‘‘financial entities’’ and are using swaps or
security-based swaps ‘‘to hedge or mitigate
commercial risk’’). If the proposed rule 3a67–4
definition of ‘‘hedging or mitigating commercial
risk’’ is used any future SEC rulemakings, including
rulemaking with respect to the end-user exception,
any necessary discussion of administrative law
matters relating to the use of proposed rule 3a67–
4 will be provided at that time.
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the substantial position calculation for
security-based swap positions held for
hedging or mitigating commercial risk.
4. Total Annual Reporting and
Recordkeeping Burden
We do not anticipate that the
proposed collection of information in
proposed rule 3a67–4 would cause the
estimated 10 entities to incur any new
costs. We believe that only highly
sophisticated market participants would
potentially meet the proposed
thresholds for the major security-based
swap participant designation and thus
have a need to take advantage of the
exclusion for positions held for hedging
or mitigating commercial risk (and be
required to meet the attendant
collection requirements). We
understand from our staff’s discussions
with industry participants that the
entities that have security-based swap
positions and exposures of this
magnitude currently create and
maintain the documentation proposed
to be required in rule 3a67–4, as part of
their ordinary course business and risk
management practices.177 Thus, we do
not believe that any new burdens or
costs will be imposed on the
approximately 10 entities that may seek
to use the exclusion. We therefore
estimate the total annual reporting and
recordkeeping burden associated with
proposed rule 3a67–4 to be minimal.
5. Collection of Information is
Mandatory
The collections of information in
proposed rule 3a67–4 would be
mandatory for those entities seeking to
exclude positions they hold for hedging
or mitigating commercial risk from the
substantial position calculation.
emcdonald on DSK2BSOYB1PROD with PROPOSALS2
6. Confidentiality
There is no proposed requirement that
the collections of information in
proposed rule 3a67–4 be provided to the
SEC or a third party on a regular,
ordinary course basis. In a situation
177 Some entities follow these types of procedures
so that their hedging transactions will qualify for
hedge accounting treatment under generally
accepted accounting principles, which requires
procedures similar to those in proposed rule 3a67–
4. Hedging relationships involving security-based
swaps that qualify for the hedging or mitigating
commercial risk exception in the proposed rule are
not limited to those recognized as hedges for
accounting purposes. We believe that all of the
estimated 10 entities that have security-based swap
positions of a magnitude that they could potentially
be deemed to be major security-based swap
participants already identify and document their
risk management activities (including their
security-based swap positions used to hedge or
mitigate commercial risks) and assess the
effectiveness of those activities as a matter of their
ordinary business practice—even if they are not
seeking hedge accounting treatment.
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where the SEC has obtained the
information, the SEC would consider
requests for confidential treatment on a
case-by-case basis.
7. Record Retention Period
Proposed rule 3a67–4 does not
contain a specific record retention
requirement. Nonetheless, we would
expect the approximately 10 entities
that may seek to use the exclusion for
positions held for hedging or mitigating
commercial risk to maintain the records
they create in connection with the
exclusion. Because we understand from
our staff’s discussions with industry
participants that the entities that have
security-based swap positions and
exposures of this magnitude currently
create and maintain the documentation
proposed to be required in rule 3a67–4,
as part of their ordinary course business
and risk management practices, we do
not expect any new burdens or costs
will be imposed to maintain the records.
8. Request for Comments
The SEC invites comments on these
estimates. Pursuant to 44 U.S.C.
3506(c)(2)(B), the SEC requests
comments in order to: (a) Evaluate
whether the collection of information is
necessary for the proper performance of
our functions, including whether the
information will have practical utility;
(b) evaluate the accuracy of our estimate
of the burden of the collection of
information; (c) determine whether
there are ways to enhance the quality,
utility, and clarity of the information to
be collected; and (d) evaluate whether
there are ways to minimize the burden
of the collection of information on those
who respond, including through the use
of automated collection techniques or
other forms of information technology.
Persons submitting comments on the
collection of information requirements
should direct them to the Office of
Management and Budget, Attention:
Desk Officer for the Securities and
Exchange Commission, Office of
Information and Regulatory Affairs,
Washington, DC 20503, and should also
send a copy of their comments to
Elizabeth M. Murphy, Secretary,
Securities and Exchange Commission,
100 F Street, NE., Washington, DC
20549–1090, with reference to File No.
S7–39–10. Requests for materials
submitted to OMB by the SEC with
regard to this collection of information
should be in writing, with reference to
File No. S7–39–10, and be submitted to
the Securities and Exchange
Commission, Records Management,
Office of Filings and Information
Services, 100 F Street, NE., Washington,
DC 20549–1090. As OMB is required to
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make a decision concerning the
collections of information between 30
and 60 days after publication, a
comment to OMB is best assured of
having its full effect if OMB receives it
within 30 days of publication.
B. Consideration of Benefits and Costs
1. Introduction
The Dodd-Frank Act added
definitions of ‘‘security-based swap
dealer’’ and ‘‘major security-based swap
participant’’ to the Exchange Act in
conjunction with other provisions that
require entities meeting either of those
definitions to register with the SEC and
to be subject to capital, margin, business
conduct and certain other requirements.
Consistent with the direction of the
Dodd-Frank Act, the SEC is proposing
rules to further define ‘‘major securitybased swap participant’’ along with
additional terms used in that definition.
The SEC also is proposing rules to
further define ‘‘security-based swap
dealer’’ and to set forth factors for
determining the availability of the de
minimis exception from that definition.
We believe that these proposed rules are
consistent with the purposes of the
Dodd-Frank Act, and, as appropriate, set
forth objective standards to facilitate
market participants’ compliance with
the amendments that the Dodd-Frank
Act made to the Exchange Act. Market
participants, however, may incur costs
associated with certain of these
proposed rules.
The SEC believes that there would be
two categories of potential costs. First,
there would be costs associated with the
regulatory requirements that would
apply to a ‘‘security-based swap dealer’’
or a ‘‘major security-based swap
participant’’ (e.g., the registration,
margin, capital, and business conduct
requirements that would be imposed on
security-based swap dealers and major
security-based swap participants).
While the specific costs and benefits
associated with these regulatory
requirements are being addressed in the
SEC’s proposals to implement those
requirements, we recognize that the
costs and benefits of these proposed
definitions are directly linked to the
costs and benefits of the requirements
applicable to dealers and major
participants. We welcome comment on
the costs and benefits of these proposed
definitions in that broader context.
Second, there may be costs that
entities incur in determining whether
they qualify as a ‘‘security-based swap
dealer’’ or a ‘‘major security-based swap
participant’’ under the proposed
definitional rules. These costs, along
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with the benefits associated with the
proposed rules, are discussed below.
2. Proposed Exchange Act rule 3a67–1—
Definition of ‘‘Major Security-Based
Swap Participant’’
emcdonald on DSK2BSOYB1PROD with PROPOSALS2
Proposed Exchange Act rule 3a67–1
would largely restate the statutory
definition of ‘‘major security-based swap
participant,’’ to consolidate the
definition and related interpretations for
ease of reference.
A person that meets the definition of
major security-based swap participant
generally will be subject to the
requirements applicable to major
security-based swap participants
without regard to the purpose for which
it enters into a security-based swap, and
without regard to the particular category
of security-based swap.178 However, the
statutory definitions provide that a
person may be designated as a major
security-based swap participant for one
or more categories of security-based
swaps or for particular activities
without being classified as a major
security-based swap participant for all
categories or activities.179 Proposed rule
3a67–1 would provide that a major
security-based swap participant that
engages in significant activity with
respect to only certain types, classes or
categories of security-based swaps or
only in connection with specified
activities, could obtain relief with
respect to other types of security-based
swaps from certain of the requirements
that are applicable to major securitybased swap participants. The rule
would have the benefit of implementing
the statutory provision and providing
that major security-based swap
participants may obtain relief from the
SEC. A person that seeks to be
considered to be a major security-based
swap participant only with respect to
one category of security-based swaps, or
only with respect to certain activities,
would be expected to incur costs in
connection with requesting an order
from the SEC. However, any such costs
would be voluntarily incurred by any
person seeking to take advantage of that
limited designation, and thus we
preliminarily do believe that those costs
would be attributable to the statute and
not to this rule.
3. Proposed Exchange Act Rule 3a67–
2—‘‘Major’’ Categories of Security-Based
Swaps
Proposed Exchange Act rule 3a67–2
would fulfill Congress’s mandate that
178 The specific costs associated with these
regulatory requirements will be addressed in the
SEC’s proposals to implement those requirements.
179 See Exchange Act section 3(a)(67)(C).
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the SEC designate ‘‘major’’ categories of
security-based swaps by setting forth
two such ‘‘major’’ categories—one
consisting of credit derivatives and the
other consisting of equity-swaps and
other security-based swaps. We believe
that these proposed categories would
have the benefit of being consistent with
the different ways in which those
products are used, as well as market
statistics and current market
infrastructures (particularly the separate
trade warehouses for credit default
swaps and equity swaps). Although, as
discussed below, this categorization is
relevant to the ‘‘substantial position’’
tests of the ‘‘major security-based swap
participant’’ definition, we believe that
the categorization itself would not
impose any costs on market
participants. While the categorization
may affect the costs that market
participants will incur from particular
statutory and regulatory requirements
applicable to major security-based swap
participants,180 those costs are being
addressed in our proposals to
implement those requirements.
4. Proposed Exchange Act Rule 3a76–
3—Definition of ‘‘Substantial Position’’
Proposed Exchange Act rule 3a67–3
would define the term ‘‘substantial
position,’’ which is used in the first and
third tests of the definition of ‘‘major
security-based swap participant.’’ The
Dodd-Frank Act requires the SEC to
define this term. We have proposed two
tests for identifying the presence of a
substantial position—one test based on
a daily average measure of
uncollateralized mark-to-market
exposure, and one based on a daily
average measure of combined
uncollateralized mark-to-market
exposure and potential future exposure.
Both of these daily measures would be
calculated and averaged over a calendar
quarter.
We believe that this proposed
definition would have the benefit of
providing objective criteria that
reasonably would measure the risks
associated with security-based swap
positions, and reflect the counterparty
risk and risk to the market factors that
are embedded within the ‘‘major
security-based swap participant’’
definition. We also believe that the
proposed use of objective numerical
criteria for the substantial position
thresholds would promote the
180 For example, distinguishing between
categories of security-based swaps may cause some
entities to incur additional costs to calculate their
major security-based swap participant status with
respect to each category. Similarly, categorization
may affect whether an entity ultimately qualifies as
a major security-based swap participant.
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predictable application and enforcement
of the requirements governing major
security-based swap participants by
permitting market participants to
readily evaluate whether their securitybased swap positions meet the
thresholds.
The first ‘‘substantial position’’ test
would encompass entities that have a
daily average uncollateralized mark-tomarket exposure of $1 billion in a major
category of security-based swaps. The
second ‘‘substantial position’’ test would
encompass entities that have a daily
average combined uncollateralized
mark-to-market exposure and potential
future exposure of $2 billion. Potential
future exposure would be measured,
consistent with bank capital rules,
largely by multiplying notional
positions by risk factors. Additional
adjustments would reflect netting
agreements, the presence of central
clearing and the presence of daily markto-market margining practices.
As previously noted, there will be
costs associated with the registration,
margin, capital, business conduct, and
other requirements that will be imposed
on major security-based swap
participants. Those costs are being
addressed in the SEC’s rule proposals to
implement those requirements. We also
believe that there will be costs incurred
by entities in determining whether they
meet the definition of major securitybased swap participant. These costs are
discussed below.
Based on the current over-the-counter
derivatives market, we estimate that no
more than 10 entities that are not
otherwise security-based swap dealers
would have either uncollateralized
mark-to-market positions 181 or
181 We believe that an estimate of an entity’s
mark-to-market exposure associated with its
security-based swap positions can be derived from
the level of an entity’s notional positions. We
recognize that the ratio of exposure to notional
amount will vary by market participant and by
position. We understand that mark-to-market
exposures associated with credit derivative
positions on average are equal to approximately
three percent of an entity’s level of notional
positions in credit derivatives. This estimate is
based on second quarter 2010 U.S. bank market
statistics involving credit derivatives, given that
banks have credit derivative positions with gross
positive fair value (which would equate to negative
fair value for the banks’ counterparties) of $403
billion, compared to total notional credit derivative
positions of $13.9 trillion. See Office of the
Comptroller of the Currency, ‘‘OCC’s Quarterly
Report on Bank Trading and Derivatives Activities’’
(Second Quarter 2010) at 4 & Table 12. This data
suggests that, on average, an entity would need to
have notional credit derivative positions of roughly
$33 billion to meet our proposed threshold for the
first substantial position test, $1 billion in mark-tomarket exposure.
We understand, based on our staff’s discussions
with industry, that approximately 39 entities have
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combined uncollateralized current
exposure and potential future exposure
of a magnitude 182 that may rise close
enough to the levels of our proposed
thresholds to necessitate monitoring to
determine whether they meet those
thresholds. Additionally, we
preliminarily believe that all of these
approximately 10 entities currently
maintain highly sophisticated financial
operations in order to achieve the large
security-based swap positions
necessitating their use of the tests.
We expect the costs associated with
the proposed substantial position tests
to be modest for these entities. We
understand that the entities that have
this magnitude of security-based swap
positions already monitor and collect all
of the data necessary for the proposed
substantial position tests. Preliminarily,
we understand that these entities
already use automated systems to gauge
their positions and exposures and assist
in their risk management. Accordingly,
we estimate that each of the entities
would incur a one-time programming
cost,183 as well as ongoing costs
credit default swap notional positions of roughly
$33 billion or above. We understand that the large
majority of those entities are banks or hedge funds
(which we would expect to fully collateralize their
positions with dealers as a matter of course). We
further understand that banks, securities firms, and
hedge funds typically collateralize most or all of
their mark-to-market exposure to U.S. banks as a
matter of practice. See OCC’s Quarterly Report on
Bank Trading and Derivatives Activities (second
quarter 2010) at 6. Therefore, it is not clear if any
entities would have uncollateralized credit default
swap positions near the proposed first substantial
position threshold of $1 billion uncollateralized
outward exposure.
182 The proposed risk multiplier of 0.1 for credit
derivatives would require an entity to have a
notional position of $20 billion in credit derivatives
to reach the proposed $2 billion potential future
exposure threshold (even before accounting for
netting adjustments). The proposed additional
multiplier of 0.2 for security-based swaps cleared
by a registered clearing agency or subject to daily
mark-to-market margining would mean that an
entity with credit derivative positions that are
cleared or subject to daily mark-to-market
margining would need a notional position in credit
derivatives of at least $100 billion to potentially
reach the proposed $2 billion potential future
exposure threshold. In this example, we are
assuming an uncollateralized outward exposure of
zero.
We understand, based on our staff’s discussions
with industry, that there are approximately 10 nondealer entities that have a notional position in
credit derivatives of over $50 billion.
183 For each of the entities, we estimate that the
initial programming would require the following
levels of work from a Compliance Attorney,
Compliance Manager, Programmer Analyst, Senior
Internal Auditor, and Chief Financial Officer. The
estimated contributions are as follows:
approximately 2 hours of work from a Compliance
Attorney to advise the entity’s compliance
department on the legal requirements associated
with the proposed tests; approximately 8 hours of
work from a Compliance Manager to assist a
Programmer Analyst in making the necessary
changes to the entity’s existing automated system
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associated with the continuing use and
monitoring of the testing.184 We
estimate that the one-time programming
cost would be approximately $13,444
per entity, and $134,440 for all
entities.185 We estimate that the annual
ongoing costs would be approximately
$7,260 per entity, and $72,600 for all
entities.186
5. Proposed Exchange Act Rule 3a67–
4—Definition of ‘‘Hedging or Mitigating
Commercial Risk’’
Proposed Exchange Act rule 3a67–4
would define the term ‘‘hedging or
mitigating commercial risk.’’ Securitybased swap positions that meet that
definition are excluded from the
‘‘substantial position’’ analysis under the
and to oversee and manage the entire programming
process; approximately 40 hours of work from a
Programmer Analyst to make the necessary
programming changes to the existing automated
system and to test the system; approximately 8
hours of work from a Senior Internal Auditor to
perform quality assurance to ensure that the
automated system is properly performing the
proposed tests; and approximately 3 hours of work
from the entity’s Chief Financial Officer to monitor
the process. We estimate that the hourly wage of a
Compliance Attorney, Compliance Manager,
Programmer Analyst, Senior Internal Auditor, and
Chief Financial Officer would be approximately
$291, $294, $190, $195, and $450, respectively. The
$291/hour figure for a Compliance Attorney, the
$294/hour figure for a Compliance Manager, the
$190/hour figure for a Programmer Analyst, and the
$195/hour figure for a Senior Internal Auditor are
from SIFMA’s Management & Professional Earnings
in the Securities Industry 2009, modified by SEC
staff to account for an 1800-hour work-year and
multiplied by 5.35 to account for bonuses, firm size,
employee benefits, and overhead. The $450/hour
figure for a Chief Financial Officer is from https://
www.payscale.com, modified by SEC staff to
account for an 1800-hour work-year and multiplied
by 5.35 to account for bonuses, firm size, employee
benefits, and overhead. See https://
www.payscale.com (last visited Nov. 1, 2010).
184 We anticipate that each entity would incur
ongoing monitoring costs to evaluate their test
results and to ensure that the tests are properly run.
We estimate that each entity would have a Senior
Internal Auditor spend approximately 4 hours each
quarter (or a total of 16 hours annually) to perform
this quality assurance. We also estimate that each
entity would need a Compliance Attorney, a
Compliance Manager, and its Chief Financial
Officer to each spend approximately 1 hour each
quarter (or a total of 4 hours annually) to monitor
the entity’s test results and the entity’s status under
the proposed rule.
185 The estimated one-time programming cost of
approximately $13,444 per entity and $134,440 for
all entities was calculated as follows: (Compliance
Attorney at $291 per hour for 2 hours) +
(Compliance Manager at $294 per hour for 8 hours)
+ (Programmer Analyst at $190 per hour for 40
hours) + (Senior Internal Auditor at $195 per hour
for 8 hours) + (Chief Financial Officer at $450 per
hour for 3 hours) × (10 entities) = $134,440.
186 The estimated ongoing monitoring cost of
approximately $7,260 per year per entity and
$72,600 per year for all entities was calculated as
follows: (Senior Internal Auditor at $195 per hour
for 16 hours) (Compliance Attorney at $291 per
hour for 4 hours) + (Compliance Manager at $294
per hour for 4 hours) + (Chief Financial Officer at
$450 per hour for 4 hours) × (10 entities) = $72,600.
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first test of the major participant
definition. The proposed rule is
intended to be objective and promote
the predictable application and
enforcement of the requirements
governing major security-based swap
participants.
For a security-based swap position to
be held for the purpose of hedging or
mitigating commercial risk under
proposed Exchange Act rule 3a67–4, the
person holding the position must satisfy
certain conditions:
(i) The person must identify and
document the risks that are being
reduced by the security-based swap
position;
(ii) The person must establish and
document a method of assessing the
effectiveness of the security-based swap
as a hedge; and
(iii) The person must regularly assess
the effectiveness of the security-based
swap as a hedge.
Proposed rule 3a67–4 would affect
whether an entity will meet the
definition of major security-based swap
participant. The specific costs
associated with these regulatory
requirements are being addressed in the
SEC’s proposals to implement those
requirements.
While we expect that there could be
some potential costs associated with the
procedural requirements of proposed
rule 3a67–4, as described in Section
VI.B.4., supra, we expect only highly
sophisticated entities to hold securitybased swap positions of a magnitude
that would require use of the proposed
tests. Thus, we do not anticipate that
these proposed procedural requirements
would cause market participants to
incur costs that they do not incur
already as a matter of their ordinary
business and risk management
practices. Accordingly, we do not
expect that the proposed definition of
‘‘hedging or mitigating commercial risk’’
would impose any costs on the
potentially affected entities beyond
those already regularly incurred by
these entities as a matter of course.
6. Proposed Exchange Act Rule 3a67–
5—Definition of ‘‘Substantial
Counterparty Exposure That Could Have
Serious Adverse Effects on The
Financial Stability of The United States
Banking System or Financial Markets’’
Proposed Exchange Act rule 3a67–5
would define ‘‘substantial counterparty
exposure that could have serious
adverse effects on the financial stability
of the United States banking system or
financial markets,’’ a term that
comprises part of the second test of the
‘‘major security-based swap participant’’
definition. This proposed rule would
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parallel the ‘‘substantial position’’
analysis discussed above, but would
examine an entity’s security-based swap
positions as a whole (rather than
focusing on a particular ‘‘major’’
category), and would not exclude
certain hedging positions. Consistent
with this broader scope, and the
proposal that there be two ‘‘major’’
categories of security-based swaps, the
thresholds used in this test would be
two times the comparable ‘‘substantial
position’’ thresholds. We believe that
this approach reasonably would
measure the counterparty exposure
associated with the entirety of an
entity’s security-based swap positions,
consistent with the risk factors in the
‘‘major security-based swap participant’’
definition. Additionally, we believe that
the proposed definition would provide
objective criteria and promote the
predictable application and enforcement
of the requirements governing major
security-based swap participants by
permitting market participants to
readily evaluate whether their securitybased swap positions meet the proposed
thresholds.
We believe that the same
approximately 10 entities would
calculate their substantial counterparty
exposure under this rule as would
undertake the substantial position
calculation under proposed rule 3a67–3.
Given that the threshold for this
proposed rule is derived from the
calculations of substantial position that
would be mandated by proposed rule
3a67–3, we do not anticipate that it
would create any costs outside of those
already covered in the discussion of the
estimated costs associated with the
proposed definition of substantial
position.
7. Proposed Exchange Act Rule 3a67–
6—Definitions of ‘‘Financial Entity’’ and
‘‘Highly Leveraged’’
Proposed Exchange Act rule 3a67–6
would define the terms ‘‘financial
entity’’ and ‘‘highly leveraged,’’ both of
which are used in the third test of the
‘‘major security-based swap participant’’
definition. The proposed definition of
‘‘financial entity’’ would be consistent
with the use of that term in the Title VII
exception from mandatory clearing for
end-users of security-based swaps
(subject to limited technical changes).
One of the two alternative proposed
definitions of ‘‘highly leveraged’’ would
be consistent with a standard used in
Title I of the Dodd-Frank Act, while the
other alternative is based on an
understanding of typical leverage ratios
for certain financial entities. We believe
that these proposed alternative
standards would apply reasonable
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objective criteria to implement and
further define the third test.
Additionally, we believe that the
proposed use of these objective
definitions and numerical criteria
would promote the predictable
application and enforcement of the
requirements governing major securitybased swap participants by permitting
market participants to readily evaluate
whether they meet the threshold for
major security-based swap participant
status.
We do not believe that the proposed
definition of ‘‘financial entity’’ would
impose any significant costs on market
entities, given the objective nature of the
definition. We also do not believe that
the proposed definition of ‘‘highly
leveraged’’—a balance sheet test that
would be based on the ratio of an
entity’s liabilities and equity, and that,
in the case of entities subject to public
reporting requirements, could be
derived from financial statements filed
with the SEC—would impose any
significant costs on entities that have
security-based swap positions large
enough to potentially meet the
‘‘substantial position’’ requirement that
is part of the third test.
8. Proposed Exchange Act Rule 3a67–
7—Timing Requirements, Reevaluation
Period and Termination of Status
Proposed Exchange Act rule 3a67–7
would set forth methods for specifying
when an entity that satisfies the tests
specified within the definition of ‘‘major
security-based swap participant’’ would
be deemed to meet that definition. The
proposed rule also would address the
termination of an entity’s status as a
major security-based swap participant.
We believe that the proposed rule
would set forth pragmatic standards for
permitting entities that have securitybased swap positions that require
registration to go through the
registration process, and to terminate
their status when appropriate. We
believe that this proposed rule would
impose no direct costs on market
entities.187
9. Proposed Exchange Act Rule 3a71–
1—Definition of ‘‘Security-Based Swap
Dealer’’
Proposed Exchange Act rule 3a71–1
largely would restate the statutory
definition of ‘‘security-based swap
dealer,’’ to consolidate the definition
and related interpretations for market
187 As noted above, we recognize that major
security-based swap participants will incur costs
associated with the registration and termination of
registration processes. These costs will be
addressed in the SEC rule’s proposals to implement
those requirements.
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80209
participants’ ease of reference. We are
not proposing to further define the four
specific tests set forth in the ‘‘securitybased swap dealer’’ definition. However,
our release contains interpretive
language that would have the benefit of
providing additional legal certainty to
market participants. While market
participants would incur certain costs to
analyze whether their security-based
swap activities cause them to be on the
‘‘dealer’’ side of the dealer-trader
distinction (which would require them
to register with the SEC and comply
with the other requirements applicable
to security-based swap dealers unless
they can take advantage of the de
minimis exception), these costs would
be incurred because of the statutory
change, rather than due to proposed rule
3a71–1. The Dodd-Frank Act
determined that persons that engage in
dealing activities involving securitybased swaps should be subject to
comprehensive regulation, and any such
analytic costs arise from Congress’s
determination to amend the Exchange
Act.188
10. Proposed Exchange Act Rule 3a71–
2—de Minimis Exception
Proposed Exchange Act rule 3a71–2
would set forth factors for determining
whether a person that otherwise would
be a security-based swap dealer can take
advantage of the de minimis exception.
The Dodd-Frank Act directed the SEC to
promulgate these factors.189 The
proposed factors would account for an
entity’s annual notional security-based
swap positions in a dealing capacity, its
total notional security-based swap
positions in a dealing capacity when the
counterparty is a ‘‘special entity,’’ 190
and its total number of counterparties
and security-based swaps as a dealer.
We believe that these factors
appropriately would focus on dealing
activities that do not warrant an entity’s
regulation as a security-based swap
dealer. We also believe that these
objective numerical criteria for the de
minimis exception would promote the
predictable application and enforcement
of the de minimis exception from
security-based swap dealer status.
In general, we would expect a person
that enters into security-based swaps in
a dealing capacity would, as a matter of
course, be aware of the notional amount
188 Based on our staff’s discussions with industry,
we estimate that approximately 50 entities may be
required to register as security-based swap dealers
following implementation of these proposed rules.
The specific costs associated with these regulatory
requirements will be addressed in the SEC’s
proposals to implement those requirements.
189 See Section 761(a)(6) of the Dodd-Frank Act.
190 See Section 15F(h)(2)(C) of the Exchange Act.
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of those positions, whether a particular
counterparty is a ‘‘special entity,’’ and
the total number of counterparties and
security-based swaps it has in a dealer
capacity. As a result, we believe that
there would be no new costs incurred
by entities in assessing the availability
of the de minimis exception. Moreover,
any costs associated with ensuring that
a person can take advantage of the de
minimis exception would be voluntarily
incurred by entities that engage in
dealing activities that seek to take
advantage of the exception.
11. Request for Comments
The SEC requests comment on these
estimated benefits and costs.
Commenters particularly are requested
to address: the accuracy of our estimate
that there would be approximately 10
entities in the market (that would not
otherwise be security-based swap
dealers) that would have security-based
swap positions of a magnitude that may
rise close enough to the levels of our
proposed thresholds to necessitate
monitoring to determine whether they
meet those thresholds; the accuracy of
our estimate that there would be
approximately 50 entities in the market
that may be required to register as
security-based swap dealers following
implementation of the proposed rules;
the accuracy of our estimates of the
costs associated with entities
performing the proposed substantial
position tests; whether the entities that
have security-based swap positions that
are significant enough to potentially
meet one or more of the tests in the
‘‘major security-based swap participant’’
definition would, as a matter of course,
already have the data necessary to
perform the two proposed substantial
position tests, and if not, what
additional data would they need and
how much time and expense would
gathering that data require; whether
these same entities would, as a matter
of course, already comply with the
proposed procedural requirements
associated with the exclusion for
positions that are for the purpose of
‘‘hedging or mitigating commercial risk;’’
and whether entities would change their
behavior to avoid meeting the proposed
definitions of ‘‘security-based swap
dealer’’ or ‘‘major security-based swap
participant,’’ and if so, what, if any,
economic costs would be associated
with such behavioral changes.
In addition, and more generally, we
request comment on the costs and
benefits of these proposed definitions in
the broader context of the substantive
rules, including capital, margin and
business conduct rules, applicable to
dealers and major participants.
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Commenters particularly are requested
to address whether the proposed scope
of the dealer and major participant
definitions are appropriate in light of
the costs and benefits associated with
those substantive rules.
C. Consideration of Burden on
Competition, and Promotion of
Efficiency, Competition, and Capital
Formation
Section 3(f) of the Exchange Act
requires the SEC, whenever it engages in
rulemaking and is required to consider
or determine whether an action is
necessary or appropriate in the public
interest, to consider whether the action
would promote efficiency, competition,
and capital formation.191 In addition,
Section 23(a)(2) of the Exchange Act 192
requires the SEC, when adopting rules
under the Exchange Act, to consider the
impact such rules would have on
competition. Section 23(a)(2) of the
Exchange Act also prohibits the SEC
from adopting any rule that would
impose a burden on competition not
necessary or appropriate in furtherance
of the purposes of the Exchange Act.
We preliminarily do not believe that
the proposed rules would result in any
burden on competition that is not
necessary or appropriate in furtherance
of the purposes of the Exchange Act. We
are proposing rules to further define
‘‘major security-based swap participant,’’
along with several terms used in that
definition. We are also proposing rules
to further define ‘‘security-based swap
dealer’’ and to set forth factors for
determining the availability of the de
minimis exception from that definition.
We believe that the proposed rules are
consistent with the purposes of Title VII
of the Dodd-Frank Act, and, as
appropriate, set forth objective
standards to facilitate market
participants’ compliance with the
amendments that Title VII of the DoddFrank Act made to the Exchange Act.
These amendments mandate that the
SEC regulate major security-based swap
participants and security-based swap
dealers, which include some, but not
all, entities that enter into securitybased swaps. Although regulation of
certain security-based swap market
participants may result in competitive
burdens to these entities when
compared to unregulated security-based
swap market participants, these burdens
stem directly from Congress’s decision
to impose regulation on a specified set
of security-based swap market
participants through the Dodd-Frank
Act.
191 15
192 15
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U.S.C. 78w(a)(2).
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While our decisions on how to further
define the terms may have some effect
on competition (e.g., our determinations
regarding the proposed definition of
substantial position will affect whether
entities qualify as major security-based
swap participants), we preliminarily do
not believe that our decisions would
impose additional competitive burdens
on entities outside of those that
Congress previously imposed through
its decision in Title VII of the DoddFrank Act to regulate and differentiate
security-based swap market
participants. Moreover, we believe that
defining substantial position will help
provide market participants with legal
certainty regarding their need to register
as major security-based swap
participants and is necessary and
appropriate to implement the purposes
of regulating security-based swap
dealers and major security-based swap
participants.
We also preliminarily believe that the
proposed rules would promote
efficiency. We believe that the proposed
rules would set forth clear objective
standards to facilitate market
participants’ compliance with the
amendments that the Dodd-Frank Act
made to the Exchange Act. Moreover,
we believe that the proposed rules
would promote the predictable
application and enforcement of the
Exchange Act. We also have considered
what effect, if any, our proposed rules
would have on capital formation. We
preliminarily do not believe that our
proposed rules would have a negative
effect on capital formation.
The SEC requests comment on the
effect of the proposed rules on
efficiency, competition, and capital
formation. Commenters are particularly
requested to address whether entities
would change their behavior to avoid
meeting the proposed definitions of
‘‘security-based swap dealer’’ or ‘‘major
security-based swap participant,’’ and if
so, how. Commenters are also requested
to address the effect, if any, that the
proposed definitions of ‘‘substantial
position,’’ ‘‘hedging or mitigating
commercial risk,’’ ‘‘substantial
counterparty exposure,’’ ‘‘financial
entity,’’ or ‘‘highly leveraged,’’ or the
proposed categories of security-based
swaps would have on business
decisions, trading behavior, transaction
costs, or capital allocation. We also
request comment on the effect, if any
that the proposed de minimis exception
to the definition of security-based swap
dealer would have on business
decisions, trading behavior, transaction
costs, or capital allocation, and if so,
how. Commenters are particularly
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encouraged to provide quantitative
information to support their views.
D. Consideration of Impact on the
Economy
For purposes of SBREFA, the SEC
must advise the Office of Management
and Budget as to whether the proposed
rules constitute a ‘‘major’’ rule. Under
SBREFA, a rule is considered ‘‘major’’
where, if adopted, it results or is likely
to result in: (1) An annual effect on the
economy of $100 million or more (either
in the form of an increase or a decrease);
(2) a major increase in costs or prices for
consumers or individual industries; or
(3) significant adverse effect on
competition, investment or innovation.
If a rule is ‘‘major,’’ its effectiveness will
generally be delayed for 60 days
pending Congressional review. We do
not believe that any of the proposed
rules, in their current form, would
constitute a major rule.
We request comment on the potential
impact of the proposed rules on the
economy on an annual basis, on the
costs or prices for consumers or
individual industries, and on
competition, investment or innovation.
Commenters are requested to provide
empirical data and other factual support
for their views to the extent possible.
E. Regulatory Flexibility Act
Certification
The Regulatory Flexibility Act
(‘‘RFA’’) 193 requires Federal agencies, in
promulgating rules, to consider the
impact of those rules on small entities.
Section 603(a) 194 of the Administrative
Procedure Act,195 as amended by the
RFA, generally requires the SEC to
undertake a regulatory flexibility
analysis of all proposed rules, or
proposed rule amendments, to
determine the impact of such
rulemaking on ‘‘small entities.’’ 196
Section 605(b) of the RFA provides that
this requirement shall not apply to any
proposed rule or proposed rule
amendment, which if adopted, would
not have a significant economic impact
on a substantial number of small
entities.197
193 5
U.S.C. 601 et seq.
U.S.C. 603(a).
195 5 U.S.C. 551 et seq.
196 Although Section 601(b) of the RFA defines
the term ‘‘small entity,’’ the statute permits the
Commissions to formulate their own definitions.
The SEC has adopted definitions for the term small
entity for the purposes of SEC rulemaking in
accordance with the RFA. Those definitions, as
relevant to this proposed rulemaking, are set forth
in Rule 0–10, 17 CFR 240.0–10. See Securities
Exchange Act Release No. 18451 (Jan. 28, 1982), 47
FR 5215 (Feb. 4, 1982) (File No. AS–305).
197 See 5 U.S.C. 605(b).
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For purposes of SEC rulemaking in
connection with the RFA, a small entity
includes: (i) When used with reference
to an ‘‘issuer’’ or a ‘‘person,’’ other than
an investment company, an ‘‘issuer’’ or
‘‘person’’ that, on the last day of its most
recent fiscal year, had total assets of $5
million or less,198 or (ii) a broker-dealer
with total capital (net worth plus
subordinated liabilities) of less than
$500,000 on the date in the prior fiscal
year as of which its audited financial
statements were prepared pursuant to
Rule 17a–5(d) under the Exchange
Act,199 or, if not required to file such
statements, a broker-dealer with total
capital (net worth plus subordinated
liabilities) of less than $500,000 on the
last day of the preceding fiscal year (or
in the time that it has been in business,
if shorter); and is not affiliated with any
person (other than a natural person) that
is not a small business or small
organization.200 Under the standards
adopted by the Small Business
Administration, small entities in the
finance and insurance industry include
the following: (i) For entities engaged in
credit intermediation and related
activities, entities with $175 million or
less in assets; 201 (ii) for entities engaged
in non-depository credit intermediation
and certain other activities, entities with
$7 million or less in annual receipts; 202
(iii) for entities engaged in financial
investments and related activities,
entities with $7 million or less in
annual receipts; 203 (iv) for insurance
carriers and entities engaged in related
activities, entities with $7 million or
less in annual receipts; 204 and (v) for
funds, trusts, and other financial
vehicles, entities with $7 million or less
in annual receipts.205
Based on feedback from industry
participants about the security-based
swap markets, the SEC preliminarily
believes that entities that would qualify
as security-based swap dealers and
major security-based swap market
participants, whether registered brokerdealers or not, exceed the thresholds
defining ‘‘small entities’’ set out above.
Thus, the SEC believes it is unlikely that
the proposed rules would have a
significant economic impact any small
entity.
For the foregoing reasons, the SEC
certifies that the proposed rules would
not have a significant economic impact
198 See
17 CFR 240.0–10(a).
17 CFR 240.17a–5(d).
200 See 17 CFR 240.0–10(c).
201 See 13 CFR 121.201 (Subsector 522).
202 See id. at Subsector 522.
203 See id. at Subsector 523.
204 See id. at Subsector 524.
205 See id. at Subsector 525.
199 See
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80211
on a substantial number of small entities
for purposes of the RFA.
The SEC encourages written
comments regarding this certification.
The SEC requests that commenters
describe the nature of any impact on
small entities and provide empirical
data to illustrate the extent of the
impact.
VII. Statutory Basis and Rule Text
List of Subjects
17 CFR Part 1
Definitions.
17 CFR Part 240
Reporting and recordkeeping
requirements, Securities.
Commodity Futures Trading
Commission
Text of Proposed Rules
For the reasons stated in this release,
the CFTC is proposing to amend 17 CFR
part 1 as follows:
PART 1—GENERAL REGULATIONS
UNDER THE COMMODITY EXCHANGE
ACT
1. The authority citation for part 1 is
revised to read as follows:
Authority: 7 U.S.C. 1a, 2, 5, 6, 6a, 6b, 6c,
6d, 6e, 6f, 6g, 6h, 6i, 6j, 6k, 6l, 6m, 6n, 6o,
6p, 7, 7a, 7b, 8, 9, 12, 12a, 12c, 13a, 13a–1,
16, 16a, 19, 21, 23, and 24, as amended by
Title VII of the Dodd-Frank Wall Street
Reform and Consumer Protection Act, Pub. L.
111–203, 124 Stat. 1376 (2010).
2. Amend § 1.3 by:
a. Adding paragraph (m); and
b. As proposed to be amended at 75
FR 63762, October 18, 2010, and 75 FR
77576, December 13, 2010, adding (ppp)
through (vvv) to read as follows:
§ 1.3
Definitions
*
*
*
*
*
(m) Eligible contract participant. This
term has the meaning set forth in
Section 1a(18) of the Commodity
Exchange Act, except that:
(1) A major swap participant, as
defined in Section 1a(33) of the
Commodity Exchange Act and
§ 1.3(qqq), is an eligible contract
participant;
(2) A swap dealer, as defined in
Section 1a(49) of the Commodity
Exchange Act and § 1.3(ppp), is an
eligible contract participant;
(3) A major security-based swap
participant, as defined in Section
3(a)(67) of the Securities Exchange Act
of 1934 (15 U.S.C. 78c(a)(67)) and
§ 240.3a67–1 of this title, is an eligible
contract participant;
(4) A security-based swap dealer, as
defined in Section 3(a)(71) of the
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Securities and Exchange Act of 1934 (15
U.S.C. 78c(a)(71)) and § 240.3a71–1 of
this title, is an eligible contract
participant;
(5) A commodity pool with one or
more direct or indirect participants that
is not an eligible contract participant is
not an eligible contract participant for
purposes of Sections 2(c)(2)(B)(vi) and
2(c)(2)(C)(vii) of the Commodity
Exchange Act; and
(6) A commodity pool that does not
have total assets exceeding $5,000,000
or that is not operated by a person
described in clause (A)(iv)(II) of Section
1a(18) of the Commodity Exchange Act
is not an eligible contract participant
pursuant to clause (A)(v) of such
Section.
*
*
*
*
*
(ppp) Swap Dealer. (1) In general. The
term ‘‘swap dealer’’ means any person
who:
(i) Holds itself out as a dealer in
swaps;
(ii) Makes a market in swaps;
(iii) Regularly enters into swaps with
counterparties as an ordinary course of
business for its own account; or
(iv) Engages in any activity causing it
to be commonly known in the trade as
a dealer or market maker in swaps.
(2) Exception. The term ‘‘swap dealer’’
does not include a person that enters
into swaps for such person’s own
account, either individually or in a
fiduciary capacity, but not as a part of
regular business.
(3) Scope. A person who is a swap
dealer shall be deemed to be a swap
dealer with respect to each swap it
enters into, regardless of the category of
the swap or the person’s activities in
connection with the swap. However, if
a person makes an application to limit
its designation as a swap dealer to
specified categories of swaps or
specified activities of the person in
connection with swaps, the Commission
shall determine whether the person’s
designation as a swap dealer shall be so
limited. A person may make such
application to limit its designation at
the same time as, or at a later time
subsequent to, the person’s initial
registration as a swap dealer.
(4) De minimis exception. A person
shall not be deemed to be a swap dealer
as a result of swap dealing activity
involving counterparties that meets each
of the following conditions:
(i) The swap positions connected with
those activities into which the person
enters over the course of the
immediately preceding 12 months have
an aggregate gross notional amount of
no more than $100 million, and have an
aggregate gross notional amount of no
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more than $25 million with regard to
swaps in which the counterparty is a
‘‘special entity’’ (as that term is defined
in Section 4s(h)(2)(C) of the Commodity
Exchange Act). For purposes of this
paragraph, if the stated notional amount
of a swap is leveraged or enhanced by
the structure of the swap, the
calculation shall be based on the
effective notional amount of the swap
rather than on the stated notional
amount.
(ii) The person has not entered into
swaps in connection with those
activities with more than 15
counterparties, other than swap dealers,
over the course of the immediately
preceding 12 months. In determining
the number of counterparties, all
counterparties that are members of a
single group of persons under common
control shall be considered to be a
single counterparty.
(iii) The person has not entered into
more than 20 swaps in connection with
those activities over the course of the
immediately preceding 12 months. For
purposes of this paragraph, each
transaction entered into under a master
agreement for swaps shall constitute a
distinct swap, but entering into an
amendment of an existing swap in
which the counterparty to such swap
remains the same and the item
underlying such swap remains
substantially the same shall not
constitute entering into a swap.
(5) Insured depository institution
swaps in connection with originating
loans to customers. Swaps entered into
by an insured depository institution
with a customer in connection with
originating a loan with that customer
shall not be considered in determining
whether such person is a swap dealer.
(i) A swap shall be considered to have
been entered into in connection with
originating a loan only if the rate, asset,
liability or other notional item
underlying such swap is, or is directly
related to, a financial term of such loan.
The financial terms of a loan include,
without limitation, the loan’s duration,
rate of interest, the currency or
currencies in which it is made and its
principal amount.
(ii) An insured depository institution
shall be considered to have originated a
loan with a customer if the insured
depository institution:
(A) Directly transfers the loan amount
to the customer;
(B) Is a part of a syndicate of lenders
that is the source of the loan amount
that is transferred to the customer;
(C) Purchases or receives a
participation in the loan; or
(D) Otherwise is the source of funds
that are transferred to the customer
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pursuant to the loan or any refinancing
of the loan.
(iii) The term loan shall not include:
(A) Any transaction that is a sham,
whether or not intended to qualify for
the exclusion from the definition of the
term swap dealer in this rule; or
(B) Any synthetic loan, including
without limitation a loan credit default
swap or loan total return swap.
(qqq) Major Swap Participant. (1) In
general. The term major swap
participant means any person:
(i) That is not a swap dealer; and
(ii)(A) That maintains a substantial
position in swaps for any of the major
swap categories, excluding both
positions held for hedging or mitigating
commercial risk, and positions
maintained by any employee benefit
plan (or any contract held by such a
plan) as defined in paragraphs (3) and
(32) of Section 3 of the Employee
Retirement Income Security Act of 1974
(29 U.S.C. 1002) for the primary purpose
of hedging or mitigating any risk
directly associated with the operation of
the plan;
(B) Whose outstanding swaps create
substantial counterparty exposure that
could have serious adverse effects on
the financial stability of the United
States banking system or financial
markets; or
(C) That is a financial entity that:
(1) Is highly leveraged relative to the
amount of capital such entity holds and
that is not subject to capital
requirements established by an
appropriate Federal banking agency (as
defined in Section 1a(2) of the
Commodity Exchange Act); and
(2) Maintains a substantial position in
outstanding swaps in any major swap
category.
(2) Scope of designation. A person
that is a major swap participant shall be
deemed to be a major swap participant
with respect to each swap it enters into,
regardless of the category of the swap or
the person’s activities in connection
with the swap. However, if a person
makes an application to limit its
designation as a major swap participant
to specified categories of swaps or
specified activities of the person in
connection with swaps, the Commission
shall determine whether the person’s
designation as a major swap participant
shall be so limited. A person may make
such application to limit its designation
at the same time as, or at a later time
subsequent to, the person’s initial
registration as a major swap participant.
(3) Timing requirements. A person
that is not registered as a major swap
participant, but that meets the criteria in
this rule to be a major swap participant
as a result of its swap activities in a
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fiscal quarter, will not be deemed to be
a major swap participant until the
earlier of the date on which it submits
a complete application for registration
as a major swap participant or two
months after the end of that quarter.
(4) Reevaluation period.
Notwithstanding paragraph (qqq)(3) of
this section, if a person that is not
registered as a major swap participant
meets the criteria in this rule to be a
major swap participant in a fiscal
quarter, but does not exceed any
applicable threshold by more than
twenty percent in that quarter:
(i) That person will not immediately
be subject to the timing requirements
specified in paragraph (qqq)(3) of this
section; but
(ii) That person will become subject to
the timing requirements specified in
paragraph (3) at the end of the next
fiscal quarter if the person exceeds any
of the applicable daily average
thresholds in that next fiscal quarter.
(5) Termination of status. A person
that is deemed to be a major swap
participant shall continue to be deemed
a major swap participant until such time
that its swap activities do not exceed
any of the daily average thresholds set
forth within this rule for four
consecutive fiscal quarters after the date
on which the person becomes registered
as a major swap participant.
(rrr) Category of swaps; major swap
category. For purposes of Sections
1a(33) and 1a(49) of the Commodity
Exchange Act and §§ 1.3(ppp) and
1.3(qqq), the terms major swap category,
category of swaps and any similar terms
mean any of the categories of swaps
listed below. For the avoidance of
doubt, the term swap as it is used in this
§ 1.3(rrr) has the meaning set forth in
Section 1a(47) of the Commodity
Exchange Act and the rules thereunder.
(1) Rate swaps. Any swap which is
primarily based on one or more
reference rates, including but not
limited to any swap of payments
determined by fixed and floating
interest rates, currency exchange rates,
inflation rates or other monetary rates,
any foreign exchange swap, as defined
in Section 1a(25) of the Commodity
Exchange Act, and any foreign exchange
option.
(2) Credit swaps. Any swap that is
primarily based on instruments of
indebtedness, including but not limited
to any swap primarily based on one or
more broad-based indices related to debt
instruments, and any swap that is an
index credit default swap or total return
swap on one or more indices of debt
instruments.
(3) Equity swaps. Any swap that is
primarily based on equity securities,
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including but not limited to any swap
based on one or more broad-based
indices of equity securities and any total
return swap on one or more equity
indices.
(4) Other commodity swaps. Any
swap that is not included in the rate
swap, credit swap or equity swap
categories.
(sss) Substantial position. (1) In
general. For purposes of Section 1a(33)
of the Commodity Exchange Act and
§ 1.3(qqq), the term substantial position
means swap positions, other than
positions that are excluded from
consideration, that equal or exceed any
of the following thresholds in the
specified major category of swaps:
(i) For rate swaps:
(A) $3 billion in daily average
aggregate uncollateralized outward
exposure; or
(B) $6 billion in:
(1) Daily average aggregate
uncollateralized outward exposure plus
(2) Daily average aggregate potential
outward exposure.
(ii) For credit swaps:
(A) $1 billion in daily average
aggregate uncollateralized outward
exposure; or
(B) $2 billion in:
(1) Daily average aggregate
uncollateralized outward exposure plus
(2) Daily average aggregate potential
outward exposure.
(iii) For equity swaps:
(A) $1 billion in daily average
aggregate uncollateralized outward
exposure; or
(B) $2 billion in:
(1) Daily average aggregate
uncollateralized outward exposure plus
(2) Daily average aggregate potential
outward exposure.
(iv) For other commodity swaps:
(A) $1 billion in daily average
aggregate uncollateralized outward
exposure; or
(B) $2 billion in:
(1) Daily average aggregate
uncollateralized outward exposure plus
(2) Daily average aggregate potential
outward exposure.
(2) Aggregate uncollateralized
outward exposure. (i) In general.
Aggregate uncollateralized outward
exposure in general means the sum of
the current exposure, obtained by
marking-to-market using industry
standard practices, of each of the
person’s swap positions with negative
value in a major swap category, less the
value of the collateral the person has
posted in connection with those
positions.
(ii) Calculation of aggregate
uncollateralized outward exposure. In
calculating this amount the person
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80213
shall, with respect to each of its swap
counterparties in a given major swap
category:
(A) Determine the dollar value of the
aggregate current exposure arising from
each of its swap positions with negative
value (subject to the netting provisions
described below) in that major category
by marking-to-market using industry
standard practices; and
(B) Deduct from that dollar amount
the aggregate value of the collateral the
person has posted with respect to the
swap positions. The aggregate
uncollateralized outward exposure shall
be the sum of those uncollateralized
amounts across all of the person’s swap
counterparties in the applicable major
category.
(iii) Relevance of netting agreements.
(A) If the person has a master netting
agreement in effect with a particular
counterparty, the person may measure
the current exposure arising from its
swaps in any major category on a net
basis, applying the terms of the
agreement. Calculation of net exposure
may take into account offsetting
positions entered into with that
particular counterparty involving swaps
(in any swap category) as well as
security-based swaps and securities
financing transactions (consisting of
securities lending and borrowing,
securities margin lending and
repurchase and reverse repurchase
agreements), to the extent these are
consistent with the offsets permitted by
the master netting agreement.
(B) Such adjustments may not take
into account any offset associated with
positions that the person has with
separate counterparties.
(3) Aggregate potential outward
exposure. (i) In general. Aggregate
potential outward exposure in any
major swap category means the sum of:
(A) The aggregate potential outward
exposure for each of the person’s swap
positions in a major swap category that
are not subject to daily mark-to-market
margining and are not cleared by a
registered clearing agency or derivatives
clearing organization, as calculated in
accordance with paragraph (sss)(3)(ii);
and
(B) The aggregate potential outward
exposure for each of the person’s swap
positions in such major swap category
that are subject to daily mark-to-market
margining or are cleared by a registered
clearing agency or derivatives clearing
organization, as calculated in
accordance with paragraph (sss)(3)(iii)
of this section.
(ii) Calculation of potential outward
exposure for swaps that are not subject
to daily mark-to-market margining and
are not cleared by a registered clearing
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agency or derivatives clearing
organization. (A) In general. (1) For
positions in swaps that are not subject
to daily mark-to-market margining and
are not cleared by a registered clearing
agency or a derivatives clearing
organization, potential outward
exposure equals the total notional
principal amount of those positions,
adjusted by the following multipliers on
a position-by-position basis reflecting
the type of swap. For any swap that
does not appropriately fall within any of
the specified categories, the ‘‘other
commodities’’ conversion factors are to
be used. If a swap is structured such
that on specified dates any outstanding
exposure is settled and the terms are
reset so that the market value of the
swap is zero, the remaining maturity
equals the time until the next reset date.
TABLE TO § 1.3 (SSS)—CONVERSION FACTOR MATRIX FOR SWAPS
Residual maturity
Foreign exchange
rate and gold
Interest rate
One year or less ......................................................
Over one to five years .............................................
Over five years ........................................................
0.00
0.005
0.015
Precious metals
(except gold)
0.01
0.05
0.075
0.07
0.07
0.08
Residual maturity
Credit
emcdonald on DSK2BSOYB1PROD with PROPOSALS2
One year or less ..................................................................................................................................
Over one to five years .........................................................................................................................
Over five years ....................................................................................................................................
(2) Use of effective notional amounts.
If the stated notional amount on a
position is leveraged or enhanced by the
structure of the position, the calculation
in paragraph (sss)(3)(ii)(A)(1) of this
section shall be based on the effective
notional amount of the position rather
than on the stated notional amount.
(3) Exclusion of certain positions. The
calculation in paragraph
(sss)(3)(ii)(A)(1) of this section shall
exclude:
(i) Positions that constitute the
purchase of an option, such that the
person has no additional payment
obligations under the position; and
(ii) Other positions for which the
person has prepaid or otherwise
satisfied all of its payment obligations.
(4) Adjustment for certain positions.
Notwithstanding paragraph
(sss)(3)(ii)(A)(1) of this section, the
potential outward exposure associated
with a position by which a person buys
credit protection using a credit default
swap or index credit default swap is
capped at the net present value of the
unpaid premiums.
(B) Adjustment for netting
agreements. Notwithstanding paragraph
(sss)(3)(ii)(A) of this section, for
positions subject to master netting
agreements the potential outward
exposure associated with the person’s
swaps with each counterparty equals a
weighted average of the potential
outward exposure for the person’s
swaps with that counterparty as
calculated under paragraph
(sss)(3)(ii)(A), and that amount reduced
by the ratio of net current exposure to
gross current exposure, consistent with
the following equation as calculated on
a counterparty-by-counterparty basis:
PNet = 0.4 * PGross + 0.6 * NGR * PGross
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Note to paragraph (sss)(3)(ii)(B): PNet is the
potential outward exposure, adjusted for
bilateral netting, of the person’s swaps with
a particular counterparty; PGross is that
potential outward exposure without
adjustment for bilateral netting; and NGR is
the ratio of net current exposure to gross
current exposure.
(iii) Calculation of potential outward
exposure for swaps that are subject to
daily mark-to-market margining or are
cleared by a registered clearing agency
or derivatives clearing organization. For
positions in swaps that are subject to
daily mark-to-market margining or
cleared by a registered clearing agency
or derivatives clearing organization:
(A) Potential outward exposure equals
the potential exposure that would be
attributed to such positions using the
procedures in paragraph (sss)(3)(ii) of
this section multiplied by 0.2.
(B) For purposes of this calculation, a
swap shall be considered to be subject
to daily mark-to-market margining if,
and for so long as, the counterparties
follow the daily practice of exchanging
collateral to reflect changes in the
current exposure arising from the swap
(after taking into account any other
financial positions addressed by a
netting agreement between the
counterparties. If the person is
permitted by agreement to maintain a
threshold for which it is not required to
post collateral, the total amount of that
threshold (regardless of the actual
exposure at any time) shall be added to
the person’s aggregate uncollateralized
outward exposure for purposes of
paragraph (sss)(1)(i)(B), (ii)(B), (iii)(B) or
(iv)(B) of this section, as applicable. If
the minimum transfer amount under the
agreement is in excess of $1 million, the
entirety of the minimum transfer
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Other commodities
0.10
0.12
0.15
Equity
0.10
0.10
0.10
0.06
0.08
0.10
amount shall be added to the person’s
aggregate uncollateralized outward
exposure for purposes of paragraph
(sss)(1)(i)(B), (ii)(B), (iii)(B) or (iv)(B), as
applicable.
(4) Calculation of daily average.
Measures of daily average aggregate
uncollateralized outward exposure and
daily average aggregate potential
outward exposure shall equal the
arithmetic mean of the applicable
measure of exposure at the close of each
business day, beginning the first
business day of each calendar quarter
and continuing through the last
business day of that quarter.
(ttt) Hedging or mitigating commercial
risk. For purposes of Section 1a(33) of
the Commodity Exchange Act and
§ 1.3(qqq), a swap position shall be
deemed to be held for the purpose of
hedging or mitigating commercial risk
when:
(1) Such position:
(i) Is economically appropriate to the
reduction of risks in the conduct and
management of a commercial enterprise,
where the risks arise from:
(A) The potential change in the value
of assets that a person owns, produces,
manufactures, processes, or
merchandises or reasonably anticipates
owning, producing, manufacturing,
processing, or merchandising in the
ordinary course of business of the
enterprise;
(B) The potential change in the value
of liabilities that a person has incurred
or reasonably anticipates incurring in
the ordinary course of business of the
enterprise; or
(C) The potential change in the value
of services that a person provides,
purchases, or reasonably anticipates
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providing or purchasing in the ordinary
course of business of the enterprise;
(D) The potential change in the value
of assets, services, inputs, products, or
commodities that a person owns,
produces, manufactures, processes,
merchandises, leases, or sells, or
reasonably anticipates owning,
producing, manufacturing, processing,
merchandising, leasing, or selling in the
ordinary course of business of the
enterprise;
(E) Any potential change in value
related to any of the foregoing arising
from foreign exchange rate movements
associated with such assets, liabilities,
services, inputs, products, or
commodities; or
(F) Any fluctuation in interest,
currency, or foreign exchange rate
exposures arising from a person’s
current or anticipated assets or
liabilities; or
(ii) Qualifies as bona fide hedging for
purposes of an exemption from position
limits under the Commodity Exchange
Act; or
(iii) Qualifies for hedging treatment
under Financial Accounting Standards
Board Accounting Standards
Codification Topic 815, Derivatives and
Hedging (formerly known as Statement
No. 133); and
(2) Such position is:
(i) Not held for a purpose that is in the
nature of speculation, investing or
trading;
(ii) Not held to hedge or mitigate the
risk of another swap or securities-based
swap position, unless that other
position itself is held for the purpose of
hedging or mitigating commercial risk
as defined by this rule or § 240.3a67–4
of this title.
(uuu) Substantial counterparty
exposure. (1) In general. For purposes of
Section 1a(33) of the Act and § 1.3(qqq),
the phrase substantial counterparty
exposure that could have serious
adverse effects on the financial stability
of the United States banking system or
financial markets means a swap
position that satisfies either of the
following thresholds:
(i) $5 billion in daily average
aggregate uncollateralized outward
exposure; or
(ii) $8 billion in:
(A) Daily average aggregate
uncollateralized outward exposure plus
(B) Daily average aggregate potential
outward exposure.
(2) Calculation methodology. For
these purposes, the terms ‘‘daily average
aggregate uncollateralized outward
exposure’’ and ‘‘daily average aggregate
potential outward exposure’’ have the
same meaning as in § 1.3(sss), except
that these amounts shall be calculated
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by reference to all of the person’s swap
positions, rather than by reference to a
specific major swap category.
(vvv) Financial entity; highly
leveraged. (1) For purposes of Section
1a(33) of the Commodity Exchange Act
and § 1.3(qqq), the term ‘‘financial
entity’’ means:
(i) A security-based swap dealer;
(ii) A major security-based swap
participant;
(iii) A commodity pool as defined in
Section 1a(10) of the Commodity
Exchange Act;
(iv) A private fund as defined in
Section 202(a) of the Investment
Advisers Act of 1940 (15 U.S.C. 80b–
2(a));
(v) An employee benefit plan as
defined in paragraphs (3) and (32) of
Section 3 of the Employee Retirement
Income Security Act of 1974 (29 U.S.C.
1002); and
(vi) A person predominantly engaged
in activities that are in the business of
banking or financial in nature, as
defined in Section 4(k) of the Bank
Holding Company Act of 1956.
(2) For purposes of Section 1a(33) of
the Commodity Exchange Act and
§ 1.3(qqq), the term ‘‘highly leveraged’’
means the existence of a ratio of an
entity’s total liabilities to equity in
excess of [8 to 1 or 15 to 1] as measured
at the close of business on the last
business day of the applicable fiscal
quarter. For this purpose, liabilities and
equity should each be determined in
accordance with U.S. generally accepted
accounting principles.
80215
3, 80b–4, 80b–11, and 7201 et seq., 18 U.S.C.
1350; and 12 U.S.C. 5221(e)(3), unless
otherwise noted.
*
*
*
*
*
Sections 3a67–1 through 3a67–7 and
sections 3a71–1 and 3a71–2 are also issued
under Pub. L. 111–203, §§ 712, 761(b), 124
Stat. 1841 (2010).
*
*
*
*
*
2. Add §§ 240.3a67–1 through
240.3a67–7 and §§ 240.3a71–1,
240.3a71–2 to read as follows:
*
*
*
*
*
Sec.
240.3a67 1—Definition of ‘‘Major Securitybased Swap Participant.’’
240.3a67 2—Categories of Security-based
Swaps.
240.3a67 3—Definition of ‘‘Substantial
Position.’’
240.3a67 4—Definition of ‘‘Hedging or
Mitigating Commercial Risk.’’
240.3a67 5—Definition of ‘‘Substantial
Counterparty Exposure.’’
240.3a67 6—Definitions of ‘‘Financial
Entity’’ and ‘‘Highly Leveraged.’’
240.3a67 7—Timing Requirements,
Reevaluation Period, and Termination of
Status.
240.3a71 1—Definition of ‘‘Security-based
Swap Dealer.
240.3a71 2—De minimis Exception.
*
*
*
*
*
§ 240.3a67–1 Definition of ‘‘Major Securitybased Swap Participant.’’
(a) General. Major security-based
swap participant means any person:
(1) That is not a security-based swap
dealer; and
(2)(i) That maintains a substantial
position in security-based swaps for any
of the major security-based swap
Securities and Exchange Commission
categories, excluding both positions
Pursuant to the Exchange Act, 15
held for hedging or mitigating
U.S.C. 78a et seq., and particularly,
commercial risk, and positions
Sections 3 and 23 thereof, and Sections
maintained by any employee benefit
712 and 761(b) of the Dodd-Frank Act,
plan (or any contract held by such a
the SEC is proposing to adopt Rules
plan) as defined in paragraphs (3) and
3a67–1, 3a67–2, 3a67–3, 3a67–4, 3a67–
(32) of section 3 of the Employee
5, 3a67–6, 3a67–7, 3a71–1, and 3a71–2
Retirement Income Security Act of 1974
under the Exchange Act.
(29 U.S.C. 1002) for the primary purpose
of hedging or mitigating any risk
Text of Proposed Rules
directly associated with the operation of
For the reasons stated in the
the plan;
preamble, the SEC is proposing to
(ii) Whose outstanding security-based
amend Title 17, Chapter II of the Code
swaps create substantial counterparty
of the Federal Regulations as follows:
exposure that could have serious
adverse effects on the financial stability
PART 240—GENERAL RULES AND
of the United States banking system or
REGULATIONS, SECURITIES
financial markets; or
EXCHANGE ACT OF 1934
(iii) That is a financial entity that:
(A) Is highly leveraged relative to the
1. The authority citation for part 240
amount of capital such entity holds and
is amended by adding the following
that is not subject to capital
citation in numerical order:
requirements established by an
Authority: 15 U.S.C. 77c, 77d, 77g, 77j,
appropriate Federal banking agency (as
77s, 77z–2, 77z–3, 77eee, 77ggg, 77nnn,
defined in 15 U.S.C. 78c(a)(72)); and
77sss, 77ttt, 78c, 78d, 78e, 78f, 78g, 78i, 78j,
(B) Maintains a substantial position in
78j–1, 78k, 78k–1, 78l, 78m, 78n, 78o, 78o–
outstanding security-based swaps in any
4, 78p, 78q, 78s, 78u–5, 78w, 78x, 78ll,
78mm, 80a–20, 80a–23, 80a–29, 80a–37, 80b– major security-based swap category.
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Federal Register / Vol. 75, No. 244 / Tuesday, December 21, 2010 / Proposed Rules
(b) Scope of designation. A person
that is a major security-based swap
participant in general shall be deemed
to be a major security-based swap
participant with respect to each
security-based swap it enters into,
regardless of the category of the
security-based swap or the person’s
activities in connection with the
security-based swap, unless the
Commission limits the person’s
designation as a major security-based
swap participant to specified categories
of security-based swaps or specified
activities of the person in connection
with security-based swaps.
§ 240.3a67–2
Swaps.
Categories of Security-based
For purposes of sections 3(a)(67) and
3(a)(71) of the Act, 15 U.S.C. 78c(a)(67)
and 78c(a)(71), and the rules
thereunder, the terms major securitybased swap category, category of
security-based swaps and any similar
terms mean either of the following
categories of security-based swaps:
(a) Security-based credit derivatives.
Any security-based swap that is based,
in whole or in part, on one or more
instruments of indebtedness (including
loans), or on a credit event relating to
one or more issuers or securities,
including but not limited to any
security-based swap that is a credit
default swap, total return swap on one
or more debt instruments, debt swap,
debt index swap, or credit spread.
(b) Other security-based swaps. Any
security-based swap not described in
paragraph (a) of this section.
§ 240.3a67–3
Position.’’
Definition of ‘‘Substantial
(a) General. For purposes of section
3(a)(67) of the Act, 15 U.S.C. 78c(a)(67),
and § 240.3a67–1 of this chapter, the
term substantial position means
security-based swap positions, other
than positions that are excluded from
consideration, that equal or exceed
either of the following thresholds in any
major category of security-based swaps:
(1) $1 billion in daily average
aggregate uncollateralized outward
exposure; or
(2) $2 billion in:
(i) Daily average aggregate
uncollateralized outward exposure; plus
(ii) Daily average aggregate potential
outward exposure.
(b) Aggregate uncollateralized
outward exposure. (1) General.
Aggregate uncollateralized outward
exposure in general means the sum of
the current exposure, obtained by
marking-to-market using industry
standard practices, of each of the
person’s security-based swap positions
with negative value in a major securitybased swap category, less the value of
the collateral the person has posted in
connection with those positions.
(2) Calculation of aggregate
uncollateralized outward exposure. In
calculating this amount the person
shall, with respect to each of its
security-based swap counterparties in a
given major security-based swap
category:
(i) Determine the dollar value of the
aggregate current exposure arising from
each of its security-based swap
positions with negative value (subject to
the netting provisions described below)
in that major category by marking-tomarket using industry standard
practices; and
(ii) Deduct from that dollar amount
the aggregate value of the collateral the
person has posted with respect to the
security-based swap positions. The
aggregate uncollateralized outward
exposure shall be the sum of those
uncollateralized amounts across all of
the person’s security-based swap
counterparties in the applicable major
category.
(3) Relevance of netting agreements.
(i) If a person has a master netting
agreement with a counterparty, the
person may measure the current
exposure arising from its security-based
swaps in any major category on a net
basis, applying the terms of the
agreement. Calculation of net exposure
may take into account offsetting
positions entered into with that
emcdonald on DSK2BSOYB1PROD with PROPOSALS2
Residual maturity
Credit
One year or less ............................................................................................
Over one to five years ...................................................................................
Over five years ..............................................................................................
(2) If a security-based swap is
structured such that on specified dates
any outstanding exposure is settled and
the terms are reset so that the market
value of the security-based swap is zero,
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particular counterparty involving
security-based swaps (in any swap
category) as well as swaps and securities
financing transactions (consisting of
securities lending and borrowing,
securities margin lending and
repurchase and reverse repurchase
agreements), to the extent these are
consistent with the offsets permitted by
the master netting agreement.
(ii) Such adjustments may not take
into account any offset associated with
positions that the person has with
separate counterparties.
(c) Aggregate potential outward
exposure. (1) General. Aggregate
potential outward exposure means the
sum of:
(i) The aggregate potential outward
exposure for each of the person’s
security-based swap positions in a major
security-based swap category that are
not cleared by a registered clearing
agency or subject to daily mark-tomarket margining, as calculated in
accordance with paragraph (c)(2) of this
section; and
(ii) The aggregate potential outward
exposure for each of the person’s
security-based swap positions in a major
security-based swap category that are
cleared by a registered clearing agency
or subject to daily mark-to-market
margining, as calculated in accordance
with paragraph (c)(3) of this section.
(2) Calculation of potential outward
exposure for security-based swaps that
are not cleared by a registered clearing
agency or subject to daily mark-tomarket margining.
(i) General. (A)(1) For positions in
security-based swaps that are not
cleared by a registered clearing agency
or subject to daily mark-to-market
margining, potential outward exposure
equals the total notional principal
amount of those positions, multiplied
by the following factors on a positionby-position basis reflecting the type of
security-based swap. For any securitybased swap that is not of the ‘‘credit’’ or
‘‘equity’’ type, the ‘‘other’’ conversion
factors are to be used:
Equity
0.10
0.10
0.10
the remaining maturity equals the time
until the next reset date.
(B) Use of effective notional amounts.
If the stated notional amount on a
position is leveraged or enhanced by the
structure of the position, the calculation
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Other
0.06
0.08
0.10
0.10
0.12
0.15
in paragraph (c)(2)(i)(A) of this section
shall be based on the effective notional
amount of the position rather than on
the stated notional amount.
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Federal Register / Vol. 75, No. 244 / Tuesday, December 21, 2010 / Proposed Rules
(C) Exclusion of certain positions. The
calculation in paragraph (c)(2)(i)(A) of
this section shall exclude:
(1) Positions that constitute the
purchase of an option, such that the
person has no additional payment
obligations under the position; and
(2) Other positions for which the
person has prepaid or otherwise
satisfied all of its payment obligations.
(D) Adjustment for certain positions.
Notwithstanding paragraph (c)(2)(i)(A)
of this section, the potential outward
exposure associated with a position by
which a person buys credit protection
using a credit default swap is capped at
the net present value of the unpaid
premiums.
(ii) Adjustment for netting
agreements. Notwithstanding paragraph
(c)(2)(i) of this section, for positions
subject to master netting agreements the
potential outward exposure associated
with the person’s security-based swaps
with each counterparty equals a
weighted average of the potential
outward exposure for the person’s
security-based swaps with that
counterparty as calculated under
paragraph (c)(2)(i) of this section, and
that amount reduced by the ratio of net
current exposure to gross current
exposure, consistent with the following
equation as calculated on a
counterparty-by-counterparty basis:
PNet = 0.4 × PGross + 0.6 × NGR × PGross
emcdonald on DSK2BSOYB1PROD with PROPOSALS2
Note to paragraph (c)(2)(ii). Where: PNet is
the potential outward exposure, adjusted for
bilateral netting, of the person’s securitybased swaps with a particular counterparty;
PGross is that potential outward exposure
without adjustment for bilateral netting; and
NGR is the ratio of net current exposure to
gross current exposure.
(3) Calculation of potential outward
exposure for security-based swaps that
are cleared by a registered clearing
agency or subject to daily mark-tomarket margining. For positions in
security-based swaps that are cleared by
a registered clearing agency or subject to
daily mark-to-market margining:
(i) Potential outward exposure equals
the potential outward exposure that
would be attributed to such positions
using the procedures in paragraph (c)(2)
of this section, multiplied by 0.2.
(ii) For purposes of this calculation, a
security-based swap shall be considered
to be subject to daily mark-to-market
margining if, and for as long as, the
counterparties follow the daily practice
of exchanging collateral to reflect
changes in the current exposure arising
from the security-based swap (after
taking into account any other financial
positions addressed by a netting
agreement between the counterparties).
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If the person is permitted by agreement
to maintain a threshold for which it is
not required to post collateral, the total
amount of that threshold (regardless of
the actual exposure at any time) shall be
added to the person’s aggregate
uncollateralized outward exposure for
purposes of paragraph (a)(2) of this
section. If the minimum transfer amount
under the agreement is in excess of $1
million, the entirety of the minimum
transfer amount shall be added to the
person’s aggregate uncollateralized
outward exposure for purposes of
paragraph (a)(2) of this section.
(d) Calculation of daily average.
Measures of daily average aggregate
uncollateralized outward exposure and
daily average aggregate potential
outward exposure shall equal the
arithmetic mean of the applicable
measure of exposure at the close of each
business day, beginning the first
business day of each calendar quarter
and continuing through the last
business day of that quarter.
§ 240.3a67–4 Definition of ‘‘Hedging or
Mitigating Commercial Risk.’’
For purposes of section 3(a)(67) of the
Act, 15 U.S.C. 78c(a)(67), and
§ 240.3a67–1 of this chapter, a securitybased swap position shall be deemed to
be held for the purpose of hedging or
mitigating commercial risk when:
(a) Such position is economically
appropriate to the reduction of risks that
are associated with the present conduct
and management of a commercial
enterprise, or are reasonably expected to
arise in the future conduct and
management of the commercial
enterprise, where such risks arise from:
(1) The potential change in the value
of assets that a person owns, produces,
manufactures, processes, or
merchandises or reasonably anticipates
owning, producing, manufacturing,
processing, or merchandising in the
ordinary course of business of the
enterprise;
(2) The potential change in the value
of liabilities that a person has incurred
or reasonably anticipates incurring in
the ordinary course of business of the
enterprise; or
(3) The potential change in the value
of services that a person provides,
purchases, or reasonably anticipates
providing or purchasing in the ordinary
course of business of the enterprise;
(b) Such position is:
(1) Not held for a purpose that is in
the nature of speculation or trading; and
(2) Not held to hedge or mitigate the
risk of another security-based swap
position or swap position, unless that
other position itself is held for the
purpose of hedging or mitigating
PO 00000
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80217
commercial risk as defined by this
section or 17 CFR 1.3(ttt); and
(c) The person holding the position
satisfies the following additional
conditions:
(1) The person identifies and
documents the risks that are being
reduced by the security-based swap
position;
(2) The person establishes and
documents a method of assessing the
effectiveness of the security-based swap
as a hedge; and
(3) The person regularly assesses the
effectiveness of the security-based swap
as a hedge.
§ 240.3a67–5 Definition of ‘‘Substantial
Counterparty Exposure.’’
(a) General. For purposes of section
3(a)(67) of the Act, 15 U.S.C. 78c(a)(67),
and § 240.3a67–1 of this chapter, the
term substantial counterparty exposure
that could have serious adverse effects
on the financial stability of the United
States banking system or financial
markets means a security-based swap
position that satisfies either of the
following thresholds:
(1) $2 billion in daily average
aggregate uncollateralized outward
exposure; or
(2) $4 billion in:
(i) Daily average aggregate
uncollateralized outward exposure; plus
(ii) Daily average aggregate potential
outward exposure.
(b) Calculation. For these purposes,
daily average aggregate uncollateralized
outward exposure and daily average
aggregate potential outward exposure
shall be calculated the same way as is
prescribed in § 240.3a67–3 of this
chapter, except that these amounts shall
be calculated by reference to all of the
person’s security-based swap positions,
rather than by reference to a specific
major security-based swap category.
§ 240.3a67–6 Definitions of ‘‘Financial
Entity’’ and ‘‘Highly Leveraged.’’
(a) For purposes of section 3(a)(67) of
the Act, 15 U.S.C. 78c(a)(67), and
§ 240.3a67–1 of this chapter, the term
financial entity means:
(1) A swap dealer;
(2) A major swap participant;
(3) A commodity pool as defined in
section 1a(10) of the Commodity
Exchange Act (7 U.S.C. 1a(10));
(4) A private fund as defined in
section 202(a) of the Investment
Advisers Act of 1940 (15 U.S.C. 80b–
2(a));
(5) An employee benefit plan as
defined in paragraphs (3) and (32) of
section 3 of the Employee Retirement
Income Security Act of 1974 (29 U.S.C.
1002); and
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Federal Register / Vol. 75, No. 244 / Tuesday, December 21, 2010 / Proposed Rules
(6) A person predominantly engaged
in activities that are in the business of
banking or financial in nature, as
defined in section 4(k) of the Bank
Holding Company Act of 1956 (12
U.S.C. 1843k).
(b) For purposes of section 3(a)(67) of
the Act, 15 U.S.C. 78c(a)(67), and
§ 240.3a67–1 of this chapter, the term
highly leveraged means the existence of
a ratio of an entity’s total liabilities to
equity in excess of [8 to 1 or 15 to 1]
as measured at the close of business on
the last business day of the applicable
fiscal quarter. For this purpose,
liabilities and equity should each be
determined in accordance with U.S.
generally accepted accounting
principles.
emcdonald on DSK2BSOYB1PROD with PROPOSALS2
§ 240.3a67–7 Timing Requirements,
Reevaluation Period, and Termination of
Status.
(a) Timing requirements. A person
that is not registered as a major securitybased swap participant, but that meets
the criteria in § 240.3a67–1 of this
chapter to be a major security-based
swap participant as a result of its
security-based swap activities in a fiscal
quarter, will not be deemed to be a
major security-based swap participant
until the earlier of the date on which it
submits a complete application for
registration pursuant to 15 U.S.C. 78o–
8 or two months after the end of that
quarter.
(b) Reevaluation period.
Notwithstanding paragraph (a) of this
section, if a person that is not registered
as a major security-based swap
participant meets the criteria in
§ 240.3a67–1 of this chapter to be a
major security-based swap participant
in a fiscal quarter, but does not exceed
any applicable threshold by more than
twenty percent in that quarter:
(1) That person will not immediately
be subject to the timing requirements
specified in paragraph (a) of this
section; but
(2) That person will become subject to
the timing requirements specified in
paragraph (a) of this section at the end
of the next fiscal quarter if the person
exceeds any of the applicable daily
average thresholds in that next fiscal
quarter.
(c) Termination of status. A person
that is deemed to be a major securitybased swap participant shall continue to
be deemed a major security-based swap
participant until such time that its
security-based swap activities do not
exceed any of the daily average
thresholds set forth within § 240.3a67–
1 of this chapter for four consecutive
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18:50 Dec 20, 2010
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fiscal quarters after the date on which
the person becomes registered as a
major security-based swap participant.
§ 240.3a71–1 Definition of ‘‘Security-based
Swap Dealer.’’
(a) General. The term security-based
swap dealer in general means any
person who:
(1) Holds itself out as a dealer in
security-based swaps;
(2) Makes a market in security-based
swaps;
(3) Regularly enters into securitybased swaps with counterparties as an
ordinary course of business for its own
account; or
(4) Engages in any activity causing it
to be commonly known in the trade as
a dealer or market maker in securitybased swaps.
(b) Exception. The term securitybased swap dealer does not include a
person that enters into security-based
swaps for such person’s own account,
either individually or in a fiduciary
capacity, but not as a part of regular
business.
(c) Scope of designation. A person
that is a security-based swap dealer in
general shall be deemed to be a securitybased swap dealer with respect to each
security-based swap it enters into,
regardless of the category of the
security-based swap or the person’s
activities in connection with the
security-based swap, unless the
Commission limits the person’s
designation as a major security-based
swap participant to specified categories
of security-based swaps or specified
activities of the person in connection
with security-based swaps.
§ 240.3a71–2
De minimis Exception.
For purposes of section 3(a)(71) of the
Act, 15 U.S.C. 78c(a)(71), and
§ 240.3a71–1 of this chapter, a person
shall not be deemed to be a securitybased swap dealer as a result of
security-based swap dealing activity
involving counterparties that meets each
of the following conditions:
(a) Notional amount of outstanding
security-based swap positions. The
security-based swap positions
connected with those activities into
which the person enters over the course
of the immediately preceding 12 months
have an aggregate gross notional amount
of no more than $100 million and have
an aggregate gross notional amount of
no more than $25 million with regard to
security-based swaps in which the
counterparty is a ‘‘special entity’’ (as that
term is defined in 15 U.S.C. 78o–8). For
purposes of this paragraph (a), if the
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Sfmt 9990
stated notional amount of a securitybased swap is leveraged or enhanced by
the structure of the security-based swap,
the calculation shall be based on the
effective notional amount of the
security-based swap rather than on the
stated notional amount.
(b) No more than 15 counterparties.
The person does not enter into securitybased swaps in connection with those
activities with more than 15
counterparties, other than securitybased swap dealers, over the course of
the immediately preceding 12 months.
In determining the number of
counterparties, all counterparties that
are members of a single affiliated group
shall be considered to be a single
counterparty.
(c) No more than 20 security-based
swaps. The person has not entered into
more than 20 security-based swaps in
connection with those activities over the
course of the immediately preceding 12
months. For purposes of this paragraph,
each transaction entered into under a
master agreement for security-based
swaps shall constitute a distinct
security-based swap, but entering into
an amendment of an existing securitybased swap in which the counterparty
to such swap remains the same and the
notional item underlying such securitybased swap remains substantially the
same shall not constitute entering into
a security-based swap.
Dated: December 1, 2010.
By the Commodity Futures Trading
Commission.
David A. Stawick,
Secretary.
Dated: December 7, 2010.
By the Securities and Exchange
Commission.
Elizabeth M. Murphy,
Secretary.
Additional Statement by the
Commodity Futures Trading
Commission Regarding the Joint
Proposed Rule Entitled ‘‘Further
Definition of ‘Swap Dealer,’ ‘SecurityBased Swap Dealer,’ ‘Major Swap
Participant,’ ‘Major Security-Based
Swap Participant,’ and ‘Eligible
Contract Participant.’’’
On this matter, Chairman Gensler and
Commissioners Dunn and Chilton voted
in the affirmative; Commissioners
Sommers and O’Malia voted in the
negative.
[FR Doc. 2010–31130 Filed 12–20–10; 8:45 am]
BILLING CODE 6351–01–P; 8011–01–P
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]]>Agencies
[Federal Register Volume 75, Number 244 (Tuesday, December 21, 2010)]
[Proposed Rules]
[Pages 80174-80218]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2010-31130]
[[Page 80173]]
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Part III
Commodity Futures Trading Commission
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17 CFR Part 1
Securities and Exchange Commission
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17 CFR Part 240
Further Definition of ``Swap Dealer,'' ``Security-Based Swap Dealer,''
``Major Swap Participant,'' ``Major Security-Based Swap Participant''
and ``Eligible Contract Participant''; Proposed Rule
Federal Register / Vol. 75 , No. 244 / Tuesday, December 21, 2010 /
Proposed Rules
[[Page 80174]]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 1
RIN 3038-AD06
SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 240
[Release No. 34-63452; File No. S7-39-10]
RIN 3235-AK65
Further Definition of ``Swap Dealer,'' ``Security-Based Swap
Dealer,'' ``Major Swap Participant,'' ``Major Security-Based Swap
Participant'' and ``Eligible Contract Participant''
AGENCY: Commodity Futures Trading Commission; Securities and Exchange
Commission.
ACTION: Joint proposed rule; proposed interpretations.
-----------------------------------------------------------------------
SUMMARY: In accordance with Section 712(d)(1) of Title VII of the Dodd-
Frank Wall Street Reform and Consumer Protection Act of 2010 (``Dodd-
Frank Act''), the Commodity Futures Trading Commission (``CFTC'') and
the Securities and Exchange Commission (``SEC'') (collectively, the
``Commissions''), in consultation with the Board of Governors of the
Federal Reserve System, are proposing rules and interpretative guidance
under the Commodity Exchange Act (``CEA''), 7 U.S.C. 1 et seq., and the
Securities Exchange Act of 1934 (``Exchange Act''), 15 U.S.C. 78a et
seq., to further define the terms ``swap dealer,'' ``security-based
swap dealer,'' ``major swap participant,'' ``major security-based swap
participant,'' and ``eligible contract participant.''
DATES: Submit comments on or before February 22, 2011.
ADDRESSES: Comments may be submitted by any of the following methods:
CFTC:
Agency Web site, via its Comments Online process: https://comments.cftc.gov. Follow the instructions for submitting comments
through the Web site.
Mail: David A. Stawick, Secretary, Commodity Futures
Trading Commission, Three Lafayette Centre, 1155 21st Street, NW.,
Washington, DC 20581.
Hand Delivery/Courier: Same as mail above.
Federal eRulemaking Portal: Comments also may be submitted
at https://www.regulations.gov. Follow the instructions for submitting
comments. ``Definitions'' must be in the subject field of responses
submitted via e-mail, and clearly indicated on written submissions. All
comments must be submitted in English, or if not, accompanied by an
English translation. All comments provided in any electronic form or on
paper will be published on the CFTC Web site, without review and
without removal of personally identifying information. All comments are
subject to the CFTC Privacy Policy.
SEC
Electronic Comments
Use the Commission's Internet comment form (https://www.sec.gov/rules/proposed.shtml);
Send an e-mail to rule-comments@sec.gov. Please include
File Number S7-39-10 on the subject line; or
Use the Federal eRulemaking Portal (https://www.regulations.gov). Follow the instructions for submitting comments.
Paper Comments
Send paper comments in triplicate to Elizabeth M. Murphy,
Secretary, Securities and Exchange Commission, 100 F Street, NE.,
Washington, DC 20549-1090.
All submissions should refer to File Number S7-39-10. This file number
should be included on the subject line if e-mail is used. To help us
process and review your comments more efficiently, please use only one
method. The Commission will post all comments on the Commission's
Internet Web site (https://www.sec.gov/rules/proposed.shtml). Comments
are also available for Web site viewing and printing in the
Commission's Public Reference Room, 100 F Street, NE., Washington, DC
20549, on official business days between the hours of 10 a.m. and 3
p.m. All comments received will be posted without change; we do not
edit personal identifying information from submissions. You should
submit only information that you wish to make available publicly.
FOR FURTHER INFORMATION CONTACT: CFTC: Mark Fajfar, Assistant General
Counsel, at 202-418-6636, mfajfar@cftc.gov, Julian E. Hammar, Assistant
General Counsel, at 202-418-5118, jhammar@cftc.gov, or David E. Aron,
Counsel, at 202-418-6621, daron@cftc.gov, Office of General Counsel,
Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st
Street, NW., Washington, DC 20581; SEC: Joshua Kans, Senior Special
Counsel, Jeffrey Dinwoodie, Attorney Advisor, or Richard Grant,
Attorney Advisor, at 202-551-5550, Division of Trading and Markets,
Securities and Exchange Commission, 100 F Street, NE., Washington, DC
20549-7010.
SUPPLEMENTARY INFORMATION:
I. Background
On July 21, 2010, President Obama signed the Dodd-Frank Act into
law.\1\ Title VII of the Dodd-Frank Act \2\ established a comprehensive
new regulatory framework for swaps and security-based swaps. The
legislation was enacted, among other reasons, to reduce risk, increase
transparency, and promote market integrity within the financial system,
including by: (1) Providing for the registration and comprehensive
regulation of swap dealers, security-based swap dealers, major swap
participants and major security-based swap participants; (2) imposing
clearing and trade execution requirements on swaps and security-based
swaps, subject to certain exceptions; (3) creating rigorous
recordkeeping and real-time reporting regimes; and (4) enhancing the
rulemaking and enforcement authorities of the Commissions with respect
to, among others, all registered entities and intermediaries subject to
the Commissions' oversight.
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\1\ See Dodd-Frank Wall Street Reform and Consumer Protection
Act, Public Law 111-203, 124 Stat. 1376 (2010). The text of the
Dodd-Frank Act may be accessed at https://www.cftc.gov./
LawRegulation/OTCDERIVATIVES/index.htm.
\2\ Pursuant to Section 701 of the Dodd-Frank Act, Title VII may
be cited as the ``Wall Street Transparency and Accountability Act of
2010.''
---------------------------------------------------------------------------
More specifically, the Dodd-Frank Act provides that the CFTC will
regulate ``swaps,'' and the SEC will regulate ``security-based swaps.''
The Dodd-Frank Act also adds to the CEA and Exchange Act definitions of
the terms ``swap dealer,'' ``security-based swap dealer,'' ``major swap
participant,'' ``major security-based swap participant,'' and
``eligible contract participant.'' These terms are defined in Sections
721 and 761 of the Dodd-Frank Act and, with respect to the term
``eligible contract participant,'' in Section 1a(18) of the CEA,\3\ as
re-designated and amended by Section 721 of the Dodd-Frank Act.
---------------------------------------------------------------------------
\3\ See 7 U.S.C. 1a(18).
---------------------------------------------------------------------------
Section 712(d)(1) of the Dodd-Frank Act provides that the CFTC and
the SEC, in consultation with the Board of Governors of the Federal
Reserve System, shall jointly further define the terms ``swap,''
``security-based swap,'' ``swap dealer,'' ``security-based swap
dealer,'' ``major swap participant,'' ``major security-based swap
participant,'' ``eligible contract participant,'' and ``security-based
swap agreement.''
[[Page 80175]]
Further, Section 721(c) of the Dodd-Frank Act requires the CFTC to
adopt a rule to further define the terms ``swap,'' ``swap dealer,''
``major swap participant,'' and ``eligible contract participant,'' and
Section 761(b) of the Dodd-Frank Act permits the SEC to adopt a rule to
further define the terms ``security-based swap,'' ``security-based swap
dealer,'' ``major security-based swap participant,'' and ``eligible
contract participant,'' with regard to security-based swaps, for the
purpose of including transactions and entities that have been
structured to evade Title VII of the Dodd-Frank Act.\4\
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\4\ The definitions of the terms ``swap,'' ``security-based
swap,'' and ``security-based swap agreement,'' and regulations
regarding mixed swaps are the subject of a separate rulemaking by
the Commissions.
---------------------------------------------------------------------------
In light of the requirements in the Dodd-Frank Act noted above, the
CFTC and the SEC issued a joint Advance Notice of Proposed Rulemaking
(``ANPRM'') on August 13, 2010, requesting public comment regarding the
definitions of ``swap,'' ``security-based swap,'' ``security-based swap
agreement,'' ``swap dealer,'' ``security-based swap dealer,'' ``major
swap participant,'' ``major security-based swap participant,'' and
``eligible contract participant'' in Title VII of the Dodd-Frank
Act.\5\ The Commissions reviewed more than 80 comments in response to
the ANPRM. The Commissions also informally solicited comments on the
definitions on their respective Web sites.\6\ In addition, the staffs
of the CFTC and the SEC have met with many market participants and
other interested parties to discuss the definitions.\7\
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\5\ See Definitions Contained in Title VII of Dodd-Frank Wall
Street Reform and Consumer Protection Act, Exchange Act Rel. No. 34-
62717, 75 FR 51429 (Aug. 20, 2010). The comment period for the ANPRM
closed on September 20, 2010.
\6\ Comments were solicited by the CFTC at https://www.cftc.gov/LawRegulation/DoddFrankAct/OTC_2_Definitions.html and the SEC at
https://www.sec.gov/spotlight/regreformcomments.shtml/.
\7\ The views expressed in the comments in response to the
ANPRM, in response to the Commissions' informal solicitation, and at
such meetings are collectively referred to as the views of
``commenters.''
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In this release, the Commissions propose to further define ``swap
dealer,'' ``security-based swap dealer,'' ``major swap participant,''
``major security-based swap participant'' and ``eligible contract
participant,'' and propose related rules, and also discuss certain
factors that are relevant to market participants when determining their
status with respect to the defined terms. In developing these
proposals, the Commissions have been mindful that the markets for swaps
and security-based swaps are evolving, and that the rules that we adopt
will, as intended by the Dodd-Frank Act, significantly affect those
markets. The rules not only will help determine which entities will be
subject to comprehensive regulation of their swap and security-based
swap activities, but may also cause certain entities to modify their
activities to avoid being subject to the regulations. As a result, we
are aware of the importance of crafting these rules carefully to
maximize the benefits of the regulation imposed by the Dodd-Frank Act,
and to do so in a way that is flexible enough to respond to market
developments. While we preliminarily believe that these proposals, if
adopted, would appropriately effect the intent of the Dodd-Frank Act,
we are very interested in commenters' views as to whether we have
achieved this purpose, and, if not, how to improve these proposals.\8\
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\8\ In addition, we recognize that the appropriateness of these
proposals also should be considered in light of the substantive
requirements that will be applicable to dealers and major
participants, including capital, margin and business conduct
requirements, which are the subject of separate rulemakings. For
example, whether the definition of a major participant is too broad
or too narrow may well depend in part on the substantive
requirements applicable to such entities, and whether those
substantive requirements are themselves appropriate may in turn
depend in part on the scope of the major participant definition. We
therefore encourage comments that take into account the interplay
between the proposed definitions and these substantive requirements.
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II. Definitions of ``Swap Dealer'' and ``Security-Based Swap Dealer''
The Dodd-Frank Act defines the terms ``swap dealer'' and
``security-based swap dealer'' in terms of whether a person engages in
certain types of activities involving swaps or security-based swaps.\9\
Persons that meet either of those definitions are subject to statutory
requirements related to, among other things, registration, margin,
capital and business conduct.\10\
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\9\ See Section 721 of the Dodd-Frank Act (defining ``swap
dealer'' in new Section 1a(49) of the CEA, 7 U.S.C. 1a(49)) and
Section 761 of the Dodd-Frank Act (defining ``security-based swap
dealer'' in new Section 3(a)(71) of the Exchange Act, 15 U.S.C.
78c(a)(71)).
\10\ The Dodd-Frank Act excludes from the Exchange Act
definition of ``dealer'' persons who engage in security-based swap
transactions with eligible contract participants. See Section
3(a)(5) of the Exchange Act, 15 U.S.C. 78c(a)(5), as amended by
Section 761(a)(1) of the Dodd-Frank Act.
The Dodd-Frank Act does not include comparable amendments for
persons who act as brokers in swaps and security-based swaps.
Because security-based swaps are a type of security, persons who act
as brokers in connection with security-based swaps must, absent an
exemption, register with the SEC as a broker pursuant to Exchange
Act section 15(a), and comply with the Exchange Act's requirements
applicable to brokers.
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The two definitions in general encompass persons that engage in any
of the following types of activity:
(i) Holding oneself out as a dealer in swaps or security-based
swaps,
(ii) Making a market in swaps or security-based swaps,
(iii) Regularly entering into swaps or security-based swaps with
counterparties as an ordinary course of business for one's own account,
or
(iv) Engaging in activity causing oneself to be commonly known in
the trade as a dealer or market maker in swaps or security-based
swaps.\11\
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\11\ See CEA section 1a(49)(A); Exchange Act section
3(a)(71)(A).
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The definitions are disjunctive, in that a person that engages in
any of the enumerated dealing activities is a swap dealer or security-
based swap dealer even if the person does not engage in any of the
other enumerated activities.
The definitions, in contrast, do not include a person that enters
into swaps or security-based swaps ``for such person's own account,
either individually or in a fiduciary capacity, but not as a part of a
regular business.'' \12\ The Dodd-Frank Act also instructs the
Commissions to exempt from designation as a dealer an entity that
``engages in a de minimis quantity of [swap or security-based swap]
dealing in connection with transactions with or on behalf of its
customers.'' \13\ Moreover, the definition of ``swap dealer'' (but not
the definition of ``security-based swap dealer'') provides that an
insured depository institution is not to be considered a swap dealer
``to the extent it offers to enter into a swap with a customer in
connection with originating a loan with that customer.'' \14\
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\12\ See CEA section 1a(49)(C); Exchange Act section
3(a)(71)(C).
\13\ See CEA section 1a(49)(D); Exchange Act section
3(a)(71)(D).
\14\ CEA section 1a(49)(A).
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The definitions also provide that a person may be designated as a
dealer for one or more types, classes or categories of swaps, security-
based swaps, or activities without being designated a dealer for other
types, classes or categories or activities.\15\
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\15\ See CEA section 1a(49)(B); Exchange Act section
3(a)(71)(B).
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The Commissions are proposing rules to further define certain
aspects of the meaning of ``swap dealer'' and ``security-based swap
dealer,'' and are providing guidance on how the Commissions propose to
interpret these terms. This release specifically addresses: (A) The
types of activities that would cause a person to be a swap dealer or
security-based swap dealer, including differences in how those two
definitions should be applied; (B) the statutory provisions requiring
the Commissions to exempt persons from the dealer
[[Page 80176]]
definitions in connection with de minimis activity; (C) the exception
from the ``swap dealer'' definition in connection with loans by insured
depository institutions; (D) the possibility that a person may be
considered a dealer for some types, classes or categories of swaps,
security-based swaps, or activities but not others; and (E) certain
interpretative issues that arise in particular situations. The
Commissions request comment on all aspects of the proposals, including
the particular points noted in the discussion below.
A. Swap and Security-Based Swap Dealing Activity
1. Comments Regarding Dealing Activities
Commenters provided numerous examples of conduct they viewed as
dealing activities--as well as conduct they did not view as dealing
activities. For example, many of the commenters stated that dealers
provide ``bid/ask'' or ``two-way'' prices for swaps on a regular basis,
or regularly participate in both sides of the swap market. Some
commenters indicated that dealers perform an intermediary function.
Other commenters stated that a person holds itself out as a dealer if
it consistently and systematically markets itself as a swap dealer to
third parties. Some commenters described market makers in the swap
markets as persons that stand ready to buy or sell swaps at all times,
are open to doing swaps business on both sides of a market, or make
bids to buy and offers to sell swaps or a type of swap at all times.
Commenters stated that a person should be included in the definition of
dealer if its sole or dominant line of business is swaps activity. One
commenter urged the Commissions to adopt a swap association's
definition of a primary member as the definition of dealer.
Some commenters stated that the definition of dealer should be read
narrowly. For example, some commenters suggested that the market maker
concept should not encompass persons that provide occasional quotes or
that do not make bids or offers consistently or at all times. Another
commenter stated that a willingness to buy or sell a swap or security-
based swap at a particular time does not constitute market making
absent the creating of a two-way market. One commenter suggested that
solely acting as a market maker should not cause a person to be a
dealer, since firms may have commercial purposes for offering two-way
trades. Another commenter stated that an entity that ``holds itself
out'' as a dealer should qualify as a swap dealer only if it
``consistently and systematically markets itself as a dealer to third-
parties.'' \16\
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\16\ See letter from Eric Dennison, Sr. Vice President and
General Counsel, Stephanie Miller, Assistant General Counsel--
Commodities, and Bill Hellinghausen, Director of Regulatory Affairs,
EDF Trading, dated September 20, 2010 (distinguishing transactions
that the commenter enters into as part of energy management
services).
---------------------------------------------------------------------------
Many commenters called for the exclusion of particular types of
persons from the definition of swap dealer or security-based swap
dealer. Several commenters maintained that commercial end-users of
swaps or security-based swaps that enter into swaps or security-based
swaps to hedge or mitigate commercial risk should be excluded from the
definitions. Another commenter stated the definitions should exclude
persons who use swaps or security-based swaps for bona fide hedging.
Other commenters indicated that cooperatives that enter into swaps in
connection with the business of their members should be excluded.
Commenters also stated that if all of a person's swaps are cleared on
an exchange or derivatives clearing organization, the person should not
be deemed to be a dealer. One commenter stated competitive power
suppliers should be excluded, and another stated that the dealer
definition should not apply to futures commission merchants that act
economically like brokers.
Commenters, particularly those in the securities industry, urged
the Commissions to interpret the definitions of swap dealer and
security-based swap dealer consistently with precedent that
distinguishes between dealers in securities and traders in securities.
However, one commenter also noted that some concepts from the
securities and commodities laws may not easily be applied to these
markets.
2. Application of the Core Tests to ``Swap Dealers'' and ``Security-
Based Swap Dealers''
The Dodd-Frank Act defines the terms ``swap dealer'' and
``security-based swap dealer'' in a functional manner, encompassing how
a person holds itself out in the market, the nature of the conduct
engaged in by the person, and how the market perceives the person's
activities. This suggests that the definitions should not be
interpreted in a constrained or overly technical manner. Rigid
standards would not provide the necessary flexibility to respond to
evolution in the ways that dealers enter into swaps and security-based
swaps. The different types of swap and security-based swap markets are
diverse, and there does not appear to be a single set of criteria that
can be determinative in all markets.
At the same time, we note that there may be certain distinguishing
characteristics of swap dealers and security-based swap dealers,
including that:
Dealers tend to accommodate demand for swaps and security-
based swaps from other parties;
Dealers are generally available to enter into swaps or
security-based swaps to facilitate other parties' interest in entering
into those instruments;
Dealers tend not to request that other parties propose the
terms of swaps or security-based swaps; rather, dealers tend to enter
into those instruments on their own standard terms or on terms they
arrange in response to other parties' interest; and
Dealers tend to be able to arrange customized terms for
swaps or security-based swaps upon request, or to create new types of
swaps or security-based swaps at the dealer's own initiative.
We also recognize that the principles relevant to identifying
dealing activity involving swaps can differ from comparable principles
associated with security-based swaps. These differences are due, in
part, to differences in how those instruments are used. For example,
because security-based swaps may be used to hedge or gain economic
exposure to underlying securities (while recognizing distinctions
between securities-based swaps and other types of securities, as
discussed below), there is a basis to build upon the same principles
that are presently used to identify dealers for other types of
securities. Accordingly, we separately address how the core tests would
apply to swap dealers and to security-based swap dealers.
a. Application to Swap Dealers
The definition of swap dealer should be informed by the differences
between swaps, on the one hand, and securities and commodities, on the
other. Transactions in cash market securities and commodities generally
involve purchases and sales of tangible or intangible property. Swaps,
in contrast, are notional contracts requiring the performance of agreed
terms by each party.\17\ Thus, many of the concepts cited by
commenters, such as whether a person buys and sells swaps or makes a
two-sided market in swaps or trades within a bid/offer spread, cannot
[[Page 80177]]
necessarily be applied to all types of swaps to determine if the person
is a swap dealer. We understand that market participants do use this
terminology colloquially to describe the process of entering into a
swap. For example, a person seeking a fixed/floating interest rate swap
may inquire as to the fixed rates, spread above the floating rate and
other payments that another person would require in order to enter into
a swap. But, while these persons may discuss bids, offers, prices and
so forth, the parties are negotiating the terms of a contract, they are
not negotiating the price at which they will transfer ownership of
tangible or intangible property. Accordingly, these concepts are not
determinative of whether a person is a ``swap dealer.''
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\17\ As discussed below, however (see note 42, infra), the Dodd-
Frank Act amended the Exchange Act definitions of ``buy,''
``purchase,'' ``sale'' and ``sell'' to apply to particular actions
involving security-based swaps.
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Instead, persons who are swap dealers may be identified by the
functional role they fulfill in the swap markets. As noted above, swap
dealers tend to accommodate demand and to be available to enter into
swaps to facilitate other parties' interest in swaps (although swap
dealers may also advance their own investment and liquidity objectives
by entering into such swaps). In addition, swap dealers can often be
identified by their relationships with counterparties. Swap dealers
tend to enter into swaps with more counterparties than do non-dealers,
and in some markets, non-dealers tend to constitute a large portion of
swap dealers' counterparties. In contrast, non-dealers tend to enter
into swaps with swap dealers more often than with other non-
dealers.\18\ The Commissions can most efficiently achieve the purposes
underlying Title VII of the Dodd-Frank Act--to reduce risk and to
enhance operational standards and fair dealing in the swap markets--by
focusing their attention on those persons whose function is to serve as
the points of connection in those markets. The definition of swap
dealer, construed functionally in the manner set forth above, will help
to identify those persons.
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\18\ Some of the commenters appeared to suggest that significant
parts of the swap markets operate without the involvement of swap
dealers. We believe that this analysis is likely incorrect, and that
the parties that fulfill the function of dealers should be
identified and are likely to be swap dealers.
---------------------------------------------------------------------------
Clause (A)(iii) of the statutory definition of swap dealer, which
includes any person that ``regularly enters into swaps with
counterparties as an ordinary course of business for its own account,''
\19\ has been the subject of significant uncertainty among commenters.
The commenters point out that its literal terms could encompass many
parties who regularly enter into swaps without engaging in any form of
swap dealing activity. In this regard, clause (A)(iii) of the
definition should be read in combination with the express exception in
subparagraph (C) of the swap dealer definition, which excludes ``a
person that enters into swaps for such person's own account, either
individually or in a fiduciary capacity, but not as a part of a regular
business.'' Thus, the difference between the inclusion in clause
(A)(iii) and the exclusion in subparagraph (C) is whether or not the
person enters into swaps as a part of, or as an ordinary course of, a
``regular business.'' \20\ We believe that persons who enter into swaps
as a part of a ``regular business'' are those persons whose function is
to accommodate demand for swaps from other parties and enter into swaps
in response to interest expressed by other parties. Conversely, persons
who do not fulfill this function should not be deemed to enter into
swaps as part of a ``regular business'' and are not likely to be swap
dealers.
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\19\ We interpret this reference to a person entering into swaps
``with counterparties * * * for its own account'' to refer to a
person entering into a swap as a principal, and not as an agent. A
person who entered into swaps as an agent for customers (i.e., for
the customers' accounts) would be required to register as either a
Futures Commission Merchant, Introducing Broker, Commodity Pool
Operator or Commodity Trading Advisor, depending on the nature of
the person's activity.
\20\ The definition of ``security-based swap dealer'' is
structured similarly, and should be interpreted similarly.
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In sum, to determine if a person is a swap dealer, we would
consider that person's activities in relation to the other parties with
which it interacts in the swap markets. If the person is available to
accommodate demand for swaps from other parties, tends to propose
terms, or tends to engage in the other activities discussed above, then
the person is likely to be a swap dealer. Persons that rarely engage in
such activities are less likely to be deemed swap dealers.
We request comment on this interpretive approach for identifying
whether a person is a swap dealer.
b. Application to Security-Based Swap Dealers
The definition of ``security-based swap dealer'' has parallels to
the definition of ``dealer'' under the Exchange Act.\21\ In addition,
security-based swaps may be used to hedge risks associated with the
ownership of certain other types of securities,\22\ and security-based
swaps may be used to gain economic exposure akin to ownership of
certain other types of securities.\23\ As a result, the SEC would
consider the same factors that are relevant to determining whether a
person is a ``dealer'' under the Exchange Act as also generally
relevant to the analysis of whether a person is a security-based swap
dealer.
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\21\ The Exchange Act in relevant part defines ``dealer'' to
mean ``any person engaged in the business of buying and selling
securities (not including security-based swaps, other than security-
based swaps with or for persons that are not eligible contract
participants) for such person's own account through a broker or
otherwise,'' but with an exception for ``a person that buys or sells
securities (not including security-based swaps, other than security-
based swaps with or for persons that are not eligible contract
participants) for such person's own account, either individually or
in a fiduciary capacity, but not as a part of a regular business.''
Exchange Act sections 3(a)(5)(A) and (B), 15 U.S.C. 78c(a)(5)(A) and
(B), as amended by Section 761(a)(1) of the Dodd-Frank Act.
\22\ For example, an entity that owns a particular security may
use a security-based swap to hedge the risks of that security.
Conversely, an entity may seek to offset exposure involving a
security-based swap by using another security as a hedge.
\23\ For example, an entity may enter into a security-based swap
to gain economic exposure akin to a long or short position in a
stock or bond, without having to engage in a cash market transaction
for that instrument.
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The Exchange Act has been interpreted to distinguish between
``dealers'' and ``traders.'' In this context, the SEC previously has
noted that the dealer-trader distinction:
Recognizes that dealers normally have a regular clientele, hold
themselves out as buying or selling securities at a regular place of
business, have a regular turnover of inventory (or participate in
the sale or distribution of new issues, such as by acting as an
underwriter), and generally provide liquidity services in
transactions with investors (or, in the case of dealers who are
market makers, for other professionals).\24\
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\24\ Securities Exchange Act Release No. 47364 (Feb. 13, 2003)
(footnotes omitted).
Other non-exclusive factors that are relevant for distinguishing
between dealers and non-dealers can include the receipt of customer
property and the furnishing of incidental advice in connection with
transactions.
The markets involving security-based swaps are distinguishable in
certain respects from markets involving cash market securities--
particularly with regard to the concepts of ``inventory'' (which
generally appears inapplicable in this context) \25\ and ``regular
place of business.'' For example, the suggestion that dealers are more
likely to operate at a ``regular place of business'' than traders
should not be construed in a way that ignores the reality of how the
security-based swap markets operate (or that
[[Page 80178]]
ignores evolution in dealing practices involving other types of
securities). Dealers may use a variety of methods to communicate their
availability to enter into security-based swaps with other market
participants. The dealer-trader distinction should not be applied to
the security-based swap markets without taking those distinctions into
account.\26\ Even in light of those differences, however, we believe
that the dealer-trader distinction provides an important analytical
tool to assist in determining whether a person is a ``security-based
swap dealer.''
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\25\ In particular, an analysis that considers dealers to differ
from traders in part because dealers have regular turnover in
``inventory'' appears not to apply in the context of security-based
swaps, given that those instruments are created by contract between
two market counterparties, rather than reflecting financial rights
issued by third-parties.
\26\ The definition of ``security-based swap dealer,'' unlike
the Exchange Act's definition of ``dealer,'' does not specifically
refer to ``buying'' and ``selling.'' We do not believe that this
language difference is significant, however, as the Dodd-Frank Act
amended the Exchange Act definitions of ``buy'' and ``purchase,''
and the Exchange Act definitions of ``sale'' and ``sell,'' to
encompass the execution, termination (prior to its scheduled
maturity date), assignment, exchange or similar transfer or
conveyance of, or extinguishing of rights or obligations under, a
security-based swap. See Dodd-Frank Act sections 761(a)(3), (4)
(amending Exchange Act sections 3(a)(13), (14)).
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Commenters have raised concerns that the ambit of the security-
based swap dealer definition could encompass end-users that use
security-based swaps for hedging their business risks. Deeming those
entities to be security-based swap dealers due to their hedging
activities could discourage their use of hedging transactions or
subject them to a regulatory framework that was not intended to address
their businesses and could subject them to unnecessary costs. Under the
dealer-trader distinction, however, we would expect entities that use
security-based swaps to hedge their business risks, absent other
activity, likely would not be dealers.\27\ Also, as discussed below,
both the ``security-based swap dealer'' definition and the dealer-
trader distinction in part turn on whether a person holds itself out as
a dealer.
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\27\ Of course, if a person's other activities satisfy the
definition of security-based swap dealer, it must comply with the
applicable requirements with regard to all of its security-based
swap activities, absent an order to the contrary, as discussed
below. Also, as discussed below, we would expect end-users to use
security-based swaps for hedging purposes less commonly than they
use swaps for hedging purposes.
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We request comment on the application of the dealer-trader
distinction as part of the analysis of whether a person is a security-
based swap dealer.
c. Issues Common to Both Definitions
i. Holding Oneself Out as, and Being Commonly Known in the Trade as, a
Swap Dealer or Security-Based Swap Dealer
As noted above, the application of these definitions to persons
that ``hold themselves out'' as dealers or that are ``commonly known in
the trade'' as dealers highlights the need for a functional
interpretation of the dealer definitions. We believe that factors that
may reasonably indicate that a person is holding itself out as a dealer
or is commonly known in the trade as a dealer may include (but are not
limited to) the following:
Contacting potential counterparties to solicit interest in
swaps or security-based swaps,
Developing new types of swaps or security-based swaps
(which may include financial products that contain swaps or security-
based swaps) and informing potential counterparties of the availability
of such swaps or security-based swaps and a willingness to enter into
such swaps or security-based swaps with the potential counterparties,
Membership in a swap association in a category reserved
for dealers,
Providing marketing materials (such as a Web site) that
describe the types of swaps or security-based swaps that one is willing
to enter into with other parties, or
Generally expressing a willingness to offer or provide a
range of financial products that would include swaps or security-based
swaps.
Notably, holding oneself out as a security-based swap dealer would
likely encompass a situation in which a person that is a ``dealer'' in
another type of security enters into a security-based swap with a
customer.\28\ Another example of holding oneself out as a security-
based swap dealer would likely be an entity expressing its availability
to provide liquidity to counterparties that seek to enter into
security-based swaps, regardless of the ``direction'' of the
transaction or across a broad spectrum of risks (e.g., credit default
swaps related to a variety of issuers).
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\28\ For example, if a person that is a dealer in securities
that are not security-based swaps enters into a security-based swap
transaction with one of its cash market customers, the person would
appear to be engaged in security-based swap dealing activity with
that customer. In that circumstance, the customer reasonably would
be expected to view the person as a dealer for purposes of the
security-based swap, making the applicable business conduct
requirements particularly important.
The determination of who is commonly known in the trade as a swap
dealer or security-based swap dealer may appropriately reflect, among
other factors, the perspective of persons with substantial experience
with and knowledge of the swap and security-based swap markets,
regardless of whether an entity is known as a dealer by persons without
that experience and knowledge.
ii. Making a Market in Swaps or Security-Based Swaps
A number of commenters suggested that the market making component
of the definitions should apply only to persons that quote a two-sided
market consistently or at all times. Some commenters also suggested
that a person's willingness to buy or to sell a swap or security-based
swap at any particular time should not be deemed to be market making
activity. While continuous two-sided quotations and a willingness to
stand ready to buy and sell a security are important indicators of
market making in the equities markets,\29\ these indicia may not be
appropriate in the context of the swap or security-based swap markets,
given that parties do not enter into many types of swaps or security-
based swaps on a continuous basis, and that parties may use a variety
of methods for communicating their willingness to enter into swaps or
security-based swaps. Any analysis that would impute to the definitions
a ``continuous'' activity requirement may cause certain persons that
engage in non-continuous dealing activities not to be regulated as swap
dealers or security-based swap dealers. We have not identified anything
in the statutory text or legislative history of the Dodd-Frank Act to
suggest that Congress intended such a result.
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\29\ See Exchange Act Release No. 58875 (Oct. 14, 2008), 73 FR
61690 (Oct. 17, 2008) (``Although determining whether or not a
market maker is engaged in bona-fide market making would depend on
the facts and circumstances of the particular activity, factors that
indicate a market maker is engaged in bona-fide market making
activities may include, for example, whether the market maker incurs
any economic or market risk with respect to the securities (e.g., by
putting their own capital at risk to provide continuous two-sided
quotes in markets).'').
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iii. No Predominance Test
Although some commenters suggested that a person should be a swap
dealer or security-based swap dealer only if such activity is the
person's sole or predominant business, the statutory definition does
not contain a predominance test or otherwise depend upon the level of
the person's dealing activity, other than the de minimis exception
discussed below. A predominance standard would not
[[Page 80179]]
provide a workable test of dealer status because many of the parties
that are commonly acknowledged as swap or security-based swap dealers
also engage in other businesses that often outweigh their swap or
security-based swap dealing business in terms of transaction volume or
other measures. Based on the plain meaning of the statutory definition,
so long as a person engages in dealing activity that is not de minimis,
as discussed below, the person is a swap dealer or security-based swap
dealer.\30\
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\30\ As one example, a non-financial company that engages in
both swap dealing and other commercial activities would fall within
the definition of swap dealer because of its swap dealing
activities, notwithstanding that it also engages in other commercial
activities.
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iv. Application of the Definition to New Types of Swaps and New
Activities
The Commissions intend to apply the definitions of swap dealer and
security-based swap dealer flexibly when the development of innovative
business models is accompanied by new types of dealer activity. As
discussed above, the Commissions generally intend to follow a ``facts-
and-circumstances'' approach with respect to identifying dealing
activities. The dealer definitions must be flexible enough to cover
appropriate persons as the swap markets evolve.
v. Request for Comment
The Commissions request comment on these interpretations of holding
oneself out as a dealer and being commonly known in the trade as a
dealer, as well as the lack of a predominance test, and the application
of the definitions to new types of swaps and new activities. Commenters
particularly are requested to address the relevance, to the dealer
analysis, of activities such as an entity's membership in a swap
execution facility (``SEF'') or a security-based SEF, or use of
facilities that may not be SEFs or security-based SEFs. Are there
factors that would lead entities to become members of SEFs that would
not make membership relevant to the dealer analysis? Commenters also
are requested to generally address how the dealer analysis should
appropriately apply the requirements applicable to dealers (e.g.,
capital, margin and business conduct requirements) to the entities that
should be subject to those requirements. In addition, commenters are
requested to address how the dealer definitions should be applied to
entities such as, for example, Federal home loan banks subject to
restrictions limiting their dealing activities to particular types of
counterparties. Finally, commenters are requested to address whether
additional guidance is advisable to help identify dealer activity and
to promote effective enforcement of the requirements applicable to swap
dealers and security-based swap dealers.
3. Designation of a Person as a Swap Dealer
The Dodd-Frank Act has amended the CEA and the Exchange Act to
require a person that meets either of the definitions to register as a
swap dealer and/or security-based swap dealer,\31\ and the Commissions
are proposing separate rules regarding this registration requirement.
In connection with the registration requirement, market participants
are in a position to assess their activities to determine whether they
function in the manner described in the definitions. In addition, the
Commissions have the authority to take enforcement actions in response
to a dealer's failure to register. In determining whether a person
meets the applicable definitions, the Commissions may use information
from other regulators, swap data repositories, registered clearing
agencies, derivatives clearing organizations and other sources.
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\31\ See CEA section 4s(a)-(b); Exchange Act section 15F(a)-(b).
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4. Application of the Swap Dealer Definition to Agricultural
Commodities
Section 723(c)(3)(B) of the Dodd-Frank Act provides that swaps in
agricultural commodities shall be subject to such terms and conditions
as the CFTC may prescribe. In a separate rulemaking, the CFTC has
proposed a definition of the term ``agricultural commodity.'' \32\
Acting under the authority in Section 723(c)(3)(B), the CFTC may
develop particular terms and conditions for the interpretation of the
swap dealer definition when it is applied to dealing in swaps in
agricultural commodities. Any such terms and conditions would not be
applicable to the definition of security-based swap dealer. The CFTC
requests comment on the application of the swap dealer definition to
dealers, including potentially agricultural cooperatives, that limit
their dealing activity primarily to swaps in agricultural commodities.
The CFTC may consider any comments on this topic for both the
definition of swap dealer and also for any rulemaking regarding swaps
in agricultural commodities.
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\32\ See 75 FR 65586 (Oct. 26, 2010).
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B. De Minimis Exemption to the Definitions
The Dodd-Frank Act requires that the Commissions exempt, from
designation as a ``swap dealer'' or ``security-based swap dealer,'' a
person who ``engages in a de minimis quantity of [swap or security-
based swap] dealing in connection with transactions with or on behalf
of its customers.'' \33\ The statutory definitions do not require that
the Commissions fix a specific level of swap activity that will be
considered de minimis, but instead require that the Commissions
``promulgate regulations to establish factors with respect to the
making of this determination to exempt.''
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\33\ See CEA section 1a(49)(D); Exchange Act section
3(a)(71)(D).
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1. Comments Regarding the De Minimis Exemption
Some commenters asserted that the de minimis exemption should be
linked to systemic risk concerns, stating that persons engaged in
dealing activities that do not pose systemic risk should be able to
take advantage of the exemption. Other commenters suggested that a
person's dealing activities should be considered de minimis if they do
not pose undue risks to the person. Commenters also expressed the view
that the application of the exemption should be based on quantitative
criteria.
2. Proposed Rule Regarding the De Minimis Exemption
The Commissions preliminarily believe that the ``de minimis''
exemption should be interpreted to address amounts of dealing activity
that are sufficiently small that they do not warrant registration to
address concerns implicated by the regulations governing swap dealers
and security-based swap dealers.\34\ In other words, the exemption
should apply only when an entity's dealing activity is so minimal that
applying dealer regulations to the entity would not be warranted.
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\34\ The Title VII requirements applicable to swap and security-
based swap dealers include, for example: requirements that dealers
conform to regulatory standards relating to the confirmation,
processing, netting, documentation and valuation of swaps and
security-based swaps (CEA section 4s(i), Exchange Act section
15F(i)); requirements that dealers disclose, to regulators,
information concerning terms and conditions of swaps or security-
based swaps, as well as information concerning trading practices,
financial integrity protections and other trading information (CEA
section 4s(j)(3), Exchange Act section 15F(j)(3)); conflicts of
interest provisions (CEA section 4s(j)(5), Exchange Act section
15F(j)(5)); and chief compliance officer requirements (CEA section
4s(k), Exchange Act section 15F(k)).
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We thus preliminarily do not agree with those commenters that
argued that
[[Page 80180]]
a de minimis quantity of dealing should be measured in relation to the
level of the person's other activities (or other swap or security-based
swap activities). Aside from the fact that the statute does not
explicitly call for a relative test, such an approach would lead to the
result that larger and more active companies, which presumably would be
more able to influence the swap markets, would be more likely to
qualify for the exemption than smaller and less active companies. Also,
a relative test not only would require a means of measuring the
person's dealing activities, but also would require a means of
measuring the larger scope of activities to which its swap dealing or
security-based swap dealing activities are to be compared, thus
introducing unnecessary complexity to the exemption's application.
Our proposed factors for the de minimis exemption seek to focus the
availability of the exemption toward entities for which registration
would not be warranted from a regulatory point of view in light of the
limited nature of their dealing activities. At the same time, we
recognize that this focus does not appear to readily translate into
objective criteria. Thus, while the proposed factors discussed below
reflect our attempt to delimit the de minimis exemption appropriately,
we recognize that a range of alternative approaches may be reasonable,
and we are particularly interested in commenters' suggestions as to the
appropriate factors.
The first proposed factor is that the aggregate effective notional
amount, measured on a gross basis, of swaps or security-based swaps
that an entity enters into over the prior 12 months in connection with
its dealing activities \35\ could not exceed $100 million.\36\ We
understand that in general the notional size of a small swap or
security-based swap is $5 million or less, and this proposed threshold
would reflect 20 instruments of that size. Given the customer
protection issues raised by swaps and security-based swaps--including
the risks that counterparties may not fully appreciate when entering
into swaps or security-based swaps--we believe that this notional
amount reflects a reasonable limit for identifying those entities that
engage in a de minimis level of dealing activity.\37\ This standard
would measure an entity's quantity of dealing on a gross basis (without
consideration of the market risk offsets associated with combining long
and short positions) to reflect the entity's overall amount of dealing
activity. Similarly, the proposed notional threshold would not account
for the amount of collateral held by or provided by the entity, nor
other risk mitigating factors, in determining whether it engages in a
de minimis quantity of dealing, given that dealer status focuses on an
entity's absolute level of activity, and is not directly based on the
risks that an entity poses or faces.\38\
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\35\ The de minimis exemption specifically places limits on a
person's dealing activity involving swaps or security-based swaps.
Thus, these limits would not apply to swap or security-based swap
activity that does not itself constitute dealing activity, such as
activity in which a person hedges or mitigates a commercial risk of
its business that is unrelated to a dealing business (i.e., as
discussed above, when the person did not accommodate demand from the
other party, respond to the other party's interest in swaps or
security-based swaps, solicit the other party, propose economic
terms, intermediate between parties, provide liquidity, or engage in
other dealing activities). See part II.A.2, supra.
\36\ See proposed CEA rule 1.3(ppp)(4)(ii); proposed Exchange
Act rule 3a71-2(a). To the extent that the stated notional amount of
a swap or security-based swap is leveraged or enhanced by its
structure, the calculation shall be based on the effective notional
amount of the swap or security-based swap rather than on its stated
notional amount.
\37\ We preliminarily believe that activity above this amount
would be sufficient to warrant dealer registration to bring about
the benefits of such registration.
\38\ Also, allowing offsets for collateral would result in a de
minimis standard that could encompass positions of virtually
unlimited size.
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In addition, the aggregate effective notional amount of such swaps
or security-based swaps, in which the person's counterparty is a
``special entity'' (as that term is defined in CEA Section 4s(h)(2)(C)
and Exchange Act Section 15F(h)(2)(C)),\39\ that an entity enters into
over the prior 12 months could not exceed $25 million.\40\ The Dodd-
Frank Act provided special protections to special entities in
connection with swaps and security-based swaps, and we preliminarily
believe that this lower proposed threshold reasonably reflects the
special protections afforded to those entities.
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\39\ The term ``special entity'' encompasses: Federal agencies;
States, State agencies and political subdivisions (including cities,
counties and municipalities); ``employee benefit plans'' as defined
under the Employee Retirement Income Security Act of 1974
(``ERISA''); ``governmental plans'' as defined under ERISA; and
endowments.
\40\ See proposed CEA rule 1.3(ppp)(4)(ii); proposed Exchange
Act rule 3a71-2(b).
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In addition, to take advantage of the de minimis exemption, the
proposed rule would provide that the entity could not have entered into
swaps or security-based swaps (as applicable) as a dealer with more
than 15 counterparties, other than security-based swap dealers, over
the prior 12 months.\41\ The Commissions preliminarily believe that an
entity that enters into swaps or security-based swaps, in a dealer
capacity, with a larger number of counterparties should be registered
to help achieve Title VII's orderly market goals, and thus cannot be
said to engage in a de minimis quantity of dealing (even if the
aggregate effective notional amount of the swaps or security-based
swaps is less than the thresholds noted above).\42\ For purposes of
determining the number of counterparties, we preliminarily believe that
counterparties who are members of an affiliated group would generally
count as one counterparty, given that the purpose of the limit is to
measure the scope of dealer's interaction with separate
counterparties.\43\
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\41\ See proposed CEA rule 1.3(ppp)(4)(iii); proposed Exchange
Act rule 3a71-2(c). That these tests measure the entity's activities
over the prior 12 months provides certainty. As of the end of each
month, the entity will know whether it may qualify for the exemption
during the following month.
\42\ Similarly, because all the de minimis factors must be
satisfied, a person who enters into only a single swap or security-
based swap, as a swap dealer, with a single counterparty could not
qualify for the de minimis exemption if that swap or security-based
swap exceeds the effective notional amount threshold.
\43\ For this purpose, an affiliated group would be defined as
any group of entities that is under common control and that reports
information or prepares its financial statements on a consolidated
basis.
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Finally, the proposed rule would provide that, to take advantage of
the de minimis exemption, the entity could not have entered into more
than 20 swaps or security-based swaps (as applicable) as a dealer
during the prior 12 months.\44\ As is the case for the limitation on
the number of counterparties, the Commissions preliminarily believe
that an entity that enters into a larger number of swaps or security-
based swaps, in a dealer capacity, would, if registered, help achieve
Title VII's orderly market goals, and thus cannot be said to engage in
a de minimis quantity of dealing. For these purposes, we would expect
that each separate transaction the entity enters into under a swap or
security-based swap master agreement in general would count as entering
into a swap or security-based swap, but that an amendment of an
existing swap or security-based swap in which the counterparty remained
the same and the underlying item remained substantially the same would
not count as a new swap or security based swap.\45\
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\44\ See proposed CEA rule 1.3(ppp)(4)(iv); proposed Exchange
Act rule 3a71-2(d).
\45\ For these purposes only, an amendment to an existing swap
or security-based swap would not need to be counted as a new swap or
security-based swap if the underlying item is substantially the same
as the original item. This may occur, for example, to reflect the
effect of a corporate action such as a merger. An amendment would be
counted as a new swap or security-based swap, however, to the extent
that the change in the underlying item modifies the economic risk
reflected by the swap or security-based swap.
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[[Page 80181]]
The proposed rule would not distinguish between different types of
swaps or security-based swaps into which entities may enter (e.g., rate
swaps versus other commodity swaps, or credit default swaps versus
equity swaps). The Commissions preliminarily do not believe that the
ceiling for distinguishing de minimis dealing activities from other
dealing activities appropriately turns upon the particular type of swap
or security-based swap.\46\
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\46\ The Exchange Act's definition of ``dealer'' does not
include a de minimis exemption. Thus, an entity that engages in
dealing activity involving securities (other than security-based
swaps with eligible contract participants) would be required to
register as a ``dealer'' under the Exchange Act, and comply with the
Exchange Act's requirements applicable to dealers, absent some other
exception or exemption from registration.
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The Commissions request comment on the proposed rule regarding the
de minimis exemption. Commenters particularly are requested to address
whether certain of the proposed factors should be modified or
eliminated; for example, should the proposed $100 million limit on
annual notional swaps or security-based swaps entered into in a dealer
capacity be raised or lowered to better implement the intended scope of
the de minimis exemption--i.e., to exclude entities for which dealer
regulation would not be warranted? Should we adopt different thresholds
that would appropriately limit the exemption so it encompasses only
those entities whose dealing activities are such that dealer regulation
is not warranted? To what extent would certain entities be expected to
reduce or otherwise adjust their dealing activity to fall within the
scope of the de minimis exemption? Would there be any adverse
implications for market participants if this happens? To what extent
could the proposed factors potentially reduce dealing activity, and in
doing so reduce the liquidity available in the swap or security-based
swap market?
Commenters also are requested to address whether the rule should
seek to identify only certain types of counterparties with which a
person could engage in dealing activities under the exemption. We also
particularly request comment on the proposed $25 million notional
threshold for dealer transactions with ``special entities,'' including
whether that proposed threshold should be raised or lowered, and
whether an entity that enters into dealing transactions with ``special
entities'' should be able to take advantage of the exemption at all. In
addition, we request comment on whether the proposed threshold for
transactions with ``special entities'' would provide a disincentive to
dealers entering into transactions with such entities.
Commenters further are requested to address whether the factors may
appropriately account for the size of the swap or security-based swap
activities compared to the size of the entity; how an entity's swaps or
security-based swaps with affiliated counterparties should be treated
for purposes of the test; and whether the exemption's factors should
vary depending on the type of swap or security-based swap at issue.
In addition, commenters are requested to address the significance
of the fact that the statutory de
