Final Rule Commodity Futures Trading Commission by alicejenny

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									                                                 30596            Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations

                                                 COMMODITY FUTURES TRADING                                 CFTC: Jeffrey P. Burns, Assistant                   further define those terms, among
                                                 COMMISSION                                              General Counsel, at 202- 418–5101,                    others.3
                                                                                                         jburns@cftc.gov, Mark Fajfar, Assistant                  In December 2010, the Commissions
                                                 17 CFR Part 1                                           General Counsel, at 202–418–6636,                     proposed rules and interpretations to
                                                                                                         mfajfar@cftc.gov, Julian E. Hammar,                   further define the meaning of the terms
                                                 RIN 3038–AD06                                                                                                 ‘‘swap dealer,’’ ‘‘security-based swap
                                                                                                         Assistant General Counsel, at 202–418–
                                                 SECURITIES AND EXCHANGE                                 5118, jhammar@cftc.gov, or David E.                   dealer,’’ ‘‘major swap participant,’’
                                                 COMMISSION                                              Aron, Counsel, at 202–418–6621,                       ‘‘major security-based swap
                                                                                                         daron@cftc.gov, Office of General                     participant,’’ and ‘‘eligible contract
                                                 17 CFR Part 240                                         Counsel; Gary Barnett, Director, at 202–              participant.’’ 4 The Commissions
                                                                                                         418–5977, gbarnett@cftc.gov, or Frank                 received approximately 968 written
                                                 [Release No. 34–66868; File No. S7–39–10]               Fisanich, Deputy Director, at 202–418–                comments in response to the Proposing
                                                                                                         5949, ffisanich@cftc.gov, Division of                 Release.5 In addition, the Staffs of the
                                                 RIN 3235–AK65                                                                                                 Commissions participated in
                                                                                                         Swap Dealer and Intermediary
                                                                                                         Oversight,Commodity Futures Trading                   approximately 114 meetings with
                                                 Further Definition of ‘‘Swap Dealer,’’
                                                                                                         Commission, Three Lafayette Centre,                   market participants and other members
                                                 ‘‘Security-Based Swap Dealer,’’ ‘‘Major
                                                                                                         1155 21st Street NW., Washington, DC                  of the public about the Proposing
                                                 Swap Participant,’’ ‘‘Major Security-
                                                                                                         20581;                                                Release,6 and the Commissions held a
                                                 Based Swap Participant’’ and ‘‘Eligible
                                                                                                           SEC: Joshua Kans, Senior Special
                                                 Contract Participant’’
                                                                                                         Counsel, Richard Grant, Special                          3 In addition, section 712(d)(1) directs the CFTC

                                                                                                         Counsel, or Richard Gabbert, Attorney                 and SEC, in consultation with the Board, jointly to
                                                 AGENCY:   Commodity Futures Trading                                                                           further define the terms ‘‘swap,’’ ‘‘security-based
                                                 Commission; Securities and Exchange                     Advisor, at 202–551–5550, Division of                 swap,’’ and ‘‘security-based swap agreement.’’
                                                 Commission.                                             Trading and Markets, Securities and                   These further definitions are the subject of a
                                                 ACTION: Joint final rule; joint interim                 Exchange Commission, 100 F Street NE.,                separate rulemaking by the Commissions. See CFTC
                                                                                                         Washington, DC 20549–7010.                            and SEC, Notice of Proposed Joint Rulemaking,
                                                 final rule; interpretations.                                                                                  Further Definition of ‘‘Swap,’’ ‘‘Security-Based
                                                                                                         SUPPLEMENTARY INFORMATION:                            Swap,’’ and ‘‘Security-Based Swap Agreement’’;
                                                 SUMMARY:    In accordance with the Dodd-                                                                      Mixed Swaps; Security-Based Swap Agreement
                                                                                                         I. Background                                         Recordkeeping, 76 FR 29818 (May 23, 2011)
                                                 Frank Wall Street Reform and Consumer
                                                                                                            On July 21, 2010, President Obama                  (‘‘Product Definitions Proposal’’). Section
                                                 Protection Act of 2010 (‘‘Dodd-Frank                                                                          712(d)(2)(A), in turn, provides that the
                                                 Act’’), the Commodity Futures Trading                   signed the Dodd-Frank Act into law.1                  Commissions shall jointly adopt such other rules
                                                 Commission (‘‘CFTC’’) and the                           Title VII of the Dodd-Frank Act                       regarding the definitions set forth in section
                                                                                                         established a statutory framework to                  712(d)(1) as they ‘‘determine are necessary and
                                                 Securities and Exchange Commission                                                                            appropriate, in the public interest, and for the
                                                 (‘‘SEC’’) (collectively, the                            reduce risk, increase transparency, and               protection of investors.’’
                                                 ‘‘Commissions’’), in consultation with                  promote market integrity within the                      In addition, section 721(c) of the Dodd-Frank Act
                                                 the Board of Governors of the Federal                   financial system by, among other things:              requires the CFTC to adopt a rule to further define
                                                 Reserve System (‘‘Board’’), are adopting                (i) providing for the registration and                the terms ‘‘swap dealer,’’ ‘‘major swap participant,’’
                                                                                                         regulation of swap dealers and major                  and ‘‘eligible contract participant’’ for the purpose
                                                 new rules and interpretive guidance                                                                           of including transactions and entities that have
                                                 under the Commodity Exchange Act                        swap participants; (ii) imposing clearing             been structured to evade Title VII. Also, section
                                                 (‘‘CEA’’), and the Securities Exchange                  and trade execution requirements on                   761(b) of the Dodd-Frank Act permits the SEC to
                                                                                                         standardized derivative products; (iii)               adopt a rule to further define the terms ‘‘security-
                                                 Act of 1934 (‘‘Exchange Act’’), to further                                                                    based swap dealer,’’ ‘‘major security-based swap
                                                 define the terms ‘‘swap dealer,’’                       creating recordkeeping and real-time                  participant,’’ and ‘‘eligible contract participant,’’
                                                 ‘‘security-based swap dealer,’’ ‘‘major                 reporting regimes; and (iv) enhancing                 with regard to security-based swaps, for the purpose
                                                 swap participant,’’ ‘‘major security-                   the Commissions’ rulemaking and                       of including transactions and entities that have
                                                                                                         enforcement authorities with respect to               been structured to evade Title VII.
                                                 based swap participant,’’ and ‘‘eligible                                                                         4 See CFTC and SEC, Notice of Proposed Joint
                                                 contract participant.’’                                 all registered entities and intermediaries
                                                                                                                                                               Rulemaking: Further Definition of ‘‘Swap Dealer,’’
                                                                                                         subject to the Commissions’ oversight.                ‘‘Security-Based Swap Dealer,’’ ‘‘Major Swap
                                                 DATES: Effective date. The effective date                  The Dodd-Frank Act particularly                    Participant,’’ ‘‘Major Security-Based Swap
                                                 for this joint final rule and joint interim             provides that the CFTC will regulate                  Participant’’ and ‘‘Eligible Contract Participant,’’
                                                 final rule: July 23, 2012, except for                   ‘‘swaps,’’ and that the SEC will regulate             Securities Exchange Act Release No. 63452, 75 FR
                                                 CFTC regulations at 17 CFR 1.3(m)(5)                    ‘‘security-based swaps.’’ The Dodd-                   80174 (Dec. 21, 2010) (‘‘Proposing Release’’).
                                                 and (6), which are effective December                                                                            Prior to issuing the Proposing Release, the
                                                                                                         Frank Act also adds definitions of the                Commissions issued a joint Advance Notice of
                                                 31, 2012.                                               terms ‘‘swap dealer,’’ ‘‘security-based               Proposed Rulemaking (‘‘ANPRM’’) requesting
                                                    Comment date. The comment period                     swap dealer,’’ ‘‘major swap participant,’’            public comment regarding the definitions of the
                                                 for the interim final rule (CFTC                        ‘‘major security-based swap participant’’             terms ‘‘swap,’’ ‘‘security-based swap,’’ ‘‘security-
                                                 regulation at 17 CFR 1.3(ggg)(6)(iii)) will                                                                   based swap agreement,’’ ‘‘swap dealer,’’ ‘‘security-
                                                                                                         and ‘‘eligible contract participant’’ to              based swap dealer,’’ ‘‘major swap participant,’’
                                                 close July 23, 2012.                                    the CEA and Exchange Act.2 Section                    ‘‘major security-based swap participant,’’ and
                                                    Compliance date. Compliance with                     712(d)(1) of the Dodd-Frank Act further               ‘‘eligible contract participant.’’ See CFTC and SEC,
                                                 the element of the CFTC regulation at 17                directs the CFTC and the SEC, in                      Advance Notice of Proposed Joint Rulemaking:
                                                 CFR 1.3(m)(8)(iii) requiring that a                                                                           Definitions Contained in Title VII of Dodd-Frank
                                                                                                         consultation with the Board, jointly to               Wall Street Reform and Consumer Protection Act,
                                                 commodity pool be formed by a                                                                                 Securities Exchange Act Release No. 62717, 75 FR
                                                 registered CPO shall be required with                     1 See Dodd-Frank Wall Street Reform and             51429 (Aug. 20, 2010). The Proposing Release and
                                                 respect to a commodity pool formed on                   Consumer Protection Act, Public Law 111–203, 124      these final rules both reflect comments received in
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                                                 or after December 31, 2012 for any                      Stat. 1376 (2010). The text of the Dodd-Frank Act     response to the ANPRM.
                                                                                                         may be accessed at http://www.cftc.gov/                  5 Comment letters received in response to the
                                                 person seeking to rely on such                          LawRegulation/OTCDERIVATIVES/index.htm.               Proposing Release may be found on the
                                                 regulation; compliance with such                          2 See Dodd-Frank Act sections 721 and 761.          Commissions’ Web sites at http://
                                                 element shall not be required with                      Sections 721(b)(2) and 761(b)(2) also provide that    comments.cftc.gov/PublicComments/
                                                 respect to a commodity pool formed                      the CFTC and SEC may by rule further define any       CommentList.aspx?id=933 and at http://
                                                                                                         other term included in an amendment made by           www.sec.gov/comments/s7-39-10/s73910.shtml.
                                                 prior to December 31, 2012.                             Title VII to the CEA or the Exchange Act,                6 Summaries of these staff meetings may be found

                                                 FOR FURTHER INFORMATION CONTACT:                        respectively.                                         on the Commissions’ Web sites at http://



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                                                                   Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations                                                30597

                                                 Joint Public Roundtable on the proposed                    (iii) regularly entering into swaps or             connection with the origination of loans
                                                 dealer and major participant                            security-based swaps with                             by insured depository institutions,17
                                                 definitions.7 After considering the                     counterparties as an ordinary course of               and to provide for the limited purpose
                                                 comments received, the Commissions                      business for one’s own account, or                    designation of dealers.18 The release
                                                 are adopting final rules and                               (iv) engaging in any activity causing              also set forth proposed interpretive
                                                 interpretations to further define these                 oneself to be commonly known in the                   guidance related to the definitions.
                                                 terms.                                                  trade as a dealer or market maker in                     After considering the comments
                                                                                                         swaps or security-based swaps.10                      received, the Commissions are adopting
                                                 II. Definitions of ‘‘Swap Dealer’’ and                  These dealer activities are enumerated                final rules and interpretations to further
                                                 ‘‘Security-Based Swap Dealer’’                          in the CEA and Exchange Act in the                    define the terms ‘‘swap dealer’’ and
                                                   The Dodd-Frank Act definitions of the                 disjunctive, in that a person that                    ‘‘security-based swap dealer.’’ In this
                                                 terms ‘‘swap dealer’’ and ‘‘security-                   engages in any one of these activities is             Adopting Release, we particularly
                                                 based swap dealer’’ focus on whether a                  a swap dealer under the CEA or                        address: (i) The general analysis for
                                                 person engages in particular types of                   security-based swap dealer under the                  identifying dealing activity involving
                                                 activities involving swaps or security-                 Exchange Act, even if such person does                swaps and security-based swaps; (ii) the
                                                 based swaps.8 Persons that meet either                  not engage in one or more of the other                exclusion from the ‘‘swap dealer’’
                                                 of those definitions are subject to                     identified activities.                                definition in connection with the
                                                 statutory requirements related to, among                   At the same time, the statutory dealer             origination of loans by insured
                                                 other things, registration, margin,                     definitions provide exceptions for a                  depository institutions; (iii) the
                                                 capital and business conduct.9                          person that enters into swaps or                      application of the dealer analysis to
                                                   The CEA and Exchange Act                              security-based swaps for the person’s                 inter-affiliate swaps and security-based
                                                 definitions in general encompass                        own account, either individually or in a              swaps; (iv) the application of the de
                                                 persons that engage in any of the                       fiduciary capacity, but not as a part of              minimis exception from the dealer
                                                 following types of activity:                            a ‘‘regular business.’’ 11 The Dodd-Frank             definitions; and (v) the limited
                                                   (i) Holding oneself out as a dealer in                Act also instructs the Commissions to                 designation of swap dealers and
                                                 swaps or security-based swaps,                          exempt from designation as a dealer a                 security-based swap dealers.
                                                   (ii) making a market in swaps or                      person that ‘‘engages in a de minimis                 A. General Considerations for the Dealer
                                                 security-based swaps,                                   quantity of [swap or security-based                   Analysis
                                                                                                         swap] dealing in connection with
                                                                                                         transactions with or on behalf of its                 1. Proposed Approach
                                                 www.cftc.gov/LawRegulation/DoddFrankAct/
                                                 Rulemakings/DF_2_Definitions/index.htm and              customers.’’ 12 Moreover, the definition                 The proposed rules to define the
                                                 http://www.sec.gov/comments/s7-39-10/                   of ‘‘swap dealer’’ (but not the definition            activities that would lead a person to be
                                                 s73910.shtml#meetings.
                                                    7 A transcript of the roundtable discussion and
                                                                                                         of ‘‘security-based swap dealer’’)                    a ‘‘swap dealer’’ and ‘‘security-based
                                                 public comments received with respect to the            provides that an insured depository                   swap dealer’’ were based closely on the
                                                 roundtable may be found on the CFTC’s Web site          institution is not to be considered a                 corresponding language of the statutory
                                                 at http://www.cftc.gov/PressRoom/Events/                swap dealer ‘‘to the extent it offers to              definitions.19 The Proposing Release
                                                 opaevent_cftcsecstaff061611.                            enter into a swap with a customer in                  further noted that the Dodd-Frank Act
                                                    8 See section 721 of the Dodd-Frank Act (adding

                                                 Section 1a(49) of the CEA, 7 U.S.C. 1a(49), to define
                                                                                                         connection with originating a loan with               defined the terms ‘‘swap dealer’’ and
                                                 ‘‘swap dealer’’) and section 761 of the Dodd-Frank      that customer.’’ 13 The statutory                     ‘‘security-based swap dealer’’ in a
                                                 Act (adding Section 3(a)(71) of the Exchange Act,       definitions further provide that a person             functional manner, and stated that those
                                                 15 U.S.C. 78c(a)(71), to define ‘‘security-based swap   may be designated as a dealer for one or              statutory definitions should not be
                                                 dealer’’).
                                                    9 The Dodd-Frank Act excludes from the
                                                                                                         more types, classes or categories of                  interpreted in a constrained, overly
                                                 Exchange Act definition of ‘‘dealer’’ persons who       swaps or security-based swaps, or                     technical or rigid manner, particularly
                                                 engage in security-based swaps with eligible            activities without being designated a                 given the diversity of the swap and
                                                 contract participants. See section 3(a)(5) of the       dealer for other types, classes or                    security-based swap markets. The
                                                 Exchange Act, 15 U.S.C. 78c(a)(5), as amended by        categories or activities.14                           Proposing Release also identified
                                                 section 761(a)(1) of the Dodd-Frank Act.
                                                    The Dodd-Frank Act does not include comparable
                                                                                                            In the Proposing Release, the                      potential distinguishing characteristics
                                                 amendments for persons who act as brokers in            Commissions proposed rules to identify                of swap dealers and security-based swap
                                                 swaps and security-based swaps. Because security-       the activity that would cause a person                dealers based on the functional role that
                                                 based swaps, as defined in section 3(a)(68) of the      to be a dealer,15 to implement the                    dealers fulfill in the swap and security-
                                                 Exchange Act, are included in the Exchange Act
                                                 section 3(a)(10) definition of ‘‘security,’’ persons
                                                                                                         exception for de minimis dealing                      based swap markets, such as: dealers
                                                 who act as brokers in connection with security-         activity,16 to implement the exception                tend to accommodate demand from
                                                 based swaps must, absent an exception or                from the swap dealer definition in                    other parties; dealers generally are
                                                 exemption, register with the SEC as a broker                                                                  available to enter into swaps or security-
                                                 pursuant to Exchange Act section 15(a), and comply
                                                 with the Exchange Act’s requirements applicable to
                                                                                                           10 See CEA section 1a(49)(A), 7 U.S.C. 1a(49)(A);
                                                                                                                                                               based swaps to facilitate other parties’
                                                                                                         Exchange Act section 3(a)(71)(A), 15 U.S.C.           interest; dealers tend not to request that
                                                 brokers.                                                78c(a)(71)(A).
                                                    In mid-2011, the SEC issued temporary                  11 See CEA section 1a(49)(C), 7 U.S.C. 1a(49)(C);
                                                                                                                                                               other parties propose the terms of swaps
                                                 exemptions under the Exchange Act in connection         Exchange Act section 3(a)(71)(C), 15 U.S.C.           or security-based swaps, but instead
                                                 with the revision of the ‘‘security’’ definition to     78c(a)(71)(C).                                        tend to enter into those instruments on
                                                 encompass security-based swaps. Among other
                                                 aspects, these temporary exemptions extended to
                                                                                                           12 See CEA section 1a(49)(D), 7 U.S.C. 1a(49)(D);
                                                                                                                                                               their own standard terms or on terms
                                                                                                         Exchange Act section 3(a)(71)(D), 15 U.S.C.           they arrange in response to other
                                                 certain broker activities involving security-based
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                                                                                                         78c(a)(71)(D).
                                                 swaps. See ‘‘Order Granting Temporary Exemptions          13 See CEA section 1a(49)(A), 7 U.S.C. 1a(49)(A).
                                                                                                                                                               parties’ interest; and dealers tend to be
                                                 under the Securities Exchange Act of 1934 in                                                                  able to arrange customized terms for
                                                                                                           14 See CEA section 1a(49)(B), 7 U.S.C. 1a(49)(B);
                                                 Connection with the Pending Revision of the
                                                 Definition of ‘‘Security’’ to Encompass Security-       Exchange Act section 3(a)(71)(B), 15 U.S.C.
                                                 Based Swaps, and Request for Comment,’’                 78c(a)(71)(B).                                          17 See proposed CFTC Regulation § 1.3(ggg)(5).
                                                                                                           15 See proposed CFTC Regulation § 1.3(ggg)(1);        18 See proposed CFTC Regulation § 1.3(ggg)(3);
                                                 Securities Exchange Act Release No. 64795 (Jul. 1,
                                                 2011), 76 FR 39927, 39939 (Jul. 7, 2011) (addressing    proposed Exchange Act rule 3a71–1(a), (b).            proposed Exchange Act rule 3a71–1(c).
                                                 availability of exemption to registration                 16 See proposed CFTC Regulation § 1.3(ggg)(4);        19 See CFTC Regulation § 1.3(ggg); Exchange Act

                                                 requirement for securities brokers).                    proposed Exchange Act rule 3a71–2.                    rule 3a71–1(a), (b).



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                                                 30598              Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations

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

                                                 definition does not depend on whether a person’s                                                                CFTC adopted a final rule on agricultural swaps
                                                                                                             24 See id. at 80176–77.
                                                 activity as a swap dealer is the person’s sole or                                                               under which swaps in agricultural commodities
                                                                                                             25 See id. at 80177.
                                                 predominant business (other than through the de                                                                 will be permitted to transact subject to the same
                                                 minimis exception discussed below).                         26 See id.
                                                                                                                                                                 rules as all other swaps. See Agricultural Swaps;
                                                    23 See Proposing Release, 75 FR at 80177.                27 See id. at 80183–84.                             Final Rule, 76 FR 49291 (Aug. 10, 2011).



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                                                                   Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations                                                    30599

                                                 201(f) of the Federal Power Act,29                       c. Additional Principles Common to                     making in the equities market, these
                                                 related to not-for-profit power systems                  Both Definitions                                       indicia may not be appropriate in the
                                                 such as rural electric cooperatives and                  i. ‘‘Hold Themselves Out’’ and                         swap and security-based swap markets.
                                                 entities operating as political                          ‘‘Commonly Known in the Trade’’ Tests                  The proposal also noted that nothing in
                                                 subdivisions of a state and on the                                                                              the statutory text or legislative history
                                                                                                             The Proposing Release identified the                suggested the intent to impute a
                                                 applicability of the exemptive authority
                                                                                                          following non-exclusive list of factors as             ‘‘continuous’’ activity requirement to
                                                 in section 722(f) of the Dodd-Frank Act
                                                                                                          potentially indicating that a person                   the dealer definitions.35
                                                 to address those considerations.
                                                                                                          meets the ‘‘hold themselves out’’ and
                                                                                                          ‘‘commonly known in the trade’’ tests of               iii. No Predominance Test
                                                 b. ‘‘Security-Based Swap Dealer’’
                                                 Activity                                                 the statutory dealer definitions:                         The Proposing Release further
                                                                                                             • Contacting potential counterparties               addressed whether a person should be
                                                    The Proposing Release noted the                       to solicit interest in swaps or security-              a dealer only if that activity is the
                                                 parallels between the definition of                      based swaps;                                           person’s sole or predominant business,
                                                 ‘‘security-based swap dealer’’ and the                      • Developing new types of swaps or                  and took the view that such an approach
                                                 definition of ‘‘dealer’’ under the                       security-based swaps (which may                        was not consistent with the statutory
                                                 Exchange Act,30 as well as the fact that                 include financial products that contain                definition. The Proposing Release
                                                 security-based swaps may be used to                      swaps or security-based swaps) and                     rejected this as an unworkable test of
                                                 hedge risks associated with owning                       informing potential counterparties of                  dealer status because many parties that
                                                 certain types of securities or to gain                   the availability of such swaps or                      commonly are acknowledged as dealers
                                                 economic exposure akin to ownership of                   security-based swaps and a willingness                 also engage in other businesses that
                                                 certain types of securities. As a result,                to enter into such swaps or security-                  outweigh their swap or security-based
                                                 the Proposing Release took the view that                 based swaps with the potential                         swap dealing business in terms of
                                                                                                          counterparties;                                        transaction volume or other measures.36
                                                 the same factors that are relevant to
                                                                                                             • Membership in a swap association
                                                 determining whether a person is a                                                                               iv. Application to New Types of Wwaps
                                                                                                          in a category reserved for dealers;
                                                 ‘‘dealer’’ under the Exchange Act also                                                                          and New Activities
                                                                                                             • Providing marketing materials (such
                                                 are generally relevant to the analysis of                as a Web site) that describe the types of                The Proposing Release noted that the
                                                 whether a person is a security-based                     swaps or security-based swaps that one                 Commissions intended to apply the
                                                 swap dealer. The Proposing Release also                  is willing to enter into with other                    dealer definitions flexibly when the
                                                 addressed the relevance of the ‘‘dealer-                 parties; or                                            development of innovative business
                                                 trader’’ distinction for identifying                        • Generally expressing a willingness                models is accompanied by new types of
                                                 dealing activity involving security-based                to offer or provide a range of financial               dealer activity, following a facts-and-
                                                 swaps,31 while recognizing that certain                  products that would include swaps or                   circumstances approach.37
                                                 concepts associated with the dealer-                     security-based swaps.33                                2. Commenters’ Views
                                                 trader distinction—particularly                             The Proposing Release further stated
                                                 concepts involving ‘‘turnover of                         that the test for being ‘‘commonly                        Numerous commenters addressed the
                                                 inventory’’ and ‘‘regular place of                       known in the trade’’ as a swap dealer or               proposed rules and interpretations in
                                                                                                          security-based swap dealer may                         connection with the ‘‘swap dealer’’ and
                                                 business’’—appeared potentially less
                                                                                                          appropriately reflect, among other                     ‘‘security-based swap dealer’’
                                                 applicable to the security-based swap
                                                                                                          factors, the perspective of persons with               definitions. Several commenters
                                                 dealer definition. In addition, the                                                                             addressed principles that are common
                                                 Proposing Release noted that under the                   substantial experience with and
                                                                                                          knowledge of the swap and security-                    to the two dealer definitions, while a
                                                 dealer-trader distinction, we would                                                                             number of commenters also addressed
                                                 expect that entities that use security-                  based swap markets (regardless of
                                                                                                          whether a particular entity is known as                interpretations in the Proposing Release
                                                 based swaps to hedge business risks,                                                                            that were specific to the ‘‘swap dealer’’
                                                 absent other activities, likely would not                a dealer by persons without that
                                                                                                          experience or knowledge). The                          definition.
                                                 be dealers.32
                                                                                                          Proposing Release also stated that                     a. ‘‘Hold Themselves Out’’ and
                                                   29 16
                                                                                                          holding oneself out as a security-based                ‘‘Commonly Known in the Trade’’ Tests
                                                          U.S.C. 824(f).
                                                                                                          swap dealer likely would encompass a
                                                    30 See Exchange Act sections 3(a)(5)(A), (B), 15                                                                Some commenters expressed the view
                                                 U.S.C. 78c(a)(5)(A), (B), as amended by Section          person who is a dealer in another type
                                                                                                                                                                 that the persons that hold themselves
                                                 761(a)(1) of the Dodd-Frank Act.                         of security entering into a security-based
                                                                                                                                                                 out as or are commonly known as
                                                    31 The Proposing Release referred to the fact that    swap with a customer, as well as a
                                                 the SEC previously has noted that the dealer-trader
                                                                                                                                                                 dealers are easy to identify.38 In
                                                                                                          person expressing its availability to
                                                 distinction: ‘‘recognizes that dealers normally have                                                            addressing the ‘‘hold themselves out’’
                                                                                                          enter into security-based swaps,
                                                 a regular clientele, hold themselves out as buying                                                              and ‘‘commonly known’’ criteria of the
                                                 or selling securities at a regular place of business,    regardless of the direction of the
                                                                                                                                                                 dealer definitions, commenters placed
                                                 have a regular turnover of inventory (or participate     transaction or across a broad spectrum
                                                                                                                                                                 particular focus on whether only dealers
                                                 in the sale or distribution of new issues, such as by    of risks.34
                                                 acting as an underwriter), and generally provide                                                                engage in the activities cited by the
                                                 liquidity services in transactions with investors (or,   ii. Market Making
                                                 in the case of dealers who are market makers, for                                                                 35 See id.
                                                 other professionals).’’ Proposing Release, 75 FR at
                                                                                                            In addressing the statutory                            36 See id. at 80178–79.
                                                                                                          definitions’ ‘‘making a market’’ test, the
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                                                 80177 (citing Securities Exchange Act Release No.                                                                 37 See id. at 80179.
                                                 47364 (Feb. 13, 2003) (footnotes omitted)). The          Proposing Release noted that while                       38 See transcript of Joint CFTC–SEC Staff
                                                 Proposing Release further noted that other non-          continuous two-sided quotations and a                  Roundtable Discussion on Proposed Dealer and
                                                 exclusive factors that are relevant for distinguishing                                                          Major Participant Definitions Under Dodd-Frank
                                                                                                          willingness to buy and sell a security
                                                 between dealers and non-dealers can include                                                                     Act, June 16, 2011 (‘‘Roundtable Transcript’’) at 22–
                                                 receipt of customer property and the furnishing of       are important indicators of market                     23 (remarks of Ron Filler, New York Law School),
                                                 incidental advice in connection with transactions.                                                              50–51 (remarks of Ron Oppenheimer, Working
                                                 See id.                                                   33 See   id. at 80178.                                Group of Commercial Energy Firms), 215 (remarks
                                                    32 See Proposing Release, 75 FR at 80177–78.           34 See   id.                                          of Bella Sanevich, NISA Investment Advisors LLC).



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                                                 30600            Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations

                                                 Proposing Release, or whether those                     a derivatives sales team, that should be                sides of the market is not market making
                                                 activities are common both to dealers                   treated as indicators of dealer activity.48             when done to obtain information about
                                                 and to other users of swaps and                         Commenters also expressed the view                      the market or to mask one’s view of the
                                                 security-based swaps. Commenters                        that this aspect of the dealer definition               market.58 One commenter stated that
                                                 particularly stated that end users                      should focus on whether a person                        futures commission merchants
                                                 contact potential counterparties,39                     solicits expressions of interest in swaps               (‘‘FCMs’’) and broker-dealers that
                                                 develop new types of swaps or security-                 from a range of market participants,49                  facilitate customers’ entering into swaps
                                                 based swaps,40 and propose terms or                     and that end users of swaps can actively                are not necessarily market makers.59
                                                 language for swap or security-based                     seek out and negotiate swaps without                    Other commenters urged the
                                                 swap agreements.41 One commenter                        necessarily being swap dealers.50                       Commissions to reject the view that
                                                 further stated that identifying dealing                                                                         market making requires continuous
                                                                                                         b. Market Making
                                                 activity based on whether a person                                                                              activity.60
                                                 develops new types of swaps or                             Several commenters generally                            A number of commenters addressed
                                                 proposes swap terms would discourage                    requested that the Commissions provide                  the issue of how the dealer definitions
                                                 innovation and the free negotiation of                  more guidance as to which activities                    should treat swaps or security-based
                                                 swaps.42 Some commenters stated that                    constitute making a market in swaps or                  swaps entered into on a trading platform
                                                 merely responding to a request for                      security-based swaps.51 Commenters                      such as a designated contract market
                                                 proposals or quotations should not, in                  also described various activities as                    (‘‘DCM’’), national securities exchange,
                                                 itself, constitute dealing.43 Commenters                indicating, or not indicating, market                   swap execution facility (‘‘SEF’’), or
                                                 also criticized the Proposing Release’s                 making activity. For example, two                       security-based SEF (collectively referred
                                                 suggestion that criteria for identifying                commenters expressed the view that                      to herein as ‘‘exchanges’’).61 Several
                                                 dealing activity include membership in                  market making is characterized by                       stated that entering into swaps or
                                                 a dealer category of a trade                            entering into swaps on one side of the                  security-based swaps on exchanges
                                                 association,44 as well as providing                     market and then establishing offsetting                 should not be considered in
                                                 marketing materials and offering a range                positions on the other side of the                      determining if a person is a dealer.62
                                                 of financial products.45 Commenters                     market.52 Other commenters equated                      Some of these commenters emphasized
                                                 also argued for more objective criteria                 market making to providing liquidity by                 the fact that parties would not know the
                                                 for identifying persons ‘‘commonly                      regularly quoting bid and offer prices for              identity of the counterparty to the swap
                                                 known’’ as dealers.46                                   swaps, and standing ready to enter into                 executed on an exchange (i.e., such
                                                    Conversely, one commenter said that                  swaps.53 One commenter stated that                      swaps are ‘‘anonymous’’),63 while other
                                                 three particular activities cited in the                market making activity is indicated by                  commenters said that such swaps do not
                                                 Proposing Release—membership in a                       a person consistently presenting itself as              constitute ‘‘accommodating demand’’
                                                 swap association category reserved for                  willing to take either side of a trade.54               for swaps or ‘‘facilitating interest’’ in
                                                 dealers, providing marketing materials                  Two commenters said that market                         swaps.64 Another commenter said that
                                                 and expressing a willingness to offer a                 makers receive tangible benefits (such as               future means of executing swaps on
                                                 range of financial products—are                         reduced trading fees) in return for the                 exchanges are likely to be diverse, and
                                                 indicative of holding oneself out as a                  obligation to transact when liquidity is                it is premature to draw conclusions
                                                 dealer or being commonly known in the                   required.55
                                                 trade as a dealer, and should be codified                  In contrast, one commenter said the                    58 See  letters from NextEra Iand Vitol.
                                                 in the final rule.47 Another commenter                  proposal correctly did not limit market                   59 See  letter from Newedge USA LLC
                                                 suggested other factors, such as having                 making to consistently quoting a two-                   (‘‘Newedge’’); see also Roundtable Transcript at 39
                                                                                                         sided market, because to do so would                    (remarks of Eric Chern, Chicago Trading Company).
                                                                                                                                                                    60 See letters from American Federation of State,
                                                    39 See letters from the Financial Services           insert a loophole into the definition.56                County and Municipal Employees (‘‘AFSCME’’),
                                                 Roundtable (‘‘FSR’’) dated February 22, 2011 (‘‘FSR     Some commenters expressed the view                      and FSR I.
                                                 I’’), the International Swap Dealers Association
                                                 (‘‘ISDA’’) dated February 22, 2011 (‘‘ISDA I’’) and
                                                                                                         that mere active participation in a                        61 While some of these commenters specially

                                                 the Midsize Bank Coalition of America (‘‘Midsize        market or entering into swaps on both                   addressed this issue in the context of whether a
                                                 Banks’’).                                               sides of a market does not necessarily                  person is a market maker in swaps, others more
                                                                                                                                                                 generally addressed the issue in terms of whether
                                                    40 See letters from the Committee on Capital
                                                                                                         constitute market making.57 Others said                 a person is a dealer. For clarity, all of those
                                                 Markets Regulation (‘‘CCMR’’) dated February 22,        that occasionally quoting prices on both                comments are being addressed in the market maker
                                                 2011 (‘‘CCMR I’’), FSR I, ISDA I and Midsize Banks.
                                                    41 See letters from the BG Americas & Global LNG
                                                                                                                                                                 context.
                                                                                                            48 See meeting with Vitol, Inc. (‘‘Vitol’’) on          62 See letters from EEI/EPSA, International Energy
                                                 (‘‘BG LNG’’) dated February 22, 2011 (‘‘BG LNG I’’),
                                                                                                         February 16, 2011.                                      Credit Association (‘‘IECA–Credit’’) dated February
                                                 CCMR I, EDF Trading North America, LLC (‘‘EDF
                                                                                                            49 See letter from Midsize Banks.                    22, 2011 (‘‘IECA–Credit I’’), and NextEra I, joint
                                                 Trading’’) and The Gavilon Group, LLC (‘‘Gavilon’’)
                                                                                                            50 See letter from EDF Trading.                      letter from Shell Trading (US) Company and Shell
                                                 dated February 21, 2011 (‘‘Gavilon II’’).
                                                    42 See letter from EDF Trading.                         51 See joint letter from American Benefits Council   Energy North America (US), L.P. (‘‘Shell Trading’’)
                                                                                                                                                                 dated February 22, 2011 (‘‘Shell Trading I’’), and
                                                    43 See meeting with American Electric Power,         and the Committee on Investment of Employee
                                                                                                                                                                 joint letter from Allston Trading, LLC, Atlantic
                                                 Calpine Corporation (‘‘Calpine’’), Constellation, DC    Benefits Assets (‘‘ABC/CIEBA’’) and letters from
                                                                                                                                                                 Trading USA LLC, Bluefin Trading LLC, Chopper
                                                 Energy LLC (‘‘DC Energy’’), Edison International        FSR I.
                                                                                                            52 See letters from DC Energy and FSR I.
                                                                                                                                                                 Trading LLC, DRW Holdings, LLC, Eagle Seven,
                                                 (‘‘Edison Int’l’’), Exelon Corp., GenOn, Southern                                                               LLC, Endeavor Trading, LLC, Geneva Trading USA,
                                                 Company, Edison Electric Institute (‘‘EEI’’) and           53 See letters from Edison Int’l, NextEra Energy
                                                                                                                                                                 LLC, GETCO, Hard Eight Futures, LLC, HTG Capital
                                                 Electric Power Supply Association (‘‘ESPA’’)            Resources, LLC (‘‘NextEra’’) dated February 22,         Partners, IMC Financial Markets, Infinium Capital
                                                 (collectively ‘‘Electric Companies’’) on April 13,      2011 (‘‘NextEra I’’) and Vitol, and joint letter from   Management LLC, Kottke Associates, LLC, Liger
                                                 2011.                                                   American Electric Power, Edison Int’l, Exelon           Investments Limited, Marquette Partners, LP, Nico
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                                                    44 See letter from ISDA I and joint letter from      Corp., and Southern Company (‘‘Utility Group’’).        Holdings LLC, Optiver US, Quantlab Financial,
                                                 National Corn Growers Association (‘‘NCGA’’) and           54 See letter from ISDA I.
                                                                                                                                                                 LLC, RGM Advisors, LLC, Tibra Trading America
                                                 Natural Gas Supply Association (‘‘NGSA’’)                  55 See joint letter from EEI and EPSA (‘‘EEI/        LLC, Traditum Group LLC, WH Trading and XR
                                                 (‘‘NCGA/NGSA’’) dated February 22, 2011 (‘‘NCGA/        EPSA’’) and letter from Vitol.                          Trading LLC (‘‘Traders Coalition’’).
                                                 NGSA I’’).                                                 56 See letter from Americans for Financial Reform       63 See letters from Shell Trading I and Traders
                                                    45 See letter from ISDA I.
                                                                                                         (‘‘AFR’’).                                              Coalition.
                                                    46 See letters from ISDA I and Peabody Energy           57 See letters from ABC/CIEBA, Managed Funds            64 See letters from EEI/EPSA, IECA–Credit I, and
                                                 Corporation (‘‘Peabody’’).                              Association (‘‘MFA’’) dated February 22, 2011           NextEra I. For further discussion of this issue, see
                                                    47 See letter from FSR I.                            (‘‘MFA I’’), and Vitol.                                 parts II.A.4 and II.A.5 below.



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                                                                    Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations                                                        30601

                                                 about how they should be treated in the                    business needs, as opposed to serving                     commenter took the view that a person
                                                 dealer definitions.65                                      the business needs of the counterparty,                   that enters into swaps primarily with
                                                    Two commenters asserted that firms                      the person’s use of swaps does not                        financial intermediaries does not have a
                                                 that provide liquidity in cleared and                      constitute a ‘‘regular business.’’ 71 Other               ‘‘regular business’’ of entering into
                                                 exchange-executed swaps by actively                        commenters said that the use of swaps                     swaps.77
                                                 participating in the market provide                        to hedge the commercial risks of a                           Some commenters said that the final
                                                 heterogeneity among liquidity providers                    business does not constitute a ‘‘regular                  rule should clarify the point at which a
                                                 and thereby disperse risk, and further                     business’’ of entering into swaps.72                      person’s episodic or occasional swap
                                                 stated that to regulate such persons as                    Some commenters also suggested that                       activities become a ‘‘regular business’’
                                                 swap dealers subject to increased capital                  the ‘‘regular business’’ exclusion should                 of entering into swaps.78 Others stated
                                                 requirements would discourage their                        be interpreted to mean ‘‘regular swap                     that the fact that a person enters into
                                                 participation in the market and increase                   dealing business’’ or ‘‘regular security-                 swaps frequently or with a large number
                                                 risk.66                                                    based swap dealing business’’ to prevent                  of counterparties does not necessarily
                                                    One commenter expressed the view                        the dealer definitions from capturing                     mean that the person has a ‘‘regular
                                                 that the statutory definition uses dealing                 hedgers.73                                                business’’ of entering into swaps.79
                                                 and market making interchangeably,                            On the other hand, two commenters                         Commenters proposed specific tests
                                                 and suggested that the analysis of                         said that the proposed interpretation                     for determining if a person has a
                                                 whether a person acts as a dealer should                   was correct in the view that the test of                  ‘‘regular business’’ of entering into
                                                 be subsumed within the analysis of                         whether a person has a ‘‘regular                          swaps. One commenter said the
                                                 whether it acts as a market maker.67                       business’’ of entering into swaps does                    determination should look to whether a
                                                                                                            not necessarily depend on whether a                       person enters into swaps to
                                                 c. Exception for Activities Not Part of a                  person’s swap activities are a                            accommodate demand from other
                                                 ‘‘Regular Business’’                                       predominant activity, because such an                     parties and to profit from a bid/ask
                                                   Several commenters addressed the                         approach would allow a person to                          spread on swaps (as opposed to swaps
                                                 exception from the dealer definitions for                  engage in a significant level of swap                     that are substitutes for physical
                                                 swap or security-based swap activities                     dealing activity without registering as a                 transactions or positions and used by at
                                                 that are not part of a ‘‘regular business.’’               swap dealer simply because the person                     least one party to hedge commercial
                                                 Some commenters supported the                              also has substantial activities in a non-                 risk), and consider specifically the
                                                 Commissions’ proposed interpretation                       swap business or businesses.74                            volume, revenues and profits of such
                                                 in the context of the ‘‘swap dealer’’                         Other commenters suggested that the                    activities, the person’s value at risk
                                                 definition and stated that this                            types of swap activities that a person                    (VaR) and exposure from such activities,
                                                 interpretation should be codified in the                   engages in are relevant to determining                    and its resources devoted to such
                                                 text of the final rule.68                                  whether the person has a ‘‘regular                        activities.80 Another commenter said
                                                   Many commenters said that the                            business’’ of entering into swaps. One                    that the determination should be based
                                                 activity of entering into swaps or                         commenter stated that a person has a                      on the nature of the person’s business,
                                                 security-based swaps should not be                         ‘‘regular business’’ of entering into                     the person’s business purpose for using
                                                 deemed to be a ‘‘regular business,’’ and                   swaps when the person has a primary                       swaps, and the person’s method of
                                                 thus not indicative of dealing activity,                   business of accommodating demand or                       executing swap transactions (e.g., a
                                                 when the person’s use of swaps or                          facilitating interest in swaps,75 while                   person whose business primarily relates
                                                 security-based swaps are ancillary to, or                  others similarly emphasized that a                        to physical commodities, who uses
                                                 in connection with, a separate non-swap                    ‘‘regular business’’ of entering into                     swaps to hedge commercial risk, and
                                                 business that is the person’s primary                      swaps is characterized by financial                       who executes swaps on an exchange
                                                 business.69 Some commenters making                         intermediation activities.76 One                          would be less likely to have a ‘‘regular
                                                 this point said that when the person’s                                                                               business’’ of entering into swaps).81
                                                 primary business relates to physical                          71 See letters from BT Pension Scheme                     One commenter argued that the
                                                 commodities, the person’s use of swaps
                                                                                                            Management Limited (‘‘BTPS’’), EDF Trading, EEI/          ‘‘regular business’’ exception should
                                                                                                            EPSA and Vitol.                                           apply to all four of the dealer tests—not
                                                 relating to those commodities does not                        72 See letters from American Petroleum Institute

                                                 constitute a ‘‘regular business.’’ 70 Other                                                                          only the test for persons that regularly
                                                                                                            (‘‘API’’) dated February 22, 2011 (‘‘API I’’), Calpine,
                                                 commenters stated that where a person                      Coalition of Physical Energy Companies (‘‘COPE’’)         enters into swaps or security-based
                                                 enters into swaps to serve its own                         dated February 22, 2011 (‘‘COPE I’’), Dominion            swaps as an ‘‘ordinary course of
                                                                                                            Resources, EDF Trading, Edison Int’l and Peabody;         business’’—and further argued that the
                                                                                                            see also Roundtable Transcript at 45 (remarks of Ed       ‘‘regular business’’ exception should be
                                                    65 See letter from Metropolitan Life Insurance
                                                                                                            Prosser, Gavilon) and letter from Church Alliance.
                                                 Company (‘‘MetLife’’).                                     In addition, three commenters said that the               linked to a ‘‘two-way market’’ base
                                                    66 See letters from Newedge and Traders                 interpretation of the provisions relating to a
                                                 Coalition; Roundtable Transcript at 39 (remarks of         ‘‘regular business’’ in the Proposing Release is          entering into swaps for its ‘‘own account’’ and
                                                 Eric Chern, Chicago Trading Company).                      correct, because it will exclude from the definition      therefore is not a swap dealer, but rather would be
                                                    67 See letter from ISDA I.                              of swap dealer those persons using swaps to hedge         an FCM or introducing broker. See letter from MFX
                                                    68 See letters from FSR I, MFA I and Midsize            commercial risk. See letters from Air Transport           Solutions, Inc. (‘‘MFX’’) dated February 22, 2011
                                                 Banks.                                                     Association of America, Inc. (‘‘ATAA’’), IECA–            (‘‘MFX I’’).
                                                    69 See Roundtable Transcript at 88 (remarks of          Credit I and joint letter from Petroleum Marketers           77 See letter from Traders Coalition.

                                                 Steve Walton, Bank of Oklahoma).                           Association of America and New England Fuel                  78 See letters from BG LNG I and WGCEF I.

                                                    70 See letters from Atmos Energy Corporation            Institute.                                                   79 See letters from NCGA/NGSA I and Vitol. One
                                                                                                               73 See letters from Church Alliance and Peabody.
                                                 (‘‘Atmos Energy’’), Dominion Resources, Inc.                                                                         of these commenters asked that the final rule clarify
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                                                                                                               74 See letters from AFR and Better Markets, Inc.       that simply because a person engages in swap
                                                 (‘‘Dominion Resources’’), EDF Trading, Edison Int’l,
                                                 EEI/EPSA, Gavilon II, Hess Corporation and its             (‘‘Better Markets’’) dated February 22, 2011 (‘‘Better    activity exceeding the thresholds for the de minimis
                                                 affiliates (‘‘Hess’’), Mississippi Public Utility Staff,   Markets I’’).                                             exception from the swap dealer definition does not
                                                 NextEra I, National Milk Producers Federation                 75 See letter from IECA–Credit I.                      necessarily mean that the person is engaged in a
                                                 (‘‘NMPF’’), Shell Trading I, Utility Group and                76 See letter from NextEra I and Shell Trading I.      ‘‘regular business’’ of swap dealing. See letter from
                                                 Working Group of Commercial Energy Firms                   Another commenter disagreed with this approach,           Vitol.
                                                                                                                                                                         80 See letter from NextEra I; see also letter from
                                                 (‘‘WGCEF’’) on the swap dealer definition dated            however, saying that a person who enters into
                                                 February 22, 2011 (‘‘WGCEF I’’), and meeting with          swaps as an intermediary between smaller                  Hess (proposing similar criteria).
                                                 Bunge on February 23, 2011.                                customers and larger financial institutions is not           81 See letter from Shell Trading I.




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                                                 30602             Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations

                                                 requirement to avoid commercial                              The commenters were not all in                      effective factors to identify swap
                                                 hedgers being encompassed by the                          agreement on this, however. Several                    dealers, particularly in bilateral
                                                 dealer definitions.82                                     commenters (including some of those                    negotiations where it is difficult to say
                                                                                                           that said swap dealers enter into swaps                which party is accommodating demand
                                                 d. Other Dealer Issues
                                                                                                           on both sides of the market) also stated               for swaps.90 Other commenters said the
                                                    Commenters also addressed other                        that there are a variety of situations in              activities of accommodating demand or
                                                 issues in the Proposing Release,                          which a person’s activity of                           facilitating interest are indicative of
                                                 including: (i) Whether Congress                           contemporaneously entering into swaps                  swap dealing only in certain
                                                 intended that there be implicit                           on both sides of the market is not                     circumstances, such as when they are
                                                 preconditions to dealer status; (ii)                      indicative of dealing activity.86 One                  not related to a person’s commodity
                                                 whether the concepts of                                   commenter said that it would not be                    business,91 or when done with the
                                                 ‘‘accommodating demand’’ for swaps or                     appropriate to require that a person                   purpose of serving the needs of the
                                                 security-based swaps or ‘‘facilitating                    enter into swaps or security-based                     other party to the swap.92 Some
                                                 interest’’ in swaps are useful in                         swaps on both sides of the market as a                 commenters argued that the statement
                                                 identifying dealers; and (iii) whether the                litmus test for dealer status, because to              in the Proposing Release that swap
                                                 interpretation of the dealer definitions                  do so would create loopholes in the                    dealers are likely involved in most or all
                                                 should depend on pre-defined, objective                   definition.87 Two commenters also                      significant parts of the swap markets is
                                                 criteria.                                                 supported rejection of any interpretation              incorrect in the market for energy
                                                                                                           that would limit the dealer definitions                swaps. There, the commenters said,
                                                 i. Preconditions                                          to encompass only those entities that                  persons can find counterparties for
                                                   Several commenters said that the                        solely or predominately act as dealers.88              swaps without the intermediation of a
                                                 proposal is overbroad and would                              In addition, commenters were                        swap dealer, and swaps entered into
                                                 encompass persons that Congress did                       particularly divided as to whether                     directly by two end users are more
                                                 not intend to regulate as dealers.83                      acting as an intermediary always is                    frequent.93
                                                 Comments in this vein said that the                       indicative of swap dealing, as some                       Other commenters, though, said that
                                                 statutory definition should be                            commenters said that a person is not a                 the proposal’s focus on accommodating
                                                 interpreted to require that persons meet                  swap dealer when it simply stands                      demand and facilitating interest strikes
                                                 certain criteria or engage in certain                     between two parties by entering into                   the right balance and that the proposed
                                                 activity, not explicitly stated in the                    offsetting swaps with each party.89                    approach is generally correct.94 Another
                                                 statute, to be covered by the swap dealer                                                                        commenter did not object to including
                                                                                                           ii. ‘‘Accommodating Demand’’ and
                                                 definition. For instance, some                                                                                   accommodating demand and facilitating
                                                                                                           ‘‘Facilitating Interest’’
                                                 commenters said that a dealer is a                                                                               risk as factors in the definition, but said
                                                 person who enters into swaps or                              A number of commenters addressed                    that those factors should be applied
                                                 security-based swaps on either side of                    the Proposing Release’s view that a                    flexibly.95
                                                 the market and who profits from fees for                  tendency to accommodate demand for
                                                                                                           swaps and a general availability to enter              iii. Application of Objective Criteria,
                                                 doing so, or from the spread between                                                                             and Additional Factors
                                                 the terms of swaps on either side of the                  into swaps to facilitate other parties’
                                                 market.84 Other commenters made a                         interest in swaps (referred to here as                    Some commenters, specifically
                                                 similar point, saying that swap dealers                   ‘‘accommodating demand’’ and                           addressing the CFTC’s proposed
                                                 are those persons that intermediate                       ‘‘facilitating interest’’) are characteristic          interpretive approach to the ‘‘swap
                                                 between swap users on either side of the                  of swap dealers. Some commenters                       dealer’’ definition, said that the final
                                                 market.85                                                 stated that accommodating demand and                   rule should set out objective criteria that
                                                                                                           facilitating interest would not be                     market participants could use to
                                                   82 See
                                                                                                                                                                  determine whether or not they are
                                                           letter from ISDA dated I.
                                                   83 See,
                                                                                                              86 The examples cited were: entering into swaps     covered by the definition and therefore
                                                            e.g., letters from BG LNG I, EDF Trading,      on either side of a market depending on a firm’s
                                                 ISDA I, NCGA/NGSA dated February 17, 2012                                                                        required to register as swap dealers.96
                                                                                                           commercial purpose for entering each particular
                                                 (‘‘NCGA/NGSA II’’) and WGCEF I, and joint letter          swap (see letters from the Industrial Energy
                                                 from American Farm Bureau Federation, American            Consumers of America (‘‘IECA–Consumers’’) and             90 See letters from NextEra I and Peabody and

                                                 Soybean Association, National Association of              WGCEF I, and letter from the Not-For-Profit Electric   meeting with Vitol on February 15, 2011.
                                                 Wheat Growers, National Cattlemen’s Beef                  End User Coalition (‘‘NFPEEU’’), consisting of            91 See letter from Shell Trading I.
                                                 Association, National Corn Growers Association,           NRECA, American Public Power Association                  92 See letters from IECA–Credit I, National
                                                 National Council of Farmer Cooperatives, National         (‘‘APPA’’) and Large Public Power Council              Association of Insurance Commissioners (‘‘NAIC’’),
                                                 Grain and Feed Association, National Milk                 (‘‘LPPC’’); see also Roundtable Transcript at 44       Vitol and WGCEF I. One of these commenters also
                                                 Producers Federation and National Pork Producers          (remarks of Ed Prosser, Gavilon)); entering into       said that entering into a bespoke swap with a
                                                 Council (‘‘Farmers’ Associations’’).                      swaps on both sides of an illiquid market for          registered swap dealer, in which the swap dealer
                                                    84 See letters from COPE I, Edison Int’l, Hess,        purposes of price discovery or to elicit bids and      lays off risk, should not be viewed as
                                                 ISDA I, Shell Trading I, Utility Group, Vitol and         offers from other market participants (see letters     accommodating demand or facilitating interest. See
                                                 WGCEF I; see also Roundtable Transcript at 43–45          from Hess, Vitol and WGCEF I); and entering into       letter from Vitol.
                                                 (remarks of Ed Prosser, Gavilon). However, other          swaps on both sides of the market as part of an           93 See letter from BG LNG I, NCGA/NGSA I,

                                                 commenters questioned whether profiting from a            investment strategy (see letter from ABC/CIEBA).       NFPEEU, NRG Energy, Inc. (‘‘NRG Energy’’) and
                                                 bid/ask spread is a relevant test of dealer status, and      87 See letter from AFR.                             WGCEF I and meeting with Vitol on February 16,
                                                 emphasized that dealers are those persons who take           88 See letters from AFR and Better Markets I.       2011.
                                                 risk by entering into swaps or security-based swaps          89 See letters from BOKF, National Association         94 See letters from AFR and MFX I.

                                                 on both sides of the market. See Roundtable               (‘‘BOK’’) dated January 13, 2012 (‘‘BOK V’’), MFX         95 See letter from National Grain and Feed
                                                 Transcript at 21, 56 (remarks of Richard Ostrander,       I, Newedge and Northland Energy Trading LLC            Association (‘‘NGFA’’) dated February 22, 2011
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                                                 Morgan Stanley) and 43 (remarks of Russ Wasson,           (‘‘Northland Energy’’); see also Roundtable            (‘‘NGFA I’’).
                                                 National Rural Electric Cooperative Association           Transcript at 48 (remarks of John Nicholas,               96 See letters from BG LNG I, EEI/EPSA, Peabody,
                                                 (‘‘NRECA’’)). Another commenter pointed out that          Newedge). One commenter queried whether the            Rep. Desjarlais and Utility Group. Some
                                                 it could be difficult to determine how a person is        final rule should clarify whether a customer           commenters said that the CFTC’s interpretive
                                                 profiting from entering into swaps. See Roundtable        relationship between the parties to a swap is          approach to the swap dealer definition should be
                                                 Transcript at 42 (remarks of Michael Masters, Better      necessary in order for the swap to be relevant in      codified in the text of the final rule. See letters from
                                                 Markets).                                                 determining whether either of the parties is a swap    Alternative Investment Management Association
                                                    85 See letters from API I, BG LNG I and NCGA/          dealer. See letter from Representative Scott           Limited (‘‘AIMA’’) dated February 22, 2011 (‘‘AIMA
                                                 NGSA II.                                                  Desjarlais (‘‘Rep. Desjarlais’’).                      I’’) and COPE I.



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                                                                   Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations                                                        30603

                                                 Others focused especially on statements                     i. Security-Based Swap Dealer                           Exchange Act interpretations are still
                                                 in the Proposing Release to the effect                   Definition                                                 relevant.108
                                                 that swap dealers are those persons who                     A number of commenters supported                           On the other hand, some commenters
                                                 ‘‘tend to’’ engage in certain activities,                the proposed use of the dealer-trader                      agreed with the CFTC’s view not to
                                                 and that persons who engage in certain                   distinction under the Exchange Act to                      apply Exchange Act interpretations to
                                                 activities are ‘‘likely’’ to be swap                     interpret the ‘‘security-based swap                        the definition of the term ‘‘swap
                                                 dealers, as being overly subjective and                  dealer’’ definition.103 Two commenters,                    dealer.’’ These commenters said that it
                                                 difficult to interpret.97                                however, specifically opposed use of the                   is appropriate not to apply the
                                                    Certain commenters suggested                                                                                     interpretations under the Exchange Act
                                                                                                          distinction in the context of security-
                                                 specific objective criteria to use to                                                                               to identify persons that meet the swap
                                                                                                          based swaps, arguing that use of the
                                                 identify swap dealers. One commenter                                                                                dealer definition under the CEA.109
                                                                                                          distinction would create confusion or
                                                 said that swap dealing activity is
                                                                                                          would be inconsistent with the goal of                     e. Application to Particular Swap
                                                 characterized by more frequent use of
                                                                                                          improved transparency.104                                  Markets
                                                 swaps; having substantial staff and
                                                 technological resources devoted to                          ii. Swap Dealer Definition                              i. Aggregators
                                                 swaps; a larger portion of revenue and                      Some commenters said that the CFTC
                                                 profit being derived from swap activity;                                                                               Certain commenters addressed
                                                                                                          should apply the dealer-trader                             persons who enter into swaps as
                                                 and owning fewer physical assets                         distinction as it has been interpreted
                                                 related to the type of swaps entered                                                                                aggregators, with most of those
                                                                                                          with respect to the definition of                          commenters discussing agricultural
                                                 into.98 Another commenter said that to                   ‘‘dealer’’ under the Exchange Act to
                                                 identify swap dealers, the CFTC should                                                                              cooperatives. Commenters said that
                                                                                                          identify swap dealers.105 Some                             agricultural cooperatives that hedge
                                                 compare a person’s revenue or profits                    commenters said that the applicable
                                                 generated by swap activity to its overall                                                                           their own risks or the risks of their
                                                                                                          interpretations under the Exchange Act                     members regarding agricultural
                                                 revenue or profits; compare a person’s                   mean that swaps a person uses for
                                                 total business volume to the volume,                                                                                commodities should be excluded from
                                                                                                          proprietary trading (including for                         the swap dealer definition because
                                                 VaR and exposure associated with the                     speculative purposes) should not be
                                                 swap activity; compare a person’s total                                                                             Congress did not intend to treat
                                                                                                          considered in determining if the person                    agricultural cooperatives as swap
                                                 business resources to the resources                      is a swap dealer because dealers enter
                                                 devoted to swap activity; and consider                                                                              dealers and because agricultural
                                                                                                          into transactions in order to profit from                  cooperatives are in effect an extension
                                                 ownership or control of physical assets                  spreads or fees regardless of their view
                                                 in the specific market or region to which                                                                           of their members.110 Some commenters
                                                                                                          of the market for the underlying item,                     said that the agricultural cooperatives’
                                                 the person’s swap activity is tied.99                    whereas traders enter into transactions
                                                    More generally, some commenters                                                                                  use of swaps allows their members to
                                                                                                          in order to take a view on the direction                   hedge risks when the members’
                                                 supported codification of more concrete                  of the market or to obtain exposure to
                                                 tests in connection with the dealer                                                                                 transactions are too small for (or
                                                                                                          movements in the price of the                              otherwise not qualified for) the futures
                                                 definitions.100 However, other                           underlying item.106 Two commenters
                                                 commenters said that the use of bright                                                                              markets.111
                                                                                                          said that if the CFTC applied the
                                                 line rules to determine whether a person                                                                               Some commenters said that an
                                                                                                          distinction, traders should be subject to
                                                 is a dealer would be inappropriate given                                                                            exclusion from the swap dealer
                                                                                                          potential registration as major swap
                                                 the dynamic nature of the swap and                                                                                  definition also should be available to
                                                                                                          participants, and dealers should be
                                                 security-based swap markets. These                                                                                  private companies that serve as
                                                                                                          subject to regulation as swap dealers.107
                                                 commenters supported a facts and                                                                                    aggregators for swaps in agricultural
                                                                                                          Commenters acknowledged differences
                                                 circumstances approach to the dealer                                                                                commodities or otherwise offer swaps
                                                                                                          between the market for swaps and the
                                                 definition as a better approach.101 One                  market for securities, but said that the
                                                 commenter also raised issues about the                                                                                 108 See letters from API I, Gavilon I and IECA–

                                                 sources of information that may be                                                                                  Consumers.
                                                                                                             103 See, e.g., letters from Coalition for Derivatives      109 See letters from AFR and AFSCME; see also
                                                 considered as part of a dealer                           End-Users (‘‘CDEU’’), CCMR I, ISDA I and MetLife.          joint meeting with AFR and Better Markets on
                                                 determination.102                                           104 See letters from AFR and AFSCME.
                                                                                                                                                                     March 17, 2011 (dealer-trader distinction not
                                                    e. Application of Exchange Act                           105 Some of these commenters said that, since           helpful in identifying swap dealers because the
                                                 ‘‘Dealer-Trader’’ distinction                            some provisions in the statutory swap dealer               transparency and operational robustness of the
                                                                                                          definition are similar to the definition of a ‘‘dealer’’   swap market is much lower than in the securities
                                                    97 See letters from BG LNG I, Chesapeake Energy
                                                                                                          under the Exchange Act, Congress intended that the         market). One commenter said the precedents should
                                                                                                          two definitions would be applied in the same way.          be applied only by the SEC to identify security-
                                                 Corporation (‘‘Chesapeake Energy’’), COPE I, ISDA        See letters from API I, BG LNG I, CDEU, IECA–              based swap dealers. See letter from NAIC.
                                                 I, Vitol and WGCEF I. Some commenters focused on         Consumers and WGCEF I. Others said that the                   110 See letters from Dairy Farmers of America
                                                 particular aspects of the swap dealer definition as      CFTC should apply these interpretations because            (‘‘DFA’’), Growmark, Land O’Lakes, Inc. (‘‘Land
                                                 requiring further detail, such as, for example, what     they have been effectively applied for a long time         O’Lakes’’) dated February 22, 2011 (‘‘Land O’Lakes
                                                 it means to be ‘‘commonly known in the trade’’ as        in the context of securities. See letters from CCMR        II’’), National Council of Farmer Cooperatives
                                                 a swap dealer (see letter from Peabody) and the          I and MFA I.                                               (‘‘NCFC’’) dated February 22, 2011 (‘‘NCFC I’’) and
                                                 definition of market making (see letters from               106 See letters from Gavilon II, and Next Era I, and    NMPF. One commenter also said that a subsidiary
                                                 Midsize Banks and Peabody).
                                                    98 See letter from Hess.
                                                                                                          meetings with Electric Companies on April 13, 2011         of an agricultural cooperative that enters into swaps
                                                                                                          and WGCEF on April 28, 2011. Another commenter             with its parent cooperative, and the members of the
                                                    99 See letter from NextEra I.
                                                                                                          said the interpretations mean that dealers and             parent cooperative, should be excluded from the
                                                    100 See, e.g., letters from EEI/EPSA, FSR I, ISDA
                                                                                                          traders can be distinguished by their activities:          swap dealer definition for the same reason. See
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                                                 I, NextEra I and WGCEF I.                                dealers hold themselves out as buying and selling          meeting with Agrivisor. Another commenter said
                                                    101 See letters from Better Markets I, Chris          on a regular basis, derive income from providing           that an agricultural cooperative’s swaps with
                                                 Barnard (‘‘Barnard’’) and Prof. Michael Greenberger,     services in the chain of distribution, and profit from     farmers and other persons for risk management
                                                 University of Maryland School of Law                     price spreads, while traders do not provide services       should be disregarded in determining if the
                                                 (‘‘Greenberger’’).                                       or extend credit but, rather, profit from changes in       cooperative is a swap dealer so long as the swaps
                                                    102 See letter from ISDA I (stating that sources of   the market value of underlying items. See letter           relate to the marketing function of the cooperative,
                                                 information considered by the Commissions in             from API I.                                                even if the swaps are not with members of the
                                                 determining dealer status should be revealed to the         107 See letters from EDF Trading and IECA–              cooperative. See letter from NMPF.
                                                 entity being evaluated).                                 Consumers.                                                    111 See letters from DFA and Growmark.




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                                                 30604             Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations

                                                 for agricultural risk management.112                    mitigate price and delivery risks directly        related to electricity is different from the
                                                 These commenters said that such an                      linked to a commercial enterprise; less           use of swaps on other physical
                                                 exclusion would reduce the costs and                    swap activity flows through                       commodities in that electricity swaps:
                                                 regulatory burdens imposed on such                      intermediaries; the markets for the               Are more highly customized to a
                                                 companies and therefore provide a                       underlying physical commodities are               particular place and time; are more
                                                 broader choice of swap providers to                     separately regulated; and the failure of          likely to relate to a short time period or
                                                 farmers and other agricultural market                   a commodity market participant is not             be more frequently entered into;
                                                 participants, which they said would                     likely to impact financial markets as a           typically can be tied to a specific
                                                 reduce risks.113                                        whole.117 Therefore, these commenters             generation, transmission or use of
                                                    One commenter discussed a small                      believe, the application of the swap              electricity; are more likely to be entered
                                                 energy firm that aggregates demand for                  dealer definition to participants in these        into directly by end-users rather than
                                                 swaps from small energy retailers and                   physical commodity swap markets                   through dealers; are likely to be entered
                                                 consumers. This commenter said that                     should be different from the application          into by electricity companies on both
                                                 such aggregators should be excluded                     to participants in the financial                  sides of the market; and in many cases
                                                 from the swap dealer definition because                 commodity swap markets.118 Some                   were subject to regulatory oversight
                                                 imposing the swap dealer regulations                    commenters said that imposing the costs           prior to the Dodd-Frank Act.121
                                                 (which would be promulgated with                        of swap dealer regulation on
                                                 large financial firms in mind) on such                  participants in the markets for physical             Commenters made various points
                                                 firms would increase costs for the                      commodity swaps would discourage                  regarding how swaps related to
                                                 aggregators, discourage the aggregators’                participation in the market, thereby              electricity should be treated for
                                                 offering of swaps, and thereby reduce                   reducing liquidity and increasing                 purposes of the swap dealer definition.
                                                 choice and efficiency in the market.114                 market concentration.119                          A coalition of not-for-profit power
                                                 Another commenter said that a firm that                                                                   utilities and electric cooperatives said
                                                 enters into swaps with microfinance                     iii. Electricity Swaps
                                                                                                                                                           that electricity cooperatives should be
                                                 lenders and offsetting swaps with                           Commenters on the use of swaps in             excluded from the swap dealer
                                                 commercial banks is akin to an                          connection with the generation and                definition because they are non-profit
                                                 introducing broker or FCM, and should                   transmission of electricity addressed a           entities that enter into swaps for the
                                                 be excluded from the swap dealer                        variety of issues. First, commenters said benefit of their members, they do not
                                                 definition on the grounds that it does                  that markets related to electricity are           hold themselves out as swap dealers,
                                                 not enter into swaps on its own                         different from markets for other physical they do not make markets, and their
                                                 initiative, but rather to provide access to             commodities in that electricity must be           swaps are not necessarily reflective of
                                                 the swap markets to smaller                             generated and transmitted at the time it          market rates.122 Other commenters said
                                                 counterparties.115                                      is needed (it cannot be stored for future         that swaps related to transactions on
                                                    Another commenter said that there is                 use); the overall demand for electricity          tariff schedules approved by FERC or
                                                 no need for any special treatment of                    is inelastic but demand at any particular
                                                                                                                                                           the Electric Reliability Council of Texas
                                                 aggregators in the swap dealer                          time is subject to external variables,
                                                                                                                                                           should be disregarded in determining if
                                                 definition. According to this                           such as weather; the generation,
                                                                                                                                                           a person is a swap dealer.123 And, some
                                                 commenter, the CFTC’s guidance                          transmission and use of electricity is
                                                                                                         widely dispersed and geographically               commenters said that any special
                                                 regarding the definition and the de
                                                 minimis exception from the definition                   specific; the markets are overseen by             treatment of swaps related to electricity
                                                 address the relevant issues properly and                regulators such as state Public Utility           should apply not only to companies that
                                                 completely.116                                          Commissions, regional transmission                generate, transmit or distribute
                                                                                                         organizations (‘‘RTOs’’) and the Federal electricity, but also to energy marketing
                                                 ii. Physical Commodity Swaps                                                                              companies that use swaps to benefit
                                                                                                         Energy Regulatory Commission
                                                    Commenters that discussed physical                   (‘‘FERC’’); and government mandates               from price changes in the underlying
                                                 commodity swaps primarily focused on                    require continuous supply of electricity energy commodities or to hedge related
                                                 swaps related to energy commodities                     and treat electricity as a ‘‘public               risks.124
                                                 such as oil, natural gas and electricity.               good.’’ 120 Commenters said that because             On the other hand, some commenters
                                                 The commenters said that the market for                 of these differences, the use of swaps            acknowledged that a person who makes
                                                 these swaps is different from the market                                                                  a market in swaps related to electricity
                                                 for swaps on interest rates and other                      117 See letters from BG LNG I, Dominion
                                                                                                                                                           by standing ready to enter into such
                                                 financial commodities because, among                    Resources, National Energy Marketers Association
                                                                                                         (‘‘NEM’’), NFPEEU, Vitol and WGCEF I joint letter swaps in order to profit from a bid/ask
                                                 other things, the swaps are used to                     from Senator Debbie Stabenow and Representative   spread would be a swap dealer, even if
                                                    112 See letters from Farmers’ Associations, NGFA
                                                                                                         Frank Lucas (many commercial end-users of swaps   the person was in the business of
                                                                                                         with inherent physical commodity price risk use   generating, transmitting or distributing
                                                 I and NMPF.                                             swaps to hedge such risk and otherwise for their
                                                    113 See id.                                          own trading objectives and not for the benefit of
                                                    114 See letter from Northland Energy. This           others) and meetings with Bunge on May 18, 2011            121 See letters from Edison Int’l, EEI/EPSA,

                                                 commenter defined an ‘‘aggregator’’ as a person         and Electric Companies on April 13, 2011.                Electric Trade Associations, FERC Staff, NextEra I
                                                 who: (i) Enters into swaps predominantly in one            118 See id.                                           and NFPEEU and meeting with Electric Companies
                                                 direction with counterparties that are using swaps         119 See letters from Dominion Resources, NEM          on April 13, 2011.
                                                 to establish bona fide hedges; and (ii) offsets risks   and NFPEEU.                                                122 See letter from NFPEEU. This commenter said

                                                 associated with such swaps using regulated futures         120 See letters from Edison Int’l, the staff of the   the exclusion from the swap dealer definition
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                                                 contracts or cleared swaps.                             FERC (‘‘FERC Staff’’), National Association of           should extend to persons acting as an operating or
                                                    115 See letter from MFX dated June 3, 2011 (‘‘MFX
                                                                                                         Regulatory Utility Commissioners (‘‘NARUC’’),            purchasing agent for other utilities in connection
                                                 II’’). This commenter said that the exclusion should    NEM, NextEra I, NFPEEU and National Rural                with energy infrastructure products, or otherwise
                                                 be available to a person who operates primarily on      Utilities Cooperative Finance Corporation (‘‘NRU         entering into energy commodity swaps on behalf of
                                                 a not-for-profit basis and limits its swap activities   CFC’’) dated February 14, 2011 (‘‘NRU CFC I’’), joint    other end users.
                                                 to offering swaps to persons in underserved markets     letter from NRECA, APPA, LPPC, EEI and EPSA                123 See letters from EDF Trading, FERC Staff and

                                                 and offsetting such swaps, and who meets other          (‘‘Electric Trade Associations’’) and meetings with      NARUC.
                                                 requirements to limit the scope of the exclusion.       Electric Companies on April 13, 2011 and NFPEEU            124 See letters from DC Energy, EDF Trading and
                                                    116 See letter from Better Markets I.                on January 29, 2011.                                     EEI/EPSA.



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                                                                   Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations                                                       30605

                                                 electricity and owned physical facilities                swaps or security-based swaps solely in                 contract participant.’’ In general, the
                                                 for that purpose.125                                     a fiduciary capacity.137                                commenters addressed when and how
                                                                                                             Commenters also suggested that the                   the definitions should be applied to
                                                 f. Suggested Exlusions From the Dealer                   dealer definitions categorically exclude,               persons based outside the U.S. and how
                                                 Definitions                                              or should be interpreted to exclude, the                the definitions should take account of
                                                    Several commenters took the view                      following types of swaps and security-                  non-U.S. requirements that may be
                                                 that the swap dealer and security-based                  based swaps: Exchange-cleared swaps                     applicable to such persons.148 The
                                                 swap dealer definitions should                           and security-based swaps,138 options to                 Commissions intend to separately
                                                 categorically exclude, or should be                      make or receive delivery of physical                    address issues related to the application
                                                 interpreted in a way that would be                       commodities,139 cash forward                            of these definitions to non-U.S. persons
                                                 expected to exclude, a variety of types                  transactions with embedded swaps and                    in the context of the application of Title
                                                 of persons or transactions. Commenters                   book-out transactions,140 swaps or                      VII to non-U.S. persons.
                                                 particularly suggested that the following                security-based swaps that are used for
                                                                                                          hedging or mitigating commercial                        g. Cost-Benefit Issues and Hedging
                                                 categories of persons should be
                                                                                                                                                                  Deterrence
                                                 excluded from the dealer definitions:                    risk,141 swaps entered into to profit from
                                                 Agricultural cooperatives and electric                   future changes in the price of the                         Several commenters emphasized the
                                                 cooperatives (as addressed above),                       underlying commodity,142 swaps or                       cost of being regulated as a dealer, and
                                                 employee benefit plans as defined in the                 security-based swaps entered into as a                  emphasized that an overbroad scope of
                                                 Employee Retirement Income Security                      fiduciary or agent for another person,143               the dealer definitions would impose
                                                 Act of 1974 (‘‘ERISA’’),126 farm credit                  swaps or security-based swaps entered                   significant unwarranted costs on entities
                                                 system institutions,127 Federal Home                     into for purposes of price discovery,144                contrary to the goals of the Dodd-Frank
                                                 Loan Banks,128 insured depository                        and, as noted above, swaps related to                   Act, and would deter the use of swaps
                                                 institutions that limit their swap dealing               items that are covered by a tariff                      and security-based swaps for
                                                 activity to riskless principal                           approved by FERC or the Electric                        hedging.149 Some commenters also
                                                 transactions,129 FCMs and broker-                        Reliability Council of Texas.145                        noted that impact of the provisions of
                                                 dealers that limit their swap dealing                       In contrast, some commenters                         section 716 of the Dodd-Frank Act on
                                                 activity to riskless principal                           opposed providing any categorical                       entities that are deemed to be swap
                                                 transactions,130 financial guaranty                      exclusions from the dealer definitions.
                                                                                                                                                                     148 See, e.g., letters from FSR I, Institute of
                                                 insurers and their affiliates that do not                One commenter stated that the
                                                                                                                                                                  International Bankers, ISDA I, Investment
                                                 enter into new swaps,131 asset                           definitions’ focus on a person’s                        Management Association, Japan Financial Services
                                                 managers,132 non-financial companies                     activities—as opposed to whether that                   Agency, Securities Industry and Financial Markets
                                                 offering swaps related to their physical                 person falls within a particular                        Association (‘‘SIFMA’’) dated February 3, 2011
                                                                                                          category—is a better means of                           (‘‘SIFMA I’’), and the World Bank Group, joint letter
                                                 commodity business,133 any person who                                                                                                ´          ˆ
                                                                                                                                                                  from the Autorite de controle prudential and the
                                                 enters into swaps or security-based                      determining whether the person is a                              ´
                                                                                                                                                                  Autorite des marches financiers, joint letter from
                                                 swaps only with registered dealers and                   swap dealer.146 Another commenter                       Bank of America Merrill Lynch, Barclays Capital,
                                                 major participants,134 persons that do                   described the requested exclusions as                   BNP Paribas S.A. (‘‘BNP Paribas’’), Citi, Credit´
                                                                                                          attempts to achieve carve-outs that are                 Agricole Corporate and Investment Bank, Credit
                                                 not pose systemic risk,135 hedge                                                                                 Suisse Securities (USA), Deutsche Bank AG
                                                 funds 136 and entities that enter into                   not provided for in the statute.147                     (‘‘Deutsche Bank’’), HSBC, Morgan Stanley, Nomura
                                                                                                             Lastly, several commenters addressed                 Securities International, Inc. (‘‘Nomura Securities’’),
                                                    125 See letter from EEI/EPSA and meeting with         the extraterritorial application of the                       ´ ´ ´ ´
                                                                                                                                                                  Societe Generale and UBS Securities LLC (‘‘Twelve
                                                 Electric Companies on April 13, 2011.                    definitions of the terms ‘‘swap dealer,’’               Firms’’), joint letter from the Bank of Tokyo-
                                                                                                                                                                  Mitsubishi UFJ, Ltd., Mizuho Corporate Bank, Ltd.
                                                    126 See letter from ABC/CIEBA.
                                                                                                          ‘‘security-based swap dealer,’’ ‘‘major                 and Sumitomo Mitsui Banking Corporation, and
                                                    127 See letter from Farm Credit Council dated
                                                                                                          swap participant,’’ ‘‘major security-                   joint letter from Barclays Bank PLC, BNP Paribas,
                                                 February 22, 2011 (‘‘Farm Credit Council I’’).
                                                    128 See letters from Credit Union National
                                                                                                          based swap participant,’’ and ‘‘eligible                Credit Suisse AG, Deutsche Bank, HSBC, Nomura
                                                                                                                                                                  Securities, Rabobank Nederland, Royal Bank of
                                                 Association (‘‘CUNA’’) and Federal Home Loan                                                                     Canada, the Royal Bank of Scotland Group pLc,
                                                                                                             137 See letters from FSR dated February 22, 2011
                                                 Banks (‘‘FHLB’’) dated February 22, 2011 (‘‘FHLB                                                                       ´ ´ ´ ´
                                                                                                                                                                  Societe Generale, the Toronto-Dominion Bank and
                                                 I’’).                                                    and Midsize Banks.                                      UBS AG.
                                                    129 See letter from BOK dated January 31, 2011           138 See letters from Commodity Markets Council
                                                                                                                                                                     149 See joint letter from Representatives Spencer
                                                 (‘‘BOK I’’); but see letter from Vitol at 7 (riskless    (‘‘CMC’’), EEI/EPSA, IECA-Credit I, NextEra I, Shell    Bachus and Frank Lucas at 2 (‘‘Casting an overly-
                                                 principal transactions are a ‘‘good model for true       Trading I, Utility Group and Vitol.                     broad net in defining [dealer and major participant]
                                                                                                             139 See letters from NextEra I and WGCEF I. The
                                                 swap dealing activity’’).                                                                                        could force some smaller participants to leave the
                                                    130 See letter from Newedge.                          commenters acknowledged that such options may           marketplace as a result of increased costs, or
                                                    131 See letter from Association of Financial          or may not be included in the definition of ‘‘swap.’’   eliminate certain types of contracts used for
                                                                                                             140 See letter from CMC.                             hedging. If either occurs, businesses will be left
                                                 Guaranty Insurers (‘‘AFGI’’).
                                                    132 See letter from BlackRock, Inc. (‘‘BlackRock’’)      141 See, e.g., letters from Edison Int’l and WGCEF   exposed to market volatility and the consequences
                                                 dated February 22, 2011 (‘‘BlackRock I’’).               I and joint letter from Senator Stabenow and            will ultimately be felt by Americans in the form of
                                                    133 Commenters making this point varied in their      Representative Lucas (also saying that definition of    increased consumer costs.’’) and letters from ISDA
                                                                                                          ‘‘hedging’’ should be consistent with respect to the    Iat 7 (‘‘The substantial additional burdens and costs
                                                 phrasing of potential exclusions, and particularly
                                                                                                          dealer and major participant definitions and the        of Dealer regulation must be reserved for those
                                                 suggested exclusions for: Agricultural firms offering
                                                                                                          end-user exception from clearing).                      whose business it is to ‘make the market,’ that is,
                                                 swaps as risk management tools related to physical
                                                                                                             142 See letters from EEI/EPSA, NextEra I, Utility    those who consistently both buy and sell. This is
                                                 commodities (see letter from NGFA I); all firms,                                                                 in accord with Dodd-Frank Act’s market regulatory
                                                 other than financial entities whose primary              Group and WGCEF I.
                                                                                                             143 See letters from Midsize Banks, NFPEEU and       goals, as well as the legislation’s obvious intent to
                                                 business is swap dealing (see letter from NEM); any                                                              preserve healthy growth and innovation in the U.S.
                                                 person that uses swaps only to reduce price              FSR I.
                                                                                                                                                                  swap markets.’’ (footnote omitted)), Peabody at 2–
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                                                 volatility, enters into a volume of swaps relating to       144 See letters from EEI/EPSA, Vitol and
                                                                                                                                                                  3 (‘‘Legal uncertainty over the application to end
                                                 any physical commodity that is less than the             WGCEF I.                                                users of the significant regulatory requirements for
                                                 volume of its trading in that commodity, and is not         145 See letters from EDF Trading, FERC Staff and
                                                                                                                                                                  [swap dealers] could lead end users to minimize
                                                 making a market (see letter from Chesapeake              NARUC.                                                  their use of swaps in order to avoid the risk of being
                                                 Energy); or any person that limit its use of swaps          146 See letter from Better Markets I.
                                                                                                                                                                  deemed to be [a swap dealer].’’), and Church
                                                 to hedging or speculating (see letters from API I).         147 See letter from AFSCME. Additional               Alliance (stating that the risk of incurring the costs
                                                    134 See letter from ISDA I.
                                                                                                          commenters emphasized the need for transparency         of dealer regulation would harm employee benefit
                                                    135 See letters from NARUC and NCGA/NGSA I.
                                                                                                          about swaps and swap activities. See letters from       plans by reducing their use of swaps and security-
                                                    136 See letter from MFA I.                            Jason Cropping and BJ D’Milli.                          based swaps for hedging and risk mitigation).



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                                                 30606             Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations

                                                 dealers or security-based swap                          terms ‘‘swap dealer’’ and ‘‘security-                 ‘‘swap dealer,’’ based upon types of
                                                 dealers.150 Also, one commenter                         based swap dealer’’ closely follow the                activities. As noted above, we are
                                                 suggested that using a qualitative test for             statutory definitions’ four tests and                 adopting a final rule under the CEA
                                                 the dealer definition might increase                    exclusion for activities that are not part            that, like the proposed rule, defines the
                                                 costs due to regulatory uncertainty.151                 of a ‘‘regular business.’’ 157 In addition,           term ‘‘swap dealer’’ using terms from
                                                    One commenter specifically suggested                 this Adopting Release sets forth                      the four statutory tests and the
                                                 that in considering the final rules, the                interpretive guidance regarding various               exclusion for swap activities that are not
                                                 Commissions should consider empirical                   elements of the final rules.                          part of ‘‘a regular business.’’ 160 The
                                                 data regarding the costs and benefits                      Because the definitions of the terms               final rule includes modifications from
                                                 flowing from the rules and issue a                      ‘‘swap dealer’’ in the CEA and                        the proposed rule that are described
                                                 second analysis of the costs and benefits               ‘‘security-based swap dealer’’ in the                 below, including provisions stating that
                                                 of the rules for public comment,152                     Exchange Act are substantially similar,               swaps entered into for hedging physical
                                                 while other commenters said that the                    the rules further defining those terms                positions as defined in the rule, swaps
                                                 consideration of cost and benefits                      and the accompanying interpretations in               between majority-owned affiliates,
                                                 should include the cumulative cost of                   this Adopting Release reflect common                  swaps entered into by a cooperative
                                                 interrelated regulatory burdens arising                 underlying principles. At the same time,              with its members, and certain swaps
                                                 from all the rules proposed under the                   the interpretations regarding the                     entered into by registered floor traders,
                                                 Dodd-Frank Act.153 Other commenters                     application of the definitions differ in              are excluded from the swap dealer
                                                 said the Commissions should consider                    certain respects given the differences in             determination.161 The Commissions, in
                                                 alternatives that would impose fewer                    the uses of and markets for swaps and                 consideration of comments received, are
                                                 costs.154                                               security-based swaps.158 For example,                 also making certain modifications to the
                                                    Another commenter said that the cost-                because security-based swaps may be                   interpretive guidance set out in the
                                                 benefit analyses in the Proposing                       used to hedge or gain economic                        Proposing Release with respect to
                                                 Release may have understated the                        exposure to underlying individual                     various elements of the statutory
                                                 benefits of the proposed rules, because                 securities (while recognizing                         definition of the term ‘‘swap dealer,’’ as
                                                 focusing on individual aspects of all the               distinctions between security-based                   described below.
                                                 rules proposed under the Dodd-Frank                     swaps and other types of securities, as                  The determination of whether a
                                                 Act prevents consideration of the full                  discussed below), there is a basis to                 person is covered by the statutory
                                                 range of benefits that arise from the                   build upon the same principles that                   definition of the term ‘‘swap dealer’’
                                                 rules as a whole, in terms of providing                 presently are used to identify dealers for            requires application of various
                                                 greater financial stability, reducing                   other types of securities. These same                 provisions of the rule further defining
                                                 systemic risk and avoiding the expense                  principles, though instructive, may be                that term, as well as the interpretive
                                                 of assistance to financial institutions in              inapplicable to swaps in certain                      guidance in this Adopting Release,
                                                 the future.155 This commenter said the                  circumstances or may be applied                       depending on the person’s particular
                                                 consideration of benefits of the                        differently in the context of dealing                 circumstances. We intend that the
                                                 proposed rules should include the                       activities involving commodity, interest              determination with respect to a
                                                 mitigated risk of a financial crisis.156                rate, or other types of swaps.                        particular person would proceed as
                                                                                                            For these reasons, we separately are
                                                 3. Final Rules and Interpretation—                                                                            follows.
                                                                                                         addressing the interpretation of the                     The person would begin by applying
                                                 General Principles                                      ‘‘swap dealer’’ and ‘‘security-based                  the statutory definition, and the
                                                    Consistent with the Proposing                        swap dealer’’ definitions.                            provisions of the rule which implement
                                                 Release, the final rules that define the                   Also, as discussed below, the
                                                                                                                                                               the four statutory tests and the
                                                                                                         Commissions are directing their
                                                                                                                                                               exclusion for swap activities that are not
                                                    150 See letters from American Bankers Association    respective staffs to report separately
                                                                                                                                                               part of ‘‘a regular business,’’ 162 in order
                                                 (‘‘ABA’’) dated November 3, 2011 (‘‘ABA I’’), BOK       regarding the rules being adopted in
                                                 I, and ISDA I. Section 716 of the Dodd-Frank Act        connection with the definition and                    to determine if the person is engaged in
                                                 prohibits any ‘‘swaps entity’’—a term that              related interpretations. These staff                  swap dealing activity. In that analysis,
                                                 encompasses swap dealers and security-based swap
                                                                                                         reports will help the Commissions                     the person would apply the interpretive
                                                 dealers—from receiving Federal assistance with                                                                guidance described in this part II.A.4,
                                                 respect to any swap, security-based swap, or other      evaluate the ‘‘swap dealer’’ and
                                                 activity of the swaps entity.                           ‘‘security-based swap dealer’’                        which provides for consideration of the
                                                    151 See letter from API I (stating that costs of
                                                                                                         definitions in all respects, including                relevant facts and circumstances. As
                                                 regulatory uncertainty stem from the use of
                                                                                                         whether new or revised tests or                       part of this consideration, the person
                                                 qualitative factors for identifying dealing, and from                                                         would apply elements of the dealer-
                                                 regulatory efforts to reach beyond ‘‘true’’ swap        approaches would be appropriate for
                                                 dealers); see also letter from Dominion Resources       identifying swap dealers and security-                trader distinction, as appropriate,
                                                 (the opportunity costs associated with regulatory       based swap dealers.159                                including as described in part II.A.4.a,
                                                 uncertainty should be considered).                                                                            below.
                                                    152 See letter from WGCEF I.                         4. Final Rules and Interpretation—                       The rule provides that certain swaps
                                                    153 See letters from ABA I, NFPEEU and WGCEF         Definition of ‘‘Swap Dealer’’                         are not considered in the determination
                                                 dated December 20, 2011, enclosing a report
                                                 prepared by NERA Economic Consulting (‘‘NERA’’)            The Dodd-Frank Act contains a                      of whether a person is a swap dealer.163
                                                 (‘‘WGCEF VIII’’); see also letter from NERA dated       comprehensive definition of the term                  In particular, swaps entered into by an
                                                 March 13, 2012.                                                                                               insured depository institution with a
                                                    154 See letters from NextEra I (referring to           157 See CFTC Regulation § 1.3(ggg)(1), (2);         customer in connection with originating
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                                                 alternative de minimis tests) and NFPEEU.               Exchange Act rule 3a71–1(a), (b).                     a loan with that customer, 164 swaps
                                                    155 See letter from Better Markets dated June 3,       158 Section 712(a)(7)(A) of the Dodd-Frank Act
                                                 2011 (‘‘Better Markets II’’).                           provides that in adopting rules and orders              160 See
                                                    156 Better Markets cited estimates that the                                                                           CFTC Regulation § 1.3(ggg)(1), (2).
                                                                                                         implementing Title VII, the Commissions shall treat     161 See
                                                 worldwide cost of the 2008 financial crisis in terms    functionally or economically similar products or                 CFTC Regulation § 1.3(ggg)(6)(ii), (iii).
                                                                                                                                                                 162 See CFTC Regulation § 1.3(ggg)(1), (2).
                                                 of lost output was between $60 trillion and $200        entities in a similar manner. Section 712(a)(7)(B),
                                                                                                         though, provides that the Commissions need not act      163 See CFTC Regulation § 1.3(ggg)(5), (6).
                                                 trillion, depending primarily on the long term
                                                 persistence of the effects. See letter from Better      in an identical manner.                                 164 See CFTC Regulation § 1.3(ggg)(5); see also

                                                 Markets II.                                               159 See part V, infra.                              part II.B, infra.



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                                                                    Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations                                                        30607

                                                 between majority-owned affiliates, 165                    are differences in the structure of those                  involving certain types of securities
                                                 swaps entered into by a cooperative                       two statutory definitions,174 we believe                   (while recognizing that some debt and
                                                 with its members,166 swaps entered into                   that their parallels—particularly their                    equity securities are not actively
                                                 for hedging physical positions as                         exclusions for activities that are ‘‘not                   traded). This suggests that in the swap
                                                 defined in the rule,167 and certain swaps                 part of a regular business’’—warrant                       context, concepts of ‘‘regularity’’ should
                                                 entered into by registered floor                          analogous interpretive approaches for                      account for a participant’s level of
                                                 traders 168 are excluded from the swap                    distinguishing dealers from non-                           activity in the market relative to the
                                                 dealer determination.                                     dealers.175 Thus, the dealer-trader                        total size of the market.
                                                    If, after completing this review (taking               distinction forms the basis for a                             • No separate issuer—Each
                                                 into account the applicable interpretive                  framework that appropriately                               counterparty to a swap in essence is the
                                                 guidance and excluding any swaps as                       distinguishes between persons who                          ‘‘issuer’’ of that instrument; in contrast,
                                                 noted above), the person determines                       should be regulated as swap dealers and                    dealers in cash market securities
                                                 that it is engaged in swap dealing                        those who should not. We also believe                      generally transact in securities issued by
                                                 activity, the next step is to determine if                that the distinction affords an                            another party. This distinction suggests
                                                 the person is engaged in more than a de                   appropriate degree of flexibility to the                   that the concept of maintaining an
                                                 minimis quantity of swap dealing.169 If                   analysis, and that it would not be                         ‘‘inventory’’ of securities is inapposite
                                                 so, the person is a swap dealer. When                     appropriate to seek to codify the                          in the context of swaps. Moreover, this
                                                 the person registers, it may apply to                     distinction in rule text.                                  distinction—along with the fact that the
                                                 limit its designation as a swap dealer to                    The Commissions recognize that the                      ‘‘swap dealer’’ definition lacks the
                                                 specified categories of swaps or                          dealer-trader distinction needs to be                      conjunctive ‘‘buying and selling’’
                                                 specified activities of the person in                     adapted to apply to swap activities in                     language of the ‘‘dealer’’ definition—
                                                 connection with swaps.170                                 light of the special characteristics of                    suggests that concepts of two-sided
                                                    In this part II.A.4., we provide                       swaps and the differences between the                      markets at times would be less relevant
                                                 interpretive guidance on the application                  ‘‘dealer’’ definition, on the one hand,                    for identifying swap dealers than they
                                                 of the ‘‘swap dealer’’ definition,                        and the ‘‘swap dealer’’ definition, on the                 would be for identifying dealers.176
                                                 modified from the Proposing Release as                    other. Relevant differences between the                       • Predominance of over-the-counter
                                                 appropriate based on comments                             swap market and the markets for                            and non-standardized instruments—
                                                 received. This guidance separately                        securities (other than security-based                      Swaps an thus far are not significantly
                                                 addresses the following: application of                   swaps) include:                                            traded on exchanges or other trading
                                                 the dealer-trader framework; the                             • Level of activity—Swap markets are                    systems, in contrast to some cash market
                                                 ‘‘holding out’’ and ‘‘commonly known’’                    marked by less activity than markets                       securities (while recognizing that many
                                                 criteria; market making; the not part of                                                                             cash market securities also are not
                                                 ‘‘a regular business’’ exception; the                     affect existing, or future, interpretations of the         significantly traded on those
                                                 exclusion of swaps entered into for                       dealer-trader distinction under the Exchange Act.
                                                                                                                                                                      systems).177 These attributes—along
                                                 hedging physical positions as defined in                     174 For example, while the ‘‘dealer’’ definition

                                                                                                           encompasses certain persons in the business of             with the lack of ‘‘buying and selling’’
                                                 the rule; and the overall interpretive
                                                                                                           ‘‘buying and selling’’ securities, the ‘‘swap dealer’’     language in the swap dealer definition,
                                                 approach to the definition.171                            definition does not address either ‘‘buying’’ or           as noted above—suggest that concepts of
                                                                                                           ‘‘selling.’’ We also note that the ‘‘dealer’’ definition
                                                 a. Use of the Dealer-Trader Distinction                   requires the conjunctive ‘‘buying and selling’’—
                                                                                                                                                                      what it means to make a market need to
                                                    We believe that the dealer-trader                      which connotes a degree of offsetting two-sided            be construed flexibly in the contexts of
                                                 distinction 172—which already forms a                     activity. In contrast, the swap dealer definition          the swap markets.
                                                 basis for identifying which persons fall
                                                                                                           (particularly the ‘‘regularly enters into’’ swaps             • Mutuality of obligations and
                                                                                                           language of the definition’s third prong) lacks that
                                                 within the longstanding Exchange Act                      conjunctive terminology.
                                                                                                                                                                      significance to ‘‘customer’’
                                                 definition of ‘‘dealer’’—in general                          175 In the Proposing Release, the CFTC did not          relationship—In contrast to a secondary
                                                 provides an appropriate framework for                     propose to use principles from the dealer-trader           market transaction involving equity or
                                                 interpreting the statutory definition of                  distinction to interpret the definition of the term        debt securities, in which the completion
                                                                                                           ‘‘swap dealer,’’ instead proposing an interpretive         of a purchase or sale transaction can be
                                                 the term ‘‘swap dealer.’’ 173 While there                 approach that focused on, among other things, a
                                                                                                           person’s functional role in the swap markets and its       expected to terminate the mutual
                                                    165 See CFTC Regulation § 1.3(ggg)(6)(i); see also     relationships with swap counterparties. See                obligations of the parties to the
                                                 part II.C, infra.                                         Proposing Release, 75 FR at 80177. There was,              transaction, the parties to a swap often
                                                    166 See CFTC Regulation § 1.3(ggg)(6)(ii); see also    however, some overlap in practice between the              will have an ongoing obligation to
                                                 part II.C, infra.                                         factors identified in the Proposing Release relating
                                                    167 See CFTC Regulation § 1.3(ggg)(6)(iii); see also   to a swap dealer’s functional role and relationships       exchange cash flows over the life of the
                                                 part II.B.4.e, infra.                                     and the principles of the dealer-trader distinction        agreement. In light of this attribute,
                                                    168 See CFTC Regulation § 1.3(ggg)(6)(iv); see also    that were proposed to be applied to identify               some market participants have
                                                                                                           security-based swap dealers. Moreover, the changes         expressed the view that they have
                                                 part II.B.4.f, infra.
                                                                                                           to the interpretive approach to the swap dealer
                                                    169 See CFTC Regulation § 1.3(ggg)(4); see also
                                                                                                           definition that we are adopting here and discussed         ‘‘counterparties’’ rather than
                                                 part II.D, infra.                                         in this part II.A.4 are in many respects similar to        ‘‘customers’’ in the context of their swap
                                                    170 See CFTC Regulation § 1.3(ggg)(3); see also
                                                                                                           the principles of the dealer-trader distinction. We        activities.
                                                 part II.E, infra.                                         also acknowledge the commenters who asked for
                                                    171 The Commissions note that interpretations of                                                                     In applying the dealer-trader
                                                                                                           additional guidance regarding the application of the
                                                 the applicability of the dealer-trader distinction to     definitions. See, e.g., letters from Gavilon II,           distinction, it also is necessary to apply
                                                 the ‘‘swap dealer’’ definition under the CEA do not       Peabody and the Utility Group, and meeting with
                                                 affect existing, or future, interpretations of the        CDEU on April 7, 2011.                                        176 The analysis also should account for the fact
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                                                 dealer-trader distinction under the Exchange Act.            Thus, while the incorporation of the dealer-trader      that a party to a swap can use other derivatives or
                                                    172 See note 31, supra. The principles embedded                                                                   cash market instruments to hedge the risks
                                                                                                           distinction in the interpretation of the term ‘‘swap
                                                 within the ‘‘dealer-trader distinction’’ are also         dealer’’ constitutes a change from the Proposing           associated with the swap position, meaning that
                                                 applicable to distinguishing dealers from non-            Release, this is simply reflective of the other            two-way trading is not necessary to maintain a flat
                                                 dealers such as hedgers or investors. See note 250,       changes to the CFTC’s interpretive approach that           risk book.
                                                 infra.                                                    we are adopting for the final rule and the overlap            177 Even though we expect trading of swaps on
                                                    173 The Commissions note that interpretations of       between the factors relating to a swap dealer’s            exchanges following the implementation of Title
                                                 the applicability of the dealer-trader distinction to     functional role and counterparty relationships and         VII, we expect there to remain a significant amount
                                                 the ‘‘swap dealer’’ definition under the CEA do not       the principles of the dealer-trader distinction.           of over-the-counter activity involving swaps.



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                                                 30608             Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations

                                                 the statutory provisions that will govern                 behalf of a counterparty; (iii) having a                    regarding securities or security-based
                                                 swap dealers in an effective and logical                  regular clientele and actively                              swaps may inform the interpretation of
                                                 way. Those statutory provisions added                     advertising or soliciting clients in                        the swap dealer definition, but will not
                                                 by the Dodd-Frank Act advance                             connection with swaps; 183 (iv) acting in                   be dispositive in identifying dealers in
                                                 financial responsibility (e.g., the ability               a market maker capacity on an                               the swap markets.185
                                                 to satisfy obligations, and the                           organized exchange or trading system
                                                                                                                                                                       b. Indicia of Holding Oneself Out as a
                                                 maintenance of counterparties’ funds                      for swaps; 184 and (v) helping to set the
                                                                                                                                                                       Dealer in Swaps or Being Commonly
                                                 and assets) associated with swap                          prices offered in the market (such as by
                                                                                                                                                                       Known in the Trade as a Dealer in
                                                 dealers’ activities,178 other counterparty                acting as a market maker) rather than
                                                                                                                                                                       Swaps
                                                 protections,179 and the promotion of                      taking those prices, although the fact
                                                 market efficiency and transparency.180                    that a person regularly takes the market                       The final rule further defining the
                                                 As a whole, the relevant statutory                        price for its swaps does not foreclose the                  term ‘‘swap dealer’’ includes the
                                                 provisions suggest that we should                         possibility that the person may be a                        provisions in the proposed rule which
                                                 interpret the ‘‘swap dealer’’ definition to               swap dealer.                                                incorporate the statutory requirements
                                                 identify those persons for which                             The Commissions further note that                        that the term includes a person that is
                                                 regulation is warranted either: (i) Due to                the following elements of the                               holding itself out as a dealer in swaps
                                                 the nature of their interactions with                     interpretive approach to the swap dealer                    or is engaging in any activity causing it
                                                 counterparties; or (ii) to promote market                 definition are also generally consistent                    to be commonly known in the trade as
                                                 stability and transparency, in light of                   with the dealer-trader distinction as it                    a dealer or market maker in swaps.186
                                                 the role those persons occupy within                      will be applied to determine if a person                       We continue to believe that the
                                                 the swap and security-based swap                          is a security-based swap dealer: (i) A                      Proposing Release appropriately
                                                 markets.                                                  willingness to enter into swaps on either                   identifies a number of factors as indicia
                                                    There are several aspects of our                       side of the market is not a prerequisite                    of ‘‘hold[ing] itself out as a dealer in
                                                 interpretive approach to the swap dealer                  to swap dealer status; (ii) the swap                        swaps’’ and ‘‘engag[ing] in any activity
                                                 definition that are particularly similar to               dealer analysis does not turn on                            causing [itself] to be commonly known
                                                 the dealer-trader distinction as it will be               whether a person’s swap dealing                             in the trade as a dealer or market maker
                                                 applied to determine if a person is a                     activity constitutes that person’s sole or                  in swaps.’’ 187 In our view, those factors
                                                 security-based swap dealer. In                            predominant business; (iii) a customer                      thus are relevant to determining if a
                                                 particular, the following activities,                     relationship is not a prerequisite to                       person is a swap dealer. For example,
                                                 which are indicative of dealing activity                  swap dealer status; and (iv) in general,                    regarding the proposed factor of
                                                 in the application of the dealer-trader                   entering into a swap for the purpose of                     ‘‘membership in a swap association in a
                                                 distinction,181 similarly are indicative                  hedging, absent other activity, is                          category reserved for dealers,’’ we note
                                                 that a person is acting as a swap                         unlikely to be indicative of dealing.                       that the bylaws of the International
                                                 dealer: 182 (i) Providing liquidity by                    Last, under the interpretive approach to                    Swaps and Derivatives Association
                                                 accommodating demand for or                               the definition of both the terms ‘‘swap                     (‘‘ISDA’’) provide that any business
                                                 facilitating interest in the instrument                   dealer’’ and ‘‘security-based swap                          organization that:
                                                 (swaps, in this case), holding oneself out                dealer,’’ whether a person is acting as a                      Directly or through an affiliate, as part of
                                                 as willing to enter into swaps                            dealer will turn upon the relevant facts                    its business (whether for its own account or
                                                 (independent of whether another party                     and circumstances, as informed by the                       as agent), deals in derivatives shall be eligible
                                                 has already expressed interest), or being                 interpretive guidance set forth in this                     for election to membership in the Association
                                                 known in the industry as being available                  Adopting Release.                                           as a Primary Member, provided that no
                                                 to accommodate demand for swaps; (ii)                                                                                 person or entity shall be eligible for
                                                                                                              At the same time, the Commissions                        membership as a Primary Member if such
                                                 advising a counterparty as to how to use                  recognize that the dealer-trader                            person or entity participates in derivatives
                                                 swaps to meet the counterparty’s                          distinction is not static, but rather has                   transactions solely for the purpose of risk
                                                 hedging goals, or structuring swaps on                    evolved over time through interpretive                      hedging or asset or liability management.188
                                                                                                           materials. The Commissions expect the                         We believe that in circumstances such
                                                   178 E.g., capital and margin requirements (CEA
                                                                                                           dealer-trader distinction to evolve over                    as this, where a category of association
                                                 section 4s(e)), and requirements for segregation of
                                                 collateral (CEA sections 4d(f), 4s(l)).                   time with respect to swaps
                                                   179 E.g., requirements with respect to business         independently of its evolution over time                       185 In interpreting the term ‘‘swap dealer,’’ we
                                                 conduct when transacting with special entities            with respect to securities or security-                     intend to consider, but do not formally adopt, the
                                                 (CEA sections 4s(h)(2), 4s(h)(4), 4s(h)(5)); disclosure   based swaps. Prior interpretations and                      body of court decisions, SEC releases, and SEC staff
                                                 requirements (CEA section 4s(h)(3)(B));                                                                               no-action letters that have interpreted the dealer-
                                                 requirements for fair and balanced communications         future developments in the law
                                                                                                                                                                       trader distinction.
                                                 (CEA section 4s(h)(3)(D)); other requirements                                                                            186 See CFTC Regulation § 1.3(ggg)(1)(i) and (iv).
                                                 related to the public interest and investor protection       183 As with the interpretation of the dealer-trader

                                                 (CEA section 4s(h)(3)(D)); and conflict of interest       distinction with respect to securities, a                     187 These factors are as follows: Contacting

                                                 provisions (CEA section 4s(j)(5)).                        nomenclature distinction between ‘‘counterparties’’         potential counterparties to solicit interest;
                                                   180 E.g., reporting and recordkeeping                   and ‘‘customers’’ is not significant for purposes of        developing new types of swaps or security-based
                                                 requirements (CEA section 4s(f)); daily trading           applying the dealer-trader distinction to swap              swaps and informing potential counterparties of
                                                 records requirements (CEA section 4s(g)); regulatory      activities. Contractual provisions related to               their availability and of the person’s willingness to
                                                 standards related to the confirmation, processing,        nomenclature, such as a provision stating that no           enter into the swap or security-based swap;
                                                 netting, documentation and valuation of security-         ‘‘customer’’ relationship is present, would not be          membership in a swap association in a category
                                                 based swaps (CEA section 4s(i)); position limit           significant if the reality of the situation is different.   reserved for dealers; providing marketing materials
                                                 monitoring requirements (CEA section 4s(j)(1)); risk      See note 271, infra, and accompanying text.                 describing the type of swaps or security-based
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                                                 management procedure requirements (CEA section               184 As with the dealer-trader distinction as it has      swaps the party is willing to enter into; and
                                                 4s(j)(2)); and requirements related to the disclosure     been interpreted under the Exchange Act with                generally expressing a willingness to offer or
                                                 of information to regulators (CEA section 4s(j)(3)).      respect to securities (and as noted below in the            provide a range of products or services that include
                                                   181 See generally part II.A.5, infra.
                                                                                                           discussion of the ‘‘makes a market in swaps’’ prong         swaps or security-based swaps. See Proposing
                                                   182 To clarify, the activities listed in the text are   of the swap dealer definition), the presence of an          Release, 75 FR at 80178.
                                                 indicative of acting as a swap dealer. Engaging in        organized exchange or trading system is not a                 188 See By-laws of ISDA at 3, available at:

                                                 one or more of these activities is not a prerequisite     prerequisite to being a market maker for purposes           https://www.isdadocs.org/membership. The
                                                 to a person being covered by the swap dealer              of the swap dealer definition, nor is acting as a           Commissions note that the Primary Members of
                                                 definition.                                               market maker a prerequisite to being a swap dealer.         ISDA are not limited to only financial firms.



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                                                                   Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations                                                      30609

                                                 membership requires that a person deal                    c. Market Making                                        exhaustive, and other activities also may
                                                 in derivatives and not limit its                             The final rule defining ‘‘swap dealer’’              be indicative of making a market in
                                                 participation in derivative transactions                  includes the provision from the                         swaps if the person engaging in them
                                                 to solely risk hedging, membership in                     proposed rule which incorporates the                    routinely stands ready to enter into
                                                 the category is an indicator of swap                      statutory requirement that this term                    swaps as principal at the request or
                                                 dealer status.189                                         include a person that ‘‘makes a market                  demand of a counterparty.
                                                                                                           in swaps.’’ 191                                            In determining whether a person’s
                                                    We take note, however, of the                                                                                  routine presence in the market
                                                 comments that these activities may be                        We have considered the comments
                                                                                                           suggesting various descriptions of                      constitutes market making under these
                                                 insufficient to establish that a person is                                                                        four factors, the dealer-trader
                                                                                                           activities that should and should not be
                                                 a swap dealer. In particular, we                                                                                  interpretative framework may be
                                                                                                           deemed to be market making in swaps
                                                 generally agree with commenters that                                                                              usefully applied.194 Under the dealer-
                                                                                                           for purposes of this rule. In
                                                 many commercial end users of swaps                        consideration of these comments, we                     trader distinction, seeking to profit by
                                                 do, from time to time, actively seek out                  clarify that making a market in swaps is                providing liquidity to the market is an
                                                 and negotiate swaps. Yet, based on the                    appropriately described as routinely                    indication of dealer activity.195 Thus, in
                                                 applicable facts and circumstances,                       standing ready to enter into swaps at the               applying these four factors, it is useful
                                                 these end users do not necessarily fall                   request or demand of a counterparty. In                 to consider whether the person is
                                                 within the definition of a swap dealer                    this regard, ‘‘routinely’’ means that the               seeking, through presence in the market,
                                                 solely because they actively seek out                     person must do so more frequently than                  compensation for providing liquidity,
                                                 and negotiate swaps from time to time.                    occasionally, but there is no                           compensation through spreads or fees,
                                                                                                           requirement that the person do so                       or other compensation not attributable
                                                    The activities described in the                                                                                to changes in the value of the swaps it
                                                 Proposing Release as indicia of holding                   continuously.192
                                                                                                              It is appropriate, in response to                    enters into.196 If not, such activity
                                                 oneself out as a swap dealer or engaging                                                                          would not be indicative of market
                                                                                                           comments asking for further guidance
                                                 in any activity causing oneself to be                                                                             making.
                                                                                                           regarding what activities constitute
                                                 commonly known as a swap dealer                                                                                      Some commenters suggested that, in
                                                                                                           making a market in swaps, to describe
                                                 should not be considered in a vacuum,                     some of the activities indicative of                    order to be a market maker in swaps, a
                                                 but should instead be considered in the                   whether a person is routinely standing                  person must make a two-way market in
                                                 context of all the activities of the swap                 ready to enter into swaps at the request                swaps.197 Nonetheless, it is possible for
                                                 participant. While the activities listed in               or demand of a counterparty. Such                       a person making a one-way market in
                                                 the Proposing Release are indicators that                 activities include routinely: (i) Quoting               swaps to be a maker of a market in
                                                 a person is holding itself out or is                      bid or offer prices, rates or other                     swaps and, therefore, within the swap
                                                 commonly known as a swap dealer,                          financial terms for swaps on an                         dealer definition. This may be true, for
                                                 these are factors to be considered in the                 exchange; (ii) responding to requests                   example, where a person routinely
                                                 analysis. They are not per se conclusive,                 made directly, or indirectly through an
                                                                                                                                                                   Corporation (‘‘FDIC’’), Prohibitions and Restrictions
                                                 and could be countered by other factors                   interdealer broker, by potential                        on Proprietary Trading and Certain Interests in, and
                                                 indicating that the person is not a swap                  counterparties for bid or offer prices,                 Relationships With, Hedge Funds and Private
                                                 dealer.190 Because of the flexibility—                    rates or other similar terms for                        Equity Funds; Proposed Rule, 76 FR 68846 (Nov. 7,
                                                                                                           bilaterally negotiated swaps; (iii)                     2011); CFTC, Prohibitions and Restrictions on
                                                 including the consideration of                                                                                    Proprietary Trading and Certain Interests in, and
                                                 applicable facts and circumstances—                       placing limit orders for swaps; or (iv)                 Relationships With, Hedge Funds and Private
                                                 needed for such an analysis, we do not                    receiving compensation for acting in a                  Equity Funds; Proposed Rule, 77 FR 8332 (Feb. 14,
                                                 believe that it is appropriate to codify                  market maker capacity on an organized                   2012). Under this approach, such a person would
                                                                                                           exchange or trading system for                          likely also be required to register as a swap dealer
                                                 this guidance in rule text, as suggested                                                                          (unless the person is excluded from the swap dealer
                                                 by some commenters.                                       swaps.193 These examples are not                        definition, such as by the exclusion of certain
                                                                                                                                                                   swaps entered into in connection with the
                                                                                                              191 See CFTC Regulation § 1.3(ggg)(1)(ii). Because   origination of a loan). The SEC has proposed to
                                                    189 However, while such membership is an
                                                                                                           the statutory swap dealer definition contains four      adopt the same approach with respect to the
                                                 indicator of swap dealer status, a person holding         disjunctive prongs, the CFTC does not agree with        interplay of the Volcker Rule and the definition of
                                                 such membership could nonetheless be excluded by          a commenter (see letter from ISDA I) who asserted       the term ‘‘security-based swap dealer.’’ See note
                                                 other provisions of the definition of the term ‘‘swap     that status as a market maker in swaps is a             272, infra.
                                                 dealer.’’ For example, an insured depository              prerequisite to a person being a swap dealer.              194 We recognize that routine presence in the
                                                 institution that limits its activity to offering swaps       192 A person that occasionally, or less than         swap market is not necessarily indicative of making
                                                 in connection with the origination of loans, as           routinely, enters into a swap at the request of a       a market in swaps. For example, persons may be
                                                 discussed below in part II.B, would not be covered        counterparty is not a maker of a market in swaps,       routinely present in the market in order to engage
                                                 by the definition simply because it holds such            and therefore is not a swap dealer on that basis.       in swaps for purposes of hedging, to advance their
                                                 membership.                                               However, we reiterate, as stated in the Proposing       investment objectives, or to engage in proprietary
                                                    190 The statutory definition of the term ‘‘swap        Release, that since many types of swaps are not         trading.
                                                 dealer’’ contains four separate clauses, or ‘‘prongs,’’   entered into on a continuous basis, it is not              195 See note 265, infra, and accompanying text.

                                                 joined by the disjunctive ‘‘or,’’ the ordinary            necessary that a person enter into swaps at the            196 In this case, the spread from which a person
                                                 meaning of which is that the prongs are stated as         request or demand of counterparties on a                profits may be between two or more swaps, or it
                                                 alternative types of swap dealer. Accordingly,            continuous basis in order for the person to be a        may be between a swap and another position or
                                                 where an assessment of all the activities of a swap       market maker in swaps and, therefore, a swap            financial instrument. In contrast, entering into
                                                 participant demonstrates that the person is not           dealer.                                                 swaps in order to obtain compensation attributable
                                                 holding itself out as a swap dealer or engaging in           193 In addition, section 619 of the Dodd-Frank Act   to changes in the value of the swaps is indicative
                                                 any activity that causes it to be commonly known          (the ‘‘Volcker Rule’’) generally prohibits banking      of using swaps for a hedging, investment or trading
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                                                 as a swap dealer, that person may, nonetheless, be        entities from engaging in proprietary trading, but      purpose.
                                                 a swap dealer based on the market making or               contains an exception for certain market making-           197 See letters cited in notes 52 to 58, supra.

                                                 regular business prongs of the swap dealer                related activities. The Commissions have proposed       Although swaps are notional contracts requiring the
                                                 definition, discussed below. The Commissions note,        an approach to the Volcker Rule under which a           performance of agreed upon terms by each party, it
                                                 however, that as discussed below in part II.A.4.g,        person could seek to avoid the Volcker Rule in          is possible to describe swap users in practical terms
                                                 the CFTC’s overall interpretive guidance, including       connection with swap activities by asserting the        as being on either ‘‘side’’ of a market. For example,
                                                 guidance regarding the dealer-trader framework,           availability of that market making exception. See       for many swaps the party paying a fixed amount is
                                                 applies to identify swap dealers under all four           SEC, Board, Office of the Comptroller of the            on one ‘‘side’’ of the market and the party paying
                                                 prongs of the statutory ‘‘swap dealer’’ definition.       Currency (‘‘OCC’’), and Federal Deposit Insurance       a floating amount is on the other ‘‘side.’’



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                                                 30610             Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations

                                                 stands ready to enter into swaps on a                   in order, as some commenters                                  The Commissions continue to believe,
                                                 particular side of the market—say,                      suggested,200 to encourage market                          as stated in the Proposing Release, that
                                                 routinely bidding for floating exposures                participants to use, or to provide                         the phrases ‘‘ordinary course of
                                                 on a swap trading platform—while                        liquidity to, exchanges. Finally, variety                  business’’ and ‘‘a regular business’’ are,
                                                 entering into transactions on the other                 of exchanges, markets, and other                           for purposes of the definition of ‘‘swap
                                                 side of the market in other instruments                 facilities for the execution of swaps are                  dealer’’ essentially synonymous. In this
                                                 (such as futures contracts). The relevant               likely to evolve in response to the                        context, we interpret these phrases to
                                                 indicator of market maker status is the                 requirements of the Dodd-Frank Act,                        focus on activities of a person that are
                                                 willingness of the person to routinely                  and there is no basis for any bright-line                  usual and normal in the person’s course
                                                 stand ready to enter into swaps at the                  rule excluding swaps executed on an                        of business and identifiable as a swap
                                                 request or demand of a counterparty (as                 exchange, given the impossibility of                       dealing business. It is not necessarily
                                                 opposed to entering into swaps to                       obtaining information about how market                     relevant whether the person conducts
                                                 accommodate one’s own demand or                         participants will interact and execute                     its swap-related activities in a dedicated
                                                 desire to participate in a particular                   swaps in the future, after the                             subsidiary, division, department or
                                                 market), be it on one or both sides of the              requirements under the Dodd-Frank Act                      trading desk, or whether such activities
                                                 market, and then to enter into offsetting               are fully in effect. For all these reasons,                are a person’s ‘‘primary’’ business or an
                                                 positions, either in the swap market or                 we have determined that it is                              ‘‘ancillary’’ business, so long as the
                                                 in other markets.                                       inappropriate to restrict the ‘‘making a                   person’s swap dealing business is
                                                    The Commissions disagree with the                    market in swaps’’ prong of the swap                        identifiable.203
                                                 commenters who said that swaps                          dealer definition (i.e., routinely standing                   We have taken into consideration
                                                 executed on an exchange should not be                   ready to enter into swaps at the request                   comments seeking additional guidance
                                                 considered in determining if a person is                or demand of a counterparty) to swaps                      regarding the types and levels of
                                                 a market maker in swaps and thus a                      that are not executed on an exchange.201                   activities that constitute having ‘‘a
                                                 swap dealer.198 First, the statutory                                                                               regular business’’ of entering into
                                                 definition of the term ‘‘swap dealer’’                  d. Exception for Activities Not Part of ‘‘a                swaps.204 In this regard, any one of the
                                                 makes no distinction between swaps                      Regular Business’’                                         following activities would generally
                                                 executed on an exchange and swaps that                     The final rule includes the provisions                  constitute both entering into swaps ‘‘as
                                                 are not, suggesting that the same                       in the proposed rule that incorporate the                  an ordinary course of business’’ and ‘‘as
                                                 protections should apply regardless of                  provisions of the statutory definition                     a part of a regular business’’: 205 (i)
                                                 the method of executing the swap.                       regarding activities that are not part of                  Entering into swaps with the purpose of
                                                 Second, from the perspective of an end                  ‘‘a regular business’’ of entering into                    satisfying the business or risk
                                                 user seeking to execute a swap on an                    swaps. One provision states that the                       management needs of the counterparty
                                                 exchange, the important consideration                   term ‘‘swap dealer’’ includes a person                     (as opposed to entering into swaps to
                                                 under our analysis is whether a market                  that ‘‘regularly enters into swaps with                    accommodate one’s own demand or
                                                 maker is ready to enter into swaps, not                 counterparties as an ordinary course of                    desire to participate in a particular
                                                 whether the market maker is aware of                    business for its own account’’; the other                  market); (ii) maintaining a separate
                                                 the counterparty’s identity. A market                   provision states that the term ‘‘swap                      profit and loss statement reflecting the
                                                 maker in swaps routinely stands ready                   dealer’’ does not include a person that                    results of swap activity or treating swap
                                                 to enter into swaps at the request or                   ‘‘enters into swaps for such person’s                      activity as a separate profit center; or
                                                 demand of a counterparty, regardless of                 own account, either individually or in a                   (iii) having staff and resources allocated
                                                 whether the counterparty and the                        fiduciary capacity, but not as a part of                   to dealer-type activities with
                                                 market maker meet on a disclosed basis                  a regular business.’’ 202                                  counterparties, including activities
                                                 through bilateral negotiations or                                                                                  relating to credit analysis, customer
                                                 anonymously through an exchange.199                        200 See, e.g., letters cited in note 66, supra. Since
                                                                                                                                                                    onboarding, document negotiation,
                                                                                                         the structures of the markets on which swaps will          confirmation generation, requests for
                                                 Similarly, the issue of whether a person                be executed are still in development, and market
                                                 is a registered FCM or broker-dealer is                 obligations have not been established, there is little     novations and amendments, exposure
                                                 not necessarily relevant to whether the                 support for comments asserting that market makers          monitoring and collateral calls,
                                                 person is a maker of a market in swaps,                 should be defined as only those persons who                covenant monitoring, and
                                                                                                         receive benefits from the market (such as reduced          reconciliation.206
                                                 if the person is routinely standing ready               trading fees) in return for the obligation to transact
                                                 to enter into swaps at the request or                   when the market requires liquidity.
                                                 demand of a counterparty. Third, we                        201 By contrast, it may be appropriate, over time,      customers’ accounts) would be required to register
                                                                                                         to tailor the specific requirements imposed on swap        as either an FCM, introducing broker, commodity
                                                 believe it would be inappropriate to                                                                               pool operator or commodity trading advisor,
                                                                                                         dealers depending on the facility on which the
                                                 disregard swaps executed on exchanges                   swap dealer executes swaps. For example, the               depending on the nature of the person’s activity.
                                                                                                                                                                       203 We recognize, as noted by one commenter (see
                                                                                                         application of certain business conduct
                                                   198 See, e.g., letters cited in note 62, supra.       requirements may vary depending on how the swap            letter from ISDA I), that the ‘‘regular business’’
                                                   199 As  discussed above, in many cases routine        is executed, and it may be appropriate, as the swap        exclusion is not limited solely to the ‘‘ordinary
                                                 presence in the swap market, without more, would        markets evolve, to consider adjusting certain of           course of business’’ test of the swap dealer
                                                 not constitute market making activity. Nevertheless,    those requirements for swaps that are executed on          definition. Our interpretations of the other three
                                                 the CFTC will, in connection with promulgation of       an exchange or through particular modes of                 tests are, and should be read to be, consistent with
                                                 final rules relating to capital requirements for swap   execution.                                                 the exclusion of activities that are not part of a
                                                 dealers and major swap participants, consider              202 Final CFTC Regulation § 1.3(ggg)(2) is              regular business.
                                                                                                                                                                       204 See, e.g., letters from BG LNG I, COPE I, IECA–
                                                 institution of reduced capital requirements for         modified from the proposal to include the word ‘‘a’’
                                                 entities or individuals that fall within the swap       before the words ‘‘regular business,’’ to conform the      Credit I, Shell Trading I, WGCEF I and Vitol (stating
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                                                 dealer definition and that execute swaps only on        text of the rule to the text of the statute. See CEA       that the proposed approach was overly subjective
                                                 exchanges, using only proprietary funds. Similarly,     section 1a(49)(C), 7 U.S.C. 1a(49)(C).                     and requesting guidance as to the specific activities
                                                 the CFTC also will consider the applicability to           As stated in the Proposing Release, we interpret        that are covered by the statutory definition).
                                                                                                                                                                       205 These activities are inconsistent with entering
                                                 such entities or individuals of the other               the reference in the definition of the term ‘‘swap
                                                 requirements imposed on swap dealers (e.g.,             dealer’’ to a person entering into swaps ‘‘with            into a swap to hedge a physical position as defined
                                                 internal business conduct standards, external           counterparties * * * for its own account’’ to refer        in § 1.3(ggg)(6)(iii). As discussed below, such
                                                 business conduct standards with counterparties),        to a person who enters into a swap as a principal,         hedging is not dealing activity.
                                                 and may adjust those swap dealer requirements as        and not as an agent. A person who enters into                 206 The three indicators of being engaged in ‘‘a

                                                 appropriate.                                            swaps as an agent for customers (i.e., for the             regular business’’ of entering into swaps described



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                                                                   Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations                                                     30611

                                                   The Commissions see merit in the                          Regarding the commenters’ assertion                 e. Interim Final Rule Excluding Swaps
                                                 comments saying that ‘‘a regular                         that the activity of entering into swaps               Entered Into for Hedging Physical
                                                 business’’ of entering into swaps can be                 in connection with a person’s physical                 Positions
                                                 characterized by entering into swaps to                  commodity business cannot constitute                      We note that some commenters said
                                                 satisfy the business or risk management                  ‘‘a regular business’’ of the person, we               that swaps used to hedge or mitigate
                                                 needs of the other party to the swap,                    believe that while in most cases this is               commercial risks should not be
                                                 and so incorporate this element into our                 not dealing activity,209 a per se                      considered in determining whether a
                                                 interpretation of the rule.207 Also, an                  exclusion of this type is not appropriate              person is a swap dealer.212 We
                                                 objective indicator of a person being                    because it is possible that in some                    understand that swaps are used to hedge
                                                 engaged in ‘‘a regular business’’ of                     circumstances a person might enter into                risks in numerous and varied ways, and
                                                 entering into swaps is when the person                   swaps that are connected to a physical                 we expect that the number of persons
                                                 accounts for the results of its swap                     commodity business but also serve                      covered by the definition will be very
                                                 activities separately, by maintaining a                                                                         small in comparison to the thousands of
                                                                                                          market functions characteristic of the
                                                 separate profit and loss statement for                                                                          persons that use swaps for hedging.
                                                                                                          functions served by swap dealers. Also,
                                                 those activities or treating them as a                                                                             In terms of the statutory definition of
                                                 separate profit center. Our interpretation               again, the statutory definition does not
                                                                                                          contain any such exclusion, but rather                 the term ‘‘swap dealer,’’ the CFTC notes
                                                 incorporates this indicator of activity                                                                         as an initial matter that there is no
                                                 that is ‘‘a regular business’’ of entering               includes any person who ‘‘regularly
                                                                                                          enters into swaps with counterparties as               specific provision addressing hedging
                                                 into swaps.                                                                                                     activity. Thus, the statutory definition
                                                   Other comments suggesting specific                     an ordinary course of business for its
                                                                                                          own account,’’ without regard to the                   leaves the treatment of hedging swaps to
                                                 criteria to identify ‘‘a regular business’’                                                                     the CFTC’s discretion; it neither
                                                 also were helpful. We agree with                         person’s particular type of business.
                                                                                                                                                                 precludes consideration of a swap’s
                                                 commenters 208 that ‘‘a regular                             Consistent with the statutory                       hedging purpose, nor does it require an
                                                 business’’ of entering into swaps can be                 definition, we interpret ‘‘a regular                   absolute exclusion of all swaps used for
                                                 characterized by having staff and                        business’’ of entering into swaps in a                 hedging.213
                                                 resources allocated to the types of                      manner that applies equally to all                        In general, entering into a swap for
                                                 activities in which swap dealers must                    market participants that engage in the                 the purpose of hedging is inconsistent
                                                 engage with their counterparties, such                   activities set forth in the statutory                  with swap dealing.214 The practical
                                                 as those noted above (e.g., credit                       definition. This will ensure that all
                                                 analysis, confirmation generation,                       participants in the swap markets are                     212 See,  e.g., letters cited in note 72, supra.
                                                 collateral calls, and covenant                           regulated in a fair and consistent                       213 In this regard, the statutory definition of the
                                                 monitoring). However, we understand                      manner, regardless of whether their
                                                                                                                                                                 term ‘‘swap dealer’’ stands in contrast to the
                                                 that some end users of swaps engage in                                                                          statutory definition of the term ‘‘major swap
                                                                                                          underlying business is primarily                       participant’’ which, as discussed further below,
                                                 some of these activities and, in certain                                                                        explicitly provides that positions in swaps held for
                                                                                                          physical or financial in nature.210
                                                 circumstances, may have staff and                                                                               hedging or mitigating commercial risk are to be
                                                 resources available for these activities.                   Finally, as noted above, the manner in              excluded in certain parts of that definition. See CEA
                                                 Therefore, this element of the definition                which persons negotiate, execute and                   section 1a(33)(A)(i)(1), 7 U.S.C. 1a(33)(A)(i)(1). The
                                                                                                                                                                 absence of any explicit requirement in the ‘‘swap
                                                 should be applied in a reasonable                        use swaps is likely to evolve in response              dealer’’ definition to exclude swaps held for
                                                 manner, taking all appropriate                           to the requirements of the Dodd-Frank                  hedging or mitigating commercial risk does not
                                                 circumstances into account. This                         Act and the other forces that will shape               support the view that Congress intended to
                                                 element does not depend on whether a                     the swap markets going forward. For                    categorically exclude all swaps that may serve as
                                                                                                                                                                 hedges in determining whether a person is covered
                                                 specific amount or percentage of                         this reason, it would be inappropriate to              by the definition.
                                                 expenses or employee time are related                    craft per se exclusions from the swap                     Similarly, the absence of any limitation in the
                                                 to these swap activities. Instead, it is                 dealer definition at a time when the                   statutory definition of the term ‘‘swap dealer’’ to
                                                 appropriate to objectively examine a                                                                            financial entities, when such limitation is included
                                                                                                          only available information about the use               elsewhere in Title VII, indicates that no such
                                                 person’s use of staff and resources                      of swaps relates to the period prior to                limitation applies to the swap dealer definition.
                                                 related to swap activities. Using staff                  implementation of the Dodd-Frank                       CEA section 2(h)(7), 7 U.S.C. 2(h)(7), specifically
                                                 and resources to a significant extent in                 Act.211                                                limits the application of the clearing mandate, in
                                                 conducting credit analysis, opening and                                                                         certain circumstances, to only ‘‘financial entities.’’
                                                                                                                                                                 That section also provides a detailed definition of
                                                 monitoring accounts and the other                           209 See CFTC Regulation § 1.3(ggg)(6)(iii) (swaps   the term ‘‘financial entity.’’ See CEA section
                                                 activities noted above, is an indication                 entered into for hedging physical positions as         2(h)(7)(C), 7 U.S.C. 2(h)(7)(C). That such a
                                                 that the person is engaged in ‘‘a regular                defined in the rule are not considered in the          limitation is included in this section, but not in the
                                                 business’’ of entering into swaps.                       determination of whether a person is a swap            swap dealer definition, does not support the view
                                                                                                          dealer).                                               that the statutory definition of the term ‘‘swap
                                                                                                             210 Regulation of firms engaged in an underlying
                                                                                                                                                                 dealer’’ should encompass only financial entities.
                                                 here are set forth in the alternative. Any one of                                                                  214 For example, under the dealer-trader
                                                 these indicators may be sufficient, based on a facts     physical business is also consistent with regulatory
                                                                                                                                                                 distinction, the Commissions would expect persons
                                                 and circumstances analysis, to reach a conclusion        practices outside the U.S. For example, non-           that use security-based swaps to hedge their
                                                 that an entity is engaged in ‘‘a regular business’’ of   financial entities register with the Financial         business risks, absent other activity, likely would
                                                 entering into swaps.                                     Services Authority in the U.K. as ‘‘Oil Market         not be dealers. See part II.A.5.b, infra. Under the
                                                    207 This element of the interpretation reflects our
                                                                                                          Participants’’ and ‘‘Energy Market Participants.’’     CFTC’s interpretive guidance, making a market in
                                                 agreement with those commenters who said that ‘‘a        See Financial Services Authority Handbook EMPS         swaps is appropriately described as routinely
                                                 regular business’’ of entering into swaps is             and OMPS, available at http://fsahandbook.info/        standing ready to enter into swaps at the request or
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                                                 characterized by having a business of                    FSA/html/handbook.                                     demand of a counterparty, and the indicia of swap
                                                 accommodating demand or facilitating interest in            211 For the same reasons, we do not believe it      dealing as a ‘‘regular business’’ include entering
                                                 swaps (see letter from IECA–Credit I), and those                                                                into swaps to satisfy the business or risk
                                                 commenters who said that ‘‘a regular business’’          would be appropriate, in determining whether a
                                                                                                                                                                 management needs of the counterparty. Entering
                                                 does not encompass the use of swaps to serve a           person has a ‘‘regular business’’ of entering into     into swaps for the purpose of hedging one’s own
                                                 person’s own business needs, as opposed to serving       swaps, to consider whether a person engages in         risks generally would not be indicative of this form
                                                 the business needs of the counterparty (see letters      activities normally associated with financial          of swap activity. See also, e.g., joint letter from
                                                 cited in note 71, supra).                                institutions, as some commenters suggested. See        Senator Stabenow and Representative Lucas (the
                                                    208 See letters cited in note 80, supra.              letters cited in note 76, supra.                                                                   Continued




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                                                 30612             Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations

                                                 difficulty lies in determining when a                     hedging.216 For example, the exclusion                       noted above, for example, one indicator
                                                 person has entered into a swap for the                    expressly includes swaps hedging price                       that a person enters into swaps as part
                                                 purpose of hedging, as opposed to other                   risks arising from the potential change                      of ‘‘a regular business’’ is that the
                                                 purposes for entering into swaps, such                    in value of existing or anticipated assets,                  person does so to satisfy the business or
                                                 as accommodating demand for swaps or                      liabilities, or services, if the hedger has                  risk management needs of the
                                                 as part of making a market in swaps,                      an exposure to physical price risk. And,                     counterparty. This aspect of the swap
                                                 and in distinguishing a swap with a                       as in the bona fide hedging rule, the                        dealer analysis turns on the
                                                 hedging purpose from a swap with a                        exclusion utilizes the word ‘‘several’’ to                   accommodation of a counterparty’s
                                                 hedging consequence. In view of these                     reflect that there is no requirement that                    needs or demands. If a person enters
                                                 uncertainties, the CFTC believes it is                    swaps hedge risk on a one-to-one                             into swaps for the purpose of hedging a
                                                 appropriate to adopt an interim final                     transactional basis in order to be                           physical position as defined in CFTC
                                                 rule that draws upon the principles of                    excluded, but rather they may hedge on                       Regulation § 1.3(ggg)(6)(iii), by contrast,
                                                 bona fide hedging that the CFTC has                       a portfolio basis.217 For these reasons,                     then the swap can be identified as not
                                                 long applied to identify when a                           swaps that qualify as enumerated                             having been entered into for the purpose
                                                 financial instrument is used for hedging                  hedging transactions and positions are                       of accommodating the counterparty’s
                                                 purposes, and excludes from the swap                      examples of the types of physical                            needs or demands.220 Also, a person’s
                                                 dealer analysis swaps entered into for                    commodity swaps that are excluded                            activity of seeking out swap
                                                 the purpose of hedging physical                           from the swap dealer analysis if the                         counterparties in order to hedge a
                                                 positions that meet the requirements of                   rule’s requirements are met.218                              physical position as defined in the rule
                                                 the rule.                                                    This provision in the final rule is                       generally would not warrant regulations
                                                    Specifically, the CFTC is adopting as                  consistent with our overall interpretive                     to promote market stability and
                                                 an interim final rule CFTC Regulation                     approach to the definition of the term                       transparency or to serve the other
                                                 § 1.3(ggg)(6)(iii), which provides that the               ‘‘swap dealer.’’ The interpretations of                      purposes of dealer regulation.221
                                                 determination of whether a person is a                    the statutory dealer definitions by both
                                                                                                           Commissions focus on a person’s                                 At the same time, however, there may
                                                 swap dealer will not consider a swap
                                                                                                           activities in relation to its counterparties                 be circumstances where a person’s
                                                 that the person enters into, if:
                                                    (i) The person enters into the swap for                and other market participants.219 As                         activity of entering into swaps is
                                                 the purpose of offsetting or mitigating                                                                                encompassed by the statutory definition
                                                 the person’s price risks that arise from                     216 See CFTC Regulation § 151.5(a)(1). The                of the term ‘‘swap dealer,’’
                                                 the potential change in the value of one                  definition of bona fide hedging in CFTC Regulation           notwithstanding that the swaps have the
                                                 or several (a) assets that the person
                                                                                                           § 1.3(z), which applies for excluded commodities, is         effect of hedging or mitigating the
                                                                                                           not relevant here, because it does not contain the           person’s commercial risk.222 Although
                                                 owns, produces, manufactures,                             requirement that the swap represents a substitute
                                                 processes, or merchandises or                             for a transaction made or to be made or a position           these swaps could, in theory, be
                                                 anticipates owning, producing,                            taken or to be taken in a physical marketing                 excluded from the swap dealer analysis,
                                                 manufacturing, processing, or
                                                                                                           channel, as required by CFTC Regulation                      we believe that a broader, per se
                                                                                                           § 1.3(ggg)(6)(iii)(B). We believe that this                  exclusion for all swaps that hedge or
                                                 merchandising; (b) liabilities that the                   requirement is an important aspect of how
                                                 person owns or anticipates incurring; or                  principles from the bona fide hedging definition are         mitigate commercial risk is
                                                                                                           useful in identifying swaps that are entered into for
                                                 (c) services that the person provides,                    the purpose of hedging as opposed to other                      220 In this way, the exclusion from the swap
                                                 purchases, or anticipates providing or                    purposes.                                                    dealer analysis of swaps hedging physical positions
                                                 purchasing;                                                  217 See CFTC, Position Limits for Futures and
                                                                                                                                                                        as defined in CFTC Regulation § 1.3(ggg)(6)(iii) is
                                                    (ii) the swap represents a substitute                  Swaps; Final Rule, 76 FR 71626, 71649 (Nov. 18,              similar to the exclusions, discussed below, of swaps
                                                 for transactions made or to be made or                    2011).                                                       between affiliates and swaps between a cooperative
                                                                                                              218 The swaps that qualify as enumerated hedging          and its members. See CFTC Regulation
                                                 positions taken or to be taken by the
                                                                                                           transactions and positions are those listed in CFTC          § 1.3(ggg)(6)(i)(ii); see also part II.C, infra. However,
                                                 person at a later time in a physical                      Regulation § 151.5(a)(2) and appendix B to part 151.         to the extent a person engages in dealing activities
                                                 marketing channel;                                        These examples are illustrative of the types of              involving swaps, the presence of offsetting
                                                    (iii) the swap is economically                         ‘‘assets,’’ ‘‘liabilities,’’ and ‘‘services’’ contemplated   positions that hedge those dealing activities would
                                                 appropriate to the reduction of the                       in CFTC Regulation § 1.3(ggg)(6)(iii), because the           not excuse the requirement that the person register
                                                                                                           price risk arising from changes in their value could         as a swap dealer.
                                                 person’s risks in the conduct and                         be offset or mitigated with a swap that represents              221 Thus, the CFTC’s interpretation of the swap
                                                 management of a commercial enterprise;                    a substitute for transactions made or to be made or          dealer definition in this regard draws upon
                                                    (iv) the swap is entered into in                       positions taken or to be taken by the person at a            principles in the dealer-trader distinction. See part
                                                 accordance with sound commercial                          later time in a physical marketing channel. To be            II.A.4.a. Additional authority for CFTC Regulation
                                                 practices; and                                            clear, notwithstanding that a swap does not fit              § 1.3(ggg)(6)(iii) is provided by subparagraph (B) of
                                                                                                           precisely within such examples, it may still satisfy         the swap dealer definition. This subparagraph
                                                    (v) the person does not enter into the                 CFTC Regulation § 1.3(ggg)(6)(iii).                          provides that a person ‘‘may be designated as a
                                                 swap in connection with activity                             Regarding commenters’ queries about dynamic               swap dealer for a single type or single class or
                                                 structured to evade designation as a                      hedging, which one commenter described as the                category of swap or activities and considered not to
                                                 swap dealer.215                                           ability to modify the hedging structure related to           be a swap dealer for other types, classes, or
                                                    Thus, although the CFTC is not                         physical assets or positions when relevant pricing           categories of swaps or activities.’’ CEA Section
                                                                                                           relationships applicable to that asset change (see           1a(49)(B), 7 U.S.C. 1a(49)(B). It thereby authorizes
                                                 incorporating the bona fide hedging                       joint letter from WGCEF and CMC), we note that               a review of a person’s various activities with respect
                                                 provisions of the CFTC’s position limits                  qualification as bona fide hedging has never been            to swaps, and a determination that some of the
                                                 rule here, the exclusion from the swap                    understood to require that hedges, once entered              person’s activities are covered by a designation as
                                                 dealer analysis draws upon language in                    into, must remain static. We expect that entites             a swap dealer, while other of the person’s activities
                                                                                                           would move to update their hedges periodically               are not. Thus, a person who enters into some swaps
                                                 the CFTC’s definition of bona fide
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                                                                                                           when pricing relationships or other market factors           for hedging physical positions as defined in CFTC
                                                                                                           applicable to the hedge change.                              Regulation § 1.3(ggg)(6)(iii), and also enters into
                                                 final rule should distinguish using swaps for                219 See parts II.A.4.e and II.A.5.a, infra. For           other swaps in connection with activities covered
                                                 hedging from swap dealing).                               example, the conclusion that a person’s relationship         by the swap dealer definition, could be designated
                                                    215 See CFTC Regulation § 1.3(ggg)(6)(iii). All five   with its counterparties can lead to associated               as a swap dealer only for the latter activities.
                                                 requirements set forth in the regulation must be met      obligations is consistent with the ‘‘shingle theory,’’          222 For example, ‘‘pay floating/receive fixed’’

                                                 with respect to the swap, in order for the swap to        which implies a duty of fair dealing when a person           swaps entered into by a swap dealer with long
                                                 be excluded from the swap dealer determination by         hangs out its shingle to do business. See note 260,          exposure to the floating side of a market would
                                                 the regulation.                                           infra.                                                       have the effect of hedging the dealer’s exposure.



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                                                                   Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations                                                      30613

                                                 inappropriate for the swap dealer                          The CFTC believes that since the                      determination of whether the person is
                                                 definition.                                             over-the-counter swap markets have                       a swap dealer.232
                                                    First, the hedging exclusion that we                 operated largely without regulatory                         We believe that, based on the CFTC’s
                                                 are adopting is in the nature of a safe                 oversight and encompass swaps used for                   experience in applying bona fide
                                                 harbor; i.e., it describes activity that will           a wide variety of commercial purposes,                   hedging principles with respect to
                                                 not be considered swap dealing activity.                no method has yet been developed to                      swaps hedging risks related to physical
                                                 As such, the CFTC believes that it is                   reliably distinguish, through a per se                   positions, the exclusion in CFTC
                                                 appropriate that the interim final rule                 rule, between: (i) Swaps that are entered                Regulation § 1.3(ggg)(6)(iii) at this time
                                                 not be cast broadly.223 This does not                   into for the purpose of hedging or                       is the best means of providing certainty
                                                 mean that other types of hedging                        mitigating commercial risk; and (ii)                     to market participants regarding which
                                                 activity that do not meet the                                                                                    swaps may be disregarded in the dealer
                                                                                                         swaps that are entered into for the
                                                 requirements of the interim final rule                                                                           analysis. However, commenters
                                                                                                         purpose of accommodating the
                                                 are necessarily swap dealing activity.                                                                           presented a range of views as to the
                                                 Rather, such hedging activity is to be                  counterparty’s needs or demands or                       exclusions from the dealer analysis that
                                                 considered in light of all other relevant               otherwise constitute swap dealing                        may be appropriate in this regard.233
                                                 facts and circumstances to determine                    activity, but which also have a hedging                  Accordingly, the CFTC is implementing
                                                 whether the person is engaging in                       consequence.228 In contrast, the CFTC                    this exclusion on an interim rule basis
                                                 activity (e.g., accommodating demand                    notes that it has set forth and modified                 and is seeking comments on all aspects
                                                 for swaps, making a market for swaps,                   standards for bona fide hedging                          of the interim rule, including any
                                                 etc.) that makes the person a swap                      transactions and granted exemptions in                   adjustments that may be appropriate in
                                                 dealer.                                                 compliance with such standards for                       the rule or accompanying interpretive
                                                    Second, the usefulness of an                         decades.229 These historically-                          guidance.
                                                 exclusion of all swaps that hedge or                    developed standards form the basis of                       The CFTC also seeks comments on
                                                 mitigate commercial risk for certain                    the interim final rule excluding from the                whether a different approach to swaps
                                                 aspects of the major swap participant                   swap dealer analysis certain swaps that                  entered into for the purpose of hedging
                                                 definition 224 is not a reason to use the               hedge the risks associated with a                        risk is appropriate to implement the
                                                 same exclusion in the swap dealer                       physical position.                                       statutory definition of the term ‘‘swap
                                                 definition, since the swap dealer                                                                                dealer.’’
                                                                                                            The exclusion in CFTC Regulation
                                                 definition serves a different function.                                                                             For example, the CFTC invites
                                                                                                         § 1.3(ggg)(6)(iii) depends not on the
                                                 The definition of the term ‘‘major swap                                                                          commenters to address whether any
                                                 participant,’’ which applies only to                    effect or consequences of the swap, but
                                                                                                                                                                  exclusion of hedging swaps from the
                                                 persons who are not swap dealers,225 is                 on whether the purpose for which a
                                                                                                                                                                  swap dealer analysis is appropriate, and
                                                 premised on the prior identification, by                person enters into a swap is to hedge a                  if so, how swaps that are entered into
                                                 the swap dealer definition, of persons                  physical position as defined in the rule.                for purposes of hedging may be
                                                 who accommodate demand for swaps,                       If so, then the swap is excluded from the                identified and distinguished from other
                                                 make a market in swaps, or otherwise                    dealer analysis because using swaps for                  swaps. Commenters are encouraged to
                                                 engage in swap dealing activity. The                    that purpose is inconsistent with, and is                address whether it is relevant to
                                                 major swap participant definition                       not, dealing activity.230 On the other                   distinguish swaps entered into for
                                                 performs the subsequent function of                     hand, if, at the time the swap is entered                purposes of hedging from swaps that
                                                 identifying persons that are not swap                   into, the person’s purpose for entering                  have a consequential result of hedging,
                                                 dealers, but hold swap positions that                   into the swap is not as defined in CFTC                  and if so, how such swaps may be
                                                 create an especially high level of risk                 regulation § 1.3(ggg)(6)(iii), or if it is               distinguished. Also, commenters may
                                                 that could significantly impact the U.S.                unclear whether the swap is for such                     address whether the exclusion should
                                                 financial system.226 Only for this                      purpose, then the fact that the swap                     be limited to swaps hedging risks
                                                 subsequent function is it appropriate to                hedges the person’s exposure in some                     related to physical positions or
                                                 apply the broader exclusion of swaps                    regard does not preclude consideration                   extended to encompass swaps hedging
                                                 held for the purpose of hedging or                      of that swap in the dealer analysis.231 In               financial risks or other types of risks.
                                                 mitigating commercial risk.227                          this latter case, all relevant facts and                    Commenters should address whether
                                                                                                         circumstances regarding the swap and                     the exclusion in CFTC Regulation
                                                   223 While we recognize that a rule delineating the
                                                                                                         the person’s activity with respect to the                § 1.3(ggg)(6)(iii) should be consistent
                                                 swap activities that do not constitute swap dealing
                                                 would simplify and make more certain, at least in
                                                                                                         swap would be relevant in the                            with the exclusion in CFTC Regulation
                                                 some contexts, the application of the swap dealer                                                                § 1.3(kkk). If so, why, and if not, why
                                                 definition, there are also reasons for caution in          228 As noted in the preceding paragraph, it is not    not? If the two exclusions should be
                                                 incorporating a categorical exclusion for hedging.      necessary to make this distinction for purposes of       consistent, does consistency require that
                                                   224 See part IV.C, infra.                             the major swap participant definition.                   that exclusions be identical, or would
                                                   225 See CEA § 1a(33)(A)(i), 7 U.S.C. 1a(33)(A)(i).       229 See, e.g., 42 FR 42751 (Aug. 8, 1977).
                                                   226 See CEA § 1a(33)(B), 7 U.S.C. 1a(33)(B).          Although the latest formulation of the definition of
                                                                                                                                                                  there be variations in application of the
                                                   227 We do not believe that the differences between    bona fide hedging—CFTC Regulation § 151.5(a)—            two exclusions? Are there market
                                                 the exclusion in the major participant definitions      was recently adopted, see CFTC, Position Limits for      participants whose swap positions
                                                 for swaps held for the purpose of hedging or            Futures and Swaps; Final Rule and Interim Final          would be classified as held for the
                                                 mitigating commercial risk and the exclusion in the     Rule, 76 FR 71626 (Nov. 18, 2011), the bona fide
                                                                                                         hedging test has been in use for decades.
                                                                                                                                                                  purpose of hedging or mitigating
                                                 swap dealer definition for certain swaps entered
                                                 into for the purpose of hedging risks related to           230 To be clear, the swaps a person enters into for   commercial risk under CFTC Regulation
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                                                 physical positions mean that the Commissions, or        hedging physical positions as defined in CFTC
                                                 the CFTC in particular, have implemented two            Regulation § 1.3(ggg)(6)(iii) are not indicative of        232 We believe that, in practice, the difficulty of

                                                 different definitions of hedging. In fact, neither of   dealing activity under any of the prongs of the swap     distinguishing, in applying the swap dealer
                                                 these exclusions define the term ‘‘hedging.’’ Rather,   dealer definition.                                       definition, swaps entered into for the purpose of
                                                 the differences between the two exclusions reflect         231 In this regard, CFTC Regulation                   hedging from other types of swaps will be
                                                 differences in the parameters that must be satisfied    § 1.3(ggg)(6)(iii) is different from certain of the      resolvable when the facts and circumstances of a
                                                 in order to ensure that hedging swaps are               CFTC’s rules regarding bona fide hedging, where a        person’s swap activities are taken into
                                                 appropriately excluded from the two different           person’s purpose in entering into a swap may not         consideration in light of our interpretive guidance.
                                                 definitions.                                            be relevant.                                               233 See, e.g., letters cited in note 141, supra.




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                                                 30614             Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations

                                                 § 1.3(kkk) but would not qualify for the                 regulation if floor traders engaging in                  as a swap dealer to be registered solely
                                                 exclusion under CFTC Regulation                          swaps in their capacity as floor traders                 as floor traders with the CFTC. Given
                                                 § 1.3(ggg)(6)(iii)? If so, specifically                  were also required to register as swap                   the limitations on the scope of the rule,
                                                 identify the types of market participants                dealers. Accordingly, the CFTC believes                  the requirements for floor traders using
                                                 and swaps. If the CFTC were to apply                     that it is appropriate not to consider                   the relief to comply with recordkeeping
                                                 in the swap dealer definition the                        such swaps when determining whether                      and risk management rules applicable to
                                                 exclusion in CFTC Regulation § 1.3(kkk)                  a person acting as a floor trader, as                    swap dealers as a condition of the relief,
                                                 in lieu of the exclusion in CFTC                         defined under CEA section 1a(23),236                     and the fact that swaps subject to the
                                                 Regulation § 1.3(ggg)(6)(iii), would there               and registered with the CFTC under                       rule are traded on a DCM or SEF and
                                                 be negative market impacts? If so, what                  CFTC Regulation § 3.11, is a swap dealer                 cleared through a DCO, the CFTC
                                                 are they? Would there be positive                        if the floor trader meets certain                        believes it is not necessary to have floor
                                                 market impacts? If so, what are they? In                 conditions. Specifically, the final rule                 traders subject to this rule register as
                                                 particular, what type(s) of swaps that                   provides that, in determining whether a                  both floor traders and swap dealers as
                                                 ‘‘hedge or mitigate commercial risk,’’                   person is a swap dealer, each swap that                  a result of swaps activities covered by
                                                 but that are not excluded under the                      the person enters into in its capacity as                the rule.238
                                                 interim rule, may constitute dealing                     a floor trader as defined by CEA section
                                                                                                                                                                   g. Additional Interpretive Issues
                                                 activity in light of the rules and                       1a(23) or on a SEF shall not be
                                                                                                                                                                   Relating to the ‘‘Swap Dealer’’
                                                 interpretive guidance regarding the                      considered for the purpose of
                                                                                                                                                                   Definition
                                                 swap dealer definition set forth in this                 determining whether the person is a
                                                 Adopting Release?                                        swap dealer, provided that the person:                      As noted above, the Commissions, in
                                                    Comments regarding the costs and                         (i) Is registered with the CFTC as a                  consideration of comments received, are
                                                 benefits related to the interim final rule               floor trader pursuant to CFTC                            making certain modifications to the
                                                 and any alternative approaches,                          Regulation § 3.11;                                       interpretive guidance concerning the
                                                 including in particular the                                 (ii) enters into swaps solely with                    definition of the term ‘‘swap dealer’’ set
                                                 quantification of such costs and                         proprietary funds for that trader’s own                  out in the Proposing Release. However,
                                                 benefits, are also invited.                              account on or subject to the rules of a                  the Commissions are retaining certain
                                                    Commenters are encouraged, to the                     DCM or SEF, and submits each such                        elements of their proposed
                                                 extent feasible, to be comprehensive and                 swap for clearing to a DCO;                              interpretation of the term ‘‘swap
                                                 detailed in providing their approach                        (iii) is not an affiliated person of a                dealer,’’ as discussed below.
                                                 and rationale. The comment period for                    registered swap dealer;                                     First, with respect to the comments
                                                 the interim final rule will close July 23,                  (iv) does not directly, or through an                 asserting that the proposed interpretive
                                                 2012.                                                    affiliated person, negotiate the terms of                approach is overly broad,239 we note
                                                                                                          swap agreements, other than price and                    that the statute provides that the term
                                                 f. Swaps Entered Into by Persons                         quantity or to participate in a request for              ‘‘swap dealer’’ means ‘‘any person’’ who
                                                 Registered as Floor Traders                              quote process subject to the rules of a                  engages in the activities described in
                                                    Commenters discussed whether the                      DCM or SEF;                                              any of the four prongs of the definition,
                                                 swap dealer definition encompasses the                      (v) does not directly or through an                   subject to the exceptions and
                                                 activity of entering into swaps on or                    affiliated person offer or provide swap                  qualifications set out in the statute. In
                                                 subject to the rules of a DCM or SEF,                    clearing services to third parties;                      view of this statutory text, these
                                                 and submitted for clearing to a                             (vi) does not directly or through an                  comments effectively assert that the
                                                 derivatives clearing organization                        affiliated person enter into swaps that                  statute should be interpreted to include
                                                 (‘‘DCO’’), particularly when firms                       would qualify as hedging physical                        preconditions to swap dealer status that
                                                 engage in that activity using only                       positions pursuant to CFTC Regulation                    are not set forth in the statute. For
                                                 proprietary funds.234 Because Title VII                  § 1.3(ggg)(6)(iii) or hedging or mitigating              example, the assertion that the swap
                                                 of the Dodd-Frank Act amended the                        commercial risk pursuant to CFTC                         dealer definition must be limited to
                                                 definition of floor trader specifically to               Regulation § 1.3(kkk), with the                          persons who enter into swaps on both
                                                 encompass activities involving                           exception of swaps that are executed                     sides of the market would impose a
                                                 swaps,235 the CFTC believes that it                      opposite a counterparty for which the                    requirement that does not exist in the
                                                 would lead to potentially duplicative                    transaction would qualify as a bona fide                 statute. Similarly, the comments to the
                                                                                                          hedging transaction;                                     effect that swap dealers are only those
                                                    234 See letter from Trading Coalition. One               (vii) does not participate in any                     persons who seek to profit by
                                                 commenter specifically discussed floor traders and       market making program offered by a                       intermediating between swap market
                                                 floor brokers and the regulatory regime that should      DCM or SEF; and                                          participants adds a requirement not set
                                                 apply to them following implementation of the               (viii) complies with the record                       forth in the statute.
                                                 Dodd Frank Act. See letter from Christopher K.           keeping and risk management
                                                 Hehmeyer.                                                                                                            We believe, though, that the activities
                                                    We note that other commenters suggested that all
                                                                                                          requirements of CFTC Regulation                          that cause a person to be covered by the
                                                 swaps cleared on an exchange should be excluded          §§ 23.201, 23.202, 23.203, and 23.600
                                                 from the dealer definitions. See letters cited in note   with respect to each such swap as if it                     238 The Commissions note the rule applies only
                                                 138, supra. However, the discussion here is limited      were a swap dealer.237                                   to CFTC-registered floor traders engaging in swaps
                                                 to persons who are registered as floor traders and          This rule permits floor traders who                   on DCMs or SEFs and cleared through DCOs. As
                                                 meet other conditions. Also, the final rule provision                                                             noted above, the SEC does not have a regulatory
                                                 discussed here does not exclude floor traders from       might otherwise be required to register                  category under the Exchange Act equivalent to floor
                                                 the definition of the term ‘‘swap dealer;’’ rather, it                                                            trader under the CEA and none of these provisions
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                                                 provides that if the stated conditions are met,             236 The definition of the term ‘‘floor trader’’
                                                                                                                                                                   apply in the context of security-based swap dealers
                                                 certain swaps entered into by floor traders are          includes a person entering into swaps on a               or any entity regulated under the Exchange Act.
                                                 excluded from the swap dealer analysis.                  ‘‘contract market.’’ See CEA section 1a(23). This        Any person engaging in security-based swap
                                                    235 See section 721(a)(11) of the Dodd-Frank Act      exclusion also encompasses swaps that a registered       transactions, whether or not these activities are
                                                 (amending the definition of the term ‘‘floor trader’’    floor trader enters into on or subject to the rules of   similar to those engaged in by floor traders, will
                                                 in CEA section 1a(23)). The Exchange Act does not        a SEF, in addition to on or subject to the rules of      need to independently consider whether they need
                                                 have an equivalent regulatory category to floor          a DCM, so long as the swap meets the conditions          to register as security-based swap dealers as a result
                                                 trader under the CEA, and thus Congress did not          stated in the exclusion.                                 of their activities.
                                                 make a similar amendment to the Exchange Act.               237 See CFTC Regulation § 1.3(ggg)(6)(iv).               239 See letters cited at notes 83 to 84, supra.




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                                                                    Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations                                                      30615

                                                 swap dealer definition should be                           point of connection to other parties                     business organization that ‘‘deals in
                                                 addressed in the context of the four                       needing access to the swap market are                    derivatives shall be eligible for election
                                                 prongs of the statutory definition. That                   indicative of a person holding itself out                to membership in the Association as a
                                                 is, the relevant question is whether a                     as a swap dealer, if the person also                     primary member, provided that no
                                                 person engages in any of the types of                      enters into swaps in conjunction with                    person or entity shall be eligible for
                                                 activities enumerated in the statute, and                  such activities.                                         membership as a Primary Member if
                                                 not whether the person meets any                             The guidance we have provided about                    such person or entity participates in
                                                 additional, supposedly implicit                            these indicia is responsive to concerns                  derivatives transactions solely for the
                                                 preconditions to swap dealer status.                       expressed by commenters about the                        purpose of risk hedging or asset or
                                                    Second, the Commissions continue to                     application of the swap dealer                           liability management.’’ 245 Hence, a
                                                 believe, as stated in the Proposing                        definition to energy markets. As                         categorical exclusion from the ‘‘swap
                                                 Release, that accommodating demand                         described above, some commenters                         dealer’’ definition based on any
                                                 and facilitating interest are                              stated that in energy markets, unlike in                 particular type of business or general
                                                 appropriately used as factors in                           some other markets, end-users often                      market activity also would be
                                                 identifying swap dealers. As noted by                      enter into swaps directly with each                      inconsistent with current industry
                                                 commenters, however, the mere fact that                    other, on both sides of the market,                      structure and practice.
                                                 a person entering into a particular swap                   without the involvement of a separate                       At the same time, however, the fact
                                                 has the effect of ‘‘accommodating                          category of businesses serving as                        that a person engages in some swap
                                                 demand’’ or ‘‘facilitating interest’’ in                   intermediaries.242 As a result, according                activities that are indicative of swap
                                                 swaps does not conclusively establish                      to these commenters, energy swap                         dealer status does not, by itself, mean
                                                 that the person is a swap dealer. Instead,                 market participants often engage in                      that the person is covered by the
                                                 the person’s overall activities in the                     some of the activities that are indicative               definition of the term ‘‘swap dealer.’’
                                                 swap market (or particular sector of the                   of swap dealer status. Some of these                     The ‘‘not as part of a regular business’’
                                                 swap market if the person is active in a                   commenters contended that our activity-                  exception and our guidance about its
                                                 variety of sectors) should be compared                     based interpretation of the swap dealer                  meaning address the issue of swap
                                                 against these factors. If, in the context of               definition could therefore result in the                 market participants that engage to some
                                                 its overall swap activities, a person                      inappropriate inclusion of energy                        extent in the activities characteristic of
                                                 fulfills a function of accommodating                       market participants in the coverage of                   swap dealers. The guidance we have
                                                 demand or facilitating interest in swaps                   the definition of the term ‘‘swap                        provided here therefore provides the
                                                 for other parties, then these factors                      dealer.’’ 243                                            appropriate approach to addressing
                                                 would be significant in the analysis and                     We believe that the language of the                    these issues in energy markets as
                                                 the person is likely to be a swap                          statutory ‘‘swap dealer’’ definition                     elsewhere.
                                                 dealer.240                                                 supports our activity-based                                 Although several commenters
                                                    Third, as discussed above, we have                      interpretation and does not support                      attempted to articulate bright-line tests
                                                 adopted some of the objective criteria                     categorical exclusions of particular                     that would differentiate swap dealers
                                                 suggested by commenters with respect                       types of persons from the ‘‘swap dealer’’                from other swap market participants,
                                                 to the indicia of holding oneself out as                   definition based on the general nature of                the suggested bright-line tests generally
                                                 a dealer or being commonly known as                        their businesses. Further evidence that                  could not be applied across the board to
                                                 a dealer, market making, and the                           such a categorical exclusion is                          all types of swap market activity. For
                                                 ‘‘regular business’’ prongs of the swap                    unwarranted is provided by the fact that                 example, some commenters suggested
                                                 dealer definition.241 For instance,                        a number of energy market                                that swap dealers can be identified as
                                                 allocating staff and technological                         participants—BP Plc., Cargill,                           those who profit from entering into
                                                 resources to swap activity, deriving                       Incorporated, Centrica Energy Limited,                   swaps on both sides of the market (and
                                                 revenue and profit from swap activity,                     ConocoPhillips, EDF Trading Limited,                     under the interpretive approach set
                                                 or responding to customer-initiated                        GASELYS, Hess Energy Trading                             forth in this Adopting Release, such
                                                 orders for swaps can all be indicative of                  Company, LLC, Hydro-Quebec, Koch                         activity may be an indicator of swap
                                                 having ‘‘a regular business’’ of entering                  Supply & Trading, LP, RWE Supply &                       dealing).246 But other commenters said
                                                                                                            Trading GmbH, Shell Energy North                         that, in certain circumstances, entering
                                                 into swaps and, therefore, indicative of
                                                                                                            America (US), L.P., STASCO, Totsa                        into swaps on both sides of the market
                                                 being a swap dealer. In addition,
                                                                                                            Total Oil Trading S.A., and Vattenfall                   is not necessarily indicative of swap
                                                 activities such as providing advice
                                                                                                            Energy Trading Netherlands N.V.—have                     dealing.247
                                                 about swaps or offering oneself as a                                                                                   The ways in which participants
                                                                                                            voluntarily joined ISDA as primary
                                                    240 The language of the four statutory tests for        dealers.244 As previously noted, any                     throughout the market use swaps are
                                                 swap dealer status (which refer to a person who                                                                     simply too diverse for swap dealer
                                                 holds itself out as a dealer, is commonly known as           242 See parts II.A.2.f.ii and iii, supra.              status to be resolved with a single, one-
                                                 a dealer, makes a market in swaps or regularly               243 See letters cited in note 117, supra. Comments     factor test. This is reflected in the
                                                 enters into swaps with counterparties) contemplate         expressing concern that the definition of the term       statutory definition of the term ‘‘swap
                                                 that a dealer is a person who, through its swap            ‘‘swap dealer’’ could include physical commodities
                                                 activities, functions to create legal relationships that
                                                                                                                                                                     dealer’’ itself. Focused as it is on types
                                                                                                            businesses also were presented to Congress during
                                                 transfer risk between independent persons. See             consideration of legislation leading to passage of the   of activities, with four prongs set forth
                                                 CEA section 1a(49)(A), 7 U.S.C. 1a(49)(A).                 Dodd-Frank Act. See Proposed Legislation by the          in the alternative to cover different
                                                    See also Proposing Release, 75 FR at 80177              U.S. Department of the Treasury Regarding the            types of swap dealing activity, the
                                                 (describing swap dealers as those persons whose            Regulation of Over-The-Counter Derivatives               statutory swap dealer definition is not
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                                                 function is to serve as the points of connection in        Markets: Hearing Before the H. Comm. On
                                                 the swap markets); letter from COPE I at 4 (‘‘Simply       Agriculture, 111th Cong. 103 (2009) (submitted           susceptible to the bright-line test that
                                                 stated, dealers are in the regular business of being       report on behalf of the Working Group of
                                                 a point of connection to the market for others that        Commercial Energy Firms). However, as noted                245 See note 188, supra.
                                                 need access to the market to hedge risk.’’):               above, there is no exclusion in the statutory              246 See letters cited in note 84, supra.
                                                 Roundtable Transcript at 21 (remarks of Richard            definition for such businesses.                            247 See letters cited in note 86, supra. As noted
                                                 Ostrander, Morgan Stanley; ‘‘a dealer is someone              244 The list of ISDA Primary Members is available     above in the discussion of market making, a swap
                                                 who is out there willing to enter into trades’’).          at http://www.isda.org/membership/                       dealer may in some circumstances enter into swaps
                                                    241 See part II.B.2.d.iii, supra.                       isdamemberslist.pdf.                                     on only one side of the market.



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                                                 30616             Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations

                                                 some commenters seek. For these                           their parallels—particularly both                          instrument; in contrast, dealers in cash
                                                 reasons, we continue to believe that it                   definitions’ exclusions for activities that                market securities generally transact in
                                                 is appropriate to apply the multi-factor                  are ‘‘not part of a regular business’’—                    securities issued by another party. This
                                                 interpretive approach set forth in this                   warrant analogous interpretive                             distinction suggests that the concept of
                                                 Adopting Release.                                         approaches for distinguishing dealers                      turnover of ‘‘inventory’’ of securities,
                                                    In closing, we emphasize that the                      from non-dealers.                                          which has been identified as a factor in
                                                 purpose of in this part IV.A.4 is to                         As discussed above,252 the                              connection with the dealer-trader
                                                 provide guidance as to how the rules                      Commissions note that interpretations                      distinction, is inapposite in the context
                                                 further defining the term ‘‘swap dealer’’                 of the applicability of the dealer-trader                  of security-based swaps. Moreover, this
                                                 will be applied in particular, complex                    distinction to the ‘‘swap dealer’’                         distinction—along with the fact that the
                                                 situations where a person’s status as a                   definition under the CEA do not affect                     ‘‘security-based swap dealer’’ definition
                                                 swap dealer may be uncertain. Even                        existing, or future, interpretations of the                lacks the conjunctive ‘‘buying and
                                                 though bright-line tests and categorical                  dealer-trader distinction under the                        selling’’ language of the ‘‘dealer’’
                                                 exclusions are inappropriate, we                          Exchange Act—both with regard to the                       definition 253—suggests that concepts of
                                                 recognize that the large majority of                      ‘‘security-based swap dealer’’ definition,                 two-sided markets at times would be
                                                 market participants use swaps for                         and with regard to the ‘‘dealer’’                          less relevant for identifying ‘‘security-
                                                 normal course hedging, financial,                         definition.                                                based swap dealers’’ than they would be
                                                 investment or trading purposes and are                       In interpreting the security-based                      for identifying ‘‘dealers.’’ 254
                                                 not swap dealers.                                         swap dealer definition in terms of the                        • Predominance of over-the-counter
                                                                                                           dealer-trader distinction, the                             and non-standardized instruments—
                                                 5. Final Rules and Interpretation—                        Commissions have been mindful that
                                                 Definition of ‘‘Security-Based Swap                                                                                  Security-based swaps thus far are not
                                                                                                           some commenters expressed the view                         significantly traded on exchanges or
                                                 Dealer’’                                                  that we instead should rely on other                       other trading systems, in contrast to
                                                 a. General Reliance on the Dealer-Trader                  interpretive factors that were identified                  some cash market securities (while
                                                 Distinction                                               in the Proposing Release (e.g.,                            recognizing that many cash market
                                                    As discussed above, we are adopting                    accommodating demand). We believe,                         securities also are not significantly
                                                 a rule under the Exchange Act that                        nonetheless, that the dealer-trader                        traded on those systems).255 These
                                                 defines ‘‘security-based swap dealer’’ in                 distinction forms the basis for a                          attributes—along with the lack of
                                                 terms of the four statutory tests and the                 framework that appropriately                               ‘‘buying and selling’’ language in the
                                                 exclusion for security-based swap                         distinguishes between persons who                          security-based swap dealer definition,
                                                 activities that are not as part of a                      should be regulated as security-based                      as noted above—suggest that concepts of
                                                 ‘‘regular business.’’ 248 Also, we believe                swap dealers and those who should not.                     what it means to make a market need to
                                                                                                           We also believe that the distinction
                                                 that the dealer-trader distinction 249—                                                                              be construed flexibly in the context of
                                                                                                           affords an appropriate degree of
                                                 which already forms a basis for                                                                                      the security-based swap market.256
                                                                                                           flexibility to the analysis, and that it
                                                 identifying which persons fall within                                                                                   • Mutuality of obligations and
                                                                                                           would not be appropriate to seek to
                                                 the longstanding Exchange Act                                                                                        significance to ‘‘customer’’
                                                                                                           codify the distinction.
                                                 definition of ‘‘dealer’’—in general                          At the same time, the Commissions                       relationship—In contrast to a secondary
                                                 provides an appropriate framework for                     recognize that the dealer-trader                           market transaction involving equity or
                                                 interpreting the meaning of ‘‘security-                   distinction needs to be adapted to apply                   debt securities, in which the completion
                                                 based swap dealer.’’ 250 While there are                  to security-based swap activities in light                 of a purchase or sale transaction can be
                                                 differences in the structure of those two                 of the special characteristics of security-                expected to terminate the mutual
                                                 statutory definitions,251 we believe that                 based swaps and the differences                            obligations of the parties to the
                                                   248 See
                                                                                                           between the ‘‘dealer’’ and ‘‘security-
                                                              Exchange Act rule 3a71–1(a), (b).                                                                         253 See  note 251, supra.
                                                   249 See    note 31, supra.
                                                                                                           based swap dealer’’ definitions.                             254 The   analysis also should account for the fact
                                                    250 The principles embedded within the ‘‘dealer-       Relevant differences include:                              that a party to a security-based swap can use other
                                                 trader distinction’’ are not solely useful for               • Level of activity—Security-based                      derivatives or cash market instruments to hedge the
                                                 distinguishing persons who constitute dealers from        swap markets are marked by less                            risks associated with the security-based swap
                                                 active ‘‘traders,’’ but also are applicable to            activity than markets involving certain                    position, meaning that two-way trading is not
                                                 distinguishing dealers from non-dealers such as                                                                      necessary to maintain a flat risk book.
                                                                                                           other types of securities (while
                                                 hedgers or investors. The ‘‘dealer-trader’’                                                                             255 Even though we expect trading of security-

                                                 nomenclature has been used for decades. See Loss,         recognizing that some debt and equity                      based swaps on security-based swap execution
                                                 Securities Regulation 722 (1st ed. 1951) (‘‘One           securities are not actively traded). This                  facilities or exchanges following the
                                                 aspect of the ‘business’ concept is the matter of         suggests that in the security-based swap                   implementation of Title VII, we expect there to
                                                 drawing the line between a ‘dealer’ and a trader—         context concepts of ‘‘regularity’’ should                  remain a significant amount of over-the-counter
                                                 an ordinary investor who buys and sells for his own                                                                  activity involving security-based swaps.
                                                 account with some frequency.’’).                          account for the level of activity in the                      256 For example, the definition of ‘‘market maker’’
                                                    251 For example, while the ‘‘dealer’’ definition       market.                                                    in Exchange Act section 3(a)(38)—which is
                                                 encompasses certain persons in the business of               • No separate issuer—Each                               applicable for purposes of the Exchange Act ‘‘unless
                                                 ‘‘buying and selling’’ securities, the ‘‘security-based   counterparty to a security-based swap in                   the context otherwise requires’’ (see Exchange Act
                                                 swap dealer’’ definition does not address either          essence is the ‘‘issuer’’ of that                          section 3(a))—defines the term ‘‘market maker’’ to
                                                 ‘‘buying’’ or ‘‘selling.’’ As we noted in the                                                                        mean ‘‘any specialist permitted to act as a dealer,
                                                 Proposing Release, we do not believe that the lack                                                                   any dealer acting in the capacity of block
                                                 of those terms in the ‘‘security-based swap dealer’’      761(a)(3), (4), which amend Exchange Act sections          positioner, and any dealer who, with respect to a
                                                 definition leads to material interpretive                 3(a)(13), (14)).                                           security, holds himself out (by entering quotations
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                                                 distinctions, as the Dodd-Frank Act amended the             At the same time, we note that the ‘‘dealer’’            in an inter-dealer communications system or
                                                 Exchange Act definitions of ‘‘buy’’ and ‘‘purchase,’’     definition requires the conjunctive ‘‘buying and           otherwise) as being willing to buy and sell such
                                                 and the Exchange Act definitions of ‘‘sale’’ and          selling’’—which connotes a degree of offsetting two-       security for his own account on a regular or
                                                 ‘‘sell,’’ to encompass the execution, termination         sided activity. In contrast, the ‘‘security-based swap     continuous basis.’’ That definition is useful in the
                                                 (prior to its scheduled maturity date), assignment,       dealer’’ definition (particularly the ‘‘regularly enters   context of systems in which standardized securities
                                                 exchange or similar transfer or conveyance of, or         into security-based swaps’’ language of the                are regularly or continuously bought and sold, but
                                                 extinguishing of rights or obligations under, a           definition’s third test) lacks that conjunctive            would not be apposite in the context of non-
                                                 security-based swap. See Proposing Release, 75 FR         terminology.                                               standardized securities or securities that are not
                                                 at 80178 n.26 (citing Dodd-Frank Act sections               252 See note 171, supra.                                 regularly or continuously transacted.



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                                                                   Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations                                                        30617

                                                 transaction, the parties to a security-                  market stability and transparency, in                     for security-based swaps, or maintaining
                                                 based swap often will have an ongoing                    light of the role those persons occupy                    a sales force in connection with
                                                 obligation to exchange cash flows over                   within the security-based swap                            security-based swap activities.264
                                                 the life of the agreement. In light of this              markets.261                                                  • Seeking to profit by providing
                                                 attribute, some market participants have                                                                           liquidity in connection with security-
                                                                                                          b. Principles for Applying the Dealer-                    based swaps. A market participant may
                                                 expressed the view that they have
                                                                                                          Trader Distinction to Security-Based                      manifest this indication of security-
                                                 ‘‘counterparties’’ rather than
                                                                                                          Swap Activity                                             based swap dealer activity—which is
                                                 ‘‘customers’’ in the context of their swap
                                                 activities.                                                 In light of the statutory security-based               consistent with the definition’s ‘‘regular
                                                    It also is necessary to use the dealer-               swap dealer definition, statutory                         business’’ requirement—by seeking
                                                 trader distinction to interpret the                      provisions applicable to security-based                   compensation in connection with
                                                 security-based swap dealer definition so                 swap dealers and market characteristics                   providing liquidity involving security-
                                                 that the statutory provisions that will                  addressed above, the Commissions                          based swaps (e.g., by seeking a spread,
                                                 govern security-based swap dealers are                   believe that the factors set forth below                  fees or other compensation not
                                                 applied in an effective and logical way.                 are relevant for identifying security-                    attributable to changes in the value of
                                                 Those statutory provisions added by the                  based swap dealers and for                                the security-based swap).265 The
                                                 Dodd-Frank Act advance financial                         distinguishing those dealers from other                   Commissions do not believe that this
                                                 responsibility (e.g., the ability to satisfy             market participants. This guidance                        necessarily requires that a person be
                                                 obligations, and the maintenance of                      seeks to address commenter requests                       available to take either side of the
                                                 counterparties’ funds and assets)                        that we further clarify the scope of the                  market at any time, or that a person
                                                 associated with security-based swap                      security-based swap dealer definition,                    continuously engage in this type of
                                                 dealers’ activities,257 other counterparty               and the Commissions believe that these                    activity, to be a security-based swap
                                                 protections,258 and the promotion of                     factors provide appropriate guidance                      dealer. Although one commenter
                                                 market efficiency and transparency.259                   without being inflexible or allowing the                  expressed the view that the security-
                                                 As a whole, the relevant statutory                       opportunity for evasion that may                          based swap dealer definition requires
                                                 provisions suggest that we should apply                  accompany a bright-line test. At the                      that a person be consistently available to
                                                 the dealer-trader distinction to interpret               same time, the determination of whether                   take either side of the market,266 in our
                                                 the security-based swap dealer                           a person is acting as a security-based                    view such an approach would be
                                                 definition in a way that identifies those                swap dealer ultimately depends on the                     underinclusive.267
                                                 persons for which regulation is                          relevant facts and circumstances. In
                                                 warranted either: (i) Due to the nature                  light of the overall context in which a                     264 A sales force, however, is not a prerequisite to

                                                 of their interactions with                               person’s activity occurs, the absence of                  a person being a security-based swap dealer. For
                                                                                                          one or more of these factors does not                     example, a person that enters into security-based
                                                 counterparties; 260 or (ii) to promote                                                                             swaps in a dealing capacity can fall within the
                                                                                                          necessitate the conclusion that a person                  dealer definition even if it uses an affiliated entity
                                                    257 E.g., capital and margin requirements             is not a security-based swap dealer.262                   to market and/or negotiate those security-based
                                                 (Exchange Act section 15F(e)), and requirements for         • Providing liquidity to market                        swaps (e.g., the person is a booking entity).
                                                 segregation of collateral (Exchange Act section 3E).     professionals or other persons in                         Depending on the applicable facts and
                                                    258 E.g., requirements with respect to business                                                                 circumstances, the affiliate that performs the
                                                 conduct when transacting with special entities
                                                                                                          connection with security-based swaps.                     marketing and/or negotiation functions may fall
                                                 (Exchange Act sections 15F(h)(2), (h)(4), (h)(5));       A market participant might manifest                       within the Exchange Act’s definition of ‘‘broker’’
                                                 disclosure requirements (Exchange Act section            this indication of dealer activity by                     (which was not revised by Title VII). See Exchange
                                                 15F(h)(3)(B)); requirements for fair and balanced        accommodating demand or facilitating                      Act section 3(a)(4)(A).
                                                 communications (Exchange Act section                                                                                 265 Indicia of this objective may include, but

                                                 15F(h)(3)(C)); other requirements related to the
                                                                                                          interest expressed by other market                        would not be limited to, maintaining separate
                                                 public interest and investor protection (Exchange        participants,263 holding itself out as                    profit/loss statements in connection with this type
                                                 Act section 15F(h)(3)(D)); and conflict of interest      willing to enter into security-based                      of activity, and/or devoting staff and resources to
                                                 provisions (Exchange Act section 15F(j)(5)).             swaps, being known in the industry as                     this type of activity.
                                                    259 E.g., reporting and recordkeeping
                                                                                                          being available to accommodate demand                       In this regard, we believe that the issue of
                                                 requirements (Exchange Act section 15F(f)); daily                                                                  whether a person tends to take the prices offered
                                                 trading records requirements (Exchange Act section                                                                 in the market, rather than helping to set those prices
                                                 15F(g)); regulatory standards related to the             customers and that such transactions will be              (such as by providing quotes, placing limit orders,
                                                 confirmation, processing, netting, documentation         handled promptly in the usual manner, in                  or otherwise accommodating demand), can be
                                                 and valuation of security-based swaps (Exchange          accordance with trade custom’’).                          relevant as a factor for distinguishing security-based
                                                 Act section 15F(i)); position limit monitoring              261 The importance of regulating dealers due to        swap dealers from non-dealers. At the same time,
                                                 requirements (Exchange Act section 15F(j)(1)); risk      the centrality of their market role was illustrated by    we are mindful that a dealer may also accept the
                                                 management procedure requirements (Exchange Act          the Government Securities Act of 1986. When               market price as part of its dealer activity (such as
                                                 section 15F(j)(2)); and requirements related to the      Congress provided for the regulation of government        when a person enters into a security-based swap to
                                                 disclosure of information to regulators (Exchange        securities dealers, Congress specifically cited the       offset the risk it assumes in connection with its
                                                 Act section 15F(j)(3)).                                  lack of regulation as contributing to the failures of     security-based swap dealing activity); as a result,
                                                    260 The conclusion that a person’s relationship       several unregulated government securities dealers.        the fact that a person regularly takes the market
                                                 with its counterparties can lead to associated           See S. Rep. No. 99–426 (1986), as reprinted in 1986       price as part of its security-based swap transactions
                                                 obligations is consistent with the ‘‘shingle theory,’’   U.S.C.C.A.N. 5395, 5400–04. The resulting statute         does not foreclose the possibility that the person
                                                 which implies a duty of fair dealing when a person       provided for a definition of ‘‘government securities      may be a security-based swap dealer.
                                                 hangs out its shingle to do business. See Securities     dealer’’ that in relevant part is parallel to the           266 See letter from ISDA I.

                                                 and Exchange Commission, Report of the Special           definitions of ‘‘dealer’’ and ‘‘security-based swap         267 It is possible for a dealer to be compensated

                                                 Study of Securities Market Part I at 238 (1963) (‘‘An    dealer,’’ particularly with regard to sharing an          for providing liquidity by entering into sequential
                                                 obligation of fair dealing, based upon the general       exclusion for activities that are not part of a           offsetting positions, or by hedging the security-
                                                 antifraud provisions of the Federal securities laws,     ‘‘regular business.’’ See Exchange Act section            based swap position by using a different type of
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                                                 rests upon the theory that even a dealer at arm’s        3(a)(44).                                                 security-based swap, a swap or some other financial
                                                                                                             262 Similarly, depending on the relevant facts and
                                                 length impliedly represents when he hangs out his                                                                  instrument. Accordingly, a rule of decision that
                                                 shingle that he will deal fairly with the public.’’;     circumstances, the presence of certain of the             permitted a person to avoid dealer regulation by
                                                 footnote omitted); Weiss, Registration and               illustrative activities described here does not           providing liquidity in connection with security-
                                                 Regulation of Brokers and Dealers 171 (1965) (‘‘the      necessitate the conclusion that the entity is a dealer.   based swaps, and laying off the associated risk
                                                 solicitation and acceptance by a broker-dealer of           263 This is to be distinguished from an entity         using a different type of security-based swap, a
                                                 orders from customers and the confirmation of            entering into security-based swaps for other              swap or a different instrument entirely, would be
                                                 transactions do constitute a representation by the       business purposes, such as to gain economic               susceptible to abuse. Moreover, as noted above, the
                                                 broker-dealer that he will deal fairly with his          exposure to a particular market.                                                                      Continued




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                                                 30618             Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations

                                                   • Providing advice in connection with                   also develop new types of security-                    security-based swap dealers,273 in our
                                                 security-based swaps or structuring                       based swaps,270 but also recognize that                view such an approach would be
                                                 security-based swaps. Advising a                          the activities of end-users related to the             contrary to the express language of the
                                                 counterparty as to how to use security-                   structuring of security-based swaps for                definition. This is not to say, of course,
                                                 based swaps to meet the counterparty’s                    purposes of hedging commercial risk are                that the presence of an organized
                                                 hedging goals, or structuring security-                   appreciably different than being in the                exchange or trading system is a
                                                 based swaps on behalf of a counterparty,                  business of structuring security-based                 prerequisite to being a market maker for
                                                 also would indicate security-based swap                   swaps on behalf of a counterparty.                     purposes of the security-based swap
                                                 dealing activity. It particularly is                         • Presence of regular clientele and                 dealer definition.274 Moreover, acting as
                                                 important that persons engaged in those                   actively soliciting clients. These dealer-             a market maker is not a prerequisite to
                                                 activities are appropriately regulated so                 trader factors would reasonably appear                 being a security-based swap dealer.275
                                                 that their counterparties will receive the                to be applicable in the security-based                 On the other hand, being a member of
                                                 protections afforded by certain of the                    swap context, just as they are applicable              an organized exchange or trading system
                                                 statutory business conduct rules (e.g.,                   in the context of other types of                       for purposes of trading security-based
                                                 special entity requirements and                           securities, as indicia of a business                   swaps does not necessarily by itself
                                                 communication requirements) 268                           model that seeks to profit by providing                make a person a security-based swap
                                                 applicable to security-based swap                         liquidity. The Commissions are mindful                 dealer.276
                                                 dealers.269 The Commissions recognize                     that some industry participants have                   As with the current application of the
                                                 commenter concerns that end-users may                     highlighted a distinction between                      dealer-trader distinction to the
                                                                                                           ‘‘counterparties’’ and ‘‘customers’’ in                Exchange Act ‘‘dealer’’ definition, the
                                                 definition of ‘‘security-based swap dealer’’ does not     connection with swaps, and have                        question of whether a person is acting
                                                 contain the ‘‘buying and selling’’ language found in                                                             as a security-based swap dealer
                                                 the general Exchange Act definition of ‘‘dealer.’’        suggested that they have no
                                                 Thus, while being regularly willing to enter into         ‘‘customers’’ in the swap context. We do               ultimately will turn upon the relevant
                                                 either side of the security-based swap market would       not believe such points of nomenclature                facts and circumstances, as informed by
                                                 suggest that a person is engaged in dealing activity,
                                                                                                           are significant for purposes of                        these criteria.
                                                 the absence of such activity should not necessarily
                                                 lead to an inference that a person is not acting as       identifying security-based swap dealers,               c. Additional Interpretive Issues
                                                 a dealer.                                                 however.271                                               Activity by hedgers. As noted above,
                                                    We also note that some commenters have stated             • Use of inter-dealer brokers. As with              a number of commenters raised
                                                 that two-way quoting by itself should not
                                                 necessarily be enough to make a person a dealer,          activities involving other types of                    concerns that an overbroad ‘‘security-
                                                 and some of those commenters specifically stated          securities, the Commissions would                      based swap dealer’’ definition would
                                                 that a person may use two-sided quotes as part of         expect that a person’s use of an inter-
                                                 the price discovery process or to elicit trading                                                                 inappropriately encompass persons
                                                 interest. See, e.g., letter from MFA I. Here too, it is
                                                                                                           dealer broker in connection with
                                                 important to consider whether the activity also has       security-based swap activities to be an                  273 See,  e.g., letter from Traders Coalition.
                                                 a dealing business purpose, such as seeking to            indication of the person’s status as a                   274 Given   the current nature of the security-based
                                                 profit by providing liquidity. Moreover, all              dealer.                                                swap market, including the present level of activity
                                                 participants in the security-based swap market,                                                                  and the present lack of significant trading of
                                                 whether or not security-based swap dealers, should           • Acting as a market maker on an                    security-based swaps on exchanges or organized
                                                 be mindful of the potential application of the            organized security-based swap                          trading systems, we believe that it would negate the
                                                 antifraud and anti-manipulation provisions of the         exchange or trading system. Acting in a                legislative intent to interpret the definition’s use of
                                                 federal securities laws to such activities. Section                                                              market making concepts to require the same use of
                                                 10(b) of the Exchange Act and Exchange Act rule           market maker capacity on an organized
                                                                                                                                                                  quotation media that are incorporated into the
                                                 10b-5 particularly prescribe the use of any               exchange or trading system for security-               interpretation of market making concepts in the
                                                 manipulative or fraudulent device in connection           based swaps would indicate that the                    context of securities that are actively traded on an
                                                 with the purchase or sale of any security, which
                                                 includes manipulative trading. See Terrance
                                                                                                           person is acting as a dealer.272 While the             organized exchange or trading system. At the same
                                                                                                           Commissions recognize that some                        time, we recognize that routine activity in the
                                                 Yoshikawa, Securities Exchange Act Release No.                                                                   security-based swap market is not necessarily
                                                 53731 (Apr. 26, 2006), 87 SEC Docket 2924, 2930–          commenters have expressed the view                     indicative of making a market in security-based
                                                 31 & n.19 (citing Ernst & Ernst v. Hochfelder, 425        that persons who solely enter into                     swaps. For example, persons may routinely be
                                                 U.S. 185, 199 (1976)). The SEC has characterized
                                                 manipulation as ‘‘the creation of deceptive value or
                                                                                                           security-based swaps on an organized                   active in the market for purposes of hedging, to
                                                                                                           security-based swap exchange or trading                advance their investment objectives, or to engage in
                                                 market activity for a security, accomplished by an                                                               proprietary trading.
                                                 intentional interference with the free forces of          system should not be regulated as                         275 The definition of ‘‘security-based swap dealer’’
                                                 supply and demand.’’ See Swartwood, Hesse, Inc.,
                                                 50 S.E.C. 1301, 1307 (1992) (citing Hochfelder, 425                                                              contains four alternative tests, only two of which
                                                 U.S. at 199; Schreiber v. Burlington Northern, Inc.,
                                                                                                             270 See letter from FSR I.                           use market making terminology. Moreover, the third
                                                 472 U.S. 1 (1985); Feldbaum v. Avon Products, Inc.,         271 For purposes of the dealer-trader analysis, as   test of the security-based swap dealer definition—
                                                 741 F.2d 234 (8th Cir. 1984)).                            it applies in the context of security-based swaps or   which addresses persons who regularly enter into
                                                    268 The SEC has proposed rules to implement            any other security, we would not expect contractual    security-based swaps as an ordinary course of
                                                                                                           provisions stating that the counterparty is not        business for their own account—appears
                                                 Title VII provisions relating to external business
                                                                                                           relying on the person’s advice to have any             particularly inapt as a proxy for market making
                                                 conduct standards for security-based swap dealers
                                                                                                           significance.                                          activity. Transacting with customers is not an
                                                 (as well as major security-based swap participants).
                                                                                                              272 Under the proposal of the SEC, the Board, the   element of this alternative test. A person thus may
                                                 See Exchange Act Release No. 64766 (June 29,
                                                 2011), 76 FR 42396 (July 18, 2011).                       OCC and the FDIC to implement the provisions of        be a security-based swap dealer even if it transacts
                                                    269 This factor would also reasonably take into        section 619 of the Dodd-Frank Act (also known as       exclusively with other market professionals. Cf.
                                                                                                           the ‘‘Volcker Rule’’), a person who claims the         OCC, ‘‘Risk Management of Financial Derivatives’’
                                                 account whether a preexisting relationship
                                                                                                           benefit of the market maker exception to that          3–4 (1997) (stating that OCC has classified banks as
                                                 involving other types of securities or other financial
                                                                                                           section’s prohibitions and restrictions on             ‘‘Tier I’’ dealers if they act as market makers by
                                                 instruments is present. For example, to the extent
                                                                                                           proprietary trading in connection with security-       ‘‘providing quotes to other dealers and brokers, and
                                                 a person has an existing broker or dealer
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                                                                                                           based swap activities would be required to register    other market professionals’’). Compare letter from
                                                 relationship with a counterparty in connection with
                                                                                                           with the SEC as a security-based swap dealer,          ISDA I (taking the view that the dealer definition
                                                 other types of securities, and also enters into a
                                                                                                           unless the person is exempt from registration or is    should be interpreted in the context of market-
                                                 security-based swap with that counterparty, a
                                                                                                           engaged in a dealing business outside the U.S., and    making concepts).
                                                 reasonable inference would be that the person
                                                 entered into the security-based swap in a dealer          is subject to substantive regulation in the              276 The analysis of the status of members of such

                                                 capacity. Any other approach would invite abuse,          jurisdiction where the business is located. See        exchanges and trading systems in part may be
                                                 as persons could seek to leverage existing                Securities Exchange Act Release No. 65545, 76 FR       influenced by the final Exchange Act rules that
                                                 relationships of trust while avoiding regulation as       68846, 68947 (Nov. 7, 2011) (proposed                  govern such systems, as well as the internal rules
                                                 a security-based swap dealer.                             implementing rule § ___.4(b)(2)(iv)(C)).               of such systems.



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                                                                    Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations                                                       30619

                                                 using security-based swaps for hedging                    swap dealing activities are relatively                   purposes, or otherwise would be
                                                 purposes.277 As we stated in the                          modest.                                                  overbroad or irrelevant.285 The
                                                 Proposing Release, however, under the                        Presence or absence of a customer                     Commissions recognize the significance
                                                 dealer-trader distinction the                             relationship. Although commenters                        of the concerns those commenters
                                                 Commissions would expect persons that                     have expressed the view that a person                    raised, and agree that these activities
                                                 use security-based swaps to hedge their                   that engages in security-based swap                      need to be considered within the
                                                 business risks, absent other activity,                    activities on an organized market should                 context of whether a person engages in
                                                 likely would not be dealers.278 We                        not be deemed to be a dealer unless it                   those activities with the purpose of
                                                 maintain that view. In other words, to                    engages in those activities with
                                                                                                                                                                    facilitating dealing activity. While we
                                                 the extent that a person engages in                       customers,281 we do not agree. It is true
                                                                                                                                                                    do not believe that any of those
                                                 security-based swap activity to hedge                     that having a customer relationship can
                                                                                                           illustrate a business model of seeking to                activities by themselves would
                                                 commercial risk, or otherwise to hedge                                                                             necessarily indicate that a person is
                                                 risks unrelated to activities that                        profit by providing liquidity, and thus
                                                                                                           provide one basis for concluding that a                  acting as a security-based swap dealer,
                                                 constitute dealing under the dealer-
                                                                                                           person is acting as a security-based                     under certain circumstances they may
                                                 trader distinction (particularly activities
                                                                                                           swap dealer. Nonetheless, the presence                   serve as an indicia of a business purpose
                                                 that have the business purpose of
                                                                                                           of market making terminology within                      of seeking to profit by providing
                                                 seeking to profit by providing liquidity
                                                 in connection with security-based                         the definition is inconsistent with the                  liquidity in connection with security-
                                                 swaps), the Commissions would not                         view that a security-based swap dealer                   based swaps.286
                                                 expect those hedging transactions to                      must have ‘‘customers.’’ Also, Title VII                 6. Requests for Exclusions From the
                                                 lead a person to be a security-based                      requirements applicable to security-
                                                                                                                                                                    Dealer Definitions
                                                 swap dealer.279 Of course, to the extent                  based swap dealers address interests
                                                 a person engages in dealing activities                    apart from customer protection.282                          Certain commenters have sought to
                                                 involving security-based swaps, the                       Accordingly, to the extent that a person                 exclude entire categories of persons
                                                 presence of offsetting positions that                     regularly enters into security-based                     from the dealer definitions,
                                                 hedge those dealing activities would not                  swaps with a view toward profiting by                    notwithstanding that some persons in
                                                 excuse the requirement that the person                    providing liquidity—rather than by                       those categories may engage in the
                                                 register as a security-based swap                         taking directional positions—that                        activities set forth in the statutory
                                                 dealer.280                                                person may be a security-based swap
                                                                                                                                                                    definition (as further defined by the
                                                                                                           dealer regardless of whether it views
                                                    No predominance test. As discussed                                                                              Commissions).287 The final rules
                                                                                                           itself as maintaining a ‘‘customer’’
                                                 in the Proposing Release, the                                                                                      nonetheless do not incorporate
                                                                                                           relationship with its counterparties.283
                                                 Commissions do not believe that the                          Criteria associated with ‘‘holding self               categorical exclusions of persons from
                                                 security-based swap dealer analysis                       out’’ as a dealer or being ‘‘commonly                    the dealer definitions because the
                                                 should appropriately turn upon whether                    known in the trade’’ as a security-based                 statutory definitions provide that ‘‘any
                                                 a person’s dealing activity constitutes                   swap dealer. The Proposing Release                       person’’ who engages in the activities
                                                 that person’s sole or predominant                         articulated a number of activities that                  enumerated in the definitions is covered
                                                 business. The separate de minimis                         could satisfy the definition’s tests for a               by the dealer definitions, unless the
                                                 exemption, however, may have the                          person ‘‘holding itself out’’ as a dealer                person’s activities fall within one of the
                                                 effect of excusing from dealer regulation                 or being ‘‘commonly known in the                         statutory exceptions.288 In this regard, it
                                                 those persons whose security-based                        trade’’ as a dealer.284 Several                          is significant that the exceptions in the
                                                                                                           commenters criticized those proposed                     dealer definitions depend on whether a
                                                   277 See,  e.g., letter from Church Alliance.            criteria, largely on the grounds that                    person engages in certain types of swap
                                                   278 See  Proposing Release, 75 FR at 80178 n.27.        those criteria would inappropriately                     or security-based swap activity, not on
                                                 The Proposing Release also noted that if a person’s
                                                 other activities satisfy the definition of security-
                                                                                                           encompass end-users who seek to use                      other characteristics of the person. That
                                                 based swap dealer, the person must comply with            security-based swaps for hedging                         is, the exceptions apply for swaps
                                                 the applicable requirements with regard to all of its                                                              between an insured depository
                                                 security-based swap activities, absent an order to          281 See  letters from ISDA I and Traders Coalition.
                                                 the contrary. We further noted in the Proposing             282 Particularly
                                                                                                                                                                    institution and its customers in
                                                                                                                                in light of the view expressed by
                                                 Release that we would expect end-users to use             some market participants that they only have
                                                                                                                                                                    connection with originating loans,289
                                                 security-based swaps for hedging purposes less            ‘‘counterparties’’ in the swap markets, and not          swaps or security-based swaps entered
                                                 commonly than they use swaps for hedging                  ‘‘customers,’’ any interpretation of the ‘‘security-     into not as a part of a regular
                                                 purposes.                                                 based swap dealer’’ definition that is predicated on
                                                    279 In addition, consistent with the exclusion
                                                                                                           the existence of a customer relationship may lead
                                                                                                                                                                    business,290 and swap or security-based
                                                 from the dealer analysis of activities involving          to an overly narrow construction of the definition.      swap dealing that is below a de minimis
                                                 majority-owned affiliates, see part II.C, infra, to the      283 For example, a person’s activity involving
                                                 extent that a person engages in activities to hedge       entering into security-based swaps on a SEF may            285 See  part II.A.2.a, supra.
                                                 positions subject to the inter-affiliate exclusion,       cause it to be a security-based swap dealer even in        286 While
                                                 absent other activity, the Commission would not                                                                                 the Proposing Release identified
                                                                                                           the absence of a customer relationship with any of       ‘‘membership in a swap association in a category
                                                 expect those hedging transactions to lead a person        its counterparties.
                                                 to be a security-based swap dealer. Conversely,              284 As noted above, these were: contacting
                                                                                                                                                                    reserved for dealers’’ as a factor in connection with
                                                 security-based swap activities connected with the                                                                  the ‘‘holding out’’ and ‘‘commonly known’’ tests,
                                                                                                           potential counterparties to solicit interest;            we recognize that, depending on the applicable
                                                 indicia of dealing discussed above (e.g., seeking to      developing new types of swaps or security-based
                                                 profit by providing liquidity in connection with                                                                   facts and circumstances, such membership may not
                                                                                                           swaps and informing potential counterparties of          be sufficient to cause a person to be a security-based
                                                 security-based swaps) themselves would suggest            their availability and of the person’s willingness to
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                                                 security-based swap dealing activity.                                                                              swap dealer if the person does nothing else to cause
                                                                                                           enter into the swap or security-based swap;              it to be considered a dealer.
                                                    280 For example, if a person were to use other
                                                                                                           membership in a swap association in a category              287 See part II.A.2.f, supra.
                                                 instruments to hedge the risks associated with its        reserved for dealers; providing marketing materials
                                                                                                                                                                       288 See CEA section 1a(49), 7 U.S.C. 1a(49);
                                                 security-based swap dealing activity, that hedging        describing the type of swaps or security-based
                                                 would not undermine the obligation of the person          swaps the party is willing to enter into; and            Exchange Act section 3(a)(71), 15 U.S.C. 78c(a)(71).
                                                                                                                                                                       289 See CEA section 1a(49)(A), 7 U.S.C. 1a(49)(A).
                                                 to register as a security-based swap dealer,              generally expressing a willingness to offer or
                                                 notwithstanding the fact that it could be asserted        provide a range of products or services that include        290 See CEA section 1a(49)(C), 7 U.S.C. 1a(49)(C);

                                                 that the dealing positions happen to hedge those          swaps or security-based swaps. See Proposing             Exchange Act section 3(a)(71)(C), 15 U.S.C.
                                                 other positions.                                          Release, 75 FR at 80178.                                 78c(a)(71)(C).



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                                                 30620             Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations

                                                 level.291 The Dodd-Frank Act does not                     not relevant in determining whether a                  swap between a borrower and the
                                                 exclude any category of persons from                      person is a swap dealer.                               lending IDI, so long as the swap’s
                                                 the coverage of the dealer definitions;                                                                          notional amount is no greater than the
                                                                                                           B. ‘‘Swap Dealer’’ Exclusion for Swaps
                                                 rather, it excludes certain activities from                                                                      loan amount, the swap’s duration is no
                                                                                                           in Connection With Originating a Loan
                                                 the dealer analysis.                                                                                             longer than the loan’s duration, and the
                                                    Given that the statutory dealer                        1. Proposed Approach                                   swap’s index and payment dates match
                                                 definitions focus on a person’s activity,                    The statutory definition of the term                the index and payment dates of the
                                                 the Commissions believe that it is                        ‘‘swap dealer’’ excludes an insured                    loan.297 Another commenter, agreeing
                                                 appropriate to determine whether a                        depository institution (‘‘IDI’’) ‘‘to the              with the proposed approach, said that
                                                 person meets any of the tests set forth                   extent it offers to enter into a swap with             there is no basis to extend the loan
                                                 in those statutory definitions, and thus                  a customer in connection with                          origination exclusion to swaps related to
                                                 is acting as a swap dealer or security-                   originating a loan with that                           the borrower’s business risks, as
                                                 based swap dealer, on a case-by-case                      customer.’’ 296 This exclusion does not                opposed to the financial terms of the
                                                 basis reflecting the applicable facts and                 appear in the definition of the term                   loan.298
                                                 circumstances.292 If a person’s swap or                   ‘‘security-based swap dealer.’’                          Other commenters, though, said that
                                                 security-based swap activities are of a                      Proposed CFTC Regulation                            this limitation to swaps connected to
                                                 nature to be covered by the statutory                     § 1.3(ggg)(5) would implement this                     the financial terms of the loan was
                                                 definitions, and those activities are not                 statutory exclusion by providing that an               inappropriate or inconsistent with the
                                                 otherwise excluded, then the person is                    IDI’s swaps with a customer in                         Dodd-Frank Act, and that any swap
                                                 covered by the definitions. The contrary                  connection with originating a loan to                  required by the loan agreement or
                                                 is equally true—a person who is not                       that customer are disregarded in                       required by the IDI as a matter of
                                                 engaged in activities covered by the                      determining if the IDI is a swap dealer.               prudent lending should be covered by
                                                 statutory definitions, or whose activities                In order to prevent evasion, the                       the exclusion.299 Some of the
                                                 are excluded from the definition, is not                  proposed rule further provided that the                commenters arguing for the broader
                                                 covered by the definitions.293 The per se                 statutory exclusion does not apply                     exclusion emphasized that the
                                                 exclusions requested by the commenters                    where the purpose of the swap is not                   exclusion should be available for any
                                                 have no foundation in the statutory text,                 linked to the financial terms of the loan;             swap with the lending IDI which
                                                 and have the potential to lead to                         the IDI enters into a ‘‘sham’’ loan; or the            reduces the borrower’s risks, such as a
                                                 arbitrary line drawing that may result in                 purported ‘‘loan’’ is actually a synthetic             commodity swap the borrower uses for
                                                 disparate regulatory treatment and                        loan such as a loan credit default swap                hedging, because reduction of
                                                 inappropriate competitive                                 or loan total return swap.                             commodity price risks faced by the
                                                 advantages.294                                                                                                   borrower also reduces the risk that the
                                                                                                           1. Commenters’ Views                                   loan will not be repaid to the IDI.300
                                                    The final rules particularly do not
                                                 include any exclusions for aggregators                       Nearly all the commenters on this                   Commenters said that if the exclusion
                                                 of swaps or other persons that use                        issue were IDIs seeking a broad                        does not apply to swaps hedging the
                                                 swaps in connection with the physical                     interpretation of the exclusion. The                   borrower’s commodity price risks, then
                                                 commodity markets, including swaps in                     commenters addressed four primary                      only IDIs that are able to create a
                                                 connection with the generation,                           issues: (i) The type of swaps that should              separately capitalized affiliate will be
                                                 transmission and distribution of                          be covered by the exclusion; (ii) the                  able to offer commodity swaps (because
                                                 electricity. It is likely, though, that a                 time period during which parties would                 section 716 of the Dodd-Frank Act
                                                 significant portion of the financial                      be required to enter into the swap in                  limits the ability of IDIs to offer
                                                 instruments used for risk management                      order for the swap to be considered to                 commodity swaps), thereby reducing
                                                 by such persons are forward contracts in                  be ‘‘in connection with originating a                  the availability of commodity swaps to
                                                 nonfinancial commodities that are                         loan;’’ (iii) which transactions should be
                                                 excluded from the definition of the term                  deemed to be ‘‘loans’’ for purposes of                    297 See letters from Branch Banking & Trust


                                                 ‘‘swap.’’ 295 Such forward contracts are                  the exclusion; and (iv) which entities                 Company (‘‘BB&T’’) dated February 3, 2011 (‘‘BB&T
                                                                                                           should be included within the                          I’’), B&F Capital Markets, Inc. (‘‘B&F Capital’’) dated
                                                                                                                                                                  February 18, 2011 (‘‘B&F Capital I’’), Capital One
                                                   291 See CEA section 1a(49)(D), 7 U.S.C. 1a(49)(D);      definition of IDI.                                     Financial Corporation (‘‘Capital One’’) and Capstar
                                                 Exchange Act section 3(a)(71)(D), 15 U.S.C.                  First, regarding the type of swap that              Bank (‘‘Capstar’’); see also joint letter from Atlantic
                                                 78c(a)(71)(D).                                            should be covered by the exclusion, as                 Capital Bank, Cobiz Bank, Cole Taylor Bank,
                                                   292 The Commissions believe that a facts and                                                                   Commerce Bank, N.A., East West Bank, First
                                                                                                           proposed, § 1.3(ggg)(5) would require
                                                 circumstances approach is particularly appropriate                                                               Business Bank, First National Bank of
                                                 here, where the broad terms of the statutory dealer       that the rate, asset, liability or other               Pennsylvania, Heartland Financial USA, Inc., Old
                                                 definitions indicate that the Commissions should          notional item underlying the swap be,                  National Bancorp, Peoples Bancorp of North
                                                 apply their expertise and discretion to interpret the     or be directly related to, a financial term            Carolina, Inc., Susquehanna Bank, The PrivateBank
                                                 statutory text.                                           of the loan (such as the loan’s principal              and Trust Co, The Savannah Bank, N.A., The
                                                   293 For example, a manufacturer, producer,                                                                     Washington Trust Company, Trustmark National
                                                 processor, or merchant that enters into swaps to
                                                                                                           amount, duration, rate of interest or                  Bank, UMB Financial Corporation, Valley National
                                                 hedge its currency or interest rate risk, absent any      currency). Some commenters agreed                      Bank, Webster Bank NA, WesBanco Bank
                                                 facts and circumstances establishing dealing              with the principle of limiting the                     (‘‘Regional Banks’’) (general support for limitation
                                                 activity, is not a swap dealer.                           exclusion to swaps that are connected to               to swaps connected to financial terms of the loan).
                                                   294 In response to the commenters concerns, the                                                                   298 See letter from Better Markets I.
                                                                                                           the financial terms of the loan, stating
                                                 Commissions have adopted certain tailored                                                                           299 See letters from BOK dated February 18, 2011

                                                 exclusions of certain types of swaps and security-        that the exclusion should cover any                    (‘‘BOK II’’), FSR I, ISDA I, Midsize Banks, OCC Staff
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                                                 based swaps in the final rule.                                                                                   at 6 (noting that ‘‘[l]oan underwriting criteria for
                                                   295 A coalition of not-for-profit power utilities and   have expressed interest in submitting an exemption     community and mid-size banks * * * may require,
                                                 electric cooperatives has advised that it plans to        application to the CFTC as well. See generally         as a condition of the loan, that the borrower be
                                                 submit a request for an exemption for transactions        section 722(e) of the Dodd-Frank Act. Such             hedged against the commodity price risks
                                                 between entities described in section 201(f) of the       exemptions, if granted after notice and comment        incidental to its business’’) and White & Case LLP
                                                 Federal Power Act, as contemplated by section             pursuant to CEA section 4(c), 7 U.S.C. 6(c), could     (‘‘White & Case’’) and joint letter from Senator
                                                 722(f) of the Dodd-Frank Act. See letter from             further address commenters’ concerns in this           Stabenow and Representative Lucas.
                                                 NFPEEU. Separately, some regional transmission            regard.                                                   300 See letters from BOK II, FSR I, OCC Staff and

                                                 organizations and independent systems operators             296 See CEA section 1a(49)(A), 7 U.S.C. 1a(49)(A).   White & Case.



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                                                                   Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations                                                  30621

                                                 borrowers that are smaller                                the notional amount of the swap is more              the exclusion should be extended to
                                                 companies.301                                             than the amount of the loan tranche                  other regulated financial institutions,
                                                    Second, regarding timing, the                          assigned to the IDI, so long as the swap             such as insurers, so as not to create an
                                                 proposed rule requested comment on                        notional amount is not more than the                 unlevel playing field.315 And the
                                                 whether this exclusion should apply                       entire amount of the loan.306 Another                Federal Home Loan Banks said that the
                                                 only to swaps that are entered into                       commenter said that the exclusion                    exclusion should be available to them
                                                 contemporaneously with the IDI’s                          should not be available if the IDI’s                 because they are subject to similar
                                                 origination of the loan (and if so, how                   participation in the loan drops below a              regulatory oversight and capital
                                                 ‘‘contemporaneously’’ should be                           minimum level (such as 20 percent)                   standards and engage in a similar
                                                 defined for this purpose), or whether                     because such use of the exclusion by                 function of extending credit as do
                                                 this exclusion also should apply to                       minimally-participating IDIs would                   commercial banks and savings
                                                 swaps entered into during part or all of                  invite abuse.307                                     associations.316 In addition, some
                                                 the duration of the loan. In response,                       Some commenters said that other                   commenters said the exclusion should
                                                 commenters said that the exclusion                        types of transactions also should be                 be broadly construed as a general
                                                 should apply to swaps entered into in                     treated as ‘‘loans’’ for purposes of the             matter, to encourage competition in the
                                                 anticipation of a loan or at any time                     exclusion. The transactions cited by                 swap market between smaller and larger
                                                 during the loan term.302 Commenters                       commenters in this regard include                    banks and to increase borrowers’ choice
                                                 said that application of the exclusion                    leases, letters of credit, financings                among potential swap providers.317
                                                 throughout the duration of the loan                       documented as sales of financial assets,                Two commenters asked for
                                                 would give IDIs and borrowers                             bank qualified tax exempt loans and                  clarification of the following technical
                                                 flexibility as to when to fix interest rates              bonds that are credit enhanced by an                 points in the proposed rule: (i) Whether
                                                 in fixed/floating swaps relating to loans                 IDI.308 Other commenters said the                    a swap would be covered by the
                                                 and would allow borrowers to make                         exclusion should apply where entities                exclusion even if it does not hedge all
                                                 other hedging decisions over a longer                     related to an IDI provide financing, such            the risks under the loan, (ii) whether a
                                                 time period.303 Commenters also said                      as loans or financial asset purchases by             swap that is within the exclusion could
                                                 that loans such as construction loans,                    bank-sponsored commercial paper                      continue to be treated as covered by the
                                                 equipment loans and committed loan                        conduits where the IDI provides                      exclusion by an IDI if the IDI transfers
                                                 facilities may allow for draws of loan                    committed liquidity,309 and transactions             the loan, and (iii) whether an IDI should
                                                 principal over an extended period of                      where a special purpose entity formed                count swaps covered by the exclusion in
                                                 time, and that swaps entered into by the                  by an IDI is the source of financing and             determining if its dealing activity is
                                                 borrower and lending IDI through the                      enters into the swap.310 Some                        above the de minimis thresholds.318
                                                 course of such a loan should be covered                   commenters said the exclusion should                 Another commenter asked whether an
                                                 by the exclusion.304                                      encompass all transactions where an IDI              IDI with swaps that are covered by the
                                                    Third, as to which transactions                        facilitates a financing,311 or all                   exclusion could be a swap dealer based
                                                 should be deemed ‘‘loans’’ for purposes                   extensions of credit by an IDI,312 or all            on other dealing activity.319 And others
                                                 of the exclusion, the proposal said that                  transactions where an IDI provides risk              asked whether the exclusion would
                                                 the exclusion should be available in                      mitigation to a borrower.313                         cover swaps used by an IDI to hedge its
                                                 connection with all transactions by                          Fourth, with respect to the types of              risks arising from a loan (i.e., a swap
                                                 which an IDI is a source of funds to a                    financial institutions that are eligible for         which the IDI enters into with a party
                                                 borrower, including, for example, loan                    the loan origination exclusion, three                other than the loan borrower).320
                                                 syndications, participations and                          commenters said that IDIs, for purposes
                                                 refinancings. Commenters agreed that                                                                           3. Final Rule
                                                                                                           of this exclusion, encompass more than                  The CFTC believes that the extent of
                                                 the exclusion should be available for
                                                                                                           banks or savings associations with                   this exclusion should be determined by
                                                 IDIs that are in a loan syndicate,
                                                                                                           federally-insured deposits. The Farm
                                                 purchasers of a loan, assignees of a loan
                                                                                                           Credit Council said the exclusion
                                                 or participants in a loan.305 On loan                                                                          savings associations a competitive advantage in
                                                                                                           should be extended to Farm Credit                    agricultural lending. See letters from Farm Credit
                                                 syndications and participations in
                                                                                                           System institutions because one of these             Council I and dated February 17, 2012 (‘‘Farm
                                                 particular, one commenter said that the                                                                        Credit Council II’’). Another commenter argued
                                                                                                           institutions enters into interest rate
                                                 exclusion should be available even if                                                                          that, to the contrary, making Farm Credit System
                                                                                                           swaps with borrowing customers                       institutions eligible for the exclusion would confer
                                                    301 See letters from ABA I and BOK I. Other
                                                                                                           identical in function to those offered by            an inappropriate competitive advantage on those
                                                 commenters addressed the relationship between the         commercial banks and savings                         institutions. See letter from ABA dated February 14,
                                                 swap dealer definition and section 619 of the Dodd-       associations in connection with loans,               2012 (‘‘ABA II’’). This commenter said that Farm
                                                 Frank Act (the ‘‘Volcker Rule’’). See joint letter from                                                        Credit System institutions have certain advantages
                                                                                                           and the institutions are subject to                  over other IDIs, and the commenter asserted that
                                                 Capital One, Fifth Third Bancorp and Regions
                                                 Financial Corporation.
                                                                                                           similar regulatory requirements and                  Farm Credit System institutions were left out of the
                                                    302 See letters from BB&T I, B&F Capital I, BOK        covered by a similar insurance                       statutory language of the exclusion in order that
                                                                                                           regime.314 Another commenter said that               they would not receive additional competitive
                                                 II, Capital One, Capstar, FSR I, Midsize Banks,
                                                 Manufacturers and Traders Trust Company                                                                        advantages. See id.
                                                                                                                                                                  315 See letter from NAIC.
                                                 (‘‘M&T’’) dated June 3, 2011 (‘‘M&T I’’) and                306 See letter from Regional Banks.                  316 See letter from FHLB I. The Credit Union
                                                 September 28, 2011 (‘‘M&T II’’), Peoples Bank Co.           307 See letter from Better Markets I.              National Association said that the Federal Home
                                                 (‘‘Peoples Bank’’), Regional Banks and White &              308 See letters from BB&T I, Capital One, FSR I,
                                                 Case.                                                                                                          Loan Banks should not be covered by the swap
                                                    303 See letters from B&F Capital I, BOK II, Capital    M&T I, Midsize Banks and Regional Banks.             dealer definition because they do not enter into
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                                                                                                             309 See letter from FSR I.
                                                 One, Capstar and M&T I and M&T II.                                                                             swaps for their own account as part of a regular
                                                                                                             310 See letter from Midsize Banks.                 business. See letter from CUNA.
                                                    304 See letters from FSR dated October 17, 2011
                                                                                                             311 See letters from Pacific Coast Bankers’          317 See letters from BB&T I, B&F Capital dated
                                                 (‘‘FSR VI’’), M&T II and Wells Fargo Bank, N.A.
                                                 (‘‘Wells Fargo’’) dated August 16, 2011 (‘‘Wells          Bancshares (‘‘PCBB’’) and Regional Banks.            June 1, 2011 (‘‘B&F Capital II’’), Capital One,
                                                 Fargo II’’).                                                312 See letters from FSR I and Midsize Banks.      Capstar, M&T I and Peoples Bank.
                                                    305 See letters from BB&T I, Midsize Banks,              313 See letter from PCBB.                            318 See letters from FSR VI and Midsize Banks.
                                                                                                                                                                  319 See letter from Better Markets I.
                                                 Regional Banks and White & Case; see also letter            314 Consequently, the Farm Credit Council

                                                 from Loan Market Association (providing                   argued, disallowing these institutions from using      320 See letters from B&F Capital I, FSR I, ISDA I,

                                                 background information on loan participations).           the exclusion would give commercial banks and        M&T I and Midsize Banks.



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                                                 30622            Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations

                                                 the language of the statutory definition,                  Since a loan involves the repayment                  some commenters (such as all swaps
                                                 which relates to an IDI that ‘‘offers to                of funds to the IDI on particular terms,                reducing a borrower’s business risks),
                                                 enter into a swap with a customer in                    a swap that relates to those terms of                   then the terms of the statute limiting the
                                                 connection with originating a loan with                 repayment should be covered by the                      exclusion to swaps that are ‘‘in
                                                 that customer.’’ The expansive                          exclusion. In addition, we recognize                    connection with originating a loan with
                                                 interpretation of the exclusion advanced                that, as stated by commenters,                          that customer’’ would be superfluous.325
                                                 by some commenters, however, would                      requirements in an IDI’s loan                           To give effect to the statutory text, the
                                                 read the statute to exclude almost any                  underwriting criteria relating to the                   exclusion is limited to a swap that is
                                                 swap that an IDI enters into with a loan                borrower’s financial stability are an                   connected to the financial terms of the
                                                 customer. That is not the exclusion that                important part of ensuring that loans are               loan or is required by the IDI’s loan
                                                 was enacted. Instead, we interpret the                  repaid.322 Therefore, the final rule                    underwriting criteria to to be in place as
                                                 statutory phrase ‘‘enter into a swap with               modifies the proposed rule to provide                   a condition of the loan in order to hedge
                                                 a customer in connection with                           that the exclusion applies to swaps                     commodity price risks incidental to the
                                                 originating a loan with that customer’’                 between an IDI and a loan borrower that                 borrower’s business.
                                                 to mean that the swap is directly                       are connected to the financial terms of                    Regarding the types of transactions
                                                 connected to the IDI’s process of                       the loan, such as, for example, the loan’s              that will be treated as a ‘‘loan’’ for
                                                 originating the loan to the customer.                   duration, interest rate, currency or                    purposes of the exclusion, courts have
                                                    Because of the statute’s direct                      principal amount, or that are required                  defined the term ‘‘loan’’ in other
                                                 reference to ‘‘originating’’ the loan, it               under the IDI’s loan underwriting                       statutory contexts based on the settled
                                                 would be inappropriate to construe the                  criteria to be in place as a condition of               meaning of the term under common
                                                 exclusion as applying to all swaps                      the loan in order to hedge commodity                    law. This definition encompasses any
                                                 entered into between an IDI and a                       price risks incidental to the borrower’s                contract by which one party transfers a
                                                 borrower at any time during the                         business.323 The first category of swaps                defined quantity of money and the other
                                                 duration of the loan. If this were the                  generally serve to transform the                        party agrees to repay the sum
                                                 intended scope of the statutory                         financial terms of a loan for purposes of               transferred at a later date.326 Rather than
                                                 exclusion, there would be no reason for                 adjusting the borrower’s exposure to                    examine at this time the many
                                                 the text to focus on swaps in connection                certain risks directly related to the loan              particularized examples of financing
                                                 with ‘‘originating’’ a loan. The CFTC                   itself, such as risks arising from changes              transactions cited by some commenters,
                                                 recognizes the concern expressed by                     in interest rates or currency exchange                  the term ‘‘loan’’ for purposes of this
                                                 commenters that: (i) there be flexibility               rates. The second category of swaps                     exclusion should be interpreted in
                                                 regarding when the IDI and borrower                     mitigate risks faced by both the                        accordance with this settled legal
                                                 enter into a swap relating to a loan, and               borrower and the lender, by reducing                    meaning.327
                                                 (ii) the expectation when an IDI                        risks that the loan will not be repaid.                    As stated in the proposed rule, this
                                                 originates a loan with a customer is                    Thus, both types of swaps are directly                  exclusion is available to all IDIs that are
                                                 often that the customer will enter into                 related to repayment of the loan.                       a source of a transfer of money to a
                                                 a swap with the IDI when there is a                     Although some commenters said that                      borrower pursuant to a loan. The final
                                                 subsequent advance, or a draw, of                       this exclusion should also apply to                     rule adopts provisions from the
                                                 principal on the loan. We do not                        other types of swaps, we believe it                     proposed rule that the exclusion is
                                                 believe, however, that the statutory term               would be inappropriate to construe this                 available to an IDI that is a source of
                                                 ‘‘origination’’ can reasonably be                       exclusion as encompassing all swaps                     money by being part of a loan syndicate,
                                                 stretched to cover the entire term of                   that are connected to a borrower’s other                being an assignee of a loan, obtaining a
                                                 every loan that an IDI makes to its                     business activities, even if the loan                   participation in a loan, or purchasing a
                                                 customers. At some point, the temporal                  agreement requires that the borrower                    loan.328 However, the proposed rule did
                                                 distance renders the link to loan                       enter into such swaps or otherwise
                                                                                                                                                                    325 Also, we believe that the broader range of
                                                 origination too attenuated, and the risk                refers to them.324 In contrast to a swap
                                                                                                                                                                 swaps serving general risk management purposes
                                                 of evasion too great, to support the                    that transforms the financial terms of a                are more likely to involve concerns regarding
                                                 exclusion. In order to balance these                    loan or is required by the IDI’s loan                   market transparency and appropriate business
                                                 competing and conflicting                               underwriting criteria to reduce the                     conduct practices addressed by swap dealer
                                                 considerations, the final rule applies the              borrower’s commodity price risks, other                 regulation than are the narrower range of swaps that
                                                                                                                                                                 are encompassed by the exclusion.
                                                 exclusion to any swap that otherwise                    types of swaps serve a more general risk                   326 See, e.g., In Re Renshaw, 222 F.3d 82, 88 (2d
                                                 meets the terms of the exclusion and is                 management purposes by reducing other                   Cir. 2000) (‘‘Because Congress did not define the
                                                 entered into no more than 90 days                       risks related to the borrower or the loan.              term ‘‘loan’’ for [11 U.S.C.] § 523(a)(8), we must
                                                 before or 180 days after the date of                    If the purpose of the exclusion were to                 interpret it according to its settled meaning under
                                                 execution of the loan agreement, or no                                                                          common law. The classic definition of a loan [is]
                                                                                                         cover the broad range of swaps cited by                 * * * as follows: To constitute a loan there must
                                                 more than 90 days before or 180 days                                                                            be (i) a contract, whereby (ii) one party transfers a
                                                 after the date of any transfer of principal             restructuring, extension or other modification of the   defined quantity of money, goods, or services, to
                                                 to the borrower from the IDI (e.g., a                   loan will, in itself, neither preclude application of   another, and (iii) the other party agrees to pay for
                                                                                                         the exclusion nor expand application of the             the sum or items transferred at a later date.’’) (citing
                                                 draw of principal) pursuant to the loan,                exclusion.                                              In re Grand Union Co., 219 F. 353, 356 (2d Cir.
                                                 so long as the aggregate notional amount                  322 See letter from OCC Staff.                        1914)).
                                                 of the swaps in connection with the                       323 The final rule provides that the second              327 The final rule adopts provisions from the

                                                 financial terms of the loan at any time                 category of swaps must hedge a price risk related       proposed rule that, in order to prevent evasion, the
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                                                 is no more than the aggregate amount of                 to a commodity other than an excluded commodity         statutory exclusion does not apply where the IDI
                                                                                                         because if the price risk relates to an excluded        originates a ‘‘sham’’ loan; or the purported ‘‘loan’’
                                                 the borrowings under the loan at that                   commodity (such as an interest rate) the swap must      is actually a synthetic loan such as a loan credit
                                                 time.321                                                be connected to the financial terms of the loan in      default swap or loan total return swap. See CFTC
                                                                                                         order to be covered by the exclusion.                   Regulation § 1.3(ggg)(5)(iii).
                                                   321 We note that because the exclusion is               324 On the other hand, there is no requirement           328 See CFTC Regulation § 1.3(ggg)(5)(ii). As is

                                                 available within the specified time period around       that the loan agreement reference a swap in order       also stated in the Proposing Release, if an IDI were
                                                 the execution of the loan agreement and any draw        for the swap to be excluded, if the swap otherwise      to transfer its participation in a loan to a non-IDI,
                                                 of principal under the loan, any amendment,             qualifies for the exclusion.                            then the non-IDI would not be able to claim this



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                                                                   Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations                                                     30623

                                                 not state explicitly how the notional                   with the financial terms of the loan at                  constitute swap dealing. Regarding
                                                 amount of a swap subject to the                         any time is not more than the aggregate                  swaps used by an IDI to hedge or lay off
                                                 exclusion must relate to the amount of                  principal amount outstanding under the                   its risks arising from a loan, we do not
                                                 money provided by an IDI that is in a                   loan at that time.334                                    believe it is appropriate to treat such
                                                 loan syndicate or is an assignee of,                       We also reiterate the interpretation in               swaps as covered by the exclusion,
                                                 participant in or purchaser of a loan. In               the Proposing Release that the word                      because the statute explicitly limits the
                                                 this regard, some commenters said that                  ‘‘offer’’ in this exclusion includes                     exclusion to swaps ‘‘with a customer,’’
                                                 a borrower and the IDIs in a lending                    scenarios where the IDI requires the                     which such hedging swaps are not.
                                                 syndicate need flexibility to allocate                  customer to enter into a swap, or where                  However, a swap that an IDI enters into
                                                 responsibility for the swap(s) related to               the customer asks the IDI to enter into                  for the purpose of hedging or laying off
                                                 the loan as they may agree.329 We                       a swap, specifically in connection with                  the risk of a swap that is covered by the
                                                 believe that, to allow for this flexibility,            a loan made by that IDI.                                 IDI exclusion will not be considered in
                                                 the exclusion may apply to a swap                          We also continue to emphasize, as                     the de minimis determination, or
                                                 (which is otherwise covered by the                      stated in the Proposing Release, that the                otherwise in evaluating whether the
                                                 exclusion) even if the notional amount                  statutory language of the exclusion                      IDI is covered by the swap dealer
                                                 of the swap is different from the amount                limits its availability to only IDIs as                  definition.337
                                                 of the loan tranche assigned to the IDI.                defined in the statute. Regarding some                      Last, we believe it is appropriate to
                                                 However, we also agree with a                           commenters’ statements about the                         require that an IDI claiming the
                                                 commenter that the IDI should have a                    competitive effect of this interpretation                exclusion report its swaps that are
                                                 substantial participation in the loan.330               of the term ‘‘insured depository                         covered by the exclusion to a swap data
                                                 The requirement of substantial                          institution,’’ we believe that the scope of              repository (‘‘SDR’’). This requirement is
                                                 participation would prevent an IDI from                 application of the swap dealer                           consistent with the prevailing practice
                                                 applying the exclusion where the IDI                    definition to various entities should be                 that IDIs handle the documentation of
                                                 makes minimal lending commitments in                    treated in the de minimis exception,                     loans made to borrowers, and will
                                                 multiple loan syndicates where it offers                which is available to all persons.                       provide for consistent reporting of
                                                                                                            In order to provide clarification in                  swaps that are covered by the exclusion,
                                                 swaps, causing its swap activity to be far
                                                                                                         response to certain technical questions                  thereby allowing the CFTC and other
                                                 out of proportion to its loan activity.331
                                                                                                         raised by commenters, we note that                       regulators to monitor the use of the
                                                    Therefore, the final rule includes a
                                                                                                         whether a swap hedges all of the risk,                   exclusion.
                                                 provision that the exclusion may apply
                                                                                                         or only some of the risk, of a loan is not                  In sum, the final rule balances the
                                                 regardless of whether the notional
                                                                                                         relevant to application of the exclusion.                need for flexibility in response to
                                                 amount of the swap is the same as the
                                                                                                         Nor is it relevant to the exclusion if the               existing lending practices, consistent
                                                 amount of the loan, but only if the IDI
                                                                                                         IDI later transfers or terminates the loan               with the constraints imposed by the
                                                 is the sole source of funds under the
                                                                                                         in connection with which the swap was                    statutory text as enacted, against the risk
                                                 loan or is committed to be, under the
                                                                                                         entered into, so long as the swap                        of establishing a gap in the regulatory
                                                 applicable loan agreements, the source                  otherwise qualifies for the exclusion                    framework enacted in Title VII.338 It
                                                 of at least 10 percent of the maximum                   and the loan was originated in good                      provides that the exclusion may be
                                                 principal amount under the loan.332 If                  faith and was not a sham.335 Further,                    claimed by a person that meets the
                                                 the IDI does not meet this 10 percent                   swaps that are covered by the exclusion                  following conditions: (i) The person is
                                                 threshold, the final rule provides that                 should not be considered in                              an IDI; (ii) the IDI enters into a swap
                                                 the exclusion may apply only if the                     determining if an IDI exceeds the de                     with the borrower that does not extend
                                                 aggregate notional amount of all the                    minimis level of swap dealing activity,                  beyond the termination of the loan; (iii)
                                                 IDI’s swaps with the customer related to                because the statute provides that swaps                  the swap is connected to the financial
                                                 the financial terms of the loan is no                   covered by the exclusion should not be                   terms of the loan or is required by the
                                                 more than the amount lent by the IDI to                 considered in determining if an IDI is a                 IDI’s loan underwriting criteria to to be
                                                 the customer.333 We also note that, in all              swap dealer, and the de minimis                          in place as a condition of the loan in
                                                 cases, application of the exclusion                     exception provides that it considers the                 order to hedge commodity price risks
                                                 requires that the aggregate notional                    ‘‘quantity of [a person’s] swap                          incidental to the borrower’s business;
                                                 amount of all swaps entered into by the                 dealing.’’ 336 The application of the                    (iv) the loan is within the common law
                                                 borrower with any person in connection                  exclusion to swaps entered into by an                    meaning of ‘‘loan’’ and it is not a sham
                                                                                                         IDI in connection with the origination of                or a synthetic loan; (v) the IDI is the
                                                 exclusion, regardless of the terms of the loan or the
                                                 manner of the transfer. Similarly, a non-IDI that is
                                                                                                         loans, however, does not mean that the                   source of money to the borrower in
                                                 part of a loan syndicate with IDIs would not be able    IDI could not be a swap dealer because                   connection with the loan either directly,
                                                 to claim the exclusion.                                 of other of the IDI’s activities that                    or (so long as the IDI is the source of at
                                                    329 See, e.g., letter from Regional Banks.
                                                                                                                                                                  least 10 percent of the entire amount of
                                                    330 See letter from Better Markets I. This              334 See CFTC Regulation § 1.3(ggg)(5)(i)(E).
                                                                                                                                                                  the loan) through syndication,
                                                 commenter suggested a minimal threshold of at           Paragraphs (D)(3) and (E) of this regulation refer to
                                                 least 20 percent of the loan. However, we believe       all swaps ‘‘in connection with the financial terms
                                                                                                                                                                  participation, assignment, purchase,
                                                 that a 10 percent commitment constitutes a              of the loan’’ in order to clarify that only such swaps   refinancing or otherwise; (vi) the IDI
                                                 substantial participation in the loan which supports    are relevant in this regard. For example, if the IDI
                                                 offering of a swap up to the loan’s full amount.        were to enter into a swap with the customer that            337 An IDI that is seeking out swap counterparties
                                                    331 For example, an IDI could act as a 0.1 percent   is not in connection with the loan’s financial terms,    to enter into swaps in order to hedge or lay off the
                                                 participant in one hundred different loans in order     the swap would not be relevant because the               risk of a swap that is subject to the IDI exclusion
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                                                 to serve as the sole swap counterparty to the           exclusion would not apply to the swap.                   would generally not be accommodating demand for
                                                 borrowers for hedging the borrowers’ interest rate         335 On the other hand, if the IDI were to transfer    swaps or facilitating interest in swaps.
                                                 risk on the loans. Thus, by lending or committing       the swap (but not the loan) to another IDI, and the         338 The final rule text in CFTC Regulation
                                                 to lend $100 million, the IDI could apply the           IDI that is the transferee of the swap is not a source   § 1.3(ggg)(5)(i) has been revised to conform the text
                                                 exclusion to swaps with an aggregate notional           of money to the borrower under the loan, then the        of the rule to the statutory provision which refers
                                                 amount of $100 billion.                                 transferee IDI would not be able to apply the            to ‘‘an insured depository institution [that] * * *
                                                    332 See CFTC Regulation § 1.3(ggg)(5)(i)(D)(1) and   exclusion to the swap.                                   enter[s] into a swap with a customer in connection
                                                 (2).                                                       336 See CEA sections 1a(49)(A) and 1a(49)(D),         with originating a loan with that customer.’’ See
                                                    333 See CFTC Regulation § 1.3(ggg)(5)(i)(D)(3).      7 U.S.C. 1a(49)(A) and 1a(49)(D).                        CEA § 1a(49)(A), 7 U.S.C. 1a(49)(A)



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                                                 30624             Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations

                                                 enters into the swap with the borrower                   dealer analysis.341 A number of                           performing the dealing activity, even if
                                                 within 90 days before or 180 days after                  commenters took the view that the                         that person’s dealing activity is limited
                                                 the date the execution of the loan                       dealer definitions should not apply                       to a trading desk or discrete business
                                                 agreement, or within 90 days before or                   when there is common control between                      unit,345 unless the person is able to take
                                                 180 days after any transfer of principal                 counterparties, or when common                            advantage of a limited designation as a
                                                 to the borrower from the IDI pursuant to                 control is combined with the                              dealer.346
                                                 the loan; (vii) the aggregate notional                   consolidation of financial statements.342
                                                                                                                                                                    b. Application to Inter-Affiliate Swaps
                                                 amount of all swaps entered into by the                  Some commenters suggested that this
                                                                                                                                                                    and Security-Based Swaps
                                                 borrower with all persons in connection                  interpretation regarding the scope of the
                                                 with the financial terms of the loan at                  dealer definitions should incorporate                        The final rules codify exclusions from
                                                 any time is not more than the aggregate                  concepts of affiliation that are found in                 the dealer definitions for a person’s
                                                 amount of the borrowings under the                       other statutory and regulatory                            swap or security-based swap activities
                                                                                                          provisions.343 Several commenters also                    with certain affiliates.347 These rules are
                                                 loan at that time; and (viii) the IDI
                                                                                                          opposed the suggestion (raised as part of                 consistent with the Proposing Release’s
                                                 agrees to report the swap to an SDR.
                                                                                                          the Proposing Release’s request for                       recognition of the need to consider the
                                                    An IDI that enters into swaps that do                 comments) that this interpretation be                     economic reality of any swaps or
                                                 not meet these conditions, and thus do                   limited to transactions among wholly                      security-based swaps that a person
                                                 not qualify for the statutory exclusion,                 owned subsidiaries.344                                    enters into with affiliates. Market
                                                 is not necessarily required to register as                                                                         participants may enter into such inter-
                                                 a swap dealer. Rather, the IDI would                     2. Final Interpretation and Rule                          affiliate swaps or security-based swaps
                                                 apply the statutory definition and the                   a. Application to Legal Persons                           for a variety of purposes, such as to
                                                 provisions of the rule (taking into                         Consistent with the Proposing                          allocate risk within a corporate group or
                                                 account the applicable interpretive                      Release, the Commissions interpret                        to transfer risks within a corporate
                                                 guidance set forth in this Adopting                      ‘‘person’’ as used in the swap dealer and                 group to a central hedging or treasury
                                                 Release), solely with respect to its swaps               security-based swap dealer definitions                    entity.
                                                 that are not subject to the IDI exclusion,               to refer to a particular legal person.                       Under the final rules, the dealer
                                                 in order to determine whether it is                      Accordingly, the dealer definitions will                  analysis will not apply to swaps and
                                                 engaged in swap dealing activity that                    apply to the particular legal person                      security-based swaps between majority-
                                                 exceeds the de minimis threshold.                                                                                  owned affiliates.348 When the economic
                                                                                                             341 See, e.g., letters from API I, COPE I, ISDA I,     interests of those affiliates are aligned
                                                 C. Application of Dealer Definitions to                  Midsize Banks, ONEOK, Inc. (‘‘ONEOK’’) and                adequately—as would be found in the
                                                 Legal Persons and to Inter-Affiliate                     Peabody.                                                  case of majority-ownership—such
                                                 Swaps and Security-Based Swaps                              Several commenters explained the widespread            swaps and security-based swaps serve to
                                                                                                          use of central hedging desks to allocate risk within
                                                 1. Proposed Approach and Commenters’                     affiliate groups or to gather risk from within a group
                                                                                                                                                                    allocate or transfer risks within an
                                                 Views                                                    and lay that risk off on the market. See, e.g., letters   affiliated group, rather than to move
                                                                                                          from EEI/EPSA, Kraft Foods Inc. (‘‘Kraft’’), MetLife      those risks out of the group to an
                                                    In the Proposing Release, the                         and Prudential Financial, Inc. (‘‘Prudential’’) dated     unaffiliated third party. For this reason,
                                                                                                          February 17, 2011 (‘‘Prudential I’’).
                                                 Commissions preliminarily concluded                                                                                and as contemplated by the Proposing
                                                                                                             Some commenters particularly stated that the use
                                                 that designation as a dealer would apply                 of a single entity to face the market on behalf of an     Release,349 we do not believe that such
                                                 on an entity-level basis (rather than to                 affiliate group had several risk-reducing and
                                                                                                          efficiency-enhancing benefits, and that those                345 Within an affiliated group of companies,
                                                 a trading desk or other business unit
                                                                                                          benefits would be lost if the dealer definitions were     however, only those legal persons that engage in
                                                 that is not organized as a separate legal                to lead corporate groups to avoid using central           dealing activities will be designated as dealers; that
                                                 person), and that an affiliated group of                 trading desks and instead require each affiliate to       designation will not be imputed to other non-dealer
                                                 legal persons could include more than                    face the market as an independent end-user. See           affiliates or to the group as a whole. A single
                                                 one dealer.339 The Proposing Release                     letters from FSR I, Philip Morris International Inc.      affiliate group may, however, have multiple swap
                                                                                                          (‘‘Philip Morris’’), Shell Trading dated June 3, 2011     or security-based swap dealers.
                                                 also stated that the dealer analysis                     (‘‘Shell Trading II’’) and Utility Group, and joint          346 Limited designation as a dealer is addressed
                                                 should consider the economic reality of                  letter from ABA Securities Association, American          in more detail below in part II.E.
                                                 swaps and security-based swaps                           Council of Life Insurers (‘‘ACLI’’), FSR, Futures            347 See CFTC Regulation § 1.3(ggg)(6)(i); Exchange
                                                                                                          Industry Association (‘‘FIA’’), Institute of              Act rule 3a71–1(d). A person’s market-facing swap
                                                 between affiliates, and preliminarily                    International Bankers, ISDA and SIFMA (‘‘Financial        or security-based swap activity may still cause that
                                                 noted that swaps or security-based                       Associations’’).                                          person to be a dealer, even if that market-facing
                                                 swaps ‘‘between persons under common                        Some commenters also stated that legislative           activity is linked to the inter-affiliate activity, to the
                                                 control may not involve the interaction                  history suggested that Congress did not intend that       extent that the market-facing activity satisfies the
                                                 with unaffiliated persons that we                        the dealer definition capture transactions involving      dealer definition. However, a person’s market-
                                                                                                          the use of an affiliate to hedge commercial risk. See     facing swap activity for hedging purposes as
                                                 believe is a hallmark of the elements of                 letters from CDEU and Prudential I.                       defined in CFTC Regulation § 1.3(ggg)(6)(iii) would
                                                 the definitions that refer to holding                       342 See letters from CDEU (common control),            not cause that person to be a dealer.
                                                 oneself out as a dealer or being                         Financial Associations (common control and                   348 See CFTC Regulation § 1.3(ggg)(6)(i); Exchange

                                                 commonly known as a dealer.’’ 340                        consolidation), MetLife (consolidation), ONEOK            Act rule 3a71–1(d)(1). For the purposes of these
                                                                                                          (common control, evaluated based on whether the           rules, the counterparties are majority-owned
                                                    Commenters supported the view that                    trading interests of the entities are aligned) and        affiliates if one party directly or indirectly holds a
                                                 swaps and security-based swaps among                     Prudential I (citing CFTC letter interpretation           majority ownership interest in the other, or if a
                                                                                                          regarding common control).                                third party directly or indirectly holds a majority
                                                 affiliates should be excluded from the                      343 See, e.g., letters from EDF Trading (proposing     interest in both, based on holding a majority of the
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                                                                                                          definition from regulations promulgated by the            equity securities of an entity, or the right to receive
                                                   339 See Proposing Release, 75 FR at 80183.             Federal Energy Regulatory Commission) and                 upon dissolution or the contribution of a majority
                                                   340 Id.The Proposing Release further noted that        Peabody (proposing definition of ‘‘affiliate’’ used in    of the capital of a partnership. See CFTC Regulation
                                                 sections 721(c) and 761(b)(3) give the Commissions       federal securities laws) and joint letter from the        § 1.3(ggg)(6)(i); Exchange Act rule 3a71–1(d)(2).
                                                 anti-evasion authority, to the extent that an entity     Bank of Tokyo-Mitsubishi UFJ, Ltd., Mizuho                   349 See Proposing Release, 75 FR at 80183 (noting

                                                 were to seek to use transactions between persons         Corporate Bank, Ltd. and Sumitomo Mitsui Banking          that swaps or security-based swaps between
                                                 under common control to avoid one of the dealer          Corp. (suggesting use of control definition in Bank       affiliates ‘‘may not involve the interaction with
                                                 definitions. See id. (erroneously referring to section   Holding Company Act).                                     unaffiliated persons that we believe is a hallmark
                                                 721(c) as section 721(b)(3).                                344 See, e.g., letters from Kraft and ONEOK.           of the elements of the definitions that refer to



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                                                                   Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations                                                         30625

                                                 swaps and security-based swaps involve                    c. Application to Cooperatives                            party, so long as the cooperative adheres
                                                 the interaction with unaffiliated persons                    Similar considerations apply, in                       to certain risk management practices.
                                                 to which dealer regulation is intended                    certain situations, to cooperative entities                  Accordingly, the final rules
                                                 to apply.                                                 that enter into swaps with their                          specifically provide that the dealer
                                                    The standard in the final rules differs                members in order to allocate risk                         analysis excludes swaps between a
                                                 from the standard suggested by the                        between the members and the                               cooperative and its members, so long as
                                                 Proposing Release, which alluded to                       cooperative. Commenters identified two                    the swaps in question are reported to
                                                 affiliates as legal persons under                         general types of such cooperatives—                       the relevant SDR by the cooperative and
                                                 ‘‘common control.’’ This change is                        ‘‘cooperative associations of producers’’                 are subject to policies and procedures of
                                                 based on our further consideration of                     as defined in section 1a(14) of the                       the cooperative which ensure that it
                                                 the issue, including consideration of                     CEA 353 and cooperative financial                         monitors and manages the risk of such
                                                 comments that an inter-affiliate                          entities such as Farm Credit System                       swaps.356 The final rules define the term
                                                 exclusion should be available when                        institutions and Federal Home Loan                        ‘‘cooperative’’ to include cooperative
                                                 common control is combined with the                       Banks.354 As is the case for affiliated                   associations of producers and any entity
                                                 consolidation of financial statements.                    groups of corporate entities, we believe                  chartered under Federal law as a
                                                 Although we are not including a                           that when one of these cooperatives                       cooperative and predominantly engaged
                                                 requirement that financial statements be                  enters into a swap with one of its                        in activities that are financial in
                                                 consolidated—as we do not believe that                    members,355 the swap serves to allocate                   nature.357 The cooperatives covered by
                                                 the scope of this exclusion should be                     or transfer risks within an affiliated                    this relief are subject to provisions of
                                                 exposed to the risk of future changes in                  group, rather than to move those risks                    Federal law providing for their
                                                 accounting standards—in our view a                        from the group to an unaffiliated third                   cooperative purpose. Cooperative
                                                 majority ownership standard is                                                                                      associations of producers have been
                                                 generally consistent with consolidation                   tightly focused to address situations in which            recognized since the passage of the
                                                 under GAAP.350 Absent majority                            counterparties have similar economic interests.           Capper-Volstead Act as being permitted
                                                 ownership, we cannot be confident that                       Another commenter noted the definition of              to engage in certain cooperative
                                                                                                           ‘‘affiliate’’ found in certain Federal Energy
                                                 there would be an alignment of                            Regulation Commission regulations—which define
                                                                                                                                                                     activities without violating antitrust
                                                 economic interests that is sufficient to                  ‘‘affiliate’’ in terms of a ten percent or five percent   laws.358 Cooperative financial
                                                 eliminate the concerns that underpin                      common ownership interest. See letter from EDF            institutions such as the Farm Credit
                                                                                                           Trading. Those relatively low ownership                   System institutions and Federal Home
                                                 dealer regulation.                                        thresholds, however, are intended to address
                                                    In taking this approach, we have also                  different concerns regarding collusion and cross-
                                                                                                                                                                     Loan Banks are chartered under Federal
                                                 considered alternatives suggested by                      subsidization, and do not appear appropriate for an       laws that limit their membership and
                                                 commenters. For example, while one                        interpretation that has the potential to reduce the       require that they serve certain public
                                                                                                           counterparty and market protections provided by           purposes.359
                                                 commenter suggested that we adopt a                       Title VII. See 18 CFR sections 35.36(a)(9), 35.39,
                                                 definition of ‘‘affiliate’’ as used in the                366.2(b), 366.3.
                                                                                                                                                                        We are aware that other persons
                                                 securities laws,351 we believe that such                     353 7 U.S.C. 1a(14). A cooperative association of      commented that their swap activities
                                                 an approach would be too broad for the                    producers is at least 75 percent owned or                 should be excluded from the dealer
                                                                                                           controlled, directly or indirectly, by producers of       analysis because they use swaps in
                                                 purpose of this exclusion from dealing                    agricultural products and must comply with the
                                                 activity, given that common control by                    Capper-Volstead Act (referred to in the CEA as the
                                                                                                                                                                     connection with a cooperative or non-
                                                 itself does not ensure that two entities’                 Act of February 18, 1922, 7 U.S.C. 291 and 292).          profit purpose, or because they
                                                 economic interests are sufficiently                       See letters from Land O’Lakes II, NCFC I and              aggregate demand for swaps arising
                                                                                                           NMPF.                                                     from numerous small entities.360
                                                 aligned.352                                                  354 See letters from Farm Credit Council I and
                                                                                                                                                                     However, the key distinction drawn in
                                                                                                           FHLB I. The NRU CFC qualifies as a cooperative
                                                 holding oneself out as a dealer or being commonly         financial entity, but we understand that it does not      granting this relief is that cooperatives
                                                 known as a dealer’’).                                     enter into a significant amount of swaps with its         covered by the exclusion enter into
                                                    350 See FASB ASC Section 810–10–25,                    members; rather, it enters into swaps with                swaps with their members in order to
                                                 Consolidation—Overall—Recognition (stating that           unaffiliated third parties. See letter from NRU CFC       allocate risk between the members and
                                                 consolidation is appropriate if a reporting entity has    I and meeting with NRU CFC on January 13, 2011.
                                                 a controlling financial interest in another entity and       355 The term ‘‘cooperative association of
                                                                                                                                                                        356 See CFTC Regulation § 1.3(ggg)(6)(ii). To be
                                                 a specific scope exception does not apply).               producers’’ also includes any organization acting
                                                    351 See letter from Peabody. The commenter did         for a group of such associations and owned or             clear, these cooperatives are not excluded from the
                                                 not specify which definition of ‘‘affiliate’’ in the      controlled by such associations. See CEA section          dealer definitions. See part II.A.6, supra. Rather,
                                                 securities laws it was proposing. For example, Rule       1a(14), 7 U.S.C. 1a(14). For a cooperative                swaps between a cooperative and its members (and
                                                 405 of the Securities Act of 1933 defines affiliate       association of producers that is acting for and           swaps that a cooperative enters into to hedge or lay
                                                 in terms of common control, see 17 CFR 230.405,           owned or controlled by such associations, we              off the risk of such swaps) are excluded from the
                                                 and Section 20(a) of the Exchange Act takes a             believe that this conclusion applies to any swap          dealer analysis. If a cooperative were to engage in
                                                 similar approach. The Investment Company Act of           between such cooperative association of producers         other swap activities that are covered by, and not
                                                 1940 (‘‘ICA’’) defines affiliate to include entities      and any cooperative association of producers that         otherwise excluded from, the statutory definition of
                                                 with a common ownership interest as low as 5              is a member of it, and any producer that is a             the term ‘‘swap dealer,’’ then it would be required
                                                 percent, ICA section 2(a)(3). Two other commenters        member of any such cooperative association of             to register as a swap dealer.
                                                                                                                                                                        357 See CFTC Regulation § 1.3(ggg)(6)(ii)(B).
                                                 proposed using a common control standard,                 producers that is itself a member of the first
                                                                                                                                                                        358 See Capper-Volstead Act section 1, 7 U.S.C.
                                                 perhaps also in reference to the Rule 405 definition      cooperative association of producers. See CFTC
                                                 of ‘‘affiliate.’’                                         Regulation § 1.3(ggg)(6)(ii)(C).                          291.
                                                    352 The definitions of ‘‘affiliate’’ and ‘‘control’’                                                                359 See Farm Credit Act of 1971, 12 U.S.C. 2001
                                                                                                              However, we do not believe that this conclusion
                                                 found in Rule 405 and other securities law                applies to any security-based swap that a                 et seq. and Federal Home Loan Bank Act, 12 U.S.C.
                                                 provisions are appropriate in the context of the          cooperative association of producers may enter into,      1421 et seq.
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                                                 prophylactic and remedial provisions in which they        nor does it apply to any swap related to a non-              360 See letter from NFPEEU (not-for-profit power

                                                 are found. Rule 405, for example, uses the terms          physical commodity (such as a rate swap). For this        utilities, electric cooperatives and related persons);
                                                 ‘‘affiliate’’ and ‘‘control’’ to identify those persons   reason, the exclusion for cooperative associations of     letters from Farmers’ Associations, NGFA I and
                                                 that have the power to effect registration of an          producers is limited to swaps that are primarily          NMPF (referring to private companies that serve as
                                                 issuer’s securities, and the broad definitions ensure     based on a commodity that is not an excluded              aggregators for swaps in agricultural commodities
                                                 that the persons with that power actually fulfill         commodity. See CFTC Regulation                            or otherwise offer swaps for agricultural risk
                                                 their obligation to do so. By comparison, the             § 1.3(ggg)(6)(ii)(A)(3). The term ‘‘excluded              management); and letter from Northland Energy
                                                 exclusion of inter-affiliate swaps and security-based     commodity’’ is defined in CEA section 1a(19), 7           (small energy firm that aggregates demand for
                                                 swaps from the dealer analysis should be more             U.S.C. 1a(19).                                            swaps from small energy retailers and consumers).



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                                                 30626             Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations

                                                 the cooperative. By contrast, the other                 compare a person’s swap or security-                      certain amendments as new swaps or
                                                 entities noted above enter into swaps                   based swap dealing activities to the                      security-based swaps).
                                                 with unaffiliated parties in order to                   person’s non-dealing activities.364
                                                                                                                                                                   2. Commenters’ Views
                                                 transfer risks between unaffiliated                        At the same time, we recognized that
                                                 parties.361 As noted above, the                         this proposed approach did not appear                     a. Basis for the Exception
                                                 Commissions believe that the                            to ‘‘readily translate into objective                        Some commenters sought to link the
                                                 contemplated scope of the statutory                     criteria.’’ We further recognized that a                  de minimis exception to systemic risk
                                                 definitions does not include instances                  range of alternative approaches may be                    criteria by taking the position that a
                                                 where a person’s swap activities transfer               reasonable, and we solicited comment                      person should have to register as a
                                                 risk within an affiliated group, but does               as to what factors should be used to                      dealer only if its dealing activities pose
                                                 extend to activities that create legal                  implement the exception.365                               systemic significance.369 One
                                                 relationships that transfer risk between                   The proposed de minimis exception                      commenter specifically objected to the
                                                 unaffiliated parties. Thus, it is                       was comprised of three factors, all of                    position in the Proposing Release that
                                                 appropriate that the dealer analysis                    which a person would have had to                          the de minimis exception should take
                                                 exclude swaps between a cooperative                     satisfy to avail itself of the exception.366              into account customer protection
                                                 and its members, but such analysis                      The first proposed factor would have                      principles.370 On the other hand, one
                                                 should include swaps between a                          limited the aggregate effective amount,                   commenter supported the rejection of a
                                                 cooperative or other aggregator and                     measured on a gross basis, of the swaps                   risk-based de minimis test.371
                                                 unaffiliated persons.                                   or security-based swaps that a person                        Some commenters argued that the de
                                                 D. De Minimis Exception                                 entered into over the prior 12 months in                  minimis test should account for
                                                                                                         connection with its dealing activities to                 proportionality criteria that would
                                                 1. Proposed Approach                                    $100 million 367 (or $25 million with                     excuse entities whose dealing activity is
                                                    The Dodd-Frank Act’s definitions of                  regard to counterparties that are                         relatively minor compared to their other
                                                 ‘‘swap dealer’’ and ‘‘security-based                    ‘‘special entities’’).368                                 activities.372
                                                 swap dealer’’ require that the                             The second proposed factor would                       b. Significance of ‘‘Customer’’ Language
                                                 Commissions exempt from dealer                          have limited a person’s swap or
                                                 designation any entity ‘‘that engages in                security-based swap dealing activity to                      One commenter took the position that
                                                 a de minimis quantity’’ of dealing ‘‘in                 no more than 15 counterparties over the                   the language within the de minimis
                                                 connection with transactions with or on                 prior 12 months (while counting                           exception that specifically referred to
                                                 behalf of customers.’’ The statutory                    counterparties that are members of an                     ‘‘transactions with or on behalf of
                                                 definitions further require the                         affiliated group as one counterparty for                  customers’’ meant that the exception
                                                 Commissions to ‘‘promulgate                             these purposes). The final proposed                       should be available only for persons
                                                 regulations to establish factors with                   factor would have limited a person’s                      who limit their swaps or security-based
                                                 respect to the making of any                            dealing activity to no more than 20                       swaps to those that are entered into with
                                                 determination to exempt.’’ 362                          swaps or security-based swaps over the                    or on behalf of customers.373 Other
                                                    In the Proposing Release, we                         prior 12 months (without counting                         commenters posited the opposite view
                                                 preliminarily concluded that the de                                                                               that the ‘‘customer’’ language should be
                                                 minimis exception ‘‘should be                             364 See
                                                                                                                                                                   read to mean that a person’s dealing
                                                                                                                    id. at 80179–80.
                                                 interpreted to address amounts of                         365 See  id. at 80180.
                                                                                                                                                                   activities with counterparties other than
                                                 dealing activity that are sufficiently                     366 Under the proposal, the factors would              customers may be disregarded for
                                                 small that they do not warrant                          consider a person’s swap or security-based swap           purposes of the exception (i.e., non-
                                                 registration to address concerns                        dealing activity as a whole, rather than separately       customer transactions would not count
                                                                                                         considering different types of swaps or security-         against the de minimis thresholds).374
                                                 implicated by the regulations governing                 based swaps. See Proposing Release, 75 FR at
                                                 swap dealers and security-based swap                    80181.                                                    Some commenters argued that
                                                 dealers. In other words, the exception                     367 See proposed Exchange Act rule 3a71–2(a).
                                                                                                                                                                      369 See, e.g., letters from CDEU, MFX II, NCGA/
                                                 should apply only when an entity’s                      The proposed standard reflected our understanding
                                                                                                         that in general the notional size of a small swap or      NGSA II and SIFMA—Regional Dealers Derivatives
                                                 dealing activity is so minimal that                     security-based swap is $5 million or less, and that       Committee (‘‘SIFMA—Regional Dealers’’).
                                                 applying dealer regulations to the entity               the proposed threshold would reflect 20                      370 See letter from WGCEF I (arguing that basing

                                                 would not be warranted.’’ 363 In taking                 instruments of that size. The standard also sought        the exception on customer protection principles
                                                 this view, we rejected the suggestion                   to reflect the customer protection issues implicated      would be contrary to the statutory framework, given
                                                                                                         by swaps and security-based swaps. See Proposing          that only ECPs are eligible to participate in off-
                                                 that the de minimis exception should                    Release, 75 FR at 80180.                                  exchange swap transactions).
                                                                                                                                                                      371 See letter from Better Markets I.
                                                                                                            The proposed notional threshold would not
                                                   361 See, e.g., letter from NFPEEU (not-for-profit
                                                                                                         consider the market risk offsets associated with             372 See, e.g., letters from FHLB I, IECA–Credit I,
                                                 power utilities and electric cooperatives generally     combining long and short positions. In addition, the      NCGA/NGSA I, NRG Energy, Peabody and WGCEF
                                                 enter into swaps between themselves, with large         proposed notional threshold would not account for         I. One commenter said the proportionality criteria
                                                 industrial consumers, and a wide range of other         the amount of collateral held or posted by the            should also consider an entity’s activities with
                                                 counterparties). Indeed, the Dodd-Frank Act             entity, or other risk mitigating factors. See id.         respect to the physical commodity underlying its
                                                 permits the CFTC to exempt agreements, contracts           368 See proposed Exchange Act rule 3a71–2(a). As       swaps. See letter from NCGA/NGSA I. But see letter
                                                 or transactions between entities described in           set forth by the statutory business conduct rules         from Better Markets I (supporting rejection of a
                                                 section 201(f) of the Federal Power Act, such as        applicable to security-based swap dealers (as set         proportionality test). Some commenters suggested
                                                 certain not-for-profit power utilities and electric     forth in Exchange Act section 15F(h)(2)(C)),              more than one alternative approach.
                                                 cooperatives. See section 722(f) of the Dodd-Frank      ‘‘special entity’’ refers to: Federal agencies; States,      373 See letter from Better Markets I. Another
                                                 Act. As noted above, a coalition of not-for-profit      State agencies and political subdivisions (including      commenter said that the ‘‘customer’’ language
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                                                 power utilities and electric cooperatives has           cities, counties and municipalities); ‘‘employee          serves to emphasize that the de minimis exception
                                                 advised that it plans to submit a request for the       benefit plans’’ as defined under the Employee             is available to entities that provide swaps to
                                                 exemption contemplated by section 722(f) of the         Retirement Income Security Act of 1974 (‘‘ERISA’’);       customers. See letter from NGFA I.
                                                 Dodd-Frank Act. See note 295 supra.                     ‘‘governmental plans’’ as defined under ERISA; and           374 See letters from ISDA I, Vitol and WGCEF I.
                                                   362 CEA section 1a(49)(D), 7 U.S.C. 1a(49)(D);
                                                                                                         endowments. Title VII imposes additional business         Another commenter said that the use of the term
                                                 Exchange Act section 3(a)(71)(D), 15 U.S.C.             conduct requirements on security-based swap               ‘‘customer’’ indicates that all transactions with
                                                 78c(a)(71)(D).                                          dealers in connection with special entities. See CEA      physical commodity customers should be
                                                   363 Proposing Release, 75 FR at 80179 (footnote       sections 4s(h)(2), 4s(h)(4), 4s(h)(5); Exchange Act       disregarded in determining if a person is a dealer.
                                                 omitted).                                               section 15F(h)(2), (4), (5).                              See letter from EDF Trading.



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                                                                   Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations                                                       30627

                                                 transactions entered into in a fiduciary                 market 382 or some other fixed value,383                 suggested a variety of other alternatives
                                                 capacity should be disregarded for                       or arguing in favor of an exposure-based                 to the proposed tests.389
                                                 purposes of the exception.375 One                        threshold in lieu of a notional
                                                                                                                                                                   d. Additional Issues
                                                 commenter questioned the proposal’s                      threshold.384 Other commenters said
                                                 use of the term ‘‘counterparty’’ in lieu                 that the aggregate notional amount of                      Some commenters emphasized the
                                                 of the statutory term ‘‘customer.’’ 376                  swaps is not a meaningful measure of an                  need to provide protections in
                                                                                                          entity’s dealing activity.385 A few                      connection with ‘‘special entities.’’ 390
                                                 c. Proposed Tests and Thresholds                         commenters supported the proposed                        Certain commenters sought to identify
                                                                                                          notional threshold.386                                   problems related to the application of
                                                    Commenters criticized the proposed                                                                             the proposed thresholds in connection
                                                                                                            Some commenters argued against
                                                 de minimis thresholds in a variety of                                                                             with particular types of businesses or
                                                                                                          basing the de minimis exception on the
                                                 ways. These included arguments that                      number of a person’s swaps or security-                  markets,391 or to aggregators or
                                                 the proposed thresholds were                             based swaps or the number of a person’s
                                                 inappropriately low,377 would harm                       counterparties,387 or supported                          disjunctive—i.e., a dealer’s activity would be de
                                                 end-users by reducing the number of                                                                               minimis if it were below either standard. See letter
                                                                                                          increasing those thresholds above the                    from Northland Energy. Other commenters raised
                                                 entities willing to enter into low-value                 proposed standard.388 Commenters also                    questions about how counterparties or transactions
                                                 swaps and security-based swaps,378                                                                                should be counted for purposes of the standard. See
                                                 would be unjustified on a cost-benefit                      382 See letter from COPE I (suggesting 0.001% of      letters from CDEU (novations should not be counted
                                                                                                          the total U.S. swap market, amounting to                 as new transactions) and J.P. Morgan (members of
                                                 basis,379 and were disproportionately                                                                             an affiliated group should be counted as one
                                                                                                          approximately $3 billion); see also letters from API
                                                 low compared to the activities of                        dated June 3, 2011 (‘‘API II’’), EDF Trading, Edison     counterparty), joint letter from BB&T, East West
                                                 recognized dealers.380 Other                             Int’l, EEI/EPSA, IECA–Credit I, NCGA/NGSA II,            Bank, Fifth Third Bank, The PrivateBank and Trust
                                                                                                                                                                   Company, Regions Bank, Sun Trust Bank, U.S. Bank
                                                 commenters said the de minimis                           NextEra, NFPEEU, Utility Group and WGCEF I
                                                                                                                                                                   National Association and Wells Fargo Bank, N.A.
                                                 thresholds should be set at a level to                   (suggesting 0.001% of the total U.S. swap market).
                                                                                                             383 See, e.g., meeting with Land O’Lakes on
                                                                                                                                                                   (‘‘Midmarket Banks’’) (questioning how to count
                                                 allow entities to engage in a meaningful                 January 6, 2011 (suggesting the threshold be
                                                                                                                                                                   multiple borrower counterparties to a loan and
                                                                                                                                                                   swap) and meeting with Land O’Lakes on January
                                                 amount of customer-facing swaps or                       increased by 2 to 5 times—i.e., to $200 million to       6, 2011 (members of a cooperative should be
                                                 security-based swaps without being                       $500 million); letters from Growmark, FHLB I and         counted as one counterparty).
                                                                                                          MFX II (each supporting $1 billion notional
                                                 required to register as dealers.381                      standard); Regional Banks (supporting $2 billion
                                                                                                                                                                      Last, some commenters said that the number of
                                                                                                                                                                   transaction or number of counterparty standards
                                                    A number of commenters particularly                   notional standard); letter from NCFC dated October
                                                                                                                                                                   should be deleted because they are not useful as
                                                 criticized the proposed notional                         31, 2011 (‘‘NCFC III’’) (supporting alternative
                                                                                                                                                                   tests of de minimis status. See letters from Gavilon
                                                                                                          notional standards of $1 billion or $3 billion
                                                 threshold, with some commenters                                                                                   II (eliminate both standards) and SIFMA—Regional
                                                                                                          depending on certain assumptions); letter from FSR
                                                                                                                                                                   Dealers (eliminate number of counterparties
                                                 suggesting that the threshold should be                  VI and joint letter from Capital One, Fifth Third        standard).
                                                 based on a percentage of the total swap                  Bancorp and Regions Financial Corporation                   389 See letters from IECA–Credit I (suggesting that
                                                                                                          (suggesting notional standard of at least $2 billion);
                                                                                                                                                                   exception exclude persons whose positions either
                                                                                                          letter from WGCEF dated June 3, 2011 regarding the
                                                                                                                                                                   are below a notional threshold or are below a
                                                   375 See,  e.g., letter from FSR I.                     swap dealer definition (‘‘WGCEF V’’) (suggesting
                                                                                                                                                                   combined proportionality and revenue threshold),
                                                                                                          notional standard of $3.5 billion); and letter from
                                                   376 See  letter from Vitol (suggesting that the                                                                 SIFMA—Regional Dealers (supporting annual
                                                                                                          IPR–GDF Suez Energy North America (suggesting
                                                 proposed language meant that dealing activity                                                                     threshold of 500 customer-facing or riskless
                                                                                                          notional standard of $10 billion). Some commenters
                                                 involved ‘‘customers’’ but not ‘‘counterparties’’).                                                               principal swaps, consistent with the de minimis
                                                                                                          suggested more than one possible threshold.
                                                    377 See, e.g., letters from API I, CDEU, DFA, EDF        384 See, e.g., letters from Farm Credit Council I,
                                                                                                                                                                   exception from the Exchange Act ‘‘broker’’
                                                                                                                                                                   definition in connection with bank brokerage
                                                 Trading, Farm Credit Council I, Growmark, Land           FSR VI and Midsize Banks. Other commenters said          activity, as well as SEC rules in connection with the
                                                 O’Lakes dated January 13, 2011 (‘‘Land O’Lakes I’’),     the threshold should account for the effect of           Exchange Act definition of ‘‘dealer’’), FHLB I
                                                 Midsize Banks, NCFC I, NCGA/NGSA II, New York            netting. See letters from API II, Chesapeake Energy,     (supporting non-quantitative test accounting for
                                                 City Bar Association—Committee on Futures and            Land O’Lakes I and MFX II. On the other hand, one        relatively small swap-related exposure compared to
                                                 Derivatives Regulation (‘‘NYCBA Committee’’),            commenter specifically supported the use of the          primary customer activity, collateral that also
                                                 Northland Energy, NRG Energy, Regional Banks and         gross notional amount. See letter from Greenberger.      provides credit support for other business done
                                                                                                             385 See letters from Farm Credit Council I, ISDA
                                                 SIFMA—Regional Dealers. Some commenters also                                                                      with the customer, an existing relationship with
                                                                                                          I, Land O’Lakes I, Midsize Banks, NCFC I, SIFMA—         customer and inability of customer to obtain swaps
                                                 said that the thresholds, particularly those for
                                                                                                          Regional Dealers and Vitol.                              from entities that primarily are dealers), Gavilon II
                                                 swaps, should vary according to the riskiness of the        386 See letters from AFR, Better Markets I,
                                                                                                                                                                   (alluding to use of non-quantitative tests), MFX II
                                                 swap or type of commodity underlying the swap.           Greenberger and NMPF. One of these commenters            (suggesting establishment of a separate qualitative
                                                 See letters from BG LNG I, Farm Credit Council I,        said that data on credit default swaps analyzed by       process by which a dealer may establish why
                                                 Gavilon II, ISDA I, NFPEEU, Vitol and WGCEF I.           the SEC’s Division of Risk, Strategy, and Financial      registration is not warranted) and DC Energy
                                                    378 See, e.g., letters from API I, BG LNG IFarm       Innovation indicates that the $100 million proposed      (thresholds should be set at a level appropriate to
                                                 Credit Council I, Midsize Banks, NCFC I, NGFA I,         notional thresholds are too high. See letters from       support the capital levels to be required for swap
                                                 Regional Banks and SIFMA—Regional Dealers and            Better Markets to CFTC and SEC dated April 6,            dealers).
                                                 meetings with Electric Companies on April 13,            2012 (‘‘Better Markets III’’).                              390 See letters from Better Markets I (arguing that
                                                                                                             387 See, e.g., letters from API II, Atmos Energy,
                                                 2011, the Asset Management Group of SIFMA                                                                         the de minimis exception should not be available
                                                 (‘‘SIFMA—AMG’’) on February 4, 2011 and WGCEF            Chesapeake Energy, COPE I, EEI/EPSA, Gavilon II,         in connection with transactions with special
                                                                                                          IECA–Credit I, Land O’Lakes I, NCGA/NGSA II,             entities), AFR (similar), Greenberger (supporting
                                                 on April 28, 2011.
                                                                                                          NEM, NextEra I, NMPF, NRG Energy, Peabody and            reduction of the notional threshold for transactions
                                                    379 See, e.g., letters from CDEU and Vitol. Another
                                                                                                          Utility Group.                                           with special entities to $5 million) and AFSCME.
                                                 commenter noted that application of a cost-benefit          388 See, e.g., letters from ISDA I (suggesting 25     Some commenters said the standard for swaps and
                                                 analysis of the de minimis threshold could be            transactions over 12 months); FHLB I (suggesting 25      security-based swaps with special entities should
                                                 challenging. See Roundtable Transcript at 193–94         counterparties and 50 transactions over 12 months)       be a notional value equal to 0.0001% of the total
                                                 (remarks of Camille Rudge, The PrivateBank and           FSR I and Midsize Banks (each suggesting 75              U.S. swap market. See letters from COPE I, EDF
                                                 Trust Company).                                          counterparties and 200 transactions over 12              Trading, EEI/EPSA, IECA–Credit I, NFPEEU and
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                                                    380 See letter from CDEU (citing statistics           months); Regional Banks (suggesting 100                  Utility Group. One commenter said the threshold
                                                 indicating that the average respondent to an ISDA        counterparties and 300 transactions over 12              for special entities should be eliminated because it
                                                                                                          months); Growmark and MFX II (suggesting                 is not useful in determining de minimis status. See
                                                 survey had an annual ‘‘event volume’’ of over
                                                                                                          thresholds should be increased by a factor of 10)        letter from Gavilon II.
                                                 297,000 OTC derivatives trade processing actions);       and meeting with Land O’Lakes on January 6, 2011            391 See letters from BG LNG I (small energy
                                                 see also letter from Regional Banks.                     (suggesting thresholds should be increased by a          companies), COPE I and Northland Energy (each
                                                    381 See meetings with Electric Companies on
                                                                                                          factor of between 2 and 5).                              discussing commodity markets, suggesting that
                                                 April 13, 2011, Gavilon on May 11, 2011 and                 One commenter said the number of transaction          notional thresholds be based on the unit of a
                                                 WGCEF on April 28, 2011.                                 and number of counterparty standards should be                                                       Continued




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                                                 30628             Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations

                                                 cooperatives.392 Other commenters                         without regard to dealing activities                     by Title VII for particular users of swaps
                                                 suggested that the exception should                       taken prior to the effectiveness of Title                and security-based swaps.410 The
                                                 focus dealer regulation toward                            VII.403 One commenter requested that a                   broader the exception, the greater the
                                                 ‘‘financial’’ entities.393 One commenter                  person that falls above the de minimis                   loss of protection.411 Moreover, in
                                                 emphasized the need for the exception                     tests be able to take advantage of                       determining the scope of the exception,
                                                 to be available when the end-user is a                    application and re-evaluation periods                    it is important to consider not only the
                                                 credit union, bank or thrift.394                          akin to those associated with the major                  current state of the swap and security-
                                                    Commenters sought clarification that                   participant definitions.404                              based swap markets, but also to account
                                                 the de minimis criteria would not apply                     Two commenters expressed support                       for how those markets may evolve in the
                                                 to transactions for hedging or                            for the proposed self-executing                          future. This is particularly important
                                                 proprietary trading purposes,395 or to                    approach of the exception.405 Some                       because the full implementation of Title
                                                 inter-affiliate transactions.396                          commenters requested clarification that                  VII—including enhancements to pricing
                                                    Commenters also raised issues related                  the de minimis exception is                              transparency and the increased access to
                                                 to the exception’s treatment of the                       independent of the loan origination                      central clearing—reasonably may be
                                                 proposed use of a rolling annual period                   exclusion in the CEA ‘‘swap dealer’’                     expected to facilitate new entrants into
                                                 for calculations,397 the proposed use of                  definition.406                                           the swap and security-based swap
                                                 ‘‘effective notional amounts,’’ 398 the                     A number of commenters also                            markets. To the extent that such
                                                 possibility of adjusting the thresholds                   addressed the application of dealer                      entrants engage in dealing activity
                                                 over time,399 how the de minimis tests                    regulation to non-U.S. entities. While                   below the de minimis threshold—either
                                                 would apply in the context of affiliated                  those comments did not specifically                      for the long term or until their activity
                                                 positions,400 and how the exception                       address the de minimis exception, the                    surpasses the threshold—the relative
                                                 would account for swaps or security-                      exception may be relevant to addressing                  amount of unregistered activity within
                                                 based swaps entered into before the                       these cross-border issues.407                            the market may be expected to increase.
                                                 definition’s effective date.401                             One commenter separately addressed                     Accordingly, a higher de minimis
                                                    Some commenters suggested that the                     the credit default swap data analysis                    threshold may not only result in a
                                                 de minimis thresholds be set higher                       made available by CFTC and SEC                           certain percentage of unregistered
                                                 initially to provide for efficient use of                 staffs.408 The commenter expressed the                   activity being transacted initially,
                                                 regulatory resources.402 One commenter                    view that this data supported the                        consistent with the current market, but
                                                 requested clarification that the                          adoption of a de minimis threshold of                    also may result in an even greater
                                                 exception would apply prospectively                       $100 million or less, particularly                       proportion of unregistered activity being
                                                                                                           focusing on the number of entities that                  transacted in the future.
                                                 commodity), NCFC I (commodity prices), NGFA I             may be excluded under particular                            On the other hand, the Commissions
                                                 (grain elevators) and WGCEF I (energy prices).            thresholds.409
                                                    392 See, e.g., letters from Growmark and Land
                                                                                                                                                                    also recognize that Congress included a
                                                 O’Lakes I.                                                3. Final Rules—General Principles for                    statutorily mandated de minimis
                                                    393 See letters from NEM, NextEra I, and NGFA
                                                                                                           Implementing the De Minimis Exception                    exception for certain swap and security-
                                                 I.                                                                                                                 based swap dealing activity, and that an
                                                    394 See letter from CUNA.                              a. Balancing Regulatory Goals and                        appropriately calibrated de minimis
                                                    395 See, e.g., letters from API I, EDF Trading,        Burdens                                                  exception has the potential to advance
                                                 Gavilon II and SIFMA—Regional Dealers.
                                                    396 See, e.g., letter from Atmos Energy Holdings,
                                                                                                              The Commissions recognize that                        other interests. For example, the de
                                                 Inc (‘‘Atmos Holdings’’).                                 implementing the de minimis exception                    minimis exception may further the
                                                    397 See letters from NCGA/NGSA I (supporting           requires a careful balancing that                        interest of regulatory efficiency when
                                                 measurement of rolling period average over 12             considers the regulatory interests that
                                                 months), NextEra I (supporting evaluation as of the       could be undermined by an unduly                            410 A number of commenters expressed particular
                                                 last day of each calendar quarter rather than over                                                                 concerns as to the threats that an overbroad
                                                 the immediate preceding 12 months) and Northland          broad exception as well as those
                                                                                                                                                                    exception would pose to special entities. See letters
                                                 Energy (requesting clarification that if a monetary       regulatory interests that may be                         from AFR (noting that Congress incorporated
                                                 notional amount is used, the evaluation periods           promoted by an appropriately limited                     special protections for special entities in reaction to
                                                 should be fixed rather than rolling).
                                                    398 See letters from ISDA I (stating that the use of
                                                                                                           exception.                                               news reports about special entities losing millions
                                                                                                              On the one hand, a de minimis                         of dollars ‘‘after signing up for derivatives deals
                                                 ‘‘effective notional amount’’ in the test introduces                                                               they did not understand,’’ and urging the
                                                 ambiguity and uncertainty) and WGCEF I (notional          exception, by its nature, will eliminate                 elimination of any de minimis exception for
                                                 amounts should be measured on a ‘‘delta-                  key counterparty protections provided                    transactions with special entities); Better Markets I
                                                 equivalent’’ basis).                                                                                               (stating that history has shown that special entities
                                                    399 See letters from Farm Credit Council I
                                                                                                             403 See  letter from FSR I.                            are vulnerable to abuse, and that they need capital,
                                                 (supporting automatic periodic increases to reflect         404 See                                                collateral and business conduct protections as
                                                                                                                      letter from WGCEF I; see also Northland
                                                 changes in market size, the size of typical contracts                                                              much as or more than any other category of market
                                                                                                           Energy (supporting grace period for registration if
                                                 and inflation), Greenberger (supporting reevaluation                                                               participants); and AFSCME (expressing skepticism
                                                                                                           the de minimis threshold is exceeded).
                                                 of the de minimis criteria on an ongoing basis), and         405 See letters from ISDA I and Northland Energy.     as to the view that dealer status would preclude
                                                 BG LNG I, EEI/EPSA, NCFC I and WGCEF I (each                                                                       firms from entering into transactions with special
                                                                                                              406 See letters from FSR VI and Midsize Banks.
                                                 supporting inflation or market size adjustments).                                                                  entities). Some of those commenters also generally
                                                    400 See meeting with Edison Int’l (requesting             407 Some commenters particularly took the view
                                                                                                                                                                    supported the proposed $100 million de minimis
                                                 clarification that an entity that is prohibited from      that the application of the dealer definitions to non-   threshold. See letters from AFR and Better Markets
                                                 coordinating its financial derivatives activities         U.S. persons should solely address those persons’        I; see also letter from Greenberger (stating that the
                                                 should determine whether it qualifies for the de          U.S. dealing activities. See letters from FSR I, ISDA    dynamic nature of the derivatives sector of the
                                                 minimis exception without considering financial                       ´ ´ ´ ´
                                                                                                           I and Societe Generale. Some commenters also             financial markets should counsel caution, and that
                                                 derivatives entered into by its affiliated entities).     specifically identified concerns of international        the de minimis threshold should be reevaluated on
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                                                    401 See letter from Covington & Burling (urging        comity in this context. See letters cited in note 148,   an ongoing basis).
                                                 clarification that lookback period will not               supra.                                                      411 Notwithstanding the reduction in protection,
                                                 commence until all the relevant regulations become           The Commissions intend to address the                 however, in the case of swaps and security-based
                                                 effective).                                               application of dealer regulation to non-U.S. persons     swaps the general antifraud provisions of the CEA
                                                    402 See letters from BGLNG I and WGCEF V. See          as part of separate releases that generally will         and the securities laws, respectively, including
                                                 also Roundtable Transcript at 50–51 (remarks of           address the application of Title VII to non-U.S.         rules to be adopted by the SEC pertaining
                                                 Ron Oppenheimer, WGCEF), 57 (remarks of Richard           persons.                                                 specifically to security-based swaps, will continue
                                                                                                              408 See letter from Better Markets III.
                                                 Ostrander, Morgan Stanley) and 208–09 (remarks of                                                                  to apply to all transactions in security-based swaps.
                                                 Bella Sanevich, NISA Investment Advisors).                   409 See id.                                           See, e.g., CEA section 4b(2), 7 U.S.C. 6b(2).



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                                                                    Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations                                                       30629

                                                 the amount of a person’s dealing activity                   counterparties,415 as discussed above, as                inappropriate or misunderstood swap or
                                                 is, in the context of the relevant market,                  well as requirements aimed at helping                    security-based swap than if the
                                                 limited to an amount that does not                          to promote effective operation and                       instrument was transacted pursuant to
                                                 warrant registration to address the                         transparency of the swap and security-                   the business conduct rules applicable to
                                                 concerns implicated by government                           based swap markets.416 The overall                       registered dealers.
                                                 regulation of swap dealers and security-                    economic benefits provided by these                         In contrast to the benefits associated
                                                 based swap dealers. To advance this                         requirements in large part will depend                   with dealer regulation, many of the
                                                 interest, it is necessary to consider the                   on the proportion of swaps and security-                 burdens of dealer regulation will accrue
                                                 benefits to the marketplace associated                      based swaps that are transacted subject                  in the short term and will fall directly
                                                 with the regulation of dealers against                      to these requirements. In other words,                   on registered dealers.419 Some of those
                                                 the total burdens and potential impacts                     the greater the dealing activity of a                    burdens may be expected to be
                                                 on competition, capital formation and                       registered dealer, the more significant                  independent of the amount of an
                                                 efficiency associated with that                             the resulting increase in market                         entity’s dealing activity (i.e., entities
                                                 regulation.412                                              efficiency,417 and the greater the                       that engage in minimal dealing activity
                                                    In addition, the exception can provide                   reduction in risks faced by the entity’s                 would still be expected to face certain
                                                 an objective test for persons who engage                    customers and counterparties.418 These                   burdens associated with the registration
                                                 in some swap or security-based swap                         benefits can be expected to accrue over                  process and the development of
                                                 activities that, in their view, potentially                 the long term and be distributed over                    compliance and other systems if they
                                                 raise the risk that they would be deemed                    the market and its participants as a                     are required to register as dealers), while
                                                 to be dealers.413 The exception also may                    whole. This is not to say, however, that                 other burdens (e.g., the impact of margin
                                                 permit persons that are not registered as                   it would be insignificant for any                        and capital rules applicable to dealers)
                                                 dealers to accommodate existing clients                     particular counterparty if its swaps or                  may be more directly linked to the
                                                 that have a need for swaps or security-                     security-based swaps were to fall                        amount of that entity’s dealing activity.
                                                 based swaps in conjunction with other                       outside of the ambit of dealer regulation.                  As discussed below, the Commissions
                                                 financial services or commercial                            For example, a customer or counterparty                  have sought to balance the various
                                                 activities, thus avoiding the need for                      that is not protected by the business                    interests associated with a de minimis
                                                 such clients to establish separate                          conduct rules applicable to dealers                      exception, as well as the benefits and
                                                 relationships with registered dealers,                      might be more likely to suffer losses                    burdens associated with such an
                                                 which may have attendant costs. The                         associated with entering into an                         exception, in developing the factors to
                                                 exception further may promote                                                                                        implement the de minimis exceptions to
                                                                                                                415 As discussed above, in part, these customer
                                                 competition in dealing activity within                                                                               the ‘‘swap dealer’’ and ‘‘security-based
                                                                                                             and counterparty protections derive from the
                                                 the swap or security-based swap                             financial responsibility requirements applicable to
                                                                                                                                                                      swap dealer’’ definitions.
                                                 markets, by helping to allow non-                           dealers, particularly: capital and margin                   However, in moving forward with
                                                 registered persons to commence                              requirements (CEA section 4s(e); Exchange Act            implementing this balancing approach,
                                                                                                             section 15F(e)), and requirements for segregation of     we recognize that the information that
                                                 providing dealing services while                            collateral (CEA sections 4d(f), 4s(l); Exchange Act
                                                 avoiding the costs associated with full-                    section 3E).
                                                                                                                                                                      currently is available regarding certain
                                                 fledged dealers. More competition                              These customer and counterparty protections also      portions of the swap market is limited.
                                                 within the market for swaps and                             derive from certain other requirements applicable to     Following the full implementation of
                                                 security-based swaps may not only                           dealers, particularly: requirements with respect to      Title VII, more information will be
                                                                                                             business conduct when transacting with special
                                                 decrease the costs for participants in the                  entities (CEA sections 4s(h)(2), 4s(h)(4), 4s(h)(5);
                                                                                                                                                                      available to permit us to assess the
                                                 market, but also may help to decrease                       Exchange Act sections 15F(h)(2), (h)(4), (h)(5));        effectiveness of this balancing for
                                                 systemic risk by lessening the current                      disclosure requirements (CEA section 4s(h)(3)(B);        particular markets and to revise the
                                                                                                             Exchange Act section 15F(h)(3)(B)); requirements         exception as appropriate.
                                                 apparent concentration of dealing                           for fair and balanced communications (CEA section
                                                 activity among a few major market                           4s(h)(3)(D); Exchange Act section 15F(h)(3)(C));
                                                                                                                                                                         In that context—and in light of the
                                                 participants.414                                            other requirements related to the public interest and    tools currently available to us—we have
                                                    The statutory requirements that apply                    investor protection (CEA section 4s(h)(3)(D);            been influenced, in particular, by
                                                                                                             Exchange Act section 15F(h)(3)(D)); and conflict of      comments taking the view that the de
                                                 to swap dealers and security-based swap                     interest provisions (CEA section 4s(j)(5); Exchange
                                                 dealers include requirements aimed at                       Act section 15F(j)(5)).
                                                                                                                                                                      minimis factors should take into
                                                 the protection of customers and                                416 Relevant provisions are: reporting and            account the size and unique attributes of
                                                                                                             recordkeeping requirements (CEA section 4s(f);           the market for swaps and security-based
                                                    412 While we are mindful that the Commissions
                                                                                                             Exchange Act section 15F(f)); daily trading records      swaps.420 We believe that factors that
                                                                                                             requirements (CEA section 4s(g); Exchange Act            exclude entities whose dealing activity
                                                 have yet to adopt all the final substantive rules           section 15F(g)); regulatory standards related to the
                                                 applicable to swap dealers and security-based swap          confirmation, processing, netting, documentation         is sufficiently modest in light of the
                                                 dealers, we nonetheless believe that we have                and valuation of security-based swaps (CEA section       total size, concentration and other
                                                 sufficient understanding of those potential                 4s(i); Exchange Act section 15F(i)); position limit
                                                 requirements to reasonably balance the relevant
                                                                                                                                                                      attributes of the applicable markets can
                                                                                                             monitoring requirements (CEA section 4s(j)(1);
                                                 factors to identify the initial level of dealing activity   Exchange Act section 15F(j)(1)); risk management
                                                                                                                                                                      be useful in avoiding the imposition of
                                                 that should be considered to be de minimis.                 procedure requirements (CEA section 4s(j)(2);
                                                 Moreover, finalizing the dealer definitions will help       Exchange Act section 15F(j)(2)); and requirements           419 Certain commenters also have expressed
                                                 provide for the orderly and informed finalization of        related to the disclosure of information to regulators   concerns that the prospect of regulation may deter
                                                 those other substantive rules governing swap                (CEA section 4s(j)(3); Exchange Act section              certain entities from engaging in limited swap or
                                                 dealers and security-based swap dealers.                    15F(j)(3)).                                              security-based swap dealing activities, see, e.g.,
                                                    413 ‘‘Congress incorporated a de minimis                    417 For example, the more swaps or security-based     letters from SIFMA—Regional Dealers and Midsize
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                                                 exception to the Swap Dealer definition to ensure           swaps a dealer enters into, the more significant will    Banks, which could reduce the availability of those
                                                 that smaller institutions that are responsibly              be the efficiency benefits associated with               instruments.
                                                 managing their commercial risk are not                      confirmation, processing, netting documentation             420 See, e.g., letters from CDEU (comparing
                                                 inadvertently pulled into additional regulation.’’          and valuation requirements applicable to dealers.        proposed thresholds with statistics regarding the
                                                 See 156 Cong. Rec. S6192 (daily ed. July 22, 2010)             418 For example, the more swaps or security-based     activities of recognized dealers) and EEI/EPSA
                                                 (letter from Senators Dodd and Lincoln to                   swaps a dealer enters into, the more significant the     (recommending that thresholds be set at an amount
                                                 Representatives Frank and Peterson).                        number of counterparties that will be protected by       equal to 0.001 percent of the aggregate size of the
                                                    414 See 478 through 487 and accompanying text,           the disclosure and other business conduct                U.S. swaps market, and 0.0001 percent for swaps
                                                 infra.                                                      obligations imposed on dealers.                          in which the counterparty is a special entity).



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                                                 30630             Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations

                                                 regulatory burdens on those entities for                some commenters have posited                               Proposing Release, these notional
                                                 which dealer regulation would not be                    measures of risk or exposure as                            standards will be based on ‘‘effective
                                                 expected to contribute significantly to                 alternatives to notional measures, such                    notional’’ amounts when the stated
                                                 advancing the customer protection,                      risk or exposure measures could, to the                    notional amount is leveraged or
                                                 market efficiency and transparency                      extent they allow for netting or                           enhanced by the structure of the swap
                                                 objectives of dealer regulation. The                    collateral offsets, potentially allow an                   or security-based swap.427
                                                 Commissions note, however, that they                    unregistered entity to engage in large
                                                 are not of the general view that the costs              amounts of swap or security-based swap                     ii. Other Tests From the Proposing
                                                 of extending regulation to any particular               dealing activity while remaining within                    Release
                                                 entity must be outweighed by the                        the de minimis exception so long as that                     The proposed rules limited the
                                                 quantifiable or other benefits to be                    entity nets or collateralizes its swap or                  number of swaps or security-based
                                                 achieved with respect to that particular                security-based swap positions. Such an                     swaps that an entity could enter into in
                                                 entity. The Commissions, rather,                        outcome could undermine the customer                       a dealing capacity, and the number of an
                                                 analyze the overall benefits and costs of               protection and market operation                            entity’s counterparties in a dealing
                                                 regulation, keeping in mind, as noted                   benefits associated with dealer                            capacity. The final rules do not include
                                                 above, that the benefits may be                         regulation. As with the proposed rules,                    those measures. In part, this reflects
                                                 distributed, accrue over the long-term,                 the notional factor in the final rules is                  commenter concerns that a standard
                                                 and be difficult to quantify or to                      based on the notional positions of an                      based on the number of swaps or
                                                 measure as easily as certain costs.421                  entity over a 12 month period, rather                      security-based swaps or counterparties
                                                 b. Specific Factors Implementing the De                 than capping the current notional                          can produce arbitrary results by giving
                                                 Minimis Exception                                       amount of a position at any time, to                       disproportionate weight to a series of
                                                                                                         better reflect the amount of an entity’s                   smaller transactions or
                                                 i. Notional Test                                        current activity.                                          counterparties.428
                                                    Consistent with the proposal, the final                 The final rules, like the proposed
                                                                                                         rules, include lower notional thresholds                   c. Significance of Statutory ‘‘Customer’’
                                                 rules implementing the de minimis                                                                                  Language
                                                 exception take into account the notional                for dealing activities in which the
                                                 amount of an entity’s swap or security-                 counterparty is a ‘‘special entity.’’ 424                     Consistent with the Proposing
                                                 based swap positions over the prior 12                  This is consistent with the fact that Title                Release, the final rules implementing
                                                 months arising from its dealing                         VII’s requirements applicable to swap                      the de minimis exception do not require
                                                 activity.422 While the Commissions                      dealers and security-based swap dealers                    the presence of any type of defined
                                                 recognize that notional amounts do not                  provide heightened protection to those                     ‘‘customer’’ relationship.
                                                 directly measure the exposure or risk                   types of entities.425 It is important that                    In adopting these rules the
                                                 associated with a swap or security-based                the de minimis exception not                               Commissions have considered
                                                 swap position, such measures do reflect                 undermine those statutory                                  alternative approaches suggested by
                                                 the relative amount of an entity’s                      protections.426 Also, consistent with the                  commenters, including one
                                                 dealing activity.423 Moreover, although                                                                            commenter’s suggestion that the de
                                                                                                         amount of derivatives contracts does not provide a         minimis exception should be available
                                                   421 For  example, it does not appear possible to      useful measure of either market or credit risks.’’         only in connection with swaps or
                                                 demonstrate empirically—let alone quantify—the          OCC Quarterly Report at 8.
                                                                                                            424 For these purposes, ‘‘special entity’’ means: (i)   security-based swaps entered into as
                                                 increase or decrease in the possibility that a
                                                 financial crisis would occur at a particular future     A Federal agency; (ii) a state, state agency, city,        part of a ‘‘customer’’ relationship.429 In
                                                 time and with a particular intensity in the absence     county, municipality, or other political subdivision       considering that alternative view,
                                                 of financial regulation or as a result of varying       of a state; (iii) any employee benefit plan, as defined    however, we believe that it is significant
                                                 levels or types of financial regulation. It also is     in section 3 of the Employee Retirement Income
                                                                                                         Security Act of 1974 (‘‘ERISA’’); (iv) any
                                                                                                                                                                    that the statutory exception lacks
                                                 difficult to demonstrate empirically that the
                                                 customer protections associated with dealer             governmental plan, as defined in section 3 of              terminology such as ‘‘existing’’ or
                                                 regulation would increase or decrease the               ERISA; or (v) any endowment, including an                  ‘‘preexisting’’ that limits the availability
                                                 likelihood that any particular market participant       endowment that is an organization described in             of the exception or otherwise to
                                                 would suffer injury (or the degree to which the         section 501(c)(3) of the Internal Revenue Code of
                                                                                                         1986. See CEA section 4s(h)(2)(C) and CFTC
                                                                                                                                                                    distinguishes a ‘‘customer’’ relationship
                                                 participant would suffer injury) associated with
                                                 entering into an inappropriate swap or security-        Regulation § 23.401(c); Exchange Act section               from other types of counterparty
                                                 based swap. At the same time, certain costs may         15F(h)(2)(C).                                              relationship. Also, while that alternative
                                                 also not be readily susceptible to quantification or       425 See CEA sections 4s(h)(2), (4), (5); see also
                                                                                                                                                                    view could still permit an unregistered
                                                 measurement, for example, the costs that might be       CFTC, Business Conduct Standards for Swap                  person to provide limited dealer
                                                 associated with diminished presence, if any, of new     Dealers and Major Swap Participants with
                                                 entrants. The inability to quantify these benefits      Counterparties; Final Rule, 77 FR 9733 (Feb. 17,           services as an accommodation to an
                                                 and costs does not mean that the benefits and costs     2012); Exchange Act sections 15F(h)(2), (4), (5)           existing customer or counterparty, an
                                                 of dealer regulation are any less substantial.          (providing additional requirements for dealers that        interpretation that predicates the
                                                    422 See CFTC Regulation § 1.3(ggg)(4); Exchange      advise special entities or that enter into swaps or        exception on the presence of a
                                                 Act rule 3a71–2(a)(1). Over the first year following    security-based swaps with special entities).
                                                 the effective date of the final rules implementing         426 The importance of the statutory protections for     particular type of ‘‘customer’’
                                                 the statutory definition of ‘‘swap’’ and ‘‘security-    special entities has been highlighted by the SEC’s         relationship would not advance other
                                                 based swap’’ as set forth in CEA section 1a(47) and     recent action in connection with the inappropriate         potential benefits associated with a de
                                                 Exchange Act section 3(a)(68), respectively, this       sale of notes linked to the performance of synthetic       minimis exception, including the
                                                 notional test will be based on the person’s dealing     collateralized debt obligations to a number of
                                                 activity following that effective date. See id.         school districts. According to a complaint filed in
                                                 Accordingly, the analysis of whether a person may       federal district court, these securities were              Litigation Release No. 22064 (Aug. 10, 2011) (http://
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                                                 take advantage of the de minimis exception will not     unsuitable for the investment needs of the school          www.sec.gov/litigation/litreleases/2011/
                                                 encompass the person’s dealing activity prior to        districts, were sold to school districts that lacked       lr22064.htm).
                                                                                                                                                                       427 For example, if an exchange of payments
                                                 that effective date, given the need for the person to   the requisite sophistication and experience to
                                                 know whether an instrument is a swap or security-       independently evaluate the risks of the investment,        associated with a $1 million notional equity swap
                                                 based swap for purposes of the analysis.                and exposed the school districts to a heightened           was based on three times the return associated with
                                                    423 ‘‘Changes in notional volumes are generally      risk of catastrophic loss ultimately led to a complete     the underlying equity, the effective notional amount
                                                 reasonable reflections of business activity, and        loss of their investments. ‘‘SEC Charges Stifel,           of the equity swap would be $3 million.
                                                                                                                                                                       428 See, e.g., letter from COPE I.
                                                 therefore can provide insight into potential revenue    Nicolaus and Former Executive with Fraud in Sale
                                                 and operational issues. However, the notional           of Investments to Wisconsin School Districts,’’ SEC           429 See letter from Better Markets I.




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                                                                   Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations                                                     30631

                                                 benefit of providing certainty in                       person’s dealing activity, the position                 necessary to prevent persons from
                                                 connection with the swap or security-                   will count against those thresholds.433                 avoiding dealer regulation by dividing
                                                 based swap activities of end-users.430                    Commenters also requested                             up dealing activity in excess of the
                                                 Accordingly, we do not believe that the                 clarification that the de minimis                       notional thresholds among multiple
                                                 ‘‘customer’’ reference standing alone                   thresholds do not apply to a person’s                   affiliates.438
                                                 provides a sufficient basis to conclude                 inter-affiliate swaps and security-based
                                                                                                         swaps, nor apply to swaps covered by                    e. Alternative Approaches We Are Not
                                                 that the exception should only be                                                                               Following
                                                 available if there is an existing                       the exclusion for swaps entered into by
                                                 relationship of some type, and the final                insured depository institutions in                         Certain commenters have suggested
                                                 rules neither require that a dealer                     connection with the origination of loans                alternative approaches to implementing
                                                 accommodate the demand of an existing                   to customers.434 Consistent with the                    the de minimis exception. While the
                                                 customer nor require the presence of a                  discussion above,435 such swaps or                      Commissions have considered those
                                                 preexisting relationship for the                        security-based swaps do not constitute                  suggested alternatives, we do not
                                                                                                         dealing activity and should not be                      believe that they provide the optimal
                                                 exception to apply.
                                                                                                         counted against the de minimis                          framework for implementing the
                                                    We also are not persuaded by the                     thresholds. Similarly, swaps between a                  exception.
                                                 different commenter suggestion that the                 cooperative and its members, as                            For example, some commenters took
                                                 statutory de minimis exception’s                        provided in CFTC Regulation                             the position that the de minimis
                                                 ‘‘customer’’ language means that an                     § 1.3(ggg)(6)(ii), and swaps entered into               exception should focus dealer
                                                 unregistered dealer should be permitted                 for the hedging purpose defined in                      regulation on those entities whose
                                                 to engage in unlimited dealing activity                 CFTC Regulation § 1.3(ggg)(6)(iii)                      dealing activities pose systemic risk,
                                                 so long as its counterparties are not                   should not be counted against the de                    and excuse other dealers from having to
                                                 customers.431 Such an unlimited                         minimis threshold.436                                   register.439 Such an approach, however,
                                                 exception would appear to be contrary                     In light of the increased notional                    would fail to account for regulatory
                                                 to the express language of the statutory                thresholds of the final rules, and the                  interests apart from the control of
                                                 exception. In addition, such an                         resulting opportunity for a person to                   systemic risk that are addressed by
                                                 approach would lead to the perverse                     evasively engage in large amounts of                    dealer regulation, including statutory
                                                 result of discouraging entities from                    dealing activity if it can multiply those               provisions that protect customers and
                                                 entering into swaps or security-based                   thresholds, the final rules provide that                counterparties in other ways, and that
                                                 swaps to facilitate risk management                     the notional thresholds to the de                       promote effective market operations and
                                                 activities of customers (while                          minimis exception encompass swap and                    transparency.440
                                                 encouraging other dealing activities),                  security-based swap dealing positions                      Some commenters also have
                                                 which appears contrary to Title VII’s                   entered into by an affiliate controlling,               suggested that the de minimis exception
                                                 general approach of seeking to limit                    controlled by or under common control                   should subsume a proportionality
                                                 undue impacts on the swap and                           with the person at issue.437 This is
                                                 security-based swap activities of                                                                               consistent with the definition of ‘‘control’’ and
                                                                                                           433 For  purposes of the de minimis exception to      ‘‘affiliate’’ in connection with Exchange Act rules
                                                 commercial end-users.                                   the security-based swap dealer definition, we note      regarding registration statements. See Exchange Act
                                                                                                         that one indicator of dealing activity under the        rule 12b–2.
                                                 d. Focus on ‘‘Dealing’’ Activity                        dealer-trader distinction is that a person profit by       The final rules use a control standard in
                                                                                                         providing liquidity in connection with security-        connection with the de minimis notional thresholds
                                                   Some commenters suggested that we                     based swaps. Accordingly, for purposes of the de        as a means reasonably designed to prevent evasion
                                                 clarify that the limitations associated                 minimis exception to the security-based swap            of the limitations of that exception. This contrasts
                                                 with the de minimis exception apply                     dealer definition, a security-based swap position       with the majority-ownership standard used by the
                                                                                                         that hedges or otherwise offsets a position that was    inter-affiliate exclusions from the dealer and major
                                                 only in connection with a person’s                      entered into as part of dealing activity would itself   participant definitions. See parts II.C.2 and IV.G.2,
                                                 dealing activities, and not to the                      comprise part of the person’s dealing activity, and     infra. That majority-ownership standard, which in
                                                 person’s hedging or proprietary trading                 hence count against the de minimis thresholds.          application will not be expected to be satisfied in
                                                 activities.432 The Commissions agree                       For purposes of the de minimis exception to the      all circumstances in which a control standard is
                                                                                                         swap dealer definition, we take the view that the       satisfied, is reasonably designed to reflect the
                                                 that the de minimis exception is                        relevant question in determining whether swaps          economic alignment that appropriately underpins
                                                 intended to permit an unregistered                      count as dealing activity against the de minimis        those exclusions.
                                                 person to engage in a limited amount of                 thresholds is whether the swaps fall within the            438 In other words, for example, if a parent entity

                                                 dealing activity without regard to the                  swap dealer definition under the statute and the        controls two subsidiaries which both engage in
                                                                                                         final rules, as further interpreted by this Adopting    activities that would cause the subsidiaries to be
                                                 person’s non-dealing activity. Thus, to                 Release. If hedging or proprietary trading activities   covered by the dealer definitions, then each
                                                 the extent that a particular swap or                    did not fall within the definition, including because   subsidiary must aggregate the swaps or security-
                                                 security-based swap position is not                     of the application of CFTC Regulation § 1.3(ggg)(6),    based swaps that result from both subsidiaries’
                                                 connected to dealing activity under the                 they would not count against the de minimis             dealing activities in determining if either subsidiary
                                                                                                         thresholds.                                             qualifies for the de minimis exception.
                                                 applicable interpretation of the statutory                 434 See, e.g., letters from Atmos Holdings and FSR
                                                                                                                                                                    The SEC expects to address the application of this
                                                 dealer definition, it will not count                    I.                                                      principle to the security-based swap activities of
                                                 against the de minimis thresholds.                         435 See parts II.B and II.C, supra.                  non-U.S. persons in a separate release.
                                                 Conversely, if a swap or security-based                    436 Swaps and security-based swaps that hedge,          439 See, e.g., letters from CDEU and SIFMA—

                                                 swap position is connected to the                       mitigate, or offset the types of swaps and security-    Regional Dealers.
                                                                                                         based swaps discussed in the foregoing paragraph,          440 We also disagree with the suggestion that it
                                                                                                         which do not constitute dealing activity, similarly     would be inconsistent with the Title VII framework
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                                                    430 As discussed above, see note 413, supra, there
                                                                                                         should not be counted against the de minimis            to consider customer protection issues in setting the
                                                 is legislative history that suggests that an intended   thresholds.                                             de minimis factors. See letter from WGCEF I. While
                                                 purpose of the exception would be to ensure that           437 See CFTC Regulation § 1.3(ggg)(4)(i); Exchange   the restrictions on the availability of swaps and
                                                 the dealer definition does not encompass ‘‘smaller      Act rule 3a71–2(a)(1). For these purposes, we           security-based swaps to non-ECPs help to mitigate
                                                 institutions that are responsibly managing their        interpret control to mean the possession, direct or     certain customer protection concerns, Title VII
                                                 commercial risk.’’                                      indirect, of the power to direct or cause the           includes specific safeguards designed to protect
                                                    431 See, e.g., letter from ISDA I.
                                                                                                         direction of the management and policies of a           dealers’ customers and counterparties regardless of
                                                    432 See, e.g., letters from SIFMA—Regional           person, whether through the ownership of voting         whether those are ECPs. It would not be consistent
                                                 Dealers and EDF Trading.                                securities, by contract or otherwise. This is           with Title VII to ignore those interests.



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                                                 30632             Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations

                                                 standard, whereby an entity may be                       exception. Those suggestions are                         standard at a level of $3 billion
                                                 excluded from dealer regulation if its                   addressed more specifically below in                     appropriately balances the relevant
                                                 dealing activity comprises only a                        the specific context of the swap dealer                  regulatory goals.
                                                 relatively small portion of its overall                  and security-based swap dealer de                           As noted above, several commenters
                                                 activities (or its overall swap or                       minimis exceptions.                                      suggested that the standard be set at an
                                                 security-based swap activities), or if its               4. Final Rules—De Minimis Exception to                   amount equal to 0.001 percent of the
                                                 dealing activity is ‘‘tangential’’ to its                Swap Dealer Definition                                   overall domestic market for swaps. The
                                                 principal business.441 We are not                                                                                 Commissions note, however, that
                                                 incorporating that type of approach into                 a. Overview of the Final Rule                            comprehensive information regarding
                                                 the de minimis factors, however,                            After considering commenters’ views,                  the total size of the domestic swap
                                                 because that approach would not appear                   the final rule implementing the de                       market is incomplete, with more
                                                 to provide a logical way to balance the                  minimis exception caps an entity’s                       information available with respect to
                                                 benefits and burdens of dealer                           dealing activity involving swaps at $3                   certain asset classes than others. The
                                                 regulation. A proportionality approach                   billion over the prior 12 months.444 This                CFTC evaluated data regarding one
                                                 could permit a large entity to engage in                 amount is based on input from                            particular type of swap—credit default
                                                 a significant amount of dealing activity                 commenters and is supported by several                   swaps (‘‘CDS’’) based on indices of debt
                                                 without being subject to dealer                          rationales, including the estimated size                 securities known as ‘‘index CDS’’—that
                                                 regulation, thus undermining the                         of the domestic swap market, among                       was provided by the SEC.446 As noted
                                                 benefits of dealer regulation. Moreover,                 others.                                                  in the CFTC analysis of this data,
                                                 a proportionality approach could lead to                    As noted above, commenters who                        however, the information is not filtered
                                                 arbitrary results by excusing a large                    suggested a fixed notional standard                      to reflect activity that would constitute
                                                 entity from dealer regulation while                      proposed that the standard be set at a                   swap dealing under the Dodd-Frank
                                                 requiring the registration of a smaller                  level between $200 million and $3.5                      Act, so it is not possible to use the data
                                                 entity that engages in less total dealing                billion in notional amount of swaps                      to draw conclusions regarding any
                                                 activity (if that smaller amount of                      entered into over a period of twelve                     specific entity’s status as a swap
                                                 dealing activity comprises a greater                     months.445 In considering these                          dealer.447 The data reflects only activity
                                                 portion of the smaller entity’s total                    comments, we are mindful of the variety                  relating to index CDS, which constitute
                                                 activity).442                                            of uses of swaps in various markets and                  a very narrow part of the overall swap
                                                    Some commenters also supported the                    therefore it is understandable that                      market, and, as noted in the CFTC
                                                 use of non-quantitative standards in                     various commenters would reach                           analysis, similar data regarding other
                                                 connection with the de minimis                           different conclusions regarding the                      types of swaps is not available.448
                                                 exception.443 Although we recognize                      appropriate standard. At the same time,                  Subject to these limitations, the data
                                                 that such an approach may help us                        we see value in setting a single standard                may help evaluate the impact of
                                                 weigh the facts and circumstances                        for all swaps so that there is a ‘‘level                 alternative approaches to implementing
                                                 associated with a particular person’s                    playing field’’ for all market participants              the de minimis exception.
                                                 dealing activity, we believe that it is                  and so that the standard can be
                                                 more appropriate to base the exception                   implemented easily without the need to                      One often-cited measure of the
                                                 on an objective quantitative standard, to                categorize swaps. Considering the                        market, the Quarterly Report on Bank
                                                 allow the exception to be self-executing,                written input of the commenters as well                  Trading and Derivatives Activities
                                                 and to promote predictability among                      as the discussions of the de minimis                     issued by the OCC (‘‘OCC Quarterly
                                                 market participants and the efficient use                standard at the Commissions’ joint                       Report’’) is both limited, in that it
                                                 of regulatory resources. Unlike the                      roundtable and numerous meetings with                    includes only data related to the
                                                 overall definitions of ‘‘swap dealer’’ and               market participants, and the benefits of                 activities of U.S. bank holding
                                                 ‘‘security-based swap dealers,’’ which                   the regulation of swap dealers (i.e.,                    companies, commercial banks and trust
                                                 consider the entirety of a person’s                      protection of customers and                              companies, and over-inclusive, in that it
                                                 activities with respect to swaps, the de                 counterparties, and promotion of the                     includes activities related to
                                                 minimis exception is only relevant to                    effective operation and transparency of                  instruments that are not or may not be
                                                 persons who have determined that they                    the swap markets), we believe a notional                 included in the final definition of
                                                 are engaged in swap or security-based                                                                             ‘‘swap’’ (including futures, forwards,
                                                 swap dealing, and are looking to                            444 CFTC Regulation § 1.3(ggg)(4). As noted above,    certain foreign exchange instruments,
                                                 determine whether the quantity of their                  for the first year following the effective date of the   and certain options) and it includes
                                                                                                          rules implementing the definition of ‘‘swap’’ the        both swaps and security-based swaps.
                                                 dealing activity is de minimis. For this                 analysis would only address activity following that
                                                 more particular and focused                              effective date. For clarity, the final rule also has
                                                                                                                                                                   Nonetheless, the Commissions believe
                                                 determination, an objective quantitative                 been revised from the proposal to provide that           that the available (imperfect) data
                                                 standard is more appropriate.                            persons taking advantage of the exception ‘‘shall be     suggests that a $3 billion notional
                                                                                                          deemed not to be’’ swap dealers (the proposed rule       standard is generally consistent with the
                                                    Commenters also made various                          used the phrasing ‘‘shall not be deemed to be’’ swap
                                                 suggestions as to the types of factors and               dealers) The final rule also reflects certain
                                                                                                                                                                   commenters’ suggestion of basing the
                                                 accompanying thresholds that should be                   structural changes consistent with the substantive       standard on a percentage of the overall
                                                 used in connection with the de minimis                   changes from the proposed rule. In addition, as          domestic market for swaps.
                                                                                                          discussed above, see part II.D.3.d, supra, the final
                                                                                                          rule has been revised to provide that the notional
                                                                                                                                                                      The total notional value of $333.1
                                                   441 See   letter from FHLB I.                          thresholds to the de minimis exception encompass         trillion in ‘‘derivatives’’ stated in the
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                                                   442 As   discussed below, if an entity is a dealer,    swap dealing positions entered into by an affiliate      most recent OCC Quarterly Report
                                                 the regulations applicable to dealers in general will    controlling, controlled by or under common control       includes approximately $221.1 trillion
                                                 govern all of the entity’s swap or security-based        with the person at issue.
                                                 swap activities and positions. Depending on the             445 One commenter suggested a threshold of $3
                                                                                                                                                                      446 The CFTC analysis was made available to the
                                                 applicable facts and circumstances, however, the         billion. See letter from COPE I (suggesting 0.001%
                                                 entity may be able to avail itself of a limited          of the total U.S. swap market, amounting to              public. See memorandum to the public comment
                                                 purpose designation as a dealer. See part II.E, infra.   approximately $3 billion). Other commenters also         file from the CFTC Office of the Chief Economist.
                                                     443 See letters from FHLB I, Gavilon II, and MFX                                                                 447 See id.
                                                                                                          supported a threshold of 0.001% of the total U.S.
                                                 II.                                                      swap market. See letters cited in note 382, supra.          448 See id.




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                                                                   Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations                                                 30633

                                                 in ‘‘swaps’’ and ‘‘credit derivatives.’’ 449             reported by U.S. commercial banks were               benefits that may arise from a de
                                                 Since some instruments that are                          interest rate contracts, many of which               minimis exception. In this way, the
                                                 security-based swaps are included in                     are swaps entered into by IDIs with                  threshold would not completely
                                                 this total,450 the total notional value of               customers in connection with the                     foreclose the availability of swaps to
                                                 swap positions at U.S. bank holding                      origination of loans which will be                   special entities from unregistered
                                                 companies, commercial banks and trust                    excluded from the determination of                   dealers, but the threshold would limit
                                                 companies at the end of the second                       whether the IDIs are swap dealers.452                the financial and other risks associated
                                                 quarter of 2011 of may be estimated to                   Finally, the OCC Quarterly Report                    with those positions for a special entity,
                                                 be somewhat less than $221.1 trillion.                   measures swap positions held at a                    which would in turn limit the
                                                    This total notional value is by nature                certain point in time, rather than the               possibility of inappropriately
                                                 under-inclusive, because it reflects only                level of swap activity over a certain time           undermining the special protections
                                                 swap positions at U.S. bank holding                      period, again indicating that the figures            that Title VII provides to special
                                                 companies, commercial banks and trust                    are broader than those that would be                 entities.
                                                 companies and not the swap positions                     subject to the de minimis figure.
                                                 of other market participants. However,                   Accordingly, it appears that notional                c. Phase-in Procedure
                                                 there are also reasons that the                          amount of the overall domestic market                   The Commissions believe that a
                                                 information from the OCC Quarterly                       for swaps that actually would be                     phase-in period for the de minimis
                                                 Report may overstate the notional value                  relevant to determining the notional                 threshold would facilitate the orderly
                                                 of swaps that would be relevant to                       standard, and thus the appropriate basis             implementation of Title VII by
                                                 estimating the size of the domestic swap                 for the 0.001 percent calculation, may               permitting market participants and the
                                                 market for purposes of the de minimis                    be significantly lower than $331 trillion.           Commissions to familiarize themselves
                                                 standard. While we believe the data is                      Because there is merit in the 0.001               with the application of the swap dealer
                                                 not sufficiently precise at this time to                 percent ratio suggested by several                   definition and swap dealer requirements
                                                 serve as the sole basis for the notional                 commenters, we believe an appropriate                and to consider the information that
                                                 standard, a standard of $3 billion seems                 balance of the goal of promoting the                 will be available about the swap market,
                                                 that it is likely generally consistent with              benefits of regulation (while recognizing            including real-time public reporting of
                                                 0.001 percent of the domestic swap                       the unquantifiable nature of those                   swap data and information reported to
                                                 market that would be relevant to a                       benefits) against the competing goal of              swap data repositories. In addition, a
                                                 potential dealer’s de minimis swap                       avoiding the imposition of burdens on                phase-in period would afford the
                                                 activity figure. First, the large majority               those entities for which regulation as a             Commissions additional time to study
                                                 of derivatives in the OCC Quarterly                      dealer would not be associated with                  the swap markets as they evolve in the
                                                 Report (approximately $229 trillion in                   achieving those benefits in a significant            new regulatory framework and allow
                                                 notional value for commercial banks                      way, would be reached by setting the                 potential swap dealers that engage in
                                                 and trust companies) are derivatives                     notional standard for swaps at a level               smaller amounts of activity (relative to
                                                 between ‘‘dealers’’ (as defined for the                  that is near (taking into account the                the current size of the market)
                                                 purposes of the report.) 451 Thus, it is                 uncertainties noted above) 0.001 percent             additional time to adjust their business
                                                 likely that a large part of the derivatives              of a reasonable estimate of the overall              practices, while at the same time
                                                 in the OCC Quarterly Report reflect                      domestic market for all swaps between                preserving a focus on the regulation of
                                                 transactions between financial                           all counterparties. We believe a $3                  the largest and most significant swap
                                                 institutions that will be swap dealers. It               billion notional value standard is                   dealers. The Commissions also
                                                 is also notable that approximately                       appropriate taking all these                         recognize that the data informing their
                                                 $204.6 trillion in notional value of the                 considerations into account.                         current view of the de minimis
                                                 derivatives (i.e., not only swaps)                                                                            threshold is based on the markets as
                                                                                                          b. Dealing Activity Involving Special
                                                                                                          Entities                                             they exist today, and that the markets
                                                   449 See  Office of the Comptroller of the Currency,                                                         will evolve over the coming years in
                                                 ‘‘Quarterly Report on Bank Trading and Derivatives          For swaps in which the counterparty               light of the new regulatory framework
                                                 Activities, Second Quarter 2011’’ at tables 1 and 2      is a special entity, the final rules set a
                                                 (http://www.occ.gov/topics/capital-markets/                                                                   and other developments.
                                                 financial-markets/trading/derivatives/dq211.pdf).        notional standard consistent with the                   We have also considered that there
                                                 These totals reflect the sum of the amounts reported     proposal of $25 million over the prior               may be some uncertainty regarding the
                                                 for the top 25 bank holding companies reported in        12 months.453 The Commissions believe                exact level of swap dealing activity,
                                                 table 1 and for all but the top 25 commercial banks      that this notional standard is
                                                 and trust companies reported in table 2.                                                                      measured in terms of a gross notional
                                                    However, this adjustment is only approximate,
                                                                                                          appropriate in light of the special                  amount of swaps, that should be
                                                 because the definitions of ‘‘swap’’ and ‘‘credit         protections that Title VII affords to                regarded as de minimis. While some
                                                 derivative’’ used in the OCC Quarterly Report are        special entities. In adopting this                   quantitative data regarding the usage of
                                                 likely to be significantly different from the final      threshold, we recognize the serious
                                                 definition of ‘‘swap’’ and ‘‘security-based swap’’ for                                                        swaps is available, there are many
                                                 purposes of the Dodd-Frank Act. For the same
                                                                                                          concerns raised by commenters stating                aspects of the swap markets for which
                                                 reason, it is uncertain how many of the notional         that the de minimis exception should                 definitive data is not available. We have
                                                 value of $54.5 trillion in options reported in the       not permit any dealing activities (by                also considered comments suggesting
                                                 OCC Quarterly Report are swaps or security-based         persons who are not registered as swap
                                                 swaps.                                                                                                        that the de minimis thresholds should
                                                                                                          dealers) involving special entities, in              be set higher initially to provide for
                                                    Also, data from the CDS trade information
                                                 warehouse maintained by the Depository Trust &           light of losses that special entities have           efficient use of regulatory resources,455
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                                                 Clearing Corporation (‘‘DTCC’’) indicates that total     incurred in the financial markets.454
                                                                                                                                                               or that implementation of the dealer
                                                 global notional CDS positions on indices amount to       However, the final rule does not fully               requirements should be phased.456 For
                                                 approximately $10.47 trillion. See http://dtcc.com/      exclude such dealing activity from the
                                                 products/derivserv/data_table_i.php?tbid=3 (data
                                                 for the week ending October 7, 2011, obtained on         exception, in light of the potential                   455 Seeletters cited in footnote 402, supra.
                                                 October 17, 2011).                                                                                              456 See,e.g., Roundtable Transcript at 35 (remarks
                                                    450 See part II.D.5, infra, for a discussion of the    452 See OCC Quarterly Report at Graph 3.            of Ron Filler, New York Law School) and letters
                                                 size of the security-based swap market.                   453 CFTC   Regulation § 1.3(ggg)(4)(i).             from FSR dated May 12, 2011 (‘‘FSR III’’) and
                                                    451 See OCC Quarterly Report at Graph 1.               454 See letters from AFR and Better Markets I.      WGCEF V.



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                                                 30634            Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations

                                                 all these reasons, the Commissions                      and below the $3 billion level                        implementation of Title VII—which
                                                 believe it is appropriate that the final                applicable after the phase-in period. The             itself is contingent on the
                                                 rules provide for a phase-in period                     report is required to be completed by                 implementation of the dealer
                                                 following the effective date during                     the CFTC staff no later than 30 months                definition—more data will be available
                                                 which higher de minimis thresholds                      following the date that a swap data                   to the CFTC via swap data repositories.
                                                 would apply.                                            repository first receives swap data under             We expect that this additional data will
                                                    In particular, during this phase-in                  the CFTC’s regulations, and the report                assist the CFTC in testing the
                                                 period, a person’s swap dealing activity                will be published for public                          assumptions and addressing the effects
                                                 over the prior 12 months is capped at a                 comment.460 The CFTC will take this                   of the final rule we are adopting to
                                                 gross notional value of $8 billion.457                  report, in conjunction with any public                implement the de minimis exception.
                                                 With respect to swaps with special                      comment on it, into account in weighing               For example, this data should help the
                                                 entities, the Commissions believe it is                 further action on the de minimis                      CFTC assess, among other things, the
                                                 appropriate that the $25 million gross                  exception at the end of the phase-in                  nature and amount of unregulated
                                                 notional value threshold apply during                   period.                                               dealing activity that occurs under the $3
                                                 the phase-in period.458 In light of the                    The final rules provide that nine                  billion threshold. The CFTC will make
                                                 available data—and the limitations of                   months after publication of its staff                 this report available for public comment
                                                 that data in predicting how the full                    report, the CFTC may, in its discretion,              so that it may benefit from additional
                                                 implementation of Title VII will affect                 either promulgate an order that the                   input and analysis regarding the swap
                                                 dealing activity in the swap markets—                   phase-in period will end as of the date               dealer definition.
                                                 the Commissions believe that the                        set forth by the CFTC in that order, or                  By making use of post-
                                                 appropriate threshold for the phase-in                  issue for public comment a notice of                  implementation data, the staff report
                                                 period is an annual gross notional level                proposed rulemaking to modify the de                  (together with public comment on the
                                                 of swap dealing activity of $8 billion or               minimis threshold, in which case the                  report) will help the CFTC better
                                                 less. In particular, the $8 billion level               CFTC would also issue an order                        evaluate the exception in light of
                                                 should still lead to the regulation of                  establishing the date that the phase-in               potential market changes resulting from
                                                 persons responsible for the vast majority               period will end.461 The period of nine                the full implementation of Title VII—
                                                 of dealing activity within the swap                     months provided in the rule is intended               including market changes resulting from
                                                 markets.                                                to provide the CFTC an opportunity to                 the de minimis exception itself—as part
                                                    Accordingly, the Commissions believe                 consider its staff report, public                     of determining whether revised de
                                                 that while a $3 billion notional                        comments on the staff report and any                  minimis thresholds would be
                                                 threshold reflects an appropriate long-                 other relevant information.                           appropriate. The report and public
                                                 term standard based on the available                       The CFTC recognizes that the                       comment thereon will also be taken into
                                                 data,459 it also is appropriate to allow a              determination of the appropriate de                   consideration by the CFTC in
                                                 degree of latitude in applying the                      minimis threshold is a significant issue              determining what action, if any, to take
                                                 threshold over time in the event that                   requiring thorough consideration of a                 with respect to the phase-in period
                                                 subsequent developments in the                          variety of regulatory and market factors.             associated with the de minimis
                                                 markets or the evaluation of new data                   At the same time, the CFTC recognizes                 exception.
                                                 from swap data reporting facilities                     the need for predictability in how the de                The final rules provide, moreover,
                                                 suggest that the thresholds should be                   minimis exception will apply.                         that the CFTC may change the
                                                 adjusted. In particular, the                            Therefore, the final rules include a                  requirements of the de minimis
                                                 implementation of swap data reporting                   finality provision, stating that the phase-           exception by rule or regulation.464
                                                 under the Dodd-Frank Act may result in                  in period will end no later than five                 Through this mechanism, the CFTC may
                                                 new data that would be useful in                        years after the date that a swap data                 revisit the rule implementing the
                                                 confirming the Commissions’                             repository first receives swap data under             exception and potentially change that
                                                 determination to establish the $3 billion               the CFTC’s regulations.462                            rule, for example, if data regarding the
                                                 threshold which applies after the phase-                   Persons who are able to avail                      post-implementation swap market
                                                 in period.                                              themselves of the higher de minimis                   suggests that different de minimis
                                                    For these reasons, review of the de                  threshold that applies during the phase-              thresholds would be appropriate.465 In
                                                 minimis exception will comprise an                      in period will not be required to do so.              determining whether to revisit the
                                                 important part of the reports that the                  In particular, a person that is engaged in            thresholds, the CFTC intends to pay
                                                 CFTC is directing its staff to conduct                  dealing activity involving swaps in                   particular attention to whether the de
                                                 with regard to the swap dealer                          excess of the $3 billion threshold may                minimis exception results in a swap
                                                 definition during the phase-in period.                  choose to commence the process for                    dealer definition that encompasses too
                                                 Among other topics, the report should                   registering as a swap dealer during the               many entities whose activities are not
                                                 consider market data addressing swap                    phase-in period.463                                      464 CFTC Regulation § 1.3(ggg)(4)(v). CEA section
                                                 dealing activity over a period of
                                                 approximately two years, and any                        d. CFTC Staff Report                                  1a(49)(D) (like Exchange Act section 3(a)(71)(D))
                                                                                                                                                               particularly states that the ‘‘Commission’’—
                                                 resulting changes in swap dealing                          As noted above, the CFTC is directing              meaning the CFTC—may exempt de minimis
                                                 activity, by dealers above and below the                its staff to report to the CFTC as to                 dealers and promulgate related regulations. We do
                                                                                                         whether changes are warranted to the                  not interpret the joint rulemaking provisions of
                                                 $8 billion phase-in threshold, and above                                                                      section 712(d) of the Dodd-Frank Act to require
                                                                                                         rules implementing the swap dealer                    joint rulemaking here, because such an
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                                                   457 See CFTC Regulation § 1.3(ggg)(4)(i).             definition, including the rule                        interpretation would read the term ‘‘Commission’’
                                                   458 This limitation regarding swaps with special      implementing the de minimis exception.                out of CEA section 1a(49)(D) (and Exchange Act
                                                 entities during the phase-in period is consistent       We are mindful that following the full                section 3(a)(71)(D)), which themselves were added
                                                 with the Dodd-Frank Act’s goal of helping special                                                             by the Dodd-Frank Act.
                                                 entities be in a position to benefit from the                                                                    465 See letter from Greenberger (stating that the
                                                                                                           460 See CFTC Regulation § 1.3(ggg)(4)(ii)(C).
                                                 counterparty protections associated with the                                                                  dynamic nature of the derivatives sector of the
                                                                                                           461 See CFTC Regulation § 1.3(ggg)(4)(ii)(C).
                                                 regulation of registered swap dealers under Title                                                             financial markets should counsel caution, and that
                                                 VII.                                                      462 See CFTC Regulation § 1.3(ggg)(4)(ii)(D).
                                                                                                                                                               the de minimis threshold should be reevaluated on
                                                   459 See, e.g., part II.D.4.a, supra.                    463 See CFTC Regulation § 1.3(ggg)(4)(vi).          an ongoing basis).



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                                                                    Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations                                                        30635

                                                 significant enough to warrant full                         types of security-based swaps (e.g.,                         As discussed above, a de minimis
                                                 regulation under Title VII, or,                            single-name or narrow-based equity                        exception eliminates key Title VII
                                                 alternatively, whether the de minimis                      swaps or total return swaps), the                         protections for some market participants
                                                 exception leads an undue amount of                         exception caps an unregistered person’s                   by regulating less dealer activity.
                                                 dealing activity to fall outside of the                    dealing activity at $150 million in                       Conversely, an appropriately applied de
                                                 ambit of the Title VII regulatory                          notional amount over the prior 12                         minimis exception may provide an
                                                 framework, or leads to inappropriate                       months.469 Also, as addressed below,                      objective test when there is doubt as to
                                                 reductions in counterparty protections                     the final rule provides for phase-in                      whether particular activities may cause
                                                 (including protections for special                         levels in excess of those $3 billion and                  a person to be deemed to be a dealer; 473
                                                 entities). The CFTC also intends to pay                    $150 million thresholds for a certain                     allow non-dealers to accommodate the
                                                 particular attention to whether                            period of time.                                           incidental security-based swap needs of
                                                 alternative approaches would more                             In addition, consistent with the                       existing clients; and help to facilitate
                                                 effectively promote the regulatory goals                   proposal, the final rule caps an                          competition by allowing the entry of
                                                 that may be associated with a de                           unregistered person’s security-based                      new dealers into the market. In
                                                 minimis exception.                                         swap dealing activity involving                           addition, as discussed above, a de
                                                                                                            counterparties that are ‘‘special entities’’              minimis exception may promote
                                                 5. Final Rules—De Minimis Exception to
                                                                                                            at $25 million in notional amount over                    regulatory efficiency by providing a
                                                 ‘‘Security-Based Swap Dealer’’
                                                                                                            the prior 12 months.470 The final rule                    framework to help focus dealer
                                                 Definition
                                                                                                            further provides that the SEC may                         regulation upon those entities for which
                                                 a. Overview of the Final Rule                              establish alternative methods of                          such regulation is warranted, rather
                                                    The final rule implementing the de                      determining the scope of the de minimis                   than upon entities that engage in
                                                 minimis exception to the ‘‘security-                       exception by rule or regulation.471                       relatively limited amounts of dealing
                                                 based swap dealer’’ definition has been                                                                              activity.474
                                                                                                            b. Interests Associated With a De
                                                 revised from the proposal in a number                                                                                i. Providing for Regulatory Coverage of
                                                                                                            Minimis Exception
                                                 of ways. As discussed above, the final                                                                               the Vast Majority of Dealing Activity
                                                 rule does not incorporate proposed                           In developing this final rule, we have
                                                 limits on the number of security-based                     sought to balance the interests advanced                     In seeking to develop a de minimis
                                                 swaps that a person may enter into in                      by the de minimis exception against the                   exception that preserves key
                                                 a dealing capacity, or on the number of                    protections that would be weakened                        counterparty and market protections
                                                 security-based swap counterparties a                       were the exception applied in an                          while promoting regulatory efficiency,
                                                 person may have when acting in a                           overbroad manner. In making this                          we have considered the comparative
                                                 dealing capacity.466 Moreover, the                         evaluation, we have taken into account                    amount of security-based swap dealing
                                                 provisions of the exception that cap an                    data regarding the security-based swap                    activity that could fall outside the ambit
                                                 unregistered person’s annual notional                      market and especially data regarding the                  of dealer regulation as a result of the
                                                 dealing activity with counterparties                       activity—including activity that may be                   exception. In doing so we have
                                                 other than ‘‘special entities’’ have been                  suggestive of dealing behavior—of                         considered not only the security-based
                                                 increased from the proposed $100                           participants in the single-name credit                    swap market as it currently exists, but
                                                 million threshold.467 Instead, the final                   default swap market.472                                   also how the market reasonably may be
                                                 rule caps such dealing activity involving                                                                            expected to change after the full
                                                 security-based swaps that are credit                          It is important to recognize that while these types
                                                                                                                                                                      implementation of Title VII.
                                                                                                            of de minimis principles are relevant to the                 In performing this comparative
                                                 default swaps—which largely would
                                                                                                            ‘‘security-based swap dealer’’ definition, they are       exercise we are, in part, drawing
                                                 consist of single-name credit default                      not applicable to the general definitions of ‘‘broker’’   inferences from the CDS Data Analysis,
                                                 swaps—at $3 billion in notional amount                     and ‘‘dealer’’ under the Exchange Act, or the broker-     a dataset released by the SEC staff that
                                                 over the prior 12 months.468 For other                     dealer registration requirements of Exchange Act
                                                                                                            section 15(a). Unlike the ‘‘security-based swap           characterizes nearly all transactions in
                                                   466 See  part II.D.3.b, supra.                           dealer’’ definition, those other definitions, with the    single-name credit default swaps during
                                                   467 For  clarity, the final rule also has been revised
                                                                                                            exception of the bank-broker definition in section        the 2011 calendar year.475 Though the
                                                                                                            3(a)(4)(B)(xi) of the Exchange Act, lack de minimis       final rules apply to all security-based
                                                 from the proposal to provide that persons taking
                                                                                                            exceptions.
                                                 advantage of the exception ‘‘shall be deemed not to           469 Exchange Act rule 3a71–2(a)(1)(ii).
                                                                                                                                                                      swaps, not just single-name credit
                                                 be’’ dealers (the proposed rule used the phrasing
                                                                                                               470 Exchange Act rule 3a71–2(a)(1)(iii).
                                                 ‘‘shall not be deemed to be’’ dealers), and to provide
                                                                                                               471 Exchange Act rule 3a71–2(d); see part II.D.5.f,    application of Title VII will be addressed in a
                                                 that such persons ‘‘shall not be subject to Section
                                                                                                            infra.                                                    separate release.
                                                 15F of the Exchange Act and the rules, regulations
                                                 and interpretations issued thereunder.’’ See                  472 Certain data has been addressed by an analysis        As discussed below, see notes 476 and 485, infra,
                                                 Exchange Act rule 3a71–2(a). The final rule also           regarding the market for single-name credit default       we also have considered more limited publicly
                                                 reflects certain structural changes consistent with        swaps performed by the SEC’s Division of Risk,            available data regarding equity swaps.
                                                 the substantive changes from the proposed rule.            Strategy, and Financial Innovation. See                      The CDS Data Analysis also included an
                                                    In addition, as discussed above, see part II.D.3.d,     ‘‘Information regarding activities and positions of       appendix of data regarding index credit default
                                                 supra, the final rule has been revised to provide          participants in the single-name credit default swap       swaps. We do not consider that data for purposes
                                                 that the notional thresholds to the de minimis             market’’ (Mar. 15, 2012) (available at http://            of the analysis described in this section because the
                                                 exception encompass swap and security-based                www.sec.gov/comments/s7-39-10/s73910-154.pdf)             statutory definition of ‘‘security-based swap’’ in
                                                 swap dealing positions entered into by an affiliate        (‘‘CDS Data Analysis’’). We believe that the data         relevant part encompasses swaps based on single
                                                 controlling, controlled by or under common control         underlying this analysis provides reasonably              securities or on narrow-based security indices. See
                                                 with the person at issue.                                  comprehensive information regarding the credit            Exchange Act sec. 3(a)(68)(A); see also Exchange
                                                    468 Exchange Act rule 3a71–2(a)(1)(i). The final        default swap activities and positions of U.S. market      Act Release No. 64372, 76 FR 29818 (May 23, 2011)
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                                                 rule, like the proposal, requires the analysis of de       participants, but note that the data does not             (proposed rules further defining ‘‘security-based
                                                 minimis levels to be based on effective notional           encompass those credit default swaps that both: (i)       swap’’ and certain other terms).
                                                                                                                                                                         473 We believe that the application of the dealer-
                                                 amounts to the extent that the stated notional             do not involve U.S. counterparties; and (ii) are
                                                 amount is leveraged or enhanced by the structure           based on non-U.S. reference entities. Our reliance        trader distinction and the guidance we have
                                                 of the security-based swap (such as, for example, if       on this data, which we believe to be the best             provided that distinguishes hedging activities from
                                                 the exchange of payments associated with an equity         available, should not be interpreted to indicate our      dealing activities in the security-based swap market
                                                 swap was based on a multiple of the return                 views as to the nature or extent of the application       will also help dealers meet their obligations.
                                                                                                                                                                         474 See part II.D.3.a, supra.
                                                 associated with the underlying equity). See                of Title VII to non-U.S. persons; instead, the SEC
                                                 Exchange Act rule 3a71–2(a)(3).                            anticipates that issues regarding the extraterritorial       475 See note 472, supra.




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                                                 30636              Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations

                                                 default swaps, the SEC believes that                       by ISDA.478 As the data show, 15 of                       criteria that consider alternative factors
                                                 these data are sufficiently representative                 these 28 potential dealers exceeded a                     for identifying dealing activity,483 and
                                                 of the market to help inform the analysis                  threshold of $100 billion notional                        certain combined criteria 484 further
                                                 because an estimated 95 percent of all                     transacted in single-name credit swaps
                                                 security-based swap transactions appear                    during 2011, which accounts for over 98                   entity’s counterparties. See id. at tables 2a through
                                                 likely to be single-name credit default                    percent of the 28 entities’ total                         2c. Those criteria similarly suggest a high degree of
                                                                                                                                                                      concentration of dealing activity within the single-
                                                 swaps.476 The SEC also recognizes that                     activity.479 At a lower threshold of $10                  name credit default swap market:
                                                 although the de minimis exception is                       billion notional, 21 of the 28 potential                     i. A criterion that identifies potential dealing
                                                 applicable to persons only with respect                    dealers are included (representing 99.7                   activity based on an entity having twenty or more
                                                 to their dealing activity, the CDS Data                    percent of the activity of potential                      counterparties in single-name security-based swaps
                                                 Analysis contains transactions reflecting                  dealers), and at an even lower threshold                  identified 16 possible dealers. Fourteen of those
                                                                                                                                                                      entities had notional transactions in excess of $100
                                                 both dealing activity and non-dealing                      of $3 billion notional, 25 potential                      billion in 2011, reflecting over 99 percent of the
                                                 activity, including transactions by                        dealers are included (representing 99.9                   total associated with all 16. The remaining two
                                                 persons who may engage in no dealing                       percent).480                                              identified entities had notional transactions in
                                                                                                               Other criteria for identifying possible                excess of $10 billion in 2011. See id. at table 2a.
                                                 activity whatsoever.477
                                                                                                                                                                         ii. A criterion that identifies potential dealing
                                                    As described more fully in the CDS                      dealing activity based on the number of                   activity based on an entity having 15 or more
                                                 Data Analysis, to ascertain which                          an entity’s non-dealer counterparties                     counterparties in single-name security-based swaps
                                                 entities might be transacting as dealers,                  similarly suggest a high degree of                        identified 33 possible dealers. Fifteen of those
                                                 and which may not be, various criteria                     concentration of dealing activity within                  entities had notional transactions in excess of $100
                                                                                                                                                                      billion in 2011, reflecting over 97 percent of the
                                                 were employed as indicia of possible                       the current security-based swap                           total associated with all 33. A total of 27 of those
                                                 dealing activity. In each case, the results                market.481 Criteria that consider the                     entities had notional transactions in excess of $10
                                                 suggest the great extent to which there                    number of an entity’s total single-name                   billion in 2011, and a total of 32 of those entities
                                                 is currently a high degree of                              security-based swap counterparties,482                    had notional transactions in excess of $3 billion in
                                                                                                                                                                      2011, both reflecting over 99 percent of the total.
                                                 concentration of potential dealing                                                                                   See id. at table 2b.
                                                 activity in the single-name credit default                    478 See CDS Data Analysis at table 3c. The SEC
                                                                                                                                                                         iii. A criterion that identifies potential dealing
                                                 swap market. For example, using the                        recognizes that the analysis of this transaction data     activity based on an entity having 10 or more
                                                                                                            is imperfect as a tool for identifying dealing
                                                 criterion that dealers are likely to                       activity, given that the presence or absence of
                                                                                                                                                                      counterparties in single-name security-based swaps
                                                 transact with many counterparties who                                                                                identified 154 possible dealers. Fifteen of those
                                                                                                            dealing activity ultimately turns upon the relevant
                                                                                                                                                                      exceeded $100 billion in notional transactions in
                                                 themselves are not dealers, analysis of                    facts and circumstances of an entity’s security-
                                                                                                                                                                      2011, reflecting over 90 percent of the total; 49 of
                                                 2011 transaction data show that only 28                    based swap transactions, as informed by the dealer-
                                                                                                                                                                      those exceeded $10 billion in notional transactions
                                                                                                            trader distinction. Criteria based on the number of
                                                 out of 1,084 market participants have                      an entity’s counterparties that are not recognized as
                                                                                                                                                                      in 2011, reflecting over 97 percent of the total; and
                                                 three or more counterparties that                                                                                    93 exceeded $3 billion in notional transactions in
                                                                                                            dealers nonetheless appear to be useful for
                                                                                                                                                                      2011, reflecting over 99 percent of the total. See id.
                                                 themselves are not recognized as dealers                   identifying apparent dealing activity in the absence
                                                                                                            of full analysis of the relevant facts and                at table 2c.
                                                                                                            circumstances, given that engaging in security-              In considering the data we are weighing these
                                                    476 While recognizing that the Commissions have                                                                   criteria less heavily than we are weighing the
                                                                                                            based swap transactions with non-dealers would be
                                                 yet to adopt final rules defining a ‘‘security-based       consistent with the conduct of seeking to profit by       criteria based on the number of counterparties who
                                                 swap,’’ we believe that single-name credit default         providing liquidity to others, as anticipated by the      are not identified by ISDA as dealers. This is
                                                 swaps will constitute roughly 95 percent of the            dealer-trader distinction. In emphasizing this            because it is reasonable to foresee a non-dealer
                                                 market, as measured on a notional basis, for               criterion for identifying dealing activity, we are not    making use of multiple dealers to get the best
                                                 instruments that will fall within that definition,         seeking to predict with precision how many entities       possible price or to make use of special expertise
                                                 with certain equity swaps (in other words, total           ultimately may register as security-based swap            possessed by certain dealers, meaning that the
                                                 return swaps based on single equities or narrow-           dealers. The ultimate number of dealers that may          criteria discussed in this footnote are more likely
                                                 based indices of equities) constituting the primary        register can also be expected to reflect growth in the    to identify entities not engaged in dealing activity.
                                                 example of security-based swaps that are not credit        market, new dealing entrants, and in some cases the          483 Other criteria in the CDS Data Analysis sought
                                                 default swaps.                                             registration of multiple dealing entities within an       to identify dealing activity based on whether an
                                                    In particular, according to data published by BIS,      affiliated group.                                         entity maintains a relatively flat book. Those
                                                 the global notional amount outstanding in equity              479 See CDS Data Analysis at table 3c. In              criteria also indicated that entities with notional
                                                 forwards and swaps as of June 2011 was $2.03               particular, those 15 entities engaged in a total of       transactions in excess of $100 billion in 2011
                                                 trillion, and the notional amount outstanding in           $11.01 trillion in notional single-name credit            represented over 97 percent of the total for all
                                                 credit default swaps was approximately $32.4               default swap transactions over 2011, which reflects       entities identified by those criteria, while entities
                                                 trillion. See Statistical Annex, BIS Quarterly             98.5 percent of the total $11.18 trillion in notional     with notional transactions in excess of $10 billion
                                                 Review (December 2011), at A10 (available at http://       transactions over 2011 for the 28 total identified        in 2011 represented over 99 of the total for all
                                                 www.bis.org/publ/qtrpdf/r_qs1112.pdf). Although            possible dealers.                                         entities identified by those criteria. See id. at tables
                                                 the BIS data reflects the global OTC derivatives              480 See id. The 21 possible dealers with a 2011        4 and 5. We are weighing those criteria less heavily
                                                 market, and not just U.S. market, we have no reason        notional in excess of $10 billion account for a total     than we are weighing the counterparty-based
                                                 to believe that these ratios differ significantly in the   of $11.15 trillion in notional single-name credit         criteria discussed above because an entity that
                                                 U.S. market. In fact, OCC data regarding U.S.              default swap transactions in 2011, or over 99.7           engages in directional trades could also appear to
                                                 entities generally confirms these ratios, in that as of    percent of the total. The 25 possible dealers in          have a flat book if its portfolio contained
                                                 June 30, 2011, U.S. commercial banks and trust             excess of $3 billion account for almost $11.18 in         transactions representing various directional bets,
                                                 companies held $15.23 trillion in notional                 notional transactions in 2011, or over 99.9 percent       but of similar aggregate notional sizes on both sides
                                                 outstanding credit derivative positions and $677           of the total.                                             of the market. See id. at 3.
                                                 billion in equity derivative positions, meaning that          481 For example, two other criteria consider the          The analysis also included one criterion that
                                                 credit derivatives accounted for approximately 95          number of an entity’s non-dealer counterparties (in       considers potential dealing activity based on a low
                                                 percent of the total credit and equity derivative          those cases identifying as dealers those persons that     propensity to post margin. See id. at table 6. While
                                                 positions held by these entities. See OCC Quarterly        have seven or more, or five or more, counterparties       we do not believe that this analysis deserves the
                                                 Report at tables 1 and 10. Cf. letter from                 not recognized as dealers by ISDA) also indicate          same degree of weight as the others, given concerns
                                                 Greenberger (referencing OCC data as relevant to           that potential dealers with notional amounts in           about the completeness of the data (see id. at 4), we
                                                 determining size of swap market).                          excess of $100 billion in 2011 account for over           note that this criterion nonetheless also indicates a
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                                                    477 A person that is engaged in security-based          98 percent of the notional transactions of all entities   high concentration of dealing activity in the market.
                                                 swap dealing activity, for example, may also engage        meeting the applicable criteria in 2011. Potential        See id. at table 6 (indicating that of the 473 entities
                                                 in proprietary trading involving security-based            dealers with notional transactions above $10 billion      identified by this criterion, the 14 entities with
                                                 swaps that would be reflected in the transaction           in 2011 (let alone those with notional transactions       notional transactions in excess of $100 billion in
                                                 data. Even accounting for such possibilities,              above $3 billion) reflect all or virtually the entire     2011 account for roughly 94 percent of the total
                                                 however, the SEC believes that the data nonetheless        notional amount of all dealers identified by those        notional transaction activity associated with all 473
                                                 support the broad conclusion described below that          criteria. See id. at tables 3a and 3b.                    entities over 2011).
                                                 dealing activity within the security-based swap               482 The CDS Data Analysis also sought to identify         484 Finally, the CDS Data Analysis also included

                                                 market is highly concentrated.                             dealing activity based on the total number of an          criteria that identified potential dealing activity



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                                                                   Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations                                                       30637

                                                 suggest a high concentration of dealing                 concentration in the market constitutes                  counterparties that are not recognized
                                                 activity within the security-based swap                 an important factor to consider in                       by ISDA as being dealers, entities with
                                                 market.                                                 balancing the regulatory burdens and                     notional transactions in excess of $100
                                                   While less data are available in                      benefits associated with a de minimis                    billion over a 12 month period represent
                                                 connection with other types of                          exception, analysis of the current                       over 98 percent of the total activity of
                                                 instruments constituting security-based                 market should not serve as the sole                      all such possible dealers over that
                                                 swaps, such as equity swaps, the                        mechanism for setting the exception.                     period, leaving two percent of possible
                                                 available data similarly suggest a high                    In particular, sole reliance on an                    dealing activity below that level.489
                                                 concentration of positions in those                     approach that focuses on current                         However, a de minimis threshold of
                                                 instruments among potential dealers.485                 measures of market concentration                         $100 billion would allow new entrants
                                                   Though inspection of the data does                    would not adequately account for likely                  to commence engaging in unregulated
                                                 not seem to suggest a single precise de                 changes to the market associated with                    dealing in competition with persons
                                                 minimis threshold, the above analysis of                the implementation of regulation. In                     who are regulated as dealers pursuant to
                                                 potential dealing activity is useful in                 part, these changes may be a direct                      Title VII, which, depending on the
                                                 that it reveals a range of possible                     result of the full implementation of Title               number and size of such entrants, could
                                                 thresholds from $100 billion to $3                      VII—including enhancements to                            significantly decrease the portion of
                                                 billion that would cover anywhere from                  transparency and increases in central                    dealing activity in the market done by
                                                 98 percent through 99.9 percent of the                  clearing—as those changes reasonably                     registered dealers (at least until the
                                                 total activity of all potential dealers in              may be expected to reduce the                            point that new entrants cross the de
                                                 2011. However, these thresholds—and                     concentration of dealing activity within                 minimis threshold, if they do at all). For
                                                 their implied market coverage ratios—                   the market over time.486 Also, to the                    example, if 15 new entrants 490 were to
                                                 only reflect levels of activity that exist              extent implementation of Title VII                       engage in security-based swap dealing
                                                 in today’s highly concentrated market.                  permits new dealers to enter the market,                 activity up to a $100 billion threshold,
                                                 In order to further narrow the range of                 the availability of a de minimis                         the result could be that nearly 15
                                                 possible thresholds, and to select an                   exception would mean those new                           percent of dealing activity within the
                                                 appropriate level for the de minimis                    dealing entrants would fall outside the                  single-name credit default swap market
                                                 exception, the analysis must consider                   ambit of dealer regulation, either for the               would be left outside of the ambit of
                                                 the potential state of the market as it                 long term or until their dealing activity                dealer regulation.491
                                                 might reasonably exist after the                        surpasses the applicable notional
                                                 implementation of Title VII.                            threshold.487 Accordingly, de minimis                       489 See CDS Data Analysis at table 3c; see also

                                                                                                                                                                  note 479, supra. As noted above, these amounts
                                                 ii. Avoiding Gaps Resulting From the                    thresholds that are based solely on the                  may not only reflect dealing activity by an entity.
                                                 Regulatory Changes in Conjunction                       current state of the market, including                   Thus, even putting aside the possibility of new
                                                 With the Exception                                      the current concentration of dealing                     unregulated entrants into the market, the portion of
                                                                                                         activity within the market, may                          dealing activity in the market that is represented by
                                                    Although the overall portion of                                                                               entities whose trailing notional dealing activity
                                                 security-based swap activity that would                 reasonably be expected to fail to account                exceeds $100 billion may in fact be less than 98
                                                 appear to be subject to dealer regulation               for the amount of dealing activity that                  percent.
                                                 based on current measures of dealing                    in the future could fall outside of the                     490 The illustrative use of new entrants for

                                                                                                         ambit of dealer regulation due to the                    purposes of this discussion is intended to reflect the
                                                                                                                                                                  potential that new entrants to the market could take
                                                 based on an entity meeting two or three of the other
                                                                                                         exception.488                                            advantage of a de minimis threshold in a way that
                                                 criteria considered. See id. at tables 7 and 8. These      For example, as discussed above,                      leads to a higher level of unregulated dealing
                                                 criteria again indicate a high degree of                when possible dealers in single-name                     activity within the market. In using this illustration
                                                 concentration of dealing activity in the market. The    credit default swaps are identified by an                we are not seeking to explicitly predict how many
                                                 analysis that addressed whether an entity met two                                                                new entrants may come into the market in response
                                                 of the other criteria identified 92 possible dealers,
                                                                                                         entity having three or more                              to any particular de minimis threshold, nor are we
                                                 with the 15 entities having notional transactions in                                                             seeking to predict how many new entrants may seek
                                                                                                            486 Cf. Bessembinder and Maxwell,                     to stay under the de minimis thresholds and how
                                                 excess of $100 billion in 2011 representing over 96
                                                 percent of the total activity of those 92 entities in   ‘‘Transparency and the Corporate Bond Market,’’          many instead would seek to use the exception as
                                                 2011. See id. at table 7. The analysis that addressed   Journal of Economic Perspectives, Spring 2008, at        a step on the way to eventually registering as a
                                                 whether an entity met three of the other criteria       217, 226 (noting that after reporting of U.S. OTC        security-based swap dealer. Rather, we simply are
                                                 identified 41 possible dealers, with the 15 entities    bond transactions through the Trade Reporting and        illustrating why it is important to account for
                                                 having notional transactions in excess of $100          Compliance Engine (‘‘TRACE’’) became mandatory,          market changes in connection with setting the de
                                                 billion in 2011, representing over 98 percent of the    the portion of trades completed by the 12 largest        minimis threshold.
                                                 total activity of those 41 entities in 2011. See id.    dealers fell from 56 percent to 44 percent).                The OTC Derivatives Supervisors Group—a group
                                                 at table 8.                                                487 We understand that large dealers have             chaired by the Federal Reserve Bank of New York
                                                    485 For example, OCC data shows that, of the five    competitive advantages under the current market,         and consisting of the CFTC and SEC as well as other
                                                 largest bank or trust companies, four have notional     in light of the desire of counterparties to engage in    international supervisors and major over-the-
                                                 equity derivative positions of above $1 billion, and    security-based swap transactions with large, well        counter derivatives market participants—currently
                                                 that those four entities account for $630 billion in    capitalized and highly rated dealers. See, e.g., Craig   recognizes 15 major OTC derivatives dealers.
                                                 notional positions out of $677 billion for all U.S.     Pirrong, Rocket Science, Default Risk and The            Accordingly, as an illustrative example, we have
                                                 commercial banks or trust companies, which              Organization of Derivatives Markets, Working             assumed that this number of significant security-
                                                 constitutes approximately 93 percent of the total.      Paper, University of Houston (2006) (available at        based swap dealers would approximately double—
                                                 See OCC Quarterly Report at table 10. Similarly, a      http://www.cba.uh.edu/spirrong/Derivorg1.pdf).           i.e., include 15 new dealers—in the wake of the
                                                 review of the equity swaps positions of the 50          The lower business costs associated with being           various regulatory changes contemplated by the
                                                 largest U.S. bank holding companies shows that          unregulated may prove to partially offset that           Dodd-Frank Act, many of which may result in
                                                 nine bank holding companies have notional equity        advantage. At the same time, we reasonably may           increased access and competition in the security-
                                                 swap positions exceeding $1 billion, and account        expect that informed counterparties will take into       based swap market (e.g., enhanced priced
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                                                 for 99.5 percent of the total positions held by such    account the lower protections—and higher risks—          transparency and increased access to central
                                                 companies, and 29 have no positions in equity           associated with transactions with unregulated            clearing). However, we emphasize that this number
                                                 swaps. (Data was compiled from each bank holding        dealers in determining whether to use regulated or       has been selected as an illustrative example, and
                                                 company’s FR 9–YC, available at http://                 unregulated dealers as counterparties.                   have accordingly provided similar examples
                                                 www.ffiec.gov/nicpubweb/nicweb/                            488 We note that there also are benefits to           assuming ten and five new entrants.
                                                 Top50Form.aspx). Cf. letter from WGCEF V                increased competition and a decrease in                     491 Fifteen new entities that each engage in $100

                                                 (referencing swap position data from bank holding       concentration of dealer activity, as contemplated by     billion in dealing activity would reflect $1.5 trillion
                                                 companies’ Forms FR Y–9C as relevant to                 Title VII, including potentially lower costs for         in additional dealing activity outside the ambit of
                                                 determining size of the swap market).                   market participants and a decrease in systemic risk.                                                  Continued




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                                                 30638             Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations

                                                   Similarly, a de minimis threshold of                       Overall, it is reasonable to conclude                notional threshold of $25 billion
                                                 $25 billion may also lead to a material                   that the higher the de minimis                          annually would permit an unregistered
                                                 reduction in the portion of the market                    threshold, the greater the likelihood that              dealer to engage in as many as 5000
                                                 covered by registered dealers. For                        the exception, combined with other                      trades of that size. The counterparties to
                                                 example, using the same assumptions as                    changes resulting from the                              these unregistered dealers would not
                                                 above, 15 new entrants up to a $25                        implementation of Title VII that may                    receive the benefit of the protections
                                                 billion threshold could leave over four                   encourage new entrants, will lead to a                  that Title VII affords to the
                                                 percent of dealing activity in the market                 proportionately larger amount of                        counterparties of registered dealers.
                                                 outside of the ambit of dealing                           unregulated (except with respect to                     These include, among others, the
                                                 regulation.492 When other metrics are                     antifraud and anti-manipulation                         segregation protections afforded to
                                                 used to identify possible dealing                         prohibitions) dealing activity.494 We                   persons who post margin to dealers in
                                                 activity, the possibility of a significant                believe that it is reasonable to interpret              connection with over-the-counter
                                                 regulatory gap remains.493                                the statutory language of the de minimis                security-based swap transactions.498
                                                                                                           exception in a way that prevents a                      Accordingly, this consideration also
                                                 dealer regulation, which could lead to roughly 14.9       proportionately large amount of dealing                 suggests that choosing a de minimis
                                                 percent of total dealing activity being outside the       activity within the security-based swap                 threshold closer to the lower end of the
                                                 ambit of dealing regulation (with that $1.5 trillion
                                                 being added to the existing $168 billion reflected        market from falling outside the ambit of                range of potential thresholds would
                                                 by entities that fall below the $100 billion              dealer regulation. Accordingly, choosing                better preserve the counterparty
                                                 threshold, and that sum divided by $11.18 trillion,       to set a lower de minimis threshold from                protections contemplated by Title VII.
                                                 under the assumption that the new entrants
                                                                                                           among the range of potential thresholds
                                                 displace business from the fifteen entities above the                                                             c. Balancing Reflected in the Final
                                                 de minimis threshold). To further illustrate, under       would limit the amount of potential
                                                                                                                                                                   Rules—Credit Default Swaps That
                                                 the same assumptions and analysis, the implied            future dealing activity that could be
                                                 unregulated market share would be roughly 10.4                                                                    Constitute Security-Based Swaps
                                                                                                           transacted without being subject to
                                                 percent for ten new entities and 6.0 percent for five                                                                The final thresholds that implement
                                                 new entities.                                             dealer rules and regulations.495
                                                    In certain regards these illustrations, on the one                                                             the de minimis exception (and
                                                                                                           iii. Promoting Statutory Counterparty                   corresponding phase-in levels) address
                                                 hand, may overestimate the effect of new entrants
                                                 because of the assumption that such entrants engage       Protections                                             security-based swaps that are credit
                                                 in dealing activities up to, but not surpassing, the         Sole reliance on an approach based on                default swaps separately from other
                                                 de minimis threshold. While it is not impossible
                                                 that some entities may seek to use the de minimis         overall market coverage in balancing                    types of security-based swaps, in light of
                                                 exception to conduct business as an unregulated           regulatory burdens and benefits would                   differences in the respective markets.
                                                 niche dealer, it also is plausible that entities          also threaten to unduly discount
                                                 generally may seek to use the exception to                important counterparty protection                       i. General Threshold for Credit Default
                                                 commence engaging in dealing activity, with the
                                                                                                           interests, as discussed above and                       Swaps That Constitute Security-Based
                                                 goal of ultimately becoming registered dealers that                                                               Swaps
                                                 are not constrained by the de minimis threshold.          highlighted in the proposal.496 For
                                                    On the other hand, these illustrations in certain      example, in light of data indicating that                  We conclude that $3 billion over the
                                                 respects may underestimate the amount of dealing          $5 million constitutes a common                         prior 12 months constitutes an
                                                 activity that can fall outside of the regulatory ambit.
                                                 For example, the amounts of security-based swap           notional size for a single-name credit                  appropriate notional threshold for
                                                 activity of persons identified in the analysis as         default swap position,497 a de minimis                  applying the de minimis exception in
                                                 dealers may not exclusively constitute dealing                                                                    connection with dealing activity
                                                 activity, meaning that persons whose notional                494 As noted above, encouraging new entrants also
                                                                                                                                                                   involving credit default swaps that
                                                 transactions over a 12-month period exceed a              has benefits flowing from increased competition
                                                 particular threshold in fact may not be engaged in                                                                constitute security-based swaps.
                                                                                                           and a decrease in concentration of dealer activity.
                                                 that amount of dealing activity, and hence may still      See note 488, supra.
                                                 be able to take advantage of the de minimis                  495 For example, 15 new dealer entrants engaged      broker activity by banks entails 500 trades annually.
                                                 exception. Also, these illustrations do not seek to                                                               See Exchange Act section 3(a)(4)(B)(xi) (excluding
                                                                                                           in up to $3 billion in dealing activity would
                                                 reflect increased activity by existing dealers that                                                               from the ‘‘broker’’ definition a bank that annually
                                                                                                           account for up to $45 billion in dealing activity.
                                                 already fall below the assumed threshold.                                                                         effects no more than 500 securities transactions,
                                                    492 Fifteen new entities each engaged in $25
                                                                                                           This result would mean approximately 0.4 percent
                                                                                                           of total potential future dealing activity could be     other than transactions subject to certain other
                                                 billion in dealing activity would reflect $375 billion    transacted by unregistered dealers, as opposed to       exceptions, so long as the transaction is not effected
                                                 in additional dealing activity outside the ambit of       the potential for approximately 15 percent of           by a bank employee that also is a broker-dealer
                                                 dealer regulation, which could lead to 4.1 percent        potential future dealing activity to be transacted by   employee).
                                                 of total dealing activity being outside the ambit of      unregistered dealers if the de minimis were set to         We further note that, while the number of
                                                 dealing regulation (with that $375 billion being                                                                  counterparties or transactions potentially
                                                                                                           $100 billion. See CDS Data Analysis at table 3c. As
                                                 added to the existing $80.2 billion reflected by                                                                  implicated by unregistered dealing activity is an
                                                                                                           with the illustrative examples above, these
                                                 entities that fall below the $25 billion threshold,
                                                                                                           calculations assume that the new entrants displace      important consideration in establishing an initial de
                                                 and that sum divided by $11.18 trillion, under the
                                                                                                           business from the entities above the de minimis         minimis level, it does not alter our view, described
                                                 assumption that the new entrants displace business
                                                                                                           threshold.                                              above, that a single de minimis standard based on
                                                 from the seventeen entities above the de minimis             496 See part II.D.3.a, supra; see also Proposing     notional value—rather than the proposal’s
                                                 threshold). To further illustrate, under the same
                                                 assumptions and analysis, the implied unregulated         Release at 80180 (highlighting ‘‘customer protection    framework of three distinct standards based on
                                                 market share would be 3.0 percent for 10 new              issues raised by swaps and security-based swaps—        notional value, number of counterparties, and
                                                 entities and 1.8 percent for 5 new entities.              including risks that counterparties may not fully       number of transactions—is an appropriate choice in
                                                 Obviously, these illustrations are subject to the         appreciate when entering into swaps and security-       light of concerns expressed by commenters that a
                                                 same limitations as are discussed above in the            based swaps’’).                                         standard based on the number of transactions or
                                                 context of the $100 million threshold illustration.          497 See Federal Reserve Bank of New York staff       counterparties can produce arbitrary results. See
                                                    493 For example, similar results are obtained          report, ‘‘An Analysis of CDS Transactions:              part II.D.3.b.ii, supra.
                                                 when possible dealing activity is identified based        Implications for Public Reporting’’ (2011) at 8            498 Exchange Act section 3E, which was added by

                                                 on whether an entity passes at least three of the         (stating that for dollar-denominated single name        section 763(d) of the Dodd-Frank Act, provides a
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                                                 other metrics discussed above. See CDS Data               CDS on corporate or sovereign reference entities, $5    series of requirements in connection with the
                                                 Analysis at table 8. Using the same types of              million represented the most common notional            segregation of assets held as collateral in security-
                                                 assumptions as are discussed above, with fifteen          size) (available at http://www.newyorkfed.org/          based swap transactions. These include
                                                 new entities, a de minimis threshold of $100 billion      research/staff_reports/sr517.pdf); see also             requirements that security-based swap dealers and
                                                 could lead to 15.0 percent of dealing activity falling    Proposing Release at 80180 (noting ‘‘that in general    major security-based swap participants provide
                                                 outside the ambit of dealer regulation, while a de        the notional seize of a small swap or security-based    their counterparties with notice that they have the
                                                 minimis threshold of $25 billion could lead to 4.2        swap is $5 million or less’’).                          right to require segregation, and that such
                                                 percent of dealing activity falling outside of               We note, by comparison, that Congress has            segregation must be at an independent third-party
                                                 regulation.                                               determined that a de minimis amount of securities       custodian.



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                                                                   Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations                                                      30639

                                                   In reaching this conclusion, we                         dealer annually to engage in up to 600                    It is important to recognize that while
                                                 recognize the significance of comments                    security-based swaps (as opposed to 20                  the commenter focused on the number
                                                 that supported the proposed $100                          transactions under the proposed                         of entities that might be excluded
                                                 million threshold,499 and that urged                      threshold, assuming a $5 million                        pursuant to the exception, and
                                                 caution in raising that proposed                          average notional size). In this regard, we              suggested that higher notional dollar
                                                 threshold,500 as well as commenters                       note that Congress, in another statutory                amount thresholds could lead to the
                                                 who supported increases to the                            de minimis exception within the                         exclusion of a larger number of entities,
                                                 threshold.501 We further recognize the                    Exchange Act, determined that 500                       the statutory provision for the de
                                                 importance of applying the de minimis                     securities transactions annually                        minimis exception does not require the
                                                 exception in a way that promotes                          constituted a de minimis amount of                      exemption of a ‘‘de minimis number’’ of
                                                 regulatory efficiency. We also recognize                  transactions for banks under the                        dealers. The statute instead requires the
                                                 the range of potential thresholds                         ‘‘broker’’ definition.503 We further                    exemption of persons engaged in a ‘‘de
                                                 suggested by the data currently                           believe that a $3 billion threshold                     minimis quantity’’ of dealing activity.507
                                                 available. Based on the competing                         appropriately addresses commenter                       The statutory language therefore
                                                 factors described above, we believe that                  concerns regarding the de minimis                       indicates that the focus of the rule
                                                 $3 billion reflects a reasonable notional                 exception being unduly narrow.504                       implementing the exception should be
                                                 threshold—though not necessarily the                         In adopting this $3 billion threshold,               the amount of an entity’s dealing
                                                 only such threshold.                                      we have carefully considered one                        activity, not how many entities
                                                   In our view, the currently available                    commenter’s view that the CDS Data                      ultimately may be able to take advantage
                                                 data regarding the single-name credit                     Analysis suggests that the proposed                     of the exception.
                                                 default swap market indicates that a                      $100 million threshold in fact is too                     Also, although the commenter
                                                 notional threshold of $3 billion would                    high, and that any increase in that                     implied that there would be no basis for
                                                 be expected to result in the regulation,                  proposed $100 million threshold would                   the rule implementing the exception to
                                                 as dealers, of persons responsible for the                be arbitrary and capricious.505 In                      take into account a market participant’s
                                                 vast majority of dealing activity within                  reaching these conclusions, the                         security-based swap dealing activity
                                                 that market, both as of today and, as                     commenter focused on the number of                      compared to total dealing activity in the
                                                 described above, in the future as the                     entities that potentially are engaged in                market, for the reasons discussed in this
                                                 benefits of the other Title VII rules are                 dealing activity but that could be                      section we believe that such an
                                                 implemented and new dealer entrants                       excluded based on particular de                         approach can appropriately provide for
                                                 come to market.502                                        minimis thresholds. For example, the                    the regulatory coverage of the vast
                                                   In providing for a $3 billion notional                  commenter indicated that pursuant to                    majority of dealing activity in a way that
                                                 threshold, we also recognize the                          one of the CDS Data Analysis’s                          promotes regulatory efficiency, without
                                                 threshold would permit an unregistered                                                                            leading to unwarranted regulatory gaps.
                                                                                                           combined metrics for identifying
                                                                                                           dealing activity, a de minimis threshold                In contrast, in our view the commenter
                                                   499 See   letters from Better Markets I and AFR.
                                                                                                           of $3 billion could lead to the exclusion               did not persuasively articulate a strong
                                                   500 See   letter from Greenberger.
                                                                                                           of up to 58 percent of all persons                      rationale for adopting the alternative
                                                    501 See, e.g., letter from COPE I.
                                                    502 Of the 28 market participants that have three      engaged in possible dealing activity.                   approach proposed in the letter, which
                                                 or more security-based swap counterparties that           The commenter further suggested that                    would appear to lead to the registration
                                                 themselves are not recognized by dealers by ISDA,         some entities engaged in dealing activity               of a number of dealers that
                                                 25 had notional single-name credit default swap                                                                   proportionately engage in a very small
                                                 positions in excess of $3 billion in 2011. The            may reduce their activities to take
                                                                                                                                                                   amount of dealing activity.508
                                                 remaining three entities in total accounted for only      advantage of the de minimis exception
                                                                                                                                                                     In support of its approach, the
                                                 $3.59 billion in notional transactions in 2011,           and hence reduce liquidity, and argued                  commenter emphasized data regarding
                                                 reflecting less than 0.1 percent of the $11.18 trillion   that there would be no basis for the
                                                 total for those 28 market participants. See CDS Data                                                              persons who meet certain combined
                                                 Analysis at table 3c.                                     exception to be based on a market                       criteria outlined in the CDS Data
                                                    The other criteria set forth in the analysis for       participant’s percentage of total
                                                 identifying possible dealing activity in general          security-based swap activity.506                        a risk-based test. We address those issues
                                                 similarly indicate that entities with notional
                                                                                                                                                                   elsewhere. See parts II.D.3.c (regarding ‘‘customer’’
                                                 transactions in excess of $3 billion in 2011 account        503 See  Exchange Act section 3(a)(4)(B)(xi); see     language) and II.D.3.e (regarding rejection of risk-
                                                 for more than 99 percent of the total notional
                                                                                                           also letter from SIFMA—Regional Dealers                 based and proportionality tests), infra.
                                                 transactions of all identified entities in 2011. See
                                                                                                           (supporting a threshold of 500 trades consistent           In addition, the letter expressed the view that a
                                                 id. at tables 2a–c, 3a–b, 4, 5, 7 and 8. While the
                                                                                                           with the statutory de minimis exception in              percentage-based formula would be difficult to
                                                 criterion based on the posting of initial margin only
                                                                                                           connection with bank brokerage activity).               implement, by requiring market participants to
                                                 indicates 98 percent coverage for all of the 473             504 For example, $3 billion is equal to the
                                                 identified entities, see id. at table 6, as discussed                                                             repeatedly calculate the ratio of their activity to
                                                 above we believe it is appropriate to provide less        threshold suggested by many commenters in the           total market activity. We concur. The $3 billion
                                                 weight to that criterion, which is based on               context of the swap market, which is much larger        threshold we are adopting reflects a fixed dollar
                                                 voluntary reporting.                                      than the security-based swap market. See letter         amount, and does not share the complications that
                                                    As noted above, see note 478, supra, we recognize      from COPE (supporting a 0.001 percent notional          would arise from an approach based on a particular
                                                 that the underlying market data encompasses all of        threshold based on the overall swaps market, which      percentage of the market.
                                                 the security-based swap activity of persons               would amount to $3 billion). Indeed, this $3 billion       507 See Exchange Act section 3(a)(71)(D).

                                                 identified as dealers, not only their dealing activity.   threshold appears to reflect roughly 0.024 percent         508 The commenter correctly pointed out that the

                                                 Because the thresholds that implement the de              of the overall market for single-name credit default    regulatory requirements applicable to registered
                                                 minimis exception address only a person’s dealing         swaps, a percentage that is much greater than the       dealers encompass counterparty protection
                                                 activity, this raises the possibility that the analysis   0.001 percent multiplier that a number of               requirements, and that the de minimis exception
                                                 overstates the extent to which a $3 billion threshold     commenters (see, e.g., letters cited in note 382,       should not defeat those requirements. We recognize
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                                                 would encompass persons responsible for dealing           supra) suggested in the swap market context. See        that the implementation of the exception should
                                                 activity within the single-name security-based swap       CDS Data Analysis at table 1 (indicating that           take those counterparty protections into account,
                                                 market. Even with that possibility, however, we           participants in the single-name credit default swap     and we have sought to do so. We do not believe,
                                                 believe that the data indicates such a high               market engage in a total of $12.6 trillion in single-   however, that those important counterparty
                                                 concentration of dealing activity within the market       name credit default swap transactions in 2011).         protection goals require a de minimis approach that
                                                                                                              505 See letter from Better Markets III.
                                                 that it is reasonable to conclude that a $3 billion                                                               focuses on the number of entities that would be
                                                 threshold likely would encompass persons                     506 The letter also raised issues regarding the      excluded, in lieu of the statutory focus on whether
                                                 responsible for the vast majority of dealing activity     ‘‘customer’’ language of the exception and argued       a particular entity engages in a de minimis quantity
                                                 within the market.                                        that the de minimis exception should not represent      of dealing activity.



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                                                 30640             Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations

                                                 Analysis. As discussed above, we                        facilitating new entrants into the                     security-based swap reporting facilities
                                                 believe that criteria based on the                      market.                                                contemplated by the Dodd-Frank Act
                                                 number of an entity’s counterparties                                                                           may suggest that the threshold should
                                                                                                         ii. Phase-in Period in Connection With
                                                 that are not recognized as dealers                                                                             be increased or decreased. In particular,
                                                                                                         Dealing Activity Involving Credit
                                                 deserve special weight due to the                       Default Swaps That Constitute Security-                the implementation of security-based
                                                 potential consistency of those criteria                 Based Swaps                                            swap data reporting under the Dodd-
                                                 with the dealer-trader distinction.509                                                                         Frank Act will result in significant new
                                                 Identifying dealer activity using those                    The final rules further provide that                data and afford an opportunity to review
                                                 criteria does not support the view that                 persons with notional dealing activity of              the Commission’s determination to
                                                 a $3 billion threshold would lead to the                $8 billion or less over the prior 12                   establish a $3 billion threshold.
                                                 exclusion of a large number of entities                 months involving credit default swaps
                                                                                                         that constitute security-based swaps                      For these reasons, an important part
                                                 engaged in dealing activity.510                                                                                of the report that the SEC is directing its
                                                                                                         would be able to avail themselves of a
                                                    Finally, we also are not persuaded by                                                                       staff conduct with regard to the
                                                                                                         phase-in period.512 Those persons
                                                 the commenter’s suggestion that a                                                                              definitions of ‘‘security-based swap
                                                                                                         would not be subject to the generally
                                                 number of entities engaged in dealing                                                                          dealer’’ and ‘‘major security-based swap
                                                                                                         applicable compliance date that occurs
                                                 activity would reduce those activities to                                                                      participant’’ (described in detail below)
                                                                                                         no later than 60 days following
                                                 take advantage of a $3 billion de                                                                              will be a consideration of the operation
                                                                                                         publication of these final rules in the
                                                 minimis threshold, and hence reduce                                                                            of the de minimis exception following
                                                                                                         Federal Register.513
                                                 liquidity in the market by five percent.                   The use of a phase-in period—in                     the full implementation of Section 15F
                                                 To reach that figure, the commenter                     connection with a person’s status as a                 under Title VII.515 The SEC will take
                                                 needed to exclude the vast majority of                  security-based swap dealer and in                      into account this report, along with
                                                 dealing activity in the market.511 While                connection with the other regulatory                   public comment on the report, in
                                                 we recognize that it is possible that                   requirements that are appurtenant to                   determining whether to propose any
                                                 current market participants may adjust                  dealer status—is intended to facilitate                changes to the rule implementing the de
                                                 their dealing activity in light of the de               the orderly implementation of Title VII.               minimis exception, including any
                                                 minimis threshold, and that this                        In addition, the phase-in period will                  increases or decreases to the $3 billion
                                                 potentially could reduce the liquidity                  afford the SEC additional time to study                threshold. The report will be linked to
                                                 provided by certain entities, we also                   the security-based swap market as it                   the availability of data regarding the
                                                 recognize that the de minimis exception                 evolves in the new regulatory                          activity of regulated security-based
                                                 has the potential to promote liquidity by               framework and will allow potential                     swap market participants in that it must
                                                                                                         dealers that engage in smaller amounts                 be completed no later than three
                                                   509 See  notes 478, 482, and 483, supra.              of activity (relative to the current size of           years 516 following a ‘‘data collection
                                                   510 For  example, the CDS Data Analysis identifies:   the market) additional time to adjust                  initiation date’’ that is the later of: the
                                                    • Three possible dealers with notional               their business practices, while at the
                                                 transactions below $3 billion in 2011—out of a total                                                           last compliance date for the registration
                                                 of 28 possible dealers—when possible dealing            same time preserving the focus of the                  and regulatory requirements for
                                                 activity is based on having three or more               regulation on the largest and most                     security-based swap dealers and major
                                                 counterparties that themselves are not identified as    significant dealers. The SEC also                      security-based swap participants under
                                                 dealers;                                                recognizes that the data informing its
                                                    • One possible dealer with notional transactions                                                            Section 15F of the Exchange Act; or the
                                                 below $3 billion in 2011– out of a total of 20
                                                                                                         current view of the de minimis                         first date on which compliance with the
                                                 possible dealers—when possible dealing activity is      threshold is based on the market as it                 trade-by-trade reporting rules for credit-
                                                 based on having five or more counterparties that        exists today, and that the market will                 related and equity-related security-
                                                 themselves are not identified as dealers; and           evolve over the coming years in light of
                                                    • Zero possible dealers with notional
                                                                                                                                                                based swaps to a registered security-
                                                                                                         the new regulatory framework and other                 based swap data repository is
                                                 transactions below $3 billion in 2011—out of a total
                                                 of 16 possible dealers—when possible dealing
                                                                                                         developments.                                          required.517
                                                 activity is based on having seven or more                  Accordingly, while the SEC believes
                                                 counterparties that themselves are not identified as    that a $3 billion notional threshold                      In light of the available data—and the
                                                 dealers.                                                reflects an appropriate long-term                      limitations of that data in predicting
                                                    See CDS Data analysis at tables 3c, 3b and 3a.       standard based on the currently                        how the full implementation of Title VII
                                                    In addition, as described above, an approach         available data,514 it also is appropriate              will affect dealing activity in the
                                                 focused on the quantity of activity is supported by
                                                 relatively consistent results depending on which        to provide for a phase-in period for                   security-based swap market—the SEC
                                                 criterion from the CDS Data Analysis is applied—        those entities with $8 billion or less in              believes that $8 billion constitutes an
                                                 i.e., each criterion shows a high amount of             dealing activity, because subsequent                   appropriate level for the availability of
                                                 concentration and a commensurately low quantity         developments in the market or the                      the phase-in period. The available data
                                                 of activity below the $3 billion threshold. By
                                                 contrast, applying different criteria results in very   evaluation of new data from the                        indicate that such a level generally
                                                 different numbers of entities excluded under any                                                               comports with the balance of interests
                                                 specified threshold, suggesting that an approach          512 Exchange   Act rule 3a71–2(a)(2).                that informed the determination of the
                                                 focused on the number of entities may be highly           513 Even  with the general 60 day compliance         appropriate long-term threshold of $3
                                                 dependent on how the possible dealing activity of       period, however, market participants will not
                                                 those entities is defined.
                                                                                                                                                                billion described above. In particular,
                                                                                                         necessarily be security-based swap dealers at the
                                                    511 In particular, in arguing that this incentive    end of 60 days. In particular, for the first year      the $8 billion level should still lead to
                                                 would reduce liquidity by five percent, the             following the effective date of the final rules        the regulation of persons responsible for
                                                 commenter excluded all business done by entities        implementing the definition of ‘‘security-based        the vast majority of dealing activity
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                                                 within the top two brackets (i.e., above $100 billion   swap’’ pursuant to the Exchange Act section
                                                 notional), on the grounds that those entities ‘‘are     3(a)(68), the de minimis analysis would only
                                                                                                                                                                  515 See Exchange Act rule 3a71–2A(a)(1); see also
                                                 assumed to transact mostly with larger entities.’’      address security-based swap dealing activity
                                                 Based on the criteria on which the commenter            following that effective date. See Exchange Act rule   part V, infra.
                                                                                                         3a71–2(a)(1). Among other things, this means that        516 See Exchange Act rule 3a71–2A(b).
                                                 relied, those 15 entities are responsible for over 96
                                                 percent of the activity of all possible dealers. See    until the rules defining ‘‘security-based swap’’ are     517 The SEC will announce the data collection

                                                 CDS Data Analysis at tables 7 and 8. Absent that        effective, no market participants would be deemed      initiation date on its Web site and publish it in the
                                                 exclusion, the estimated reduction of liquidity         to be security-based swap dealers.                     Federal Register. See Exchange Act rule 3a71–
                                                 would amount to a small fraction of a percent.             514 See note 502, supra.                            1(a)(2)(iii).



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                                                                   Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations                                                    30641

                                                 within the market.518 In addition, we do                  date certain, which will be five years                     Persons who are able to avail
                                                 not believe that providing a phase-in                     following the data collection initiation                 themselves of the phase-in period, of
                                                 period for persons with notional dealing                  date.522                                                 course, will not be required to do so.
                                                 activity over the prior 12 months of less                    These provisions should allow                         Any person that chooses to register with
                                                 than $8 billion would lead to a risk of                   sufficient time for the staff to complete                the SEC as a security-based swap dealer
                                                 an undue portion of the market falling                    its report, for the SEC to receive and                   shall be deemed to be a security-based
                                                 outside of the ambit of dealer regulation,                review public comment on the report,                     swap dealer subject to all applicable
                                                 even after considering the potential                      and for the SEC to draw conclusions                      regulatory requirements for such
                                                 entry of unregulated new dealers into                     regarding establishing the phase-in                      registrants, regardless of whether the
                                                 the market.519                                            termination date or proposing potential                  person engages in security-based swap
                                                    The final rule provides that the phase-                changes to the rule implementing the de                  dealing activity in an amount that is
                                                 in period will continue until the                         minimis exception, in a way that also                    below the applicable de minimis
                                                 ‘‘phase-in termination date’’ that the                    promotes the orderly and predictable                     threshold or phase-in level.525
                                                 SEC will publish on its Web site and in                   termination of the phase-in period.523
                                                 the Federal Register.520 In particular,                      This phase-in period will not be                      d. Balancing Reflected in the Final
                                                 the rule provides that nine months                        available in connection with the $25                     Rules—Other Types of Security-Based
                                                 following publication of that report, and                 million threshold for dealing activity                   Swaps
                                                 after giving due consideration of the                     involving special entities, discussed
                                                 report and associated public comment,                     below. In addition, the final rule                         The final rule provides that the de
                                                 the SEC may either: (1) Terminate the                     provides that this phase-in period will                  minimis exception for dealing activity
                                                 phase-in period and by order establish                    not be available in connection with                      involving security-based swaps other
                                                 and publish the phase-in termination                      security-based swap dealing activities                   than credit default swaps will be based
                                                 date; or (2) determine that it is necessary               involving natural persons, other than                    on a threshold of $150 million notional
                                                 or appropriate in the public interest to                  natural persons who qualify as ECPs by                   over the prior 12 months.526 In addition,
                                                 propose an alternative de minimis                         virtue of CEA section 1a(18)(A)(xi)(II),                 a phase-in period will be available in
                                                 threshold, in which case the SEC, by                      which addresses natural persons who                      connection with persons whose dealing
                                                 order published in the Federal Register,                  have $5 million or more invested on a                    activity involving those instruments is
                                                 will provide notice of that                               discretionary basis and who enter into                   $400 million or less in notional amount
                                                 determination and establish the phase-                    a security-based swap to manage the                      over the prior 12 months.
                                                 in termination date.521 If the SEC does                   risk associated with their assets and                       These amounts reflect roughly one-
                                                 not establish the phase-in termination                    liabilities.524 These limitations to the                 twentieth of the corresponding amounts
                                                 date in either of those ways, the phase-                  availability of the phase-in period are                  associated with the exception for credit
                                                 in termination date shall automatically                   consistent with the Dodd-Frank Act’s                     default swaps that constitute security-
                                                 occur in any event on what would be a                     goal of helping special entities be in a                 based swaps. As discussed above, while
                                                    518 Of the 28 market participants that have three
                                                                                                           position to benefit from the                             less data is available regarding other
                                                 or more security-based swap counterparties that           counterparty protections associated                      types of security-based swaps than is
                                                 themselves are not recognized by dealers by ISDA,         with the regulation of registered                        available regarding single-name credit
                                                 23 had notional single-name credit default swap           security-based swap dealers under Title                  default swaps, the available data is
                                                 transactions in excess of $8 billion in 2011. The         VII, as well as the SEC’s mandate to
                                                 remaining five entities in total accounted for only                                                                consistent in indicating that those other
                                                 $12.3 billion in notional transactions in 2011,           protect participants in the securities                   types of security-based swaps on a
                                                 reflecting roughly 0.1 percent of the $11.18 total for    markets.                                                 notional basis currently comprise
                                                 the 28 market participants. See CDS Data Analysis
                                                 at table 3c. Only two of the 28 entities identified                                                                roughly one-twentieth of the total
                                                 as possible dealers by that criterion had annual
                                                                                                             522 Exchange    Act rule 3a71–2(a)(2)(iii)(B).         amount of instruments that will be
                                                                                                             523 This  approach balances the fact that the SEC
                                                 notional transactions between $3 billion and $8                                                                    expected to constitute security-based
                                                 billion in 2011.                                          believes that its $3 billion and $150 million de
                                                                                                           minimis thresholds are appropriate in light of the       swaps.527 In light of this significantly
                                                    Most of the other criteria set forth in the analysis
                                                 for identifying possible dealing activity in general      currently available data and the market’s need for       smaller market, we believe that a $3
                                                 similarly indicate that entities with notional            a degree of certainty as to the length of this phase-    billion notional threshold would
                                                 transactions in excess of $8 billion in 2011 account      in period, on the one hand, against the possibility      threaten to cause an overly large portion
                                                 for more than 99 percent of the total notional            that the staff report and the accompanying public
                                                 transactions of all identified entities that year. See    comment may demonstrate that revision to these           of dealing activity within the market to
                                                 id. at tables 2a–b, 3a–b, 4 and 5. While the criterion    thresholds is necessary, on the other hand.              fall outside the ambit of dealer
                                                 based on an entity having 10 or more counterparties          524 See Exchange Act rule 3a71–2(a)(2)(i). In other   regulation.
                                                 only indicates 98 percent coverage for all of the 154     words, the phase-in period will still be available in
                                                 identified entities at an $8 billion transaction level,   connection with dealing activities with natural             In this regard, we note that it is likely
                                                 see id. at table 2c, as noted above this criterion may    persons who are ECPs because they have entered           that there are fewer barriers to entry in
                                                 identify persons who in reality are not engaged in        into a security-based swap for hedging purposes.         connection with acting as a dealer in
                                                 dealing activity. See note 482, supra. Also, while        While we recognize the importance of Title VII
                                                 the criterion based on the posting of initial margin      protections to natural persons who engage in
                                                                                                                                                                    security-based swaps such as equity
                                                 only indicates 97 percent coverage for all of the 473     security-based swap activity, we also recognize the      swaps and total return swaps on debt
                                                 identified entities at an $8 billion transaction level,   benefit of facilitating such persons’ use of security-   than there are in connection with acting
                                                 see id. at table 6, as discussed above that criterion     based swaps as hedges. Accordingly, persons who          as a dealer in single-name credit default
                                                 is based on voluntary reporting.                          engage in dealing activity with natural persons who
                                                    519 For example, 15 new dealer entrants up to $8       are ECPs under other provisions of the ECP
                                                                                                                                                                      525 See Exchange Act rule 3a71–2(e).
                                                 billion in annual notional dealing activity would         definition will be subject to the applicable de
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                                                 account for $120 billion in dealing activity. This        minimis threshold for all of their dealing activity,       526 Exchange   Act rule 3a71–2(a)(1)(ii). The
                                                 would amount to roughly 1.2 percent of the total          without the availability of the phase-in period.         proposal requested comment on whether different
                                                 notional single-name security-based swap activity            Persons who engage in dealing activity with           segments of the security-based swap market should
                                                 over 12 months of entities identified as possible         natural persons who are not ECPs will fall within        be treated differently. See Proposing Release at
                                                 dealers by virtue of having three or more                 the Exchange Act definition of ‘‘dealer,’’ which has     80101 (‘‘Commenters further are requested to
                                                 counterparties that are not recognized by dealers by      no de minimis exception. See Exchange Act section        address * * * whether the [de minimis]
                                                 ISDA. See CDS Data Analysis at table 2c.                  3(a)(5)(A) (generally excluding dealers in security-     exemption’s factors should vary depending on the
                                                    520 Exchange Act rule 3a71–2(a)(2)(i).
                                                                                                           based swaps from the Exchange Act definition of          type of swap or security-based swap at issue.’’).
                                                    521 Exchange Act rule 3a71–2(a)(2)(iii)(A).            ‘‘dealer,’’ unless the counterparty is not an ECP).        527 See note 476, supra.




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                                                 30642             Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations

                                                 swaps.528 We also note that because                     for single-name credit default swaps—                    million notional size—but the threshold
                                                 equity swaps and total return swaps on                  particularly highlights how the use of a                 would limit the financial and other risks
                                                 debt can serve as close economic                        phase-in period that is linked to the                    associated with those positions for a
                                                 proxies for equity and debt securities,                 availability of post-implementation data                 special entity, which would in turn
                                                 an overly broad de minimis threshold in                 is appropriate.531                                       limit the possibility of inappropriately
                                                 connection with such instruments could                     As above, a person who is eligible to                 undermining the special protections
                                                 threaten to undermine the Exchange Act                  take advantage of the phase-in period in                 that Title VII provides to special
                                                 framework for regulating persons who                    connection with these types of security-                 entities.
                                                 act as dealers in equity and debt.                      based swaps may nonetheless register as                    In reaching this conclusion we
                                                    At the same time—notwithstanding                     a security-based swap dealer.                            recognize that special entities do
                                                 the smaller scope of this market and the                                                                         participate in the single-name credit
                                                 lesser availability of data regarding                   e. Dealing Activity Involving Special                    default swap market, given that an
                                                 dealing activity within the market—we                   Entities                                                 analysis of market data indicates that in
                                                 do not believe that it is necessary to                     Consistent with the proposal, the final               2011 special entities were parties to
                                                 make the de minimis exception                           rules in general will cap an entity’s                    over $40 billion in single-name credit
                                                 unavailable in connection with dealing                  dealing activity involving security-based                default swap transactions.535 At the
                                                 activity involving security-based swaps                 swaps at no more than $25 million                        same time, the impact of this $25
                                                 that are not credit default swaps. In this              notional amount over the prior 12                        million threshold—particularly
                                                 regard we particularly note that the                    months when the counterparty to the                      concerns that the threshold may
                                                 limited available data regarding equity                 security-based swap is a special                         foreclose the ability of special entities to
                                                 swaps suggests a high degree of                         entity.532 There will be no phase-in                     access dealers in the market—appears to
                                                 concentration in dealing activity                       period in connection with transactions                   be mitigated by the fact that the
                                                 involving those instruments,529 which                   involving special entities. In adopting                  counterparties to those special entities
                                                 indicates that an appropriately sized de                this threshold, we recognize the serious                 tend to engage in notional transactions
                                                 minimis threshold can be expected to                    concerns raised by commenters that                       in single-name credit default swap well
                                                 promote regulatory efficiency.                          stated that the de minimis exception                     in excess of the general de minimis
                                                    Balancing those factors, we conclude                 should not permit any dealing activities                 standards.536 In light of the underlying
                                                 that a $150 million annual notional                     involving special entities in light of                   counterparty protection issues, we see
                                                 threshold is appropriate to implement                   losses that special entities have incurred               no basis to distinguish between types of
                                                 the de minimis exception in connection                  in the financial markets,533 as well as                  security-based swaps in setting this
                                                 with security-based swaps that are not                  the special protection that Title VII                    special entity threshold.
                                                 credit default swaps, consistent with                   affords special entities.534                               For similar reasons, in the future as
                                                 our understanding of the comparative                       At this time, the final rule does not                 we consider whether to amend the de
                                                 size of that market as applied to the                   fully exclude such dealing activity from                 minimis exception we expect to pay
                                                 threshold applicable to credit default                  the exception, in light of the potential                 particular attention to whether the
                                                 swap dealing activity. For reasons                      benefits that may arise from a de                        threshold for transactions involving
                                                 similar to those described above, we                    minimis exception. In this way, the                      special entities should further be
                                                 conclude that there should be a phase-                  threshold would not completely                           lowered.
                                                 in period available to persons whose                    foreclose the availability of security-                  f. Future Revisions to the Rule
                                                 annual notional dealing activity in                     based swaps to special entities from
                                                 connection with security-based swaps                    unregistered dealers—as $25 million                         As noted above and described in
                                                 that are not credit default swaps is no                 would annually accommodate up to five                    detail below in part V, the SEC is
                                                 more than $400 million in annual 12-                    single-name credit default swaps of a $5                 directing its staff to report on whether
                                                 month notional amount. This phase-in                                                                             changes are warranted to the rules and
                                                 period is subject to the same limitations                 531 The SEC expects that the staff report should       interpretations implementing the
                                                 regarding transactions involving special                be especially helpful for providing data regarding       security-based swap dealer definition,
                                                 entities and natural persons as apply to                dealing activity in connection with those other          including the rule implementing the de
                                                 the phase-in period for credit default                  types of security-based swaps to consider the            minimis exception.537 The SEC will take
                                                                                                         impact of the termination of the phase-in period, as
                                                 swaps. It also will be subject to the same              well as potential changes to the de minimis
                                                                                                                                                                  the report and associated public
                                                 provisions regarding the termination of                 exception in connection with these instruments.          comment into account in determining
                                                 the phase-in period as apply in                           532 Exchange Act rule 3a71–2(a)(1)(iii).               whether to propose any changes to the
                                                 connection with credit default swaps.530                  533 See letters from AFR and Better Markets I.         rule implementing the exception.538
                                                 The comparative lack of data involving                    534 In this regard we note that Title VII authorizes
                                                                                                                                                                  Consistent with that possibility, the
                                                 these markets—in contrast to the market                 the SEC to impose special business conduct               final rule provides that the SEC may
                                                                                                         requirements when a security-based swap dealer is
                                                                                                         counterparty to a special entity. See Exchange Act       change the requirements of the de
                                                   528 For example, persons registered with the SEC
                                                                                                         section 15F(h)(5). In proposing rules to implement       minimis exception by rule or
                                                 as broker-dealers in connection with other types of     these requirements, the SEC requested comment            regulation.539 Through this mechanism,
                                                 securities would appear to be well positioned to act    regarding the scope of the ‘‘special entity’’
                                                 as dealers in connection with equity swaps, as such     definition, including, for example, regarding              535 See  CDS Data Analysis at table 9.
                                                 broker-dealers already would be expected to have        whether the SEC should interpret ‘‘special entity’’        536 See  id. at n.8 (noting that the average notional
                                                 systems in place to enter into equity positions to      to exclude a collective investment vehicle in which
                                                 hedge their equity swap dealing positions.              one or more special entities have invested. See          activity of those 16 counterparties was $680 billion,
                                                   529 As noted above, four commercial banks and
                                                                                                         Exchange Act Release No. 64766 (June 29, 2011), 76       with the lowest being approximately $9 billion).
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                                                                                                                                                                     537 See Exchange Act rule 3a71–2A(a)(1).
                                                 trust companies accounted for 93 percent of all         FR 42396, 42422 (July 18, 2011). For purposes of
                                                 equity positions held by such companies as of June      interpreting this special entity threshold to the de        538 See notes 520 through 522, supra, and

                                                 30, 2011, and nine bank holding companies               minimis exception—particularly with regard to            accompanying text.
                                                 accounted for over 99 percent of all equity positions   when a special entity would be a counterparty to            539 Exchange Act rule 3a71–2(d). Exchange Act
                                                 held by the fifty largest such companies as of          a person that is engaged in dealing activity—the         section 3(a)(71)(D) particularly states that the
                                                 December 2011. See note 485, supra.                     SEC believes that it will be appropriate to be guided    ‘‘Commission’’—meaning the SEC—may exempt de
                                                   530 See Exchange Act rule 3a71–2(a)(2); see also      by final interpretations regarding when a dealer will    minimis dealers and promulgate related regulations.
                                                 notes 520 through 522, supra, and accompanying          be a counterparty to a special entity for purposes       We do not interpret the joint rulemaking provisions
                                                 text.                                                   of those business conduct requirements.                  of section 712(d) of the Dodd-Frank Act to require



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                                                                   Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations                                                   30643

                                                 the SEC may revisit the rule                               Accordingly, the final rules have been               transparency concerns apart from risk
                                                 implementing the exception and                          revised from the proposal to provide for                concerns.
                                                 potentially change that rule, for                       a timing standard that is similar to what
                                                 example, if data regarding the security-                we are using in connection with the                     E. Limited Purpose Designation as a
                                                 based swap market following the                         major participant definition.542 That is,               Dealer
                                                 implementation of Section 15F under                     if an entity that has relied on the de                  1. Proposed Approach
                                                 Title VII suggests that different de                    minimis exception no longer is able to
                                                 minimis thresholds would be                             rely on the exception because its dealing                  The definitions of the terms ‘‘swap
                                                 appropriate.540 In determining whether                  activity exceeds a relevant threshold,                  dealer’’ and ‘‘security-based swap
                                                 to revisit the thresholds, the SEC                      the entity would have two months,                       dealer’’ provide that the Commissions
                                                 intends to pay particular attention to                  following the end of the month in which                 may designate a person as a dealer for
                                                 whether the de minimis exception                        it no longer is able to take advantage of               one type, class or category of swap or
                                                 results in a dealer definition that                     the exception, to submit a completed                    security-based swap, or specified swap
                                                 encompasses too many entities whose                     application to register as a swap dealer                or security-based swap activities,
                                                 activities are not significant enough to                or security-based swap dealer.543                       without the person being considered a
                                                 warrant full regulation under Title VII,                   Also, akin to the major participant                  dealer for other types, classes, categories
                                                 or, alternatively, whether the de                       definitions,544 a person registered as a                or activities.547
                                                 minimis exception leads an undue                        swap dealer or security-based swap                         In the Proposing Release, we noted
                                                 amount of dealing activity to fall outside              dealer may apply to withdraw that
                                                 of the ambit of the Title VII regulatory                                                                        that these provisions represent
                                                                                                         registration, while continuing to engage                permissive grants of authority that do
                                                 framework, or leads to inappropriate                    in a limited amount of dealing activity
                                                 reductions in counterparty protections                                                                          not require the Commissions to provide
                                                                                                         in reliance on the de minimis exception,
                                                 (including protections for special                                                                              limited designations.548 We further
                                                                                                         if that person has been registered as a
                                                 entities). The SEC also intends to pay                                                                          stated that a person that is covered by
                                                                                                         dealer for at least 12 months.545 This
                                                 particular attention to whether                         should help ensure that persons do not                  the definitions of the terms ‘‘swap
                                                 alternative approaches would more                       rapidly move in and out of dealer status                dealer’’ or ‘‘security-based swap dealer’’
                                                 effectively promote the regulatory goals                based on short-term fluctuations in their               would be considered a dealer for all
                                                 that may be associated with a de                        swap or security-based swap activities.                 types, classes or categories of the
                                                 minimis exception.                                                                                              person’s swaps or security-based swaps,
                                                                                                            The final rules implementing the de
                                                                                                         minimis exception do not provide any                    or activities involving swaps or security-
                                                 6. Registration Period for Entities That                                                                        based swaps, in light of the difficulty of
                                                 Exceed the De Minimis Factors                           reevaluation period for entities that
                                                                                                         engage in a level of dealing activity                   seeking to separate a person’s dealing
                                                   The de minimis exception raises                       above the de minimis thresholds, in                     activities from their non-dealing
                                                 implementation issues akin to those                     contrast to the major participant                       activities involving swaps or security-
                                                 associated with the major participant                   definitions.546 We do not believe that                  based swaps, unless such person sought
                                                 definition, in that both provisions use                 there is an appropriate basis for such a                and received designation as a dealer for
                                                 tests that have retrospective elements to               provision, particularly given that dealer               only specified categories of swaps or
                                                 determine whether an entity must                        regulation addresses customer                           security-based swaps, or specified
                                                 register and be subject to future                       protection and market operation and                     activities.549 We explained that this
                                                 regulation. As a result, some                                                                                   would provide persons the opportunity
                                                 commenters have suggested that entities                    542 Compare CFTC Regulation § 1.3(hhh)(3);           to seek a limited designation based on
                                                 that surpass the de minimis thresholds                  Exchange Act rule 3a67–8(a) (providing that             applicable facts and circumstances, and
                                                 should be able to take advantage of a                   persons who meet the criteria to be major               that we anticipated that a dealer could
                                                 grace period to undertake the process of                participants will have two months to submit a
                                                                                                                                                                 seek a limited designation at the time of
                                                 registering as swap dealers or security-                completed registration application).
                                                                                                            543 See CFTC Regulation § 1.3(ggg)(4)(ii);           its initial registration or later.550
                                                 based swap dealers.541 Otherwise,                       Exchange Act rule 3a71–2(b). As discussed below
                                                 absent such a ‘‘roll-in’’ period, entities                                                                         In the Proposing Release, the CFTC
                                                                                                         with regard to the implementation period for the
                                                 whose dealing activities surpass the                    major participant definitions, persons will have        further noted that non-financial entities
                                                 relevant de minimis factors would                       additional time to comply with the applicable           such as physical commodity firms
                                                                                                         requirements following the submission of a              potentially may conduct dealing activity
                                                 immediately be in violation of dealer                   completed application. See part IV.L.3, infra.
                                                 registration requirements. In light of                     544 Compare CFTC Regulation § 1.3(hhh)(5);
                                                                                                                                                                 through a division rather than through
                                                 these concerns, and the interest of                     Exchange Act rule 3a67–8(c) (providing that a major     a separately incorporated subsidiary,
                                                 avoiding undue market disruptions, the                  participant may be deemed to no longer be a major       and that such an entity’s swap dealing
                                                 Commissions believe that it is                          participant if its swap or security-based swap          activity would not be a core component
                                                                                                         positions are below the relevant thresholds for four
                                                 appropriate to provide entities that                    quarters).
                                                                                                                                                                 of its overall business. The CFTC added
                                                 exceed applicable the de minimis                           545 See CFTC Regulation § 1.3(ggg)(4)(ii);           that if this type of entity registered as a
                                                 factors a period of time to register as                 Exchange Act rule 3a71–2(c). Consistent with this       dealer, certain swap dealer requirements
                                                 dealers.                                                approach, moreover, the final rule has been revised     would apply to the dealing activities of
                                                                                                         from the proposal to clarify that the de minimis
                                                                                                         exception in general is not available to a registered
                                                                                                                                                                 the division, but not necessarily to the
                                                 joint rulemaking here, because such an                  swap dealer or security-based swap dealer. See          swap activities of other parts of the
                                                 interpretation would read the term ‘‘Commission’’       CFTC Regulation § 1.3(hhh)(1)(i); Exchange Act rule     entity.551
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                                                 out of Exchange Act section 3(a)(71)(D), which itself   3a71–2(a)(1) (revised language clarifying
                                                 was added by the Dodd-Frank Act.                        availability of exception to a person that is not a        547 CEA section 1a(49)(B); Exchange Act section
                                                    540 See letter from Greenberger (stating that the    swap dealer or security-based swap dealer).
                                                 dynamic nature of the derivatives sector of the            546 Compare CFTC Regulation § 1.3(hhh)(4);           3(a)(71)(B).
                                                                                                                                                                    548 See Proposing Release, 75 FR at 80182.
                                                 financial markets should counsel caution, and that      Exchange Act rule 3a67–8(b) (providing for a
                                                                                                                                                                    549 See id.; see also proposed CFTC Regulation
                                                 the de minimis threshold should be reevaluated on       reevaluation period in connection with the major
                                                 an ongoing basis).                                      participant definitions when a person does not          § 1.3(ggg)(3); proposed Exchange Act rule 3a71–1(c).
                                                    541 See letters from Northland Energy and                                                                       550 See Proposing Release, 75 FR at 80182.
                                                                                                         exceed any applicable threshold by more than 20
                                                 WGCEF I.                                                percent in a calendar quarter).                            551 See id.




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                                                 30644              Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations

                                                 2. Commenters’ Views                                       for limited designations. Some                           d. Application of Regulatory
                                                   A number of commenters addressed                         commenters supported the ability of a                    Requirements to Limited Dealers
                                                 the limited designation of dealers in                      person to apply for limited designations                   Commenters also addressed issues
                                                 conjunction with the limited                               at the time of initial registration,559                  related to the application of regulatory
                                                 designation of major participants. Many                    while one commenter sought                               requirements to limited dealers. One
                                                                                                            clarification on how and when a person
                                                 of the issues those commenters raised                                                                               commenter recommended that dealer
                                                                                                            could apply for limited swap dealer
                                                 thus are relevant to both sets of                                                                                   regulatory requirements generally
                                                                                                            status.560 Some commenters suggested
                                                 definitions.                                                                                                        should apply only to a division
                                                                                                            that entities should be considered to
                                                                                                                                                                     undertaking limited dealing activities;
                                                 a. Presumption of Full Designation                         have a provisional limited designation
                                                                                                                                                                     that commenter further stated that
                                                   A number of commenters objected to                       upon the filing of a completed
                                                                                                                                                                     capital requirements should be
                                                 the proposed presumption that an entity                    application for limited dealer
                                                                                                                                                                     calculated based only on the activities
                                                 would be designated as a dealer (or                        designation.561
                                                                                                               Some commenters requested further                     of that division, while recognizing that
                                                 major participant) for all categories of                                                                            capital must be held by the entity as a
                                                                                                            clarification as to what factors or criteria
                                                 swaps or security-based swaps and all of                                                                            whole.567 Other commenters argued that
                                                                                                            would be considered relevant to limited
                                                 the person’s activities connected to                                                                                capital and margin requirements should
                                                                                                            designation determinations.562 One
                                                 swaps or security-based swaps. Several                                                                              only be applied to an entity on a limited
                                                                                                            commenter stated that non-financial
                                                 commenters argued that this approach                                                                                basis.568
                                                                                                            companies should have a presumption
                                                 would be contrary to Congressional
                                                                                                            of limited swap dealer designation                       e. Miscellaneous Issues
                                                 intent,552 conflict with the statutory
                                                                                                            under certain circumstances.563 Another
                                                 language,553 or conflict with underlying                                                                               One commenter recommended that
                                                                                                            commenter took the view that
                                                 policy concerns.554 One commenter                                                                                   non-financial entities that are deemed to
                                                                                                            commercial firms should be able to
                                                 suggested that the Commissions lack the                                                                             be limited dealers (or major
                                                                                                            determine whether to register a legal
                                                 statutory authority to apply swap dealer                                                                            participants) be permitted to be treated
                                                                                                            entity or a division as a dealer.564 One
                                                 requirements to an entity’s non-swap                                                                                as end-users for the aspects of their
                                                                                                            commenter suggested the analysis
                                                 dealing activities.555                                                                                              businesses that are not subject to the
                                                                                                            consider the complexity of an entity’s
                                                                                                                                                                     limited designation.569 The commenter
                                                 b. Potential Types of Limited                              dealing and non-dealing activities, and
                                                                                                                                                                     further suggested that the swaps ‘‘push-
                                                 Designations                                               further suggested that limited
                                                                                                                                                                     out’’ rule requirements of section 716 of
                                                   A number of commenters addressed                         designations should automatically be
                                                                                                                                                                     the Dodd-Frank Act be interpreted so
                                                 potential types of limited designations.                   available if an entity’s dealing activities
                                                                                                                                                                     that an insured depository institution
                                                 One expressed support for limited swap                     do not exceed 50 percent of its total
                                                                                                                                                                     that is a limited purpose dealer would
                                                 dealer designations for particularized                     swap activities.565 Commenters also
                                                                                                                                                                     only have to push out the dealing
                                                 business units and for particular swap                     raised issues related to how a person’s
                                                                                                                                                                     portion of its swap business, and be
                                                 categories,556 while another requested                     status as a financial or a non-financial
                                                                                                                                                                     allowed to retain the other aspects of its
                                                 that limited swap dealer designations be                   entity affects a person’s eligibility for
                                                                                                                                                                     swaps business.570 One commenter
                                                 available based on any reasonable                          limited designations.566
                                                                                                                                                                     requested clarification as to whether a
                                                 commercial groupings.557 Some                                 559 See letters from MFA I (specifically requesting   person that is a limited purpose dealer
                                                 commenters urged that limited dealer                       that the rules provide that an entity can receive a      in connection with one category of swap
                                                 designations should be available for the                   limited purpose designation at the time of their         could be a major participant in
                                                 branches or business units of foreign                      initial registration) and FSR I.                         connection with another category (in
                                                                                                               560 See letter from National Futures Association
                                                 swap dealers and security-based swap                                                                                light of the statutory language excluding
                                                                                                            (‘‘NFA’’).
                                                 dealers with U.S.-based customers or                          561 See letters from Capital One, Farm Credit         dealers from the major participant
                                                 U.S. business lines.558                                    Council I and FHLB I.                                    definitions).571
                                                                                                               562 See letters from BG LNG I and ISDA I.
                                                 c. Applications for Limited Designations                      563 See letter from Cargill (arguing that a firm
                                                                                                                                                                     3. Final Rules and General Principles
                                                    A number of commenters addressed                        should be presumptively entitled to limited swap           Consistent with the proposal, the final
                                                 issues relating to the application process                 dealer status if: it is a non-financial company; its     rules retain the presumption that a
                                                                                                            non-dealing activities include (but need not be
                                                    552 See letters from Cargill Incorporated
                                                                                                            limited to) production, merchandising or processing
                                                                                                            of physical commodities; the firm’s dealing              (suggesting that an entity’s status as a financial
                                                 (‘‘Cargill’’), CDEU and Investment Company                 activities take place in a separately identifiable       company should be relevant to limited dealer
                                                 Institute (‘‘ICI’’) dated February 22, 2011 (‘‘ICI I’’).   division or business unit with separate                  determinations).
                                                    553 See letters from MetLife and WGCEF I.                                                                           567 See letter from Cargill.
                                                                                                            management; and dealing revenues are less than 30
                                                    554 See letter from Cargill (stating that limited
                                                                                                            percent of the firm’s total revenues in the firm’s          568 See letter from FSR I (recommending that to
                                                 designation promotes the policy of encouraging             most recent fiscal year).                                the extent that capital requirements are tied to swap
                                                 non-financial firms that primarily are engaged in             564 See letter from WGCEF VII (stating that so long   activity or exposures, that only activities or
                                                 non-dealing businesses to continue to conduct              as a registered swap dealer bears the onus of            exposures in the designated category be reflected in
                                                 limited dealing activities, adding that such firms         demonstrating compliance with regulatory                 the calculation).
                                                 ‘‘do not present the potential systemic risks of           requirements, regulators ‘‘should not dictate’’             569 See id. (recommending that the corporate
                                                 financial firms,’’ and that their full designation as      whether the firm registers a legal entity or a           treasurer of an entity with a limited designation as
                                                 dealers would discourage them from providing risk          division as a dealer; also requesting guidance as to     a swap dealer for ‘‘other commodity swaps’’ as a
                                                 management products).                                      how applicable regulatory requirements may apply         result of its energy derivatives activity be able to
                                                    555 See letter from EDF Trading.
                                                                                                            to a subdivision of a legal entity that registers as a   hedge the entity’s interest rate and currency risk
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                                                    556 See letter from Capital One.                        dealer, and requesting a safe harbor from                without being subject to the business conduct,
                                                    557 See letters from NCGA/NGSA II (particularly         enforcement action when a decision to register only      reporting, recordkeeping or other rules applicable to
                                                 referring to groupings based on individual physical        a particular desk or division as a dealer is made in     dealers and major participants).
                                                 commodities) and WGCEF dated June 9, 2011                  good faith).                                                570 See id.

                                                 (‘‘WGCEF VII’’) (limited designation should permit            565 See letter from Capital One.                         571 See letter from NFA. As discussed below, see
                                                 firms to structure organization of limited purpose            566 Compare letter from Capital One (stating that     752, infra, a person who is designated as a dealer
                                                 registrans as appropriate in particular                    all market participants, including financial             in connection with particular types of swaps or
                                                 circumstances).                                            institutions, should be allowed to apply for limited     security-based swaps may be major participants
                                                    558 See letters cited in note 148, supra.               swap dealer designations) with letter from Cargill       with regard to other types.



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                                                                    Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations                                                       30645

                                                 person who meets one of the dealer                           We similarly are not persuaded by the                 documentation and confirmations.580
                                                 definitions will be deemed to be a                         view that the Commissions lack the                      An applicant for a limited purpose
                                                 dealer with regard to all of its swaps or                  authority to apply dealer regulation to                 designation would have to demonstrate
                                                 security-based swaps activities, unless                    non-dealing activities of a registered                  how it would satisfy those transaction-
                                                 the CFTC or SEC exercises its authority                    swap dealer or security-based swap                      specific requirements in the context of
                                                 to limit the person’s designation as a                     dealer.576 Certain of the statutory                     a limited designation.
                                                 dealer to specified categories of swaps                    requirements applicable to swap dealers                    Other statutory requirements
                                                 or security-based swaps, or specified                      and security-based swap dealers—such                    applicable to dealers particularly focus
                                                 activities.572 As discussed in the                         as capital requirements—simply do not                   on the entity itself. These include
                                                 Proposing Release, moreover, a person                      distinguish between a person’s dealing                  requirements related to registration,
                                                 may apply for a limited designation                        activities and their non-dealing                        capital, risk management, supervision,
                                                 when it submits a registration                             activities.577 In other words, absent a                 and chief compliance officers.581 Here
                                                 application, or at a later time.573 The                    limited designation, the statutory                      too, an applicant for a limited purpose
                                                 final rules also contain a technical                       requirements applicable to dealers                      designation would have to demonstrate
                                                 change from the proposed rules to                          address the regulation of all of a dealer’s             how it would satisfy those requirements
                                                 clarify that limited designations may be                   swap or security-based swap                             in the context of limited designations.
                                                 based on a particular type, class or                       activities.578                                             A limited purpose designation might
                                                 category of swap or security-based-                                                                                be appropriate, for example, where a
                                                                                                            b. Demonstration of Compliance With                     commercial agricultural company is a
                                                 swap.574                                                   Dealer Requirements                                     dealer in swaps related to a thinly-
                                                 a. Default Presumption of Full                                The Commissions will consider                        traded commodity, such as a particular
                                                 Designation                                                limited purpose applications on an                      fertilizer, but is not a dealer in, and does
                                                    Consistent with the proposal, the final                 individual basis through analysis of the                not wish to be subject to the swap dealer
                                                 rules retain the standard that a person                    unique circumstances of each applicant,                 requirements with respect to its swaps
                                                 that satisfies the ‘‘swap dealer’’ or                      given that the types of entities that                   that relate to broadly-traded
                                                 ‘‘security-based swap dealer’’ definition                  engage in swap or security-based swap                   commodities like corn or wheat (or
                                                 in general would be considered a dealer                    dealing are diverse and their                           where, say, a commercial energy
                                                 for all types, classes or categories of the                organization and activities are varied.579              company is a dealer in swaps involving
                                                 person’s swaps or security-based swaps,                       Regardless of the type of limited                    a commodity to be delivered at a
                                                 or all activities involving swaps or                       designation being requested, the                        particular location and does not wish to
                                                 security-based swaps.                                      Commissions will not designate a                        be subject to the swap dealer
                                                    The Commissions are not persuaded                       person as a limited purpose dealer                      requirements for its swaps involving
                                                 by the suggestion that this presumption                    unless it can demonstrate that it can                   that commodity to be delivered at other
                                                 is inconsistent with the statute,                          fully comply with the requirements                      locations, for which it is not a swap
                                                 legislative intent or underlying policy.                   applicable to dealers.                                  dealer). A limited designation might
                                                                                                               Certain of the statutory requirements                also be appropriate so that the swap
                                                 Not only is the relevant statutory
                                                                                                            applicable to dealers particularly focus                dealer requirements do not apply to
                                                 language written as a grant of authority
                                                                                                            on the entity’s swap or security-based                  interest rate or currency swaps that the
                                                 rather than a specific mandate to
                                                                                                            swap activities and positions. These                    agricultural or energy company enters
                                                 designate certain entities as limited
                                                                                                            include, among other aspects,                           into in managing its financial risk.
                                                 purpose dealers, but the presumption
                                                                                                            requirements related to trading records,
                                                 also reasonably reflects the difficulty of                                                                           580 See, e.g., CEA section 4s(h)(3), Exchange Act
                                                 separating a dealer’s dealing activities                   brokers and dealers from engaging in certain            section 15F(h)(3) (business conduct standards,
                                                 from its non-dealing activities, and the                   securities-related activity in contravention of SEC-    including disclosure requirements, for dealers);
                                                 challenges of applying dealer regulatory                   prescribed rules with respect to financial              CEA section 4s(g), Exchange Act section 15F(g)
                                                 requirements to only a portion of a                        responsibility or related practices. This provision     (daily trading record requirements for dealers); CEA
                                                                                                            does not distinguish between those activities that      section 4s(i); Exchange Act section 15F(i)
                                                 dealer’s swap or security-based swap                       cause a person to fall within the ‘‘broker’’ or         (documentation requirements for dealers).
                                                 activities.575                                             ‘‘dealer’’ definitions, and other activities that         581 See, e.g., CEA section 4s(a)(1), Exchange Act

                                                                                                            themselves do not cause that person to be a broker      section 15F(a)(1) (registration requirements for
                                                    572 CFTC Regulation§ 1.3(ggg)(3); Exchange Act          or dealer. The SEC’s authority extends to all           dealers); CEA section 4s(e), Exchange Act section
                                                 rule 3a71–1(c).                                            securities activities by those brokers or dealers.      15F(e) (capital and margin requirements for
                                                    573 The SEC expects to address the process for             576 See letter from EDF Trading.                     dealers). The Dodd-Frank Act provides that in
                                                 submitting an application for limited designation as          577 See, e.g., CEA section 4s(e); Exchange Act       setting the capital requirements for swap dealers
                                                 a security-based swap dealer, along with principles        section 15F(e).                                         and security-based swap dealers (as well as major
                                                                                                                                                                    participants) that are subject to a limited
                                                 to be used by the SEC in analyzing such                       578 The substantive regulations applicable to
                                                                                                                                                                    designation, the Commissions and the prudential
                                                 applications, as part of separate rulemakings.             dealers, of course, can account for the nature of a
                                                                                                                                                                    regulators must take into account the risks
                                                    574 The rules particularly have been revised from       dealer’s particular swap or security-based swap
                                                                                                                                                                    associated with other types, classes, or categories of
                                                 the proposal to add ‘‘type’’ and ‘‘class’’ language to     activities.
                                                                                                                                                                    swaps or security-based swaps engaged in, and the
                                                 supplement the use of the term ‘‘category.’’ This             The SEC also intends to address limited              other swap or security-based swap activities
                                                 change is consistent with the statutory language. In       designation issues in the context of a separate         conducted by, that person ‘‘that are not otherwise
                                                 addition, the final rules related to limited               release addressing the application of Title VII to      subject to regulation applicable to that person by
                                                 designations for ‘‘security-based swap dealers’’           non-U.S. entities.                                      virtue of the status of the person’’ as a dealer or
                                                 corrects an erroneous reference to major participant          579 Consistent with this approach, applications to
                                                                                                                                                                    major participant. See CEA section 4s(e)(2)(C);
                                                 designation.                                               limit a person’s dealer designation to ‘‘specified      Exchange Act section 15F(e)(2)(C). In the case of a
                                                    575 This approach also is consistent with the           categories’’ of swaps or security-based swaps (see      commercial agricultural or energy company that
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                                                 treatment of dealers of other types of securities          CFTC Regulation § 1.3(ggg)(3); Exchange Act rule        obtains a limited purpose designation for a
                                                 under the Exchange Act. When a person’s securities         3a71–1(c)), would not be required to interpret the      particular business unit, the CFTC does not expect
                                                 activities cause them to be a ‘‘dealer’’ for purposes      term ‘‘category’’ consistently with the use of that     that this provision will generally require the limited
                                                 of the Exchange Act, the statutory requirements and        term in connection with the major participant           purpose designee to calculate its required capital on
                                                 regulations applicable to dealers will apply to all        definitions. CFTC Regulation § 1.3(iii) and             the basis of swaps engaged in, or activities
                                                 of that person’s securities activities, regardless of      Exchange Act rule 3a67–2, defining the terms            conducted by, other business units within the
                                                 whether particular activities would not have caused        ‘‘major swap category’’ and ‘‘major security-based      company, to the extent those swaps or activities do
                                                 the entity to fall within the ‘‘dealer’’ definition. For   swap category,’’ respectively, do not apply for this    not generate risk beyond the agricultural or energy
                                                 example, Exchange Act section 15(c)(3)(A) prohibits        purpose.                                                company’s ordinary commercial line of business.



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                                                 30646             Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations

                                                    A limited purpose designee could be                   provisions mean that persons can                           on a similar basis.589 In some cases,
                                                 a particular business unit within a                      engage in neither swaps nor security-                      discussed below in detail, if a Forex
                                                 company. Additionally, a limited                         based swaps transactions with persons                      Pool does not satisfy the ECP definition
                                                 designation might be considered to                       that are not ECPs on SEFs, on security-                    applicable to commodity pools engaging
                                                 ‘‘split the desk’’ by applying the swap                  based SEFs, or on a bilateral, off-                        in the types of foreign currency
                                                 dealer requirements solely to the                        exchange basis.                                            transactions noted above 590 and it
                                                 designee’s limited activities involving                     The Dodd-Frank Act also amended                         engages in these types of foreign
                                                 swaps not entered into for the purpose                   the ECP definition by: 586 (i) Providing                   currency transactions (such
                                                 of hedging a physical position as                        that, for purposes of CEA sections                         transactions, ‘‘retail forex transactions’’
                                                 defined in CFTC Regulation                               2(c)(2)(B)(vi) and 2(c)(2)(C)(vii), the term               and such commodity pools, ‘‘Retail
                                                 § 1.3(ggg)(6)(iii). Any particular limited               ECP does not include a commodity pool                      Forex Pools’’), the transactions will be
                                                 purpose application will be analyzed in                  in which any participant is not itself an                  subject to a regulatory regime that
                                                 light of the unique circumstances                        ECP; (ii) raising the monetary threshold                   imposes certain requirements and
                                                 presented by the applicant.                              that governmental entities may use to                      restrictions on the counterparties to the
                                                    A key challenge that any applicant to                 qualify as ECPs, in certain situations,                    Retail Forex Pool, and, if the Retail
                                                 a limited dealer designation will face is                from $25 million in investments owned                      Forex Pool engages in retail forex
                                                 the need to demonstrate full compliance                  and invested on a discretionary basis to                   transactions other than with certain
                                                 with the requirements that apply to the                  $50 million in investments owned and                       counterparties, on the commodity pool
                                                 type, class or category of swap or                       invested on a discretionary basis; 587                     operator (‘‘CPO’’) who operates the
                                                 security-based swap, or the activities                   and (iii) replacing the ‘‘total asset’’                    Retail Forex Pool. These requirements
                                                 involving swaps or security-based                        standard for individuals to qualify as                     and restrictions do not apply if the
                                                 swaps, that fall within the swap dealer                  ECPs with an ‘‘amounts invested on a                       Forex Pool satisfies the ECP definition
                                                 designation.                                             discretionary basis’’ standard.588                         applicable to commodity pools engaging
                                                                                                                                                                     in the types of foreign currency
                                                 III. Amendments to the Definition of                        Commodity pools may, among other                        transactions noted above.
                                                 Eligible Contract Participant                            things, enter into transactions involving                     The Commissions are adopting further
                                                                                                          foreign currency. ECP status is                            definitions of the term ‘‘eligible contract
                                                 A. Background                                            important for commodity pools that                         participant’’ in the following six
                                                    The Dodd-Frank Act makes it                           enter into the following types of foreign                  respects: (i) Generally prohibiting a
                                                 unlawful for a person that is not an                     currency transactions (such commodity                      Forex Pool from qualifying as an ECP if
                                                 eligible contract participant (‘‘ECP’’) to               pools, ‘‘Forex Pools’’): (i) Off-exchange                  such Forex Pool directly enters into
                                                 enter into a swap other than on, or                      foreign currency futures; (ii) off-                        retail forex transactions 591 and has one
                                                 subject to the rules of, a DCM.582 In                    exchange options on foreign currency                       or more direct participants that are not
                                                 addition, section 763(e) of the Dodd-                    futures; (iii) off-exchange options on                     ECPs; 592 (ii) clarifying that, in
                                                 Frank Act makes it unlawful for a                        foreign currency; (iv) leveraged or                        determining whether a direct
                                                 person to effect a transaction in a                      margined foreign currency transactions;                    participant in a Forex Pool is an ECP,
                                                 security-based swap with or for a person                 and (v) foreign currency transactions                      the indirect participants in the Forex
                                                 that is not an ECP unless the transaction                that are financed by the offeror, the                      Pool will not be considered unless such
                                                 is effected on a national securities                     counterparty or a person acting in                         Forex Pool, a commodity pool holding
                                                 exchange registered with the SEC.583                     concert with the offeror or counterparty                   a direct or indirect (through one or more
                                                 Moreover, section 768(b) of the Dodd-                                                                               intermediate tiers of pools) interest in
                                                 Frank Act makes it unlawful for a                        security-based swap, it shall be unlawful for any
                                                 person to offer to sell, offer to buy or                 person, directly or indirectly, to make use of any            589 See CEA sections 2(c)(2)(B)(vi) and

                                                 purchase, or sell a security-based swap                  means or instruments of transportation or                  2(c)(2)(C)(vii), 7 U.S.C. 2(c)(2)(B)(vi) and 7 U.S.C.
                                                                                                          communication in interstate commerce or of the             2(c)(2)(C)(vii). In this context, the term ‘‘off-
                                                 to a person that is not an ECP unless a                  mails to offer to sell, offer to buy or purchase or sell   exchange’’ means other than on or subject to the
                                                 registration statement under the                         a security-based swap to any person who is not an          rules of an organized exchange, as defined in CEA
                                                 Securities Act of 1933 (‘‘Securities                     eligible contract participant as defined in section        section 1a(37), 7 U.S.C. 1a(37).
                                                 Act’’) 584 is in effect with respect to that             1a(18) of the Commodity Exchange Act (7 U.S.C.                590 See CEA section 1a(18)(A)(iv), 7 U.S.C.
                                                                                                          1a(18)).’’ The Commissions note that market                1a(18)(A)(iv); see also CFTC Regulation § 1.3(m)(5)
                                                 security-based swap.585 These                            participants must make the determination of ECP            (exporting the look-through language of CEA
                                                                                                          status with respect to the parties to transactions in      section 1a(18)(A)(iv) to CEA section 1a(18)(A)(v)).
                                                    582 In particular, section 723(a)(2) of the Dodd-     security-based swaps and mixed swaps prior to the          The Dodd-Frank Act amended the ECP definition to
                                                 Frank Act adds new subsection (e) to CEA section         offer to sell or the offer to buy or purchase the          include a provision that specifically applies to
                                                 2 (7 U.S.C. 2(e)), providing that ‘‘[i]t shall be        security-based swap or mixed swap.                         Forex Pools engaging in these types of foreign
                                                 unlawful for any person, other than an eligible             586 See Sections 741(b)(10) and 721(a)(9) of the
                                                                                                                                                                     currency transactions. See Section 741(b)(10) of the
                                                 contract participant, to enter into a swap unless the    Dodd-Frank Act; see also Financial Regulatory              Dodd-Frank Act (adding a provision to CEA section
                                                 swap is entered into on, or subject to the rules of,     Reform, A New Foundation: Rebuilding Financial             1a(18)(A)(iv), 7 U.S.C. 1a(18)(A)(iv), stating
                                                 a board of trade designated as a contract market         Supervision and Regulation, available at http://           ‘‘provided, however, that for purposes of section
                                                 under section 5.’’                                       www.treasury.gov/initiatives/Documents/                    2(c)(2)(B)(vi) and section 2(c)(2)(C)(vii), the term
                                                    583 In particular, section 763(e) of the Dodd-Frank   FinalReport_web.pdf, at 48–49 (June 17, 2009).             ‘eligible contract participant’ shall not include a
                                                 Act adds paragraph (l) to Exchange Act section 6            587 See CEA section 1a(18)(A)(vii), 7 U.S.C.            commodity pool in which any participant is not
                                                 (15 U.S.C. 78f(l)), providing that ‘‘[i]t shall be       1a(18)(A)(vii).                                            otherwise an eligible contract participant.’’). See
                                                 unlawful for any person to effect a transaction in          588 See CEA section 1a(18)(A)(xi), 7 U.S.C.             part III.B below for a discussion of this provision.
                                                 a security-based swap with or for a person that is       1a(18)(A)(xi). The Dodd-Frank Act did not amend            This provision applies only with respect to retail
                                                 not an eligible contract participant, unless such        the monetary thresholds for individuals to qualify         forex transactions. This means that a Retail Forex
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                                                 transaction is effected on a national securities         as ECPs. As such, an individual can qualify as an          Pool, as defined above, that is not an ECP for retail
                                                 exchange registered pursuant to subsection (b).’’        ECP if such individual has amounts invested on a           forex transaction purposes could be an ECP for
                                                    584 15 U.S.C. 77a et seq.
                                                                                                          discretionary basis, the aggregate of which is in          other transactions it enters into that are not retail
                                                    585 In particular, section 768(b) of the Dodd-Frank   excess of (i) $10,000,000, or (ii) $5,000,000 if such      forex transactions.
                                                                                                                                                                        591 In many commodity pool structures, this is the
                                                 Act adds paragraph (d) to Securities Act section 5       individual also enters into the agreement, contract,
                                                 (15 U.S.C. 77e(d)), providing that                       or transaction in order to manage the risk associated      master fund alone.
                                                 ‘‘[n]otwithstanding the provisions of section 3 or 4,    with an asset owned or liability incurred, or                 592 But see note 652, infra, with respect to single

                                                 unless a registration statement meeting the              reasonably likely to be owned or incurred, by such         level Forex Pools using retail forex transactions
                                                 requirements of section 10(a) is in effect as to a       individual.                                                solely to hedge.



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                                                                    Federal Register / Vol. 77, No. 100 / Wednesday, May 23, 2012 / Rules and Regulations                                                         30647

                                                 such Forex Pool, or any commodity pool                     B. Commodity Pool Look-Through for                       qualify as an ECP can enter into a retail
                                                 in which such Forex Pool holds a direct                    Retail Forex Transactions                                forex transaction described in CEA
                                                 or indirect interest has been structured                                                                            section 2(c)(2)(B)(i)(I) only with one of
                                                                                                            1. Statutory Provisions
                                                 to evade Subtitle A of Title VII of the                                                                             the federally-regulated counterparties
                                                 Dodd-Frank Act; 593 (iii) prohibiting a                       Prior to the Dodd-Frank Act, clause                   enumerated in CEA sections
                                                 commodity pool from qualifying as an                       (A)(iv) of the ECP definition provided                   2(c)(2)(B)(i)(II)(aa) (U.S. financial
                                                 ECP unless it has total assets exceeding                   that a commodity pool was an ECP if it                   institutions),600 (bb) (certain brokers,
                                                 $5 million and is operated by a person                     had $5 million in total assets and was                   dealers and their associated persons),601
                                                 described in CEA section                                   operated by a person regulated under                     (cc) (certain futures commission
                                                 1a(18)(A)(iv)(II);594 (iv) explicitly                      the CEA, regardless of whether each                      merchants (‘‘FCMs’’) and their affiliated
                                                 including swap dealers, security-based                     participant in the commodity pool was                    persons),602 (dd) (certain financial
                                                 swap dealers, major swap participants,                     itself an ECP.597 Section 741(b)(10) of                  holding companies) 603 or (ff) (certain
                                                 and major security-based swap                              the Dodd-Frank Act added a proviso to                    retail foreign exchange dealers
                                                 participants in the definition of ECP; (v)                 clause (A)(iv) 598 stating that a Forex                  (‘‘RFEDs’’)) 604 (each an ‘‘Enumerated
                                                 permitting a non-ECP to qualify as an                      Pool will not qualify as an ECP, solely                  Counterparty’’ and collectively
                                                 ECP, with respect to certain swaps,                        for purposes of CEA sections                             ‘‘Enumerated Counterparties’’); the
                                                 based on the collective net worth of its                   2(c)(2)(B)(vi) or 2(c)(2)(C)(vii) (i.e., retail          counterparty restriction does not apply
                                                 owners, subject to several conditions,                     forex transactions) if any participant in                to retail forex transactions described in
                                                 including that the owners are ECPs; and                    the Forex Pool is itself not an ECP.599                  CEA section 2(c)(2)(C)(i)(I)(bb) 605
                                                 (vi) permitting a Forex Pool to qualify as                    Thus, for purposes of retail forex                    entered into by a Forex Pool that does
                                                 an ECP notwithstanding that it has one                     transactions, the Dodd-Frank Act                         not qualify as an ECP, though such
                                                 or more direct participants that are not                   imposed a requirement to ‘‘look                          transactions are subject to antifraud
                                                 ECPs if the Forex Pool (a) is not formed                   through’’ a Forex Pool—meaning that                      protections and related enforcement
                                                 for the purpose of evading regulation                      ECP status would be limited to Forex                     provisions if entered into with a
                                                 under CEA sections 2(c)(2)(B) or (C) or                    Pools in which each participant is itself
                                                 related rules, regulations or orders, (b)                  an ECP. This is important for two                           600 7 U.S.C. 2(c)(2)(B)(i)(II)(aa). The term

                                                 has total assets exceeding $10 million                     reasons. First, a Forex Pool that does not               ‘‘financial institution’’ is defined in CEA Section
                                                                                                                                                                     1a(21), 7 U.S.C. 1a(21).
                                                 and (c) is formed and operated by a                                                                                    601 7 U.S.C. 2(c)(2)(B)(i)(II)(bb). This category is
                                                 registered CPO or by a CPO who is                          (which the Commissions are addressing to a limited       comprised of each:
                                                 exempt from registration as such                           extent in the discussion of the new line of business        (AA) [] broker or dealer registered under section
                                                                                                            ECP category in part III.F, infra, and in Regulation
                                                 pursuant to § 4.13(a)(3). In addition, the                 § 1.3(m)(7)(ii)(C) under the CEA); (v) the meaning of
                                                                                                                                                                     15(b) (except paragraph (11) thereof) or 15C of the
                                                 Commissions are issuing interpretive                                                                                Securities Exchange Act of 1934 (15 U.S.C. 78o(b),
                                                                                                            the new ‘‘amounts invested on a discretionary            78o–5); [and] (BB) [ ] associated person of a broker
                                                 guidance regarding the definition of ECP                   basis’’ element of the individual prong of the ECP       or dealer registered under section 15(b) (except
                                                 to correct an inaccurate statutory cross-                  definition (CEA section 1a(18)(A)(xi), 7 U.S.C.          paragraph (11) thereof) or 15C of the Securities
                                                                                                            1a(18)(A)(xi)); (vi) whether persons can be ECPs in      Exchange Act of 1934 (15 U.S.C. 78o(b), 78o–5)
                                                 reference with respect to the ability of                   anticipation of receiving, but before they have, the     concerning the financial or securities activities of
                                                 government entities to qualify as ECPs                     necessary assets; and (vii) that swap dealers are not    which the broker or dealer makes and keeps records
                                                 under CEA section 1a(18)(A)(vii).595 The                   among the entities listed in CEA section                 under section 15C(b) or 17(h) of the Securities
                                                 Commissions also are issuing                               2(c)(2)(B)(i)(II), 7 U.S.C. 2(c)(2)(B)(i)(II), as        Exchange Act of 1934 (15 U.S.C. 78o–5(b), 78q(h)).
                                                 interpretive guidance with respect to the                  acceptable counterparties to non-ECPs engaging in           602 7 U.S.C. 2(c)(2)(B)(i)(II)(cc). This category is
                                                                                                            retail forex transactions.                               comprised of each:
                                                 ECP status of Forex Pools whose                               597 Clause (A)(iv) of the pre-Dodd-Frank Act ECP
                                                                                                                                                                        (cc)(AA) []futures commission merchant that is
                                                 participants are limited solely to non-                    definition also included a commodity pool operated       primarily or substantially engaged in the business
                                                 U.S. persons and which are operated by                     by a foreign person performing a similar role or         activities described in section 1a of this Act, is
                                                 CPOs located outside the United States,                    function as a person regulated under the CEA and         registered under this Act, is not a person described
                                                                                                            subject as such to foreign regulation (regardless of     in item (bb) of this subclause, and maintains
                                                 its territories or possessions.                            whether the foreign person was itself an ECP).           adjusted net capital equal to or in excess of the
                                                    The Commissions note that                                  598 The proviso states ‘‘provided, however, that      dollar amount that applies for purposes of clause
                                                 commenters raised interpretive and                         for purposes of section 2(c)(2)(B)(vi) and section       (ii) of this subparagraph; [and] (BB) [ ] affiliated
                                                 other issues related to the ECP                            2(c)(2)(C)(vii), the term ‘eligible contract             person of a futures commission merchant that is
                                                 definition that the Commissions may                        participant’ shall not include a commodity pool in       primarily or substantially engaged in the business
                                                                                                            which any participant is not otherwise an eligible       activities described in section 1a of this Act, is
                                                 consider in the future.596                                 contract participant.’’ CEA section 1a(18)(A)(iv); 7     registered under this Act, and is not a person
                                                                                                            U.S.C. 1a(18)(A)(iv).                                    described in item (bb) of this subclause, if the
                                                    593 Section 721(c) of the Dodd-Frank Act requires          599 See CEA section 1a(18)(A)(iv), 7 U.S.C.           affiliated person maintains adjusted net capital
                                                 the CFTC to adopt a rule to further define the terms       1a(18)(A)(iv). In other words, the proviso in section    equal to or in excess of the dollar amount that
                                                 ‘‘swap,’’ ‘‘swap dealer,’’ ‘‘major swap participant,’’     1a(18)(A)(iv) does not reference or implicate ECP        applies for purposes of clause (ii) of this
                                                 and ‘‘eligible contract participant,’’ in order ‘‘[t]o     status for purposes of (i) CEA section 2(e), 7 U.S.C.    subparagraph and is not a person described in such
                                                 include transactions and entities that have been           2(e) (which, as discussed above, permits non-ECPs        item (bb), and the futures commission merchant
                                                 structured to evade’’ subtitle A of Title VII (or an       to trade swaps only on or subject to the rules of a      makes and keeps records under section 4f(c)(2)(B)
                                                 amendment to the CEA made by subtitle A).                  DCM); (ii) Securities Act section 5(d) (which, as        of this Act concerning the futures and other
                                                    594 7 U.S.C. 1a(18)(A)(iv)(II).
                                                                                                            discussed above, makes it unlawful for a person to       financial activities of the affiliated pe