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2012-18383

  • Federal Register, Volume 77 Issue 146 (Monday, July 30, 2012)[Federal Register Volume 77, Number 146 (Monday, July 30, 2012)]

    [Rules and Regulations]

    [Pages 44441-44456]

    From the Federal Register Online via the Government Printing Office [www.gpo.gov]

    [FR Doc No: 2012-18383]

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    COMMODITY FUTURES TRADING COMMISSION

    17 CFR Part 50

    RIN 3038-AD60

    Swap Transaction Compliance and Implementation Schedule: Clearing

    Requirement Under Section 2(h) of the CEA

    AGENCY: Commodity Futures Trading Commission.

    ACTION: Final rule.

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    SUMMARY: The Commodity Futures Trading Commission (Commission or CFTC)

    is adopting regulations to establish a schedule to phase in compliance

    with the clearing requirement under new section 2(h)(1)(A) of the

    Commodity Exchange Act (CEA or Act), enacted under Title VII of the

    Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank

    Act). The schedule will provide additional time for compliance with

    this requirement. This additional time is intended to facilitate the

    transition to the new regulatory regime established by the Dodd-Frank

    Act in an orderly manner that does not unduly disrupt markets and

    transactions.

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

    FOR FURTHER INFORMATION CONTACT: Sarah E. Josephson, Deputy Director,

    202-418-5684, sjosephson@cftc.gov; Brian O'Keefe, Associate Director,

    202-418-5658. bokeefe@cftc.gov; or Peter Kals, Attorney-Advisor, 202-

    418-5466, pkals@cftc.gov, Division of Clearing and Risk, Commodity

    Futures Trading Commission, Three Lafayette Centre, 1155 21st Street

    NW., Washington, DC 20581.

    SUPPLEMENTARY INFORMATION:

    Table of Contents

    I. Background

    II. Comments on the Notices of Proposed Rulemaking

    A. Comment Period

    B. Harmonization

    C. Cross-Border and Affiliate Transactions

    D. Comprehensive Implementation Schedule

    E. Prerequisite Rules

    F. Definitions

    1. Active Fund

    2. Third-Party Subaccount

    3. Category 1 and Category 2 Entities

    G. Compliance Schedule for the Clearing Requirement

    4. Application to All Swap Types

    5. Timing of Implementation Schedules

    III. Cost-Benefit Considerations

    IV. Related Matters

    A. Regulatory Flexibility Act

    B. Paperwork Reduction Act

    I. Background

    Section 723(a)(3) of the Dodd-Frank Act amended the CEA to provide,

    under new section 2(h)(1)(A) of the CEA, that it shall be unlawful for

    any person to engage in a swap unless that person submits such swap for

    clearing to a derivatives clearing organization (DCO) that is

    registered under the CEA or a DCO that is exempt from registration

    under the CEA if the swap is required to be cleared (the Clearing

    Requirement).\1\ Section 2(h)(2) charges the Commission with the

    responsibility for determining whether a swap is required to be cleared

    (a Clearing Requirement determination), through one of two avenues: (1)

    Pursuant to a Commission-initiated review; or (2) pursuant to a

    submission from a DCO of each swap, or any group, category, type, or

    class of swaps that the DCO ``plans to accept for clearing.'' \2\ The

    Commission is proposing its first Clearing Requirement determination

    concurrently with its adoption of this compliance schedule rule. The

    finalization of that proposal will trigger the compliance schedule

    provided for under this adopting release.

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    \1\ Section 2(h)(7) of the CEA provides an exception to the

    Clearing Requirement when one of the counterparties to a swap (i) is

    not a financial entity, (ii) is using the swap to hedge or mitigate

    commercial risk, and (iii) notifies the Commission how it generally

    meets its financial obligations associated with entering into a non-

    cleared swap.

    \2\ Under section 2(h)(2)(B)(ii), the Commission must consider

    swaps listed for clearing by a DCO as of the date of enactment of

    the Dodd-Frank Act.

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    On September 20, 2011, the Commission published proposed Sec.

    39.5(e) \3\ to phase in compliance of the Clearing Requirement upon the

    Commission's issuance of a Clearing Requirement determination pursuant

    to Sec. 39.5(b) or (c).\4\ That notice of proposed rulemaking (NPRM)

    also included an implementation schedule for the requirement pursuant

    to amended section 2(h)(8)(A), which requires a swap subject to the

    Clearing

    [[Page 44442]]

    Requirement to be executed on a designated contract market (DCM) or

    swap execution facility (SEF), unless no SEF or DCM makes the swap

    available to trade (the Trade Execution Requirement). The Commission is

    hereby adopting proposed Sec. 39.5(e), as newly designated Sec.

    50.25, to establish a schedule for compliance only for the Clearing

    Requirement. A separate rulemaking will promulgate the final

    implementation schedule for the Trade Execution Requirement.\5\

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    \3\ Commission regulations referred to herein are found at 17

    CFR Ch. 1.

    \4\ See 76 FR 58186 (Sept. 20, 2011).

    \5\ The Commission will address the proposed compliance

    schedules for trading documentation and margining under section 4s

    of the CEA, 76 FR 58176 (Sept. 20, 2011), at the same time that it

    finalizes the underlying documentation and margin rules.

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    The compliance schedule for the Clearing Requirement is based on

    the type of market participants entering into a swap subject to the

    Clearing Requirement. The compliance schedule balances several goals.

    First, the Commission believes that some market participants, such as

    certain managed accounts, referred to under Sec. 50.25 as ``Third-

    Party Subaccounts,'' may require additional time to bring their swaps

    into compliance with the Clearing Requirement. Pursuant to Sec.

    39.5(e) (finalized as Sec. 50.25), these market participants would be

    afforded additional time to clear their swaps so that they will be able

    to document new client clearing arrangements, connect to market

    infrastructure such as DCOs, and prepare themselves and their customers

    for the new regulatory requirements.

    Another goal of the compliance schedule is to have adequate

    representation of market participants involved at the outset of

    implementing a new regime for requiring certain swaps to be cleared.

    The Commission believes that having a cross-section of market

    participants involved at the outset of formulating and designing the

    rules and infrastructure under which the Clearing Requirement is

    implemented will best meet the needs of all market participants.

    The compliance schedule set forth in Sec. 50.25 defines three

    categories of market participants: Category 1 Entities,\6\ Category 2

    Entities,\7\ and all other market participants. As described in Sec.

    50.25(b), a swap between two Category 1 Entities must comply with the

    Clearing Requirement no later than 90 days after the publication of the

    Clearing Requirement determination in the Federal Register.\8\ A swap

    between a Category 2 Entity and a Category 1 Entity or another Category

    2 Entity must comply within 180 days, and all other swaps must be

    submitted for clearing no later than 270 days after the Clearing

    Requirement determination is published in the Federal Register. To

    clarify, the swap is subject to the latest compliance date for one of

    the counterparties. In other words, if a Category 1 Entity enters into

    a swap with a Category 2 Entity, both parties have 180 days to submit

    the swap for clearing. However, the counterparty entitled to the later

    compliance date may elect to clear the swap earlier, and in that event,

    its counterparty is required to oblige.

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    \6\ A Category 1 Entity is defined under Sec. 50.25(a) to

    include a swap dealer; security-based swap dealer; major swap

    participant; major security-based swap participant; or active fund

    (also defined by Sec. 50.25(a)).

    \7\ A Category 2 Entity is defined under Sec. 50.25(a) to

    include a commodity pool; a private fund as defined in section

    202(a) of the Investment Advisers Act of 1940 other than an active

    fund; or a person predominantly engaged in activities that are in

    the business of banking, or in activities that are financial in

    nature as defined in section 4(k) of the Bank Holding Company Act of

    1956, provided that, in each case, the entity is not a Third-Party

    Subaccount. As proposed, this category contained employee benefit

    plans under the Employee Retirement Income and Security Act of 1974,

    but under the final rule, these plans will not be included in

    Category 2. See below for further discussion.

    \8\ As proposed, the rule required compliance within 90, 180, or

    270 days after the effective date set by the Commission for a

    Clearing Requirement determination. In order to clarify precisely

    when the compliance period will commence, the Commission has

    modified the rule to indicate that the compliance periods begin as

    of the date of publication of final Clearing Requirement

    determination rules in the Federal Register. From this point, market

    participants have either 90, 180, or 270 days to come into

    compliance.

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    II. Comments on the Notices of Proposed Rulemaking

    The Commission received 26 comments during the six-week public

    comment period following publication of the NPRM. The Commission

    considered each of these comments in formulating the final regulation,

    Sec. 39.5(e) (finalized as Sec. 50.25).

    A. Comment Period

    The Commission published the NPRM in the Federal Register on

    September 20, 2011, and the public comment period closed on November 4,

    2011.

    Financial Services Roundtable (FSR) comments that the public should

    be able to comment on an implementation schedule for each swap subject

    to the Clearing Requirement because the characteristics of one

    particular swap may necessitate a very different schedule from another.

    Pursuant to Sec. 39.5(b)(5) in the case of swap submissions and

    Sec. 39.5(c)(2) in the case of Commission-initiated reviews, the

    public will have an opportunity to comment on each of the Commission's

    proposed Clearing Requirement determinations, and to comment on whether

    the Commission should employ the compliance schedule for that

    determination. In this manner, the public will have an opportunity to

    comment on whether use of the compliance schedule is appropriate for a

    given Clearing Requirement determination covering particular swaps.

    B. Harmonization

    The NPRM reflects consultation with the staff of the Securities and

    Exchange Commission (SEC), prudential regulators, and international

    regulatory authorities. With respect to the latter, the Commission is

    mindful of the benefits of harmonizing its regulatory framework with

    that of its counterparts in foreign countries. The Commission therefore

    has monitored global advisory, legislative, and regulatory proposals,

    and has consulted with foreign regulators in developing the final

    regulations.

    Vanguard, the Federal Home Loan Banks (FHLBs), and the Investment

    Company Institute (ICI) each recommend that the Commission coordinate

    the compliance schedule for the Clearing Requirement, as well as

    implementation schedules concerning other Dodd-Frank Act requirements,

    with the SEC, the prudential regulators, and international regulators

    to avoid market disruption and avoid regulatory arbitrage. The American

    Council of Life Insurers (ACLI) urges the Commission to coordinate with

    the SEC and international regulators to achieve reductions in

    compliance costs. A joint letter by the Futures Industry Association,

    the International Swaps and Derivatives Association, and the Securities

    Industry and Financial Markets Association (FIA/ISDA/SIFMA) urges the

    Commission to coordinate implementation schedules with those introduced

    by the SEC, the National Futures Association, self-regulatory

    organizations, and market infrastructure providers.

    In addition to the regulators referenced above, the Commission has

    consulted with other U.S. financial regulators including: (1) The Board

    of Governors of the Federal Reserve System; (2) the Office of the

    Comptroller of the Currency; and (3) the Federal Deposit Insurance

    Corporation. Staff from each of these agencies has had the opportunity

    to provide oral and/or written comments to this adopting release, as

    well as to the proposal.

    [[Page 44443]]

    C. Cross-Border and Affiliate Transactions

    The NPRM did not differentiate between domestic and foreign swap

    dealers (SDs), major swap participants (MSPs) or their counterparties,

    and did not address affiliate transactions.

    MarkitSERV and the Alternative Investment Management Association

    (AIMA) each comment that the NPRM, as well as other proposals setting

    forth implementation schedules for complying with Dodd-Frank Act

    requirements, should clarify the status of cross-border transactions.

    Better Markets states that trading relationships between an SD or MSP

    and its affiliate or an international counterparty should not be

    treated any differently than any other trading relationship. FIA/ISDA/

    SIFMA comments that the Commission should publish guidance concerning

    the extraterritorial application of Title VII prior to the commencement

    of any implementation schedule.

    The Commission separately has issued guidance on the cross-border

    application of Title VII, including the Clearing Requirement.\9\ With

    regard to inter-affiliate transactions, the Commission will be

    considering this issue in an upcoming proposal.

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    \9\ See Cross-Border Application of Certain Swaps Provisions of

    the Commodity Exchange Act, 77 FR 41213 (July 12, 2012).

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    D. Comprehensive Implementation Schedule

    This adopting release pertains exclusively to the implementation of

    the Clearing Requirement.

    The Coalition for Derivatives End-Users (CDE), a joint letter by

    the Edison Electric Institute, the National Rural Electric Cooperative

    Association, and the Electric Power Supply Association (Joint

    Associations); ICI; and MarkitSERV each argue that the Commission

    should create an implementation plan addressing all of its final Dodd-

    Frank rules and that the Clearing Requirement compliance schedule

    should be part of that comprehensive schedule. CDE comments further

    that a comprehensive schedule is important to end-users, particularly

    in the areas of recordkeeping and reporting. The Joint Associations

    also comment that a comprehensive schedule should detail compliance

    dates, both specific and market-wide, for each registered entity and

    that the Commission should request further comment on this subject as

    more final rules are published.

    Vanguard comments that in implementing Title VII, the Commission

    should focus first on systemic risk issues and then issues relating to

    transparency and trade practices. Implementation schedules should be

    organized by type of participant and asset class. The schedules should

    also allow for voluntary compliance.

    ACLI argues that the Commission has not provided sufficient

    guidance concerning new rules and effective dates in order for market

    participants to conduct a prudent review of resource planning. ACLI

    maintains that complying with only some rules creates a risk that

    documents will have to be renegotiated when other rules are phased in.

    In this adopting release, the Commission is focused on providing

    additional time to market participants that may require more time to

    comply with one of the key elements of the Dodd-Frank Act--the Clearing

    Requirement. The compliance schedule that is the subject of this

    adopting release was proposed at the same time as three other

    compliance schedules--schedules for the Trade Execution Requirement and

    two important requirements under section 4s of the CEA, documentation

    and margin for uncleared swaps. Each of these proposed compliance

    schedules responded to particular concerns from market participants,

    especially those that are not required to register with the Commission.

    The Commission also has published compliance dates for phasing in

    implementation in nearly all of its final rules.\10\ In addition, the

    Commission has twice published on its Web site general schedules

    regarding the sequence and timing for its own consideration of final

    rules.\11\

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    \10\ See, e.g., Swap Data Recordkeeping and Reporting

    Requirements, 77 FR 2136, 2195-2196 (Jan. 13, 2012); Business

    Conduct Standards for Swap Dealers and Major Swap Participants with

    Counterparties, 77 FR 9734, 9803 (Feb. 17, 2012); and Derivatives

    Clearing Organization General Provisions and Core Principles, 76 FR

    69334, 69408 (Nov. 8, 2011).

    \11\ See http://www.cftc.gov/LawRegulation/DoddFrankAct/index.htm.

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    In response to ACLI, as discussed further below, the Commission has

    finalized all the documentation requirements necessary for compliance

    with the Clearing Requirement.\12\ With regard to Vanguard's comment,

    the Commission intends to implement the Clearing Requirement based on

    specific classes of swaps, beginning with those asset classes that are

    currently being cleared. The Commission believes that implementation of

    the Clearing Requirement will serve to reduce systemic risk by

    mitigating counterparty credit risk through the use of the marking-to-

    market, margining, and risk mutualization provided by central

    counterparties. The adoption of this compliance schedule is an

    important step toward implementing that requirement. In addition, the

    compliance schedule expressly allows for voluntary clearing prior to

    the required compliance date, and market participants currently are

    free to clear all swaps offered for clearing by DCOs on a voluntary

    basis.

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    \12\ See Customer Clearing Documentation, Timing of Acceptance

    for Clearing, and Clearing Member Risk Management, 77 FR 21278

    (April 9, 2012).

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    E. Prerequisite Rules

    The preamble to the NPRM stated that prior to requiring compliance

    with any Clearing Requirement determination, the Commission must

    publish the following final rules: Definitions of swap, SD, and MSP;

    End-User Exception to Mandatory Clearing of Swaps; and Protection of

    Cleared Swaps Customer Collateral.

    The FHLBs comment that the rule text of an implementation rule

    should state that the compliance schedule will not take effect until

    the Commission has published applicable final rules. The FHLBs believe

    that it is insufficient for the preamble to make this point.

    The Joint Associations state that they cannot comment on the

    adequacy of either the compliance schedule for the Clearing Requirement

    or other implementation schedules until various final rules have been

    published, including the definitions of swap, SD, and MSP. The Joint

    Associations want to see how many of their comments to these rules have

    been adopted because this will affect how long it will take their

    members to comply with Title VII requirements. ICI comments that

    parties cannot prepare for centralized clearing until the Commission

    publishes the final rule concerning the definition of swap.

    Citadel, FHLBs, and FIA/ISDA/SIFMA each recommend that the

    Commission publish final rules related to clearing, such as customer

    clearing documentation, timing of acceptance for clearing, and clearing

    member risk management, prior to phasing in the Clearing Requirement.

    FHLBs state that the prior publication of the Customer Clearing

    Documentation, Timing of Acceptance for Clearing, and Clearing Member

    Risk Management rules is important so that market participants can

    fully appreciate risks and not have to renegotiate documentation.

    The Committee on Investment of Employee Benefit Assets (CIEBA)

    recommends that the Commission not impose the Clearing Requirement

    until full physical segregation is available for margin of cleared

    swaps. CIEBA also

    [[Page 44444]]

    comments that if the Commission publishes final segregation rules for

    cleared swaps customer collateral at the same time that it phases in

    the Clearing Requirement, then market participants' limited resources

    would be overwhelmed. ICI comments that parties cannot prepare for

    centralized clearing until the Commission publishes the final rule

    concerning the Protection of Cleared Swaps Customer Collateral. ICI

    also argues that the documentation requirements under section 4s(i) of

    the CEA must be finalized before market participants are required to

    comply with mandatory clearing.

    CME recommends that the Commission finalize the DCO Conflicts of

    Interest rules prior to requiring compliance with the Clearing

    Requirement.

    The American Bankers Association (ABA) believes that end-user banks

    not be required to comply with the Clearing Requirement until 180 days

    after the Commission determines whether end-user banks will be exempt

    from the Clearing Requirement.

    AIMA believes the Commission should publish final rules concerning

    the Margin Requirement, as well as customer collateral protection

    rules, prior to phasing in the Clearing Requirement.

    The Commission has finalized all four of the rules identified in

    the NPRM that it needed to be completed prior to requiring compliance

    with the Clearing Requirement (namely, the End-User Exception to

    Mandatory Clearing of Swaps; \13\ Protection of Cleared Swaps Customer

    Collateral; \14\ the Further Definition of ``Swap Dealer,'' ``Security-

    Based Swap Dealer,'' ``Major Swap Participant,'' ``Major Security-Based

    Swap Participant'' and ``Eligible Contract Participant''; \15\ and the

    Further Definition of ``Swap,'' ``Security-Based Swap,'' and

    ``Security-Based Swap Agreement''; Mixed Swaps; Security-Based Swap

    Agreement Recordkeeping).\16\ In addition, the Commission has finalized

    rules related to Customer Clearing Documentation, Timing of Acceptance

    for Clearing, and Clearing Member Risk Management.\17\ Finalizing these

    rules addresses the FHLBs' concerns about having to revise

    documentation more than once and provides certainty as to swap

    processing requirements and expectations regarding risk management for

    clearing members. On the other hand, in response to CME's comment, the

    Commission does not believe it is necessary for final DCO Conflicts of

    Interest rules to be in effect before requiring compliance with the

    Clearing Requirement because these rules do not relate directly to the

    clearing process, customer connectivity, clearinghouse risk management,

    or other matters that would affect the implementation of the Clearing

    Requirement.

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    \13\ End-User Exception to the Clearing Requirement for Swaps,

    adopted by the Commission on July 10, 2012, available at

    www.cftc.gov.

    \14\ Protection of Cleared Swaps Customer Contracts and

    Collateral; Conforming Amendments to the Commodity Broker Bankruptcy

    Provisions, 77 FR 6336 (Feb. 7, 2012).

    \15\ Further Definition of ``Swap Dealer,'' ``Security-Based

    Swap Dealer,'' ``Major Swap Participant,'' ``Major Security-Based

    Swap Participant'' and ``Eligible Contract Participant,'' 77 FR

    30596 (May 23, 2012).

    \16\ Further Definition of ``Swap,'' ``Security-Based Swap,''

    and ``Security-Based Swap Agreement''; Mixed Swaps; Security-Based

    Swap Agreement Recordkeeping, Section VII, adopted by the Commission

    on July 10, 2012, available at www.cftc.gov.

    \17\ Customer Clearing Documentation, Timing of Acceptance for

    Clearing, and Clearing Member Risk Management, 77 FR 21278, (April.

    9, 2012).

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    In response to the FHLBs' request that the implementation rule text

    include a provision that the rule is not effective until the

    definitions of SD, MSP, and swap are finalized, the Commission

    reiterates that all of the pre-requisite rules for the Clearing

    Requirement have been adopted. With regard to CIEBA's comment about

    full physical segregation, the Commission published its final rule

    concerning Protection of Cleared Swaps Customer Collateral on February

    7, 2012.\18\ In that rulemaking, the Commission indicated that it may

    address issues related to collateral held in third-party safekeeping

    accounts at some point in the future. However, given that a fully

    operational segregation regime is required to be in place by November

    8, 2012, the Commission does not believe that it is necessary for this

    additional matter to be resolved prior to requiring compliance with the

    Clearing Requirement.

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

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

    In response to ICI's comment, the Commission clarifies that

    finalization of the swap trading relationship documentation

    requirements for SDs and MSPs under section 4s(i) of the CEA is not

    required for compliance with the Clearing Requirement because the

    documentation that is the subject of those rules relates primarily to

    bilaterally-executed, uncleared swap transactions, and none of the

    provisions in proposed Sec. 23.504 pertain directly to the Clearing

    Requirement. Similarly, in response to AIMA's comment, final margin

    rules for uncleared swaps are not required to be finalized prior to

    requiring compliance with the Clearing Requirement as these are

    related, but distinct, provisions under the Dodd-Frank Act.

    F. Definitions

    Under Sec. 39.5(e)(1), the Commission proposed definitions of the

    terms ``Category 1 Entity,'' ``Category 2 Entity,'' ``Active Fund,''

    and ``Third-Party Subaccount.'' The definitions set forth in proposed

    Sec. 39.5(e) (now Sec. 50.25) would apply specifically to provisions

    contained in part 39 (now part 50) and only those other rules that

    explicitly cross-reference these definitions. The Commission is

    adopting the definitions as proposed, with the exceptions discussed

    below.

    1. Active Fund

    As proposed under Sec. 39.5(e)(1), ``any private fund as defined

    in section 202(a) of the Investment Advisers Act of 1940, that is not a

    third-party subaccount and that executes 20 or more swaps per month''

    would be defined as an ``Active Fund'' and subject to the shortest

    implementation schedule for compliance with the Clearing Requirement.

    Numerous commenters, such as Better Markets, Chris Barnard, and

    AIMA, agree with the Commission that using a market participant's

    average monthly trading volume would be an appropriate proxy for

    determining an entity's ability to comply with the Clearing Requirement

    and would be better than a proxy based on notional volume or open

    interest. AIMA agrees with the NPRM's proposal that Active Funds be

    subject to the 90-day deadline.

    Other commenters express concerns about solely relying on monthly

    volumes as a proxy, especially without further defining the types of

    swaps that would be included in the calculation. ACLI states that the

    frequency of trading is not an appropriate indicator of a market

    participant's experience or resources. The Association of Institutional

    Investors (AII) states that the definition should specify the type of

    swaps that count towards the threshold. CDE recommends a minimum

    average monthly notional threshold to avoid capturing smaller end-

    users. CDE also states that hedges and inter-affiliate swaps should be

    excluded from this monthly average threshold. Managed Funds Association

    (MFA) similarly requests clarification regarding those swaps that would

    be included in the monthly swap calculation. Specifically, MFA requests

    clarification as to whether novations, amendments, or partial tear-ups

    would be included.

    Commenters also focus on the average monthly threshold of 20 swaps

    per

    [[Page 44445]]

    month for the preceding 12 months. FIA/ISDA/SIFMA proposes that the

    threshold be an average of 200 trades per month. Vanguard proposes a

    similar threshold. Both AII and MFA think the proposed threshold was

    overly inclusive. MFA also highlights its belief that the proposed

    definition would be difficult to administer, while unnecessarily

    creating another tier of market participants for the purposes of the

    implementation schedules.

    In response to these comments, the Commission is increasing the

    average monthly threshold to 200 swap trades per month for the

    preceding 12 months. The Commission believes that monthly trading

    volume is a suitable proxy for determining the appropriate

    implementation schedule for a swap counterparty. By increasing the

    threshold to 200, as recommended by FIA/ISDA/SIFMA, as well as

    Vanguard, the risk of capturing smaller, less experienced swap

    counterparties should be substantially diminished. The market

    participants engaging in this level of swap activity should be able to

    access the resources necessary to meet the 90-day implementation

    schedule. In light of the number of transactions currently being

    cleared on a voluntary basis by funds, the Commission does not believe

    that an increase in the threshold of monthly swap trades will

    negatively impact the goal of broad market participation in the

    implementation of the Clearing Requirement. The Commission believes

    this increase in the average monthly threshold also addresses CDE's

    concerns about smaller market participants using swaps only to hedge

    risk.

    Further, by maintaining the concept of Active Fund, the Commission

    believes that it will continue to ensure adequate representation across

    the spectrum of market participants during the first phase of the

    implementation of the Clearing Requirement. As a result of this

    participation, processes and infrastructure will be established to

    serve all segments of the market, not just SDs and MSPs, which are

    included in the initial phase of the compliance schedule for the

    Clearing Requirement.

    In response to AII and MFA, the Commission clarifies that the

    average monthly threshold of swaps applies to new swaps that the entity

    enters into, and it does not apply to novations, amendments, or partial

    tear-ups. In addition, the Commission clarifies that the 200 swap

    threshold includes any swap, as defined under the CEA and Sec. 1.3,

    and not just those swaps that would be subject to the relevant Clearing

    Requirement determination and attendant compliance schedule.

    2. Third-Party Subaccount

    Under Sec. 39.5(e) (finalized herein as Sec. 50.25), Third-Party

    Subaccounts are excluded from the definitions of Category 1 Entity and

    Category 2 Entity, with the effect that such subaccounts will have 270

    days, the longest period, in which to comply with the Clearing

    Requirement. The NPRM defined Third-Party Subaccounts as ``a managed

    account that requires the specific approval by the beneficial owner of

    the account to execute documentation necessary for executing,

    confirming, margining, or clearing swaps.'' The purpose of excluding

    Third-Party Subaccounts from the defined categories was to ensure that

    investment managers, who may be faced with bringing numerous accounts

    into compliance, would have adequate time to do so.

    Commenters question whether the definition was broad enough to

    provide sufficient time for Third-Party Subaccounts to comply with the

    Clearing Requirement. ICI noted that Third-Party Subaccounts, whether

    subject to the specific execution authority of the beneficiary or not,

    require managers to work closely with clients when entering into

    trading agreements on the customer's behalf. As such, ICI feels that no

    distinction should be made based on specific execution authority or

    lack thereof. ICI comments that all Third-Party Accounts should be

    uniformly classified and be given 270 days to comply. AII similarly

    states that the definition is too narrow given the administrative work

    required to manage an account, regardless of the execution authority.

    Further, AII states that execution authority is not an industry

    standard. The term, as proposed, therefore divides the universe of

    managed accounts inappropriately. FIA/ISDA/SIFMA recommends that all

    accounts managed by third parties, regardless of the execution

    authority, should be given the most time to comply with the Clearing

    Requirement.

    Based on the comments received, the Commission is revising the

    definition of Third-Party Subaccount to mean ``an account that is

    managed by an investment manager that (1) is independent of and

    unaffiliated with the account's beneficial owner or sponsor, and (2) is

    responsible for the documentation necessary for the account's

    beneficial owner to clear swaps.'' In modifying this definition, the

    Commission is taking into account the point made by AII, FIA/ISDA/

    SIFMA, and ICI that all investment managers will need additional time

    to comply with a Clearing Requirement regardless of whether they have

    explicit execution authority. However, the definition retains the nexus

    between the investment manager and the documentation needed for

    clearing swaps. In other words, if the investment manager has no

    responsibility for documenting the clearing arrangements, then that

    account would be required to clear its swaps subject to required

    clearing within 180 days. For those accounts under the revised

    definition, however, the Commission believes that the 270-day deadline

    is more appropriate. Given the general notice investment managers have

    had about the Dodd-Frank Act's Clearing Requirement since the enactment

    of the statute in July, 2010, managers should have been able to

    consider and plan the infrastructure and resources that are necessary

    for all of their accounts, including Third-Party Subaccounts, to comply

    with the Clearing Requirement. Thus, the 180- and 270-day deadlines

    should provide adequate time to accommodate all managed accounts.

    3. Category 1 and Category 2 Entities

    The compliance schedule is organized according to the type of

    market participant. To the extent that the Commission determines that a

    compliance schedule is warranted in connection with a Clearing

    Requirement determination (i.e. to comply with the Clearing

    Requirement) a market participant defined as a Category 1 Entity will

    have 90 days to comply, a Category 2 Entity will have 180 days, and all

    others will have 270 days. According to the proposed definitions, a

    Category 1 Entity includes an SD, a security-based swap dealer, an MSP,

    a major security-based swap participant, or an Active Fund. A Category

    2 Entity includes a commodity pool, a private fund, as defined by the

    Investment Advisers Act of 1940, an ERISA plan, or a person

    predominantly engaged in banking or other financial activities, as

    defined by section 4(k) of the Bank Holding Company Act. A Category 2

    Entity would not include an Active Fund or a Third-Party Subaccount.

    Encana Marketing (USA) Inc. (Encana) and the Joint Associations

    comment that non-financial end users should be expressly included in

    the category with the longest timeframe. CDE argues that financial end-

    users should be treated identically to non-financial end-users because

    they do not pose systemic risk, and, therefore, should be given the

    most time to comply with the Clearing Requirement, and not included in

    Category 2. ICI seeks clarification that a market participant can

    determine whether it is an MSP for purposes of the compliance schedule

    for the Clearing

    [[Page 44446]]

    Requirement at the same time that it is required to review its status

    as an MSP under other Commission and SEC rules.

    CIEBA states that in-house ERISA funds should be in the group with

    the longest compliance time, and not Category 2 Entities. CIEBA notes

    that such funds do not pose systemic risk, and they typically rely upon

    third-party managers for some portion of their fund management.

    Splitting in-house and external accounts (i.e. those accounts meeting

    definition of Third-Party Subaccount and permitted 270 days) of the

    same ERISA plan will impact risk management given different

    implementation schedules. CIEBA also states that this distinction will

    cause pension funds to bear the costs of compliance because they will

    need to comply prior to their third-party managers, who would be better

    positioned to provide insight and service in this regard.

    The Commission believes that the definitions of Category 1 Entity

    should be finalized as proposed, but that the definition of Category 2

    Entity should be modified by removing the reference to ERISA plans. In

    response to Encana and the Joint Associations, non-financial end users

    are adequately addressed in Sec. 39.5(e)(2)(iii) (now Sec.

    50.25(b)(3))--unless the swap transactions are eligible to claim the

    exception from the Clearing Requirement under section 2(h)(7) of the

    CEA, the parties are given 270 days to comply with the Clearing

    Requirement. With respect to issues raised by CDE regarding those

    financial entities included in Category 2, based on numerous meetings

    with participants in the swap market, the Commission believes that

    financial entities are capable of complying with the Clearing

    Requirement 90 days sooner than non-financial entities. Accordingly,

    the compliance schedule has correctly situated Category 2 Entities

    based upon their ability to meet the requirements of the underlying

    regulations. Moreover, the distinction between financial and non-

    financial entities has a statutory basis in section 2(h)(7) of the CEA.

    The Commission recognizes the concerns raised by CIEBA regarding

    splitting in-house and external accounts (i.e., those accounts meeting

    the definition of Third-Party Subaccount and permitted 270 days) of the

    same ERISA plan. In response to these concerns, the Commission is

    removing the reference to employee benefit plans as defined in

    paragraphs (3) and (32) of section 3 of the Employee Retirement Income

    and Security Act of 1974. As a result, these ERISA plans will be

    afforded the longest compliance period (270 days).

    With regard to ICI's comment, a potential MSP can review its

    obligation to register as an MSP at the same time it is reviewing where

    it fits under the Clearing Requirement compliance schedule. In many

    instances, MSPs will have to review their registration obligations

    ahead of complying with the Clearing Requirement. However, if an entity

    discovers that it has crossed the threshold established under the MSP

    rules and is required to register during the 90-day period for Category

    1 Entities, the Commission would consider allowing that entity to

    petition for additional time to come into compliance with the Clearing

    Requirement.\19\

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

    \19\ Similarly, the Commission would consider allowing entities

    to petition for additional time to comply to the extent that they

    discover that they have exceeded the de minimis threshold under the

    swap dealer definition and are required to register during the 90-

    day period for Category 1.

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

    G. Compliance Schedule for the Clearing Requirement

    As mentioned above, Sec. 39.5(e)(2) provides that when the

    Commission determines that an implementation schedule is appropriate in

    connection with a given Clearing Requirement determination, market

    participants within the definition of Category 1 will have 90 days to

    comply, those within the definition of Category 2 will have 180 days,

    and all others 270 days to implement the Clearing Requirement.

    4. Application to All Swap Types

    The Clearing Requirement compliance schedule is based upon the

    nature of a given swap market participant, considering the

    participant's risk profile, compliance burden, resources, and

    expertise. The schedule does not contemplate different implementation

    timeframes based upon the characteristics of particular swaps.

    AIMA states that it does not believe further implementation

    schedules are necessary based on the nature of the swap itself. Better

    Markets, Citadel, and MFA comment that the compliance schedule should

    apply, however, to all swaps within a ``group'' or ``class,'' as

    defined by the Commission's Clearing Requirement determination.

    Commenters such as CDE state that the Commission should publish an

    implementation schedule specific to the characteristics of a particular

    type of swap. CDE comments that because it is unlikely that end-users,

    and other entities relied upon by end-users, will be able to meet the

    requirements necessary to comply with clearing determinations for all

    swap products at the same time, the Commission should phase in

    implementation deadlines by swap type, according to the amount of

    systemic risk posed by a particular swap.

    MarkitSERV asserts that all Dodd-Frank Act requirements should be

    phased-in by asset class, taking into account that different asset

    classes have various levels of product standardization,

    electronification, volumes, and types of counterparties. FIA/ISDA/SIFMA

    also states that there should be a separate compliance schedule for

    each asset class. FIA/ISDA/SIFMA also states that the Commission should

    require credit default swaps and interest rate swaps to be cleared

    first because those products are already being cleared. Commodity and

    equity swaps, according to FIA/ISDA/SIFMA, should be required to be

    cleared later because the marketplace is currently clearing fewer of

    those products.

    AIMA, CDE, ICI, and MarkitSERV state that the compliance schedule

    should require the Commission to phase in each Clearing Requirement

    determination as set forth in Sec. 39.5(e). FHLB and ICI comment that

    the Commission should have the flexibility to extend clearing

    implementation dates, but not shorten them. Citadel counters that the

    compliance schedule should only be triggered when a determination is

    issued for a new category of swaps.

    This rule affords the Commission discretion to determine whether to

    apply the compliance schedule in connection with a particular Clearing

    Requirement determination. The Commission agrees that while the

    schedule may be necessary in connection with some Clearing Requirement

    determinations, especially those covering new classes of swaps, there

    also may be determinations that are sufficiently similar to prior ones

    that no compliance schedule is necessary. As such, the Commission will

    determine whether or not to apply the Sec. 39.5(e) (now Sec. 50.25)

    compliance schedule as part of its analysis in connection with each

    Clearing Requirement determination.

    Further, it remains the Commission's intention that those swaps

    currently being cleared will be subject to the first Clearing

    Requirement determinations. As a result, market participants initially

    will comply with the Clearing Requirement using established platforms

    and technology. This should limit a market participant's burden in

    transitioning to clearing, as the use of existing infrastructure will

    mean less time and expense necessary to develop independent programs,

    technology, or platforms to clear such transactions.

    [[Page 44447]]

    5. Timing of Implementation Schedules

    Citadel and Better Markets comment that they agree with the

    proposed compliance schedule because market participants have had

    notice of the movement towards clearing for one to three years, and the

    clearing infrastructure already exists with regard to interest rate and

    credit default swap products. Citadel and Tradeweb believe the proposed

    schedule correctly staggers compliance according to category of market

    participant. Citadel does not support extending the 270-day timeframe

    because 270 days would grant sufficient time to market participants

    without providing so much time as to engender a material, competitive

    advantage or regulatory arbitrage. AIMA believes the proposed schedule

    grants sufficient time to each category of market participant so that

    they will be able to comply with the Clearing Requirement. Similarly,

    the Joint Associations and The Westpac Group (Westpac) generally agree

    with phasing in implementation with the Clearing Requirement according

    to category of participant.

    CIEBA states that because SDs, MSPs, and Active Funds will be the

    first focus for all third party vendors, ERISA plans will be competing

    for these resources only after the first implementation deadline has

    passed, leaving only 90 days for a crowded market place to comply. With

    limited resources, such a tight timeframe may lead to inadequate

    agreements and/or increased risk exposure. Further, inadequate

    agreements caused by lack of resources and rushed documentation will

    create even further cost disparity for clearing between U.S. pension

    plans and European ones that will not be required to clear swaps. As

    such, CIEBA recommends that Category 2 Entities have more than 180 days

    to comply. Likewise, FIA/ISDA/SIFMA note that the compliance schedule

    should be lengthened and that buy-side entities, which may currently be

    categorized as Category 1 Entities, should not be required to commence

    clearing until the second quarter of 2013 at the earliest.

    CDE argues that SDs and MSPs should comply before establishing

    other end-user deadlines. CDE believes that if Category 1 Entities

    cannot comply, then that will compound problems for Category 2 and 3

    Entities. If an implementation schedule must be set, the CDE recommends

    one year for end-users, in light of their limited internal resources

    and the competition for external resources.

    ACLI comments that complex issues will surface as market

    participants try to combine the agency framework presently existing in

    the futures markets (i.e., customer-futures commission merchant) with

    the principal-to-principal framework that has existed in the over-the-

    counter swaps market. In addition to executing the necessary

    agreements, insurers will want to ensure they enter into agreements

    with parties that serve them best. The combination of these factors

    means that timeframes are too short and may result in smaller firms

    accepting unfavorable agreements with fewer counterparties, possibly

    concentrating risk. ACLI also highlights that insurers face an

    additional burden in ensuring that compliance with the Clearing

    Requirement is consistent with their state regulatory obligations.

    Vanguard argues that additional time will be required to enter into

    the new agreements necessitated by the move to a cleared derivatives

    market. Vanguard highlights the large volume of such agreements and the

    lack of market standards. ICI also finds the compliance schedule to be

    too short in light of the needs to build and test new systems, adapt to

    new regulatory requirements, and educate customers about these changes.

    Mastercard Worldwide urges the Commission to give non-bank firms at

    least 270 days to comply with the Clearing Requirement in respect of

    their foreign currency hedging activities, even if the firm is covered

    by section 4(k) of the Bank Holding Company Act. Westpac comments that

    Category 1 Entities should have at least 180 days to comply with the

    Clearing Requirement, noting that not all SDs, particularly smaller

    ones, are currently DCO members. Regional Banks also request that small

    SDs have at least 180 days to comply with the Clearing Requirement in

    light of their relative lack of resources and experience, as compared

    to larger SDs.

    ACLI and FSR believe that the compliance schedule for the

    respective entity categories should run consecutively rather than

    concurrently. For example, the 180 days given to Category 2 Entities to

    comply with the Clearing Requirement should begin only after the

    expiration of the 90 days given to Category 1 Entities.

    FSR does not believe there are sufficient resources, either

    internally, at market participants, or externally, at third party

    vendors, for the compliance schedule to run concurrently. If the

    schedule were to run concurrently, then resources would be allocated

    sequentially to the detriment of entities in the later implementation

    groups. ACLI, Joint Associations, and the Coalition of Physical Energy

    Companies (COPE) each express concern that the proposed compliance

    schedule does not provide sufficient time for the software companies

    and other vendors, upon which many smaller market participants rely, to

    develop, test, and debug the software and other technology that will be

    needed to ensure compliance with the Clearing Requirement. The Joint

    Associations and COPE each suggests the Commission take affirmative

    steps to solicit feedback from these software makers, particularly from

    vendors that provide ``position and trade capture software,'' in order

    to determine the amount of time market participants will need to

    implement software necessary to comply with the Clearing Requirement.

    The Commission is finalizing the compliance schedule for the

    Clearing Requirement as proposed, except for the changes described

    above for ERISA plans and Third-Party Subaccounts. The Commission

    believes that the 90-, 180-, and 270-day implementation periods will

    give market participants sufficient time to comply with the Clearing

    Requirement. The Commission agrees with commenters such as Citadel and

    Better Markets that the move to required clearing has been proceeding

    for two years under the Dodd-Frank Act. This period should have allowed

    parties to contemplate and design implementation plans and to identify

    the resources needed to execute those plans. With the Commission's

    decision to focus on those swaps that are currently cleared when

    considering its initial Clearing Requirement determinations, market

    participants will be working with clearing offerings that are seasoned

    and established, justifying the timeframes provided for in the

    compliance schedule. For these reasons, the Commission also declines to

    change the concurrent nature of the compliance schedule.

    Given the final rules for the definitions of swap dealers, and the

    threshold used in terms of annual notional volume of swaps for such

    swap dealers, the Commission does not believe it necessary to further

    distinguish between larger swap dealers and smaller ones for purposes

    of the implementation periods related to Clearing Requirements.\20\

    Similarly, the Commission does not believe it practicable to make

    distinctions between entities covered by section 4(k) of the Bank

    Holding Company Act for the purpose of establishing a 180-day

    [[Page 44448]]

    implementation period as compared to a 270-day period.

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

    \20\ Further Definition of ``Swap Dealer,'' ``Security-Based

    Swap Dealer,'' ``Major Swap Participant,'' ``Major Security-Based

    Swap Participant'' and ``Eligible Contract Participant,'' 77 FR

    30596 (May 23, 2012).

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

    In response to CDE, the Commission also notes that certain swaps

    would not be subject to the Clearing Requirement under section 2(h)(7)

    of the CEA when one of the counterparties to a swap (i) is not a

    financial entity, (ii) is using the swap to hedge or mitigate

    commercial risk, and (iii) notifies the Commission how it generally

    meets its financial obligations associated with entering into a non-

    cleared swap. If a market participant can claim an exemption, the

    Clearing Requirement will not be applicable. In all other cases, the

    implementation schedule for a Clearing Requirement would provide for up

    to 180 or 270 days for such market participants.

    In response to concerns that state regulatory obligations for

    insurance companies might create obstacles to compliance with

    implementation schedules as suggested by ACLI, the Commission observes

    that those insurers would have a minimum of six months to work with

    their state regulators to address the matter. If no solution could be

    found within that time period, an affected insurer would be able to

    petition the Commission for specific relief.

    The Commission also has taken affirmative steps to ensure that

    external providers of services to derivative market participants, such

    as derivatives software providers, have been included in the dialogue

    concerning implementation scheduling. At the May 2011 Implementation

    Roundtable, these vendors voiced their opinions with respect to how an

    implementation schedule could provide sufficient time for market

    participants relying on ``off-the-shelf'' derivatives tracking software

    to deploy such software such that they could comply with the Clearing

    Requirement. The Commission will continue to develop its understanding

    of technology issues and will solicit comment on this issue in

    forthcoming proposed Clearing Requirement determinations.

    III. Cost-Benefit Considerations

    A. Pre-Dodd-Frank Context

    Prior to the enactment of the Dodd-Frank Act,\21\ swaps were not

    subject to required clearing. However, the limited market data that is

    available suggests that over-the-counter (OTC) swap markets have been

    migrating into clearing over the last few years in response to natural

    market incentives as well as in anticipation of the Dodd-Frank Act's

    clearing requirement. LCH.Clearnet data, for example, shows that the

    outstanding volume of interest rate swaps cleared by LCH has grown

    steadily since at least November 2007, as has the monthly registration

    of new trade sides. Together, those facts indicate increased demand for

    LCH clearing services related to interest rate swaps, a portion of

    which preceded the Dodd-Frank Act.\22\ Data available through CME and

    TriOptima indicate similar patterns of growing demand for interest rate

    swap clearing services, though their publicly available data does not

    provide a picture of demand prior to the passage of the Dodd-Frank Act

    in July 2010.\23\ The trend toward increased clearing of swaps is

    likely to continue as the Commission begins determining that certain

    swaps are required to be cleared (Clearing Requirement determination).

    In fact, the Tabb Group estimates that 60-80% of the swaps market

    measured by notional amount will be cleared within five years of the

    time that the Dodd-Frank Act is implemented.\24\

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

    \21\ Dodd-Frank Wall Street Reform and Consumer Protection Act,

    Pub. L. No. 111-203, 124 Stat. 1376 (2010).

    \22\ See http://www.lchclearnet.com/swaps/volumes/.

    \23\ See http://www.cmegroup.com/trading/interest-rates/cleared-otc/index.html#data and http://www.trioptima.com/repository/historical-reports.html.

    \24\ See Tabb Group, ``Technology and Financial Reform: Data,

    Derivatives and Decision Making.''

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

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

    In the wake of the financial crisis of 2008, Congress determined,

    among other things, that swaps shall be cleared upon Commission

    determination. Specifically, section 723(a)(3) of the Dodd-Frank Act

    amended section 2(h)(1)(A) of the CEA to make it ``unlawful for any

    person to engage in a swap unless that person submits such swap for

    clearing to a derivatives clearing organization that is registered

    under this Act or a derivatives clearing organization that is exempt

    from registration under this Act if the swap is required to be

    cleared.'' \25\ The statutory swap clearing requirement is designed to

    standardize and reduce counterparty risk associated with swaps, and, in

    turn, mitigate the potential systemic impact of such risks and reduce

    the likelihood for swaps to cause or exacerbate instability in the

    financial system.\26\ It reflects a fundamental premise of the Dodd-

    Frank Act: The use of properly functioning central clearing can reduce

    systemic risk.

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

    \25\ Section 2(h)(2) of the CEA charges the Commission with

    responsibility for determining whether a swap is required to be

    cleared (a Clearing Requirement determination).

    \26\ When a bilateral swap is moved into clearing, the

    clearinghouse becomes the counterparty to each of the original

    participants in the swap. This standardizes counterparty risk for

    the original swap participants in that they each bear the same risk

    attributable to facing the clearinghouse as counterparty. In

    addition, clearing mitigates counterparty risk to the extent that

    the clearinghouse is a more creditworthy counterparty relative to

    those that each participant in the trade might have otherwise faced.

    This is because a clearinghouse benefits from netting with

    counterparties and may compel counterparties to post additional

    initial margin as collateral or force them to reduce their

    outstanding positions when markets move against them. Clearinghouses

    have demonstrated resilience in the face of past market stress. Most

    recently, they remained financially sound and effectively settled

    positions in the midst of turbulent events in 2007-2008 that

    threatened the financial health and stability of many other types of

    entities.

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

    C. Final Rule

    The rule contained in this adopting release addresses one aspect of

    required swap clearing under section 2(h) of the CEA: Implementation

    scheduling following a Commission determination that a class of swaps

    is required to be cleared. In other words, is immediate clearing

    required or is implementation subject to some delay. On September 20,

    2011, the Commission published a NPRM.\27\ The Commission proposed a

    phased-in compliance schedule for swaps subject to Clearing Requirement

    determinations that distinguishes among Category 1 Entities, Category 2

    Entities, and all other entities (referred to for purposes of this

    section III as ``Category 3 Entities''); those entities, respectively,

    would have 90 days, 180 days, and 270 days, from the date of the

    Clearing Requirement determination to comply with the Clearing

    Requirement.\28\ The NPRM also requested comment with respect to the

    costs and benefits of the proposed schedule, including, specifically,

    data, assumptions, calculations, or other information to quantify its

    costs and benefits, as well as alternatives to it. The Commission

    received 26 comment letters in response, none of which provided

    quantitative analysis regarding the costs or benefits of the proposed

    compliance schedule.\29\

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

    \27\ See 76 FR 58186.

    \28\ The schedule contained in the NPRM, like the one contained

    in this adopting release, can be used at the option of the

    Commission when issuing Clearing Requirement determinations.

    \29\ ACLI provides an estimate for one member's information

    technology and legal costs to comply with all Title VII

    requirements. The estimate does not include any calculations and

    does not separate out any costs they believe are directly

    attributable to this rule.

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

    These comments touch upon a variety of issues, and include a number

    that supported the Commission's approach as proposed. Others note

    certain areas of concern about costs or benefits under

    [[Page 44449]]

    the rule as proposed, and either expressly propose alternatives or

    raise issues that have caused the Commission to consider alternatives

    to it. Among other things, commenters responded to the phased approach,

    the entities included in Category 1, Category 2, and Category 3, the

    amount of time that the schedule provides for entities in each

    category, and the optionality of the schedule.

    In the absence of this rule, market participants would be required

    to comply with the Clearing Requirement immediately upon issuance of a

    Clearing Requirement determination by the Commission. Pursuant to the

    rule, however, when the Commission deems it appropriate, market

    participants will be provided additional time as prescribed in the

    rule's schedule to comply with Clearing Requirement determinations.

    Category 1 entities, which include, among others, SDs, MSPs, and Active

    Funds,\30\ will have 90 days from the date that a Clearing Requirement

    determination is published in the Federal Register to comply. Category

    2 Entities, which include commodity pools; private funds as defined by

    the Investment Advisers Act of 1940, other than Active Funds; and

    banks; but not Third-Party Subaccounts, will have 180 days to comply

    with a new Clearing Requirement determination. Category 3 Entities are

    those with Third-Party Subaccounts, as well as any other entity not

    eligible to claim an exception under section 2(h)(7) of the CEA,

    including ERISA plans, and they will have 270 days to comply with a

    Clearing Requirement determination once it is published in the Federal

    Register.

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

    \30\ An ``Active Fund'' is any private fund as defined in

    section 202(a) of the Investment Advisers Act of 1940, that is not a

    third-party subaccount and that executes 200 or more swaps per

    month. The Commission does not intend to use the designation for any

    purpose beyond this rule.

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

    The discussion that follows considers the costs and benefits of,

    and alternatives to, the rule in this adopting release.

    D. Statutory Mandate To Consider the Costs and Benefits of the

    Commission's Action: CEA Section 15(a)

    Section 15(a) of the CEA \31\ requires the Commission to consider

    the costs and benefits of its actions before promulgating a regulation

    under the CEA or issuing certain orders. Section 15(a) further

    specifies that the costs and benefits shall be evaluated in light of

    five broad areas of market and public concern: (1) Protection of market

    participants and the public; (2) efficiency, competitiveness, and

    financial integrity of futures markets; (3) price discovery; (4) sound

    risk management practices; and (5) other public interest

    considerations. The Commission considers the costs and benefits

    resulting from its discretionary determinations with respect to the

    section 15(a) factors.

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

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

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

    In this rulemaking the Commission is not imposing clearing

    requirements, but is exercising its discretion to stagger required

    clearing implementation according to a particular schedule and subject

    to the conditions specified in these rules. For purposes of this

    analysis, the Commission considers the costs and benefits attributable

    to its choices in this rulemaking--e.g., to stagger the implementation

    of clearing requirements and to do so in the manner prescribed--against

    those that would arise absent this Commission action--i.e., if

    implementation of the Dodd-Frank Act's Clearing Requirement for those

    swaps that the Commission separately determines to be subject to

    clearing was not staggered according to the rule's schedule.

    For reasons discussed in more detail below, the cost and benefits

    associated with requiring clearing immediately upon the Clearing

    Requirement determination for a swap class, or after some longer versus

    shorter period of delay, are not susceptible to meaningful

    quantification. As described above, these are not the costs and

    benefits of implementing Clearing Requirement determinations, but

    rather the costs and benefits of implementing them more slowly than

    would be required in the absence of this rule. The Commission is not

    aware of any analog to either an immediate or delayed requirement to

    establish the capability to clear that would produce data that the

    Commission could use to estimate the difference in costs and benefits

    between the two. Moreover, any data that might be gleaned from the

    experiences of an individual market participant establishing a

    relationship with a futures commission merchant (FCM) during normal

    market conditions would not reflect the influence of a number of

    effects that are likely to result from the simultaneous implementation

    of many market participants in a series of three waves. This

    coordinated movement creates both costs and benefits that cannot be

    quantified using data drawn from current market conditions.

    Notwithstanding these limitations, the Commission identifies and

    considers the costs and benefits of this rule in qualitative terms.

    E. Costs and Benefits of This Rule

    Determining whether to implement required clearing immediately upon

    Commission determination or after some period of delay necessarily

    involves cost and benefit tradeoffs. On the one hand, delaying required

    clearing implementation also delays the benefits of clearing of certain

    swaps, including reduced counterparty risk and increased stability in

    the financial system. These benefits are substantial, and any delay in

    their realization represents a cost to the market and the public. On

    the other hand, requiring implementation immediately or within a very

    compressed timeframe creates certain costs for industry participants.

    Reducing these costs--enumerated below--by extending the implementation

    schedule represents a benefit.

    First, to meet pressing timelines, some firms will need to contract

    additional staff or hire vendors to handle some necessary tasks or

    projects. Additional staff hired or vendors contracted in order to meet

    more pressing timelines represent an additional cost for market

    participants. Moreover, a tightly compressed timeframe raises the

    likelihood that more firms will be competing to procure services at the

    same time; this could put firms that conduct fewer swaps at a

    competitive disadvantage in obtaining those services, making it more

    difficult for them to meet required timelines.\32\ In addition, it

    could enable service providers to command a pricing premium when

    compared to times of ``normal'' or lesser competition for similar

    services. That premium represents an additional cost when compared to a

    longer implementation timeline.

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

    \32\ See letter from CIEBA.

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

    Second, if entities are not able to comply with Clearing

    Requirement determinations by the required date, they may avoid

    transacting swaps that are required to be cleared until such a time as

    they are able to comply. In this event, liquidity that otherwise would

    result from those foregone swaps would be reduced, making the swaps

    more expensive for market participants taking the other side. Moreover,

    firms compelled to withdraw from the market pending implementation of

    required clearing measures will either leave certain positions un-

    hedged--potentially increasing the firm's own default risk, and

    therefore the risk to their counterparties and the public.

    Alternatively, firms compelled to withdraw from the market for a period

    of time could attempt to approximate

    [[Page 44450]]

    their foregone swap hedges using other, likely more expensive,

    instruments. And to the extent the withdrawing entities are market

    makers, they will forsake the revenue potential that otherwise would

    exist for the period of their market absence.

    Third, firms may have to implement technological solutions, sign

    contracts, and establish new operational procedures before industry

    standards have emerged that address new problems effectively. To the

    extent that this occurs, it is likely to create costs. Firms may have

    to incur additional costs later to modify their technology platforms

    and operational procedures further, and to renegotiate contracts--

    direct costs that a more protracted implementation schedule would have

    avoided.\33\ Moreover, costs created by the adoption of standards that

    fail to address certain problems, or attributable to undesired

    competitive dynamics resulting from such standards, may be

    longstanding.

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

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

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

    Given the factors identified above, this rulemaking aims to strike

    the optimal cost-balance tradeoff amidst the competing concerns.

    Shorter timelines will tend to push greater numbers of swaps into

    clearing more quickly, reducing the counterparty and systemic exposures

    in ways that were intended by the Dodd-Frank Act--a benefit. But,

    shorter timelines also increase the costs as discussed above. Longer

    timelines have the opposite effect, decreasing the costs described

    above, but increasing the amount of time during which counterparty and

    systemic exposures that would otherwise be mitigated by required

    clearing persist.

    In theory, the optimal tradeoff between the two is the point at

    which the marginal cost of an additional one-day delay in

    implementation equals the marginal benefits of the same incremental

    delay. But it is not possible, at this stage, to determine the marginal

    costs or benefits of each day of delay. To estimate such values

    reliably requires data that does not yet exist--i.e., data gleaned in

    the midst of the transition process. Therefore, neither the Commission

    nor commenters are able to assert conclusively that any particular

    schedule is more or less advantageous relative to all others that the

    Commission might have considered. Thus, in the face of these practical

    limitations, the Commission has relied on qualitative considerations,

    informed by commenters, to guide the necessary tradeoff determinations.

    The Commission, informed by its consideration of comments and

    alternatives, discussed in the sections above and below, believes that

    the approach contained in this adopting release is reasonable and

    appropriate in light of the tradeoffs described above. The schedule

    established here gives the Commission the opportunity to provide

    additional time to entities in ways that generally align with: (1)

    Their resources and expertise, and therefore their ability to comply

    more quickly; and (2) their level of activity in the swap markets, and

    therefore the possible impact of their swap activities on the stability

    of the financial system. Entities with the most expertise in, and

    systems capable to transact, swaps also are likely to be those whose

    swaps represent a significant portion of all transactions in the swap

    markets. They are more likely to be able to comply quickly, and the

    benefits of requiring them to do so are greater than would be the case

    for less active entities. On the other hand, entities with less system

    capability and in-house swap expertise may need more time to comply

    with Clearing Requirement determinations, but it is also likely that

    their activities represent a smaller proportion of the overall market,

    and therefore are less likely to create or exacerbate shocks to the

    financial system.\34\ The Commission believes that Category 1

    encompasses entities likely possessing more advanced systems and

    expertise, and whose swap activities constitute a significant portion

    of overall swap market transactions, while Categories 2 and 3 encompass

    those likely to have relatively less developed infrastructure and whose

    swap activities constitute a less significant proportion of the market.

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

    \34\ OCC data demonstrates that among insured U.S. commercial

    banks, ``the five banks with the most derivatives activity hold 96

    percent of all derivatives, while the largest 25 banks account for

    nearly 100% of all contracts.'' The report is limited to insured

    U.S. commercial banks, and also includes derivatives that are not

    swaps. However, swap contracts are included among the derivatives in

    the report, constituting approximately 63 percent of the total

    notional value of all derivatives. These statistics suggest that a

    relatively small number of banks hold the majority of swap positions

    that could create or contribute to distress in the financial system.

    Data is insufficient, however, to generalize the conclusions to non-

    banking institutions. See ``OCC's Quarterly Report on Bank Trading

    and Derivatives Activities: Fourth Quarter 2011'' at 11. http://www.occ.treas.gov/topics/capital-markets/financial-markets/trading/derivatives/dq411.pdf.

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

    The Commission notes that clearing of certain swaps, and in

    particular interest rate and credit default swaps, has been occurring

    for some time; by implication, this indicates that the requisite

    technology, contractual terms, and operational standards among

    clearinghouses, clearing members, and some clients exist.\35\ The

    Commission also notes that it is likely that the degree to which firms

    have already implemented such technology, contracts, and operational

    patterns varies considerably, particularly among potential customers of

    FCMs, and that the legal, technological, and operational changes that

    are necessary for less frequent swap market participants may be more

    substantial. However, given the availability of FCMs (through which

    market participants may clear swaps) as well as the technology and

    contractual standards necessary to clear swaps, the Commission believes

    that a number of firms can reduce the costs associated with meeting

    compliance timelines by forming necessary FCM relationships and

    contracts, and implementing the necessary technology, before the

    Commission begins issuing Clearing Requirement determinations.\36\

    Nonetheless, the Commission considered these concerns, among other

    issues, when determining to grant Category 2 and Category 3 Entities an

    extended 180 and 270 days, respectively, rather than requiring them to

    comply at the same time as Category 1 Entities.

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

    \35\ For example, CME and ICE both began clearing credit default

    swaps (CDS) in 2009. As of March 2012, ICE had cleared more than $11

    trillion notional in CDS, and had 26 clearing members in CDS. CME

    began clearing interest rate swaps in 2010 and currently has open

    interest of $210 billion notional and 15 clearing members in

    interest rate swaps. Moreover, by March of 2010, 26 of the largest

    market makers were clearing interest rate derivatives. At that time,

    ISDA asserted that ``In excess of 90% of new dealer-to-dealer volume

    in Eligible Trades of Interest Rate Derivative products, and total

    dealer-to-dealer volume in Eligible Trades of Credit Derivative

    products is now cleared through CCPs.'' See http://www.newyorkfed.org/newsevents/news/markets/2010/100301_letter.pdf.

    \36\ The Commission understands approximately 2.5 months is

    sufficient for some market participants to enter into a clearing

    arrangement with an FCM for purposes of clearing swaps. See External

    Meeting with Blackrock, 4/2/2012. http://www.cftc.gov/LawRegulation/DoddFrankAct/ExternalMeetings/dfmeeting_040212_1463.

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

    Moreover, use of the schedule contained in this release is at the

    Commission's discretion; in situations where the Commission determines

    that the benefits of delayed implementation do not justify the

    additional costs of such a delay, the Commission may require immediate

    compliance with Clearing Requirement determinations. Therefore, in

    situations where the Commission determines that a swap must be cleared,

    and further believes that clearing the swap will not necessitate

    significant changes to market participants' technology, legal

    arrangements, or operational patterns, the Commission is likely to

    determine that immediate compliance is

    [[Page 44451]]

    warranted. In these cases, the benefits of required clearing will be

    realized immediately.

    The discretionary nature of the schedule contained in the adopting

    release, however, may create some uncertainty for market participants,

    and consequently may create some costs as market participants take

    steps to protect themselves from the impact of such uncertainty. For

    example, if a market participant believes that the Commission may issue

    a determination that a particular swap must be cleared, but is not

    certain whether clearing will be required immediately or according to

    the schedule contained in this release, that entity may begin

    developing the capacity to clear such a swap prior to a determination

    by the Commission in order to reduce the risk that it would be forced

    to stop trading the swap while it comes into compliance. If that

    participant's belief that the Commission will require the swap to be

    cleared is incorrect, the participant will have unnecessarily borne the

    cost of preparing for such a possibility. The Commission considered

    this cost, but believes that the notice and comment approach that the

    Commission will use when issuing Clearing Requirement determinations

    mitigates it. Each proposed Clearing Requirement determination will be

    published in the Federal Register and will be available for public

    comment for a period of at least 30 days; the Commission anticipates

    clarifying in each proposed Clearing Requirement determination whether

    compliance will be required immediately upon the final determination or

    according to the schedule contained in this rule. This approach will

    provide market participants with notice regarding the expected timeline

    for compliance, which will mitigate costs associated with uncertainty

    about compliance timelines.

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

    Commenters propose or otherwise highlight points that suggest

    alternatives with respect to various aspects of the NPRM.\37\ These

    aspects, as categorized for discussion below, are: (1) Phased approach;

    (2) entity categorization; (3) schedule increments; and (4) schedule

    discretion.

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

    \37\ Other commenters raise issues beyond the scope of this

    rule--i.e., implementation timing of required clearing--that,

    consequently, are beyond, and not appropriate for Commission

    consideration in, this rulemaking. Specifically, some commenters

    request that the Commission establish a comprehensive schedule for

    implementation of all rules and requirements pursuant to the Dodd-

    Frank Act. (See Barnard, MFA.) Others request a comprehensive

    schedule of clearing requirement determinations (See, e.g., CDEU),

    an issue already addressed by the Dodd-Frank Act and the rule

    regarding the Process for Review of Swaps for Mandatory Clearing.

    See section 2(h)(2)(B)(ii) of the CEA; 76 FR 44473.

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

    Phased Approach

    A number of commenters express support generally for additional

    time to comply with Clearing Requirement determinations and for a

    phased approach that distinguishes between various types of

    entities.\38\ Commenters note that the additional clarity provided by

    the schedule will encourage industry participants to commit resources

    to overcoming structural and economic barriers that prevent widespread

    clearing.\39\ Some commenters, however, maintain that the phased

    approach used to implement clearing requirement determinations should

    not be applied to exchange trade requirements.\40\ The AIMA believes

    that effective required clearing will enable execution of swaps on SEFs

    and DCMs and that linking the trading and clearing compliance schedules

    could delay the transition into central clearing. In response to these

    comments, the Commission has decided to limit the scope of this rule to

    Clearing Requirement determinations, to retain the phased approach to

    required clearing, and to address implementation of trade execution in

    a separate rule.

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

    \38\ See letters from Encana, Vanguard, ICI, FSR, MFA, FIA/ISDA/

    SIFMA, AII, MarkitSERV, and AIMA.

    \39\ See MFA letter.

    \40\ See letters from AIMA and MFA.

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

    Some commenters note that a phased approach could complicate

    implementation for large investor advisor firms that may have multiple

    funds in separate categories. Specifically, AII expresses concern that

    it may be difficult for institutional advisers to execute block trades

    for multiple clients during the implementation period because they will

    have to consider whether each client must comply with the Clearing

    Requirement. Nevertheless, AII recommends retaining the phased approach

    with at least 18 months for entities to comply. The Commission

    recognizes that such complexities exist and could introduce certain

    costs for large investor adviser firms. However, it is not clear that

    delaying the implementation period would alleviate this concern,

    although prolonging the implementation period likely would exacerbate

    the issue by extending the time during which such concerns are

    relevant. Moreover, the Commission notes that the benefits of required

    clearing are substantial and that further delays create costs borne by

    market participants and the public. In these circumstances, the

    Commission considers the latter consideration most compelling and,

    accordingly, has determined not to delay implementation beyond what is

    set forth in the schedule in the adopting release.

    Finally, relative to the alternative of immediate implementation

    following a Commission Clearing Requirement determination--the result

    in the absence of this rule--the Commission believes that the phased

    approach reflected in this adopting release is superior. The immediate

    implementation alternative would not mitigate the costs, enumerated

    above, to market participants and the public. In contrast, while

    delaying implementation also entails a different set of costs, also

    discussed above, the Commission has carefully tailored the rule's

    phased approach to contain and dampen them.

    Entity Categorization

    Commenters generally agree that some buy-side representation in

    Category 1 is valuable in order to ensure that buy-side interests are

    represented as technological and legal standards begin to form,\41\

    though commenters express varied views about whether Active Funds

    should play that role, and what entities should be included in that

    group. Some commenters state their belief that transaction volume is an

    appropriate proxy for a firm's level of expertise in conducting swaps

    and, therefore, is a useful criterion for identifying the buy-side

    entities that are best equipped to make the transition as part of

    Category 1.\42\ Some express concern, however, that as defined in the

    NPRM, the term ``Active Fund'' could be over-inclusive and recommend

    raising the threshold number of swaps or excluding swaps that are

    hedges or have a notional value below $10 million.\43\

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

    \41\ See AIMA letter.

    \42\ See letters from Barnard and AIMA.

    \43\ See letters from AII and CDEU.

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

    The Commission's intent in selecting Active Funds to participate in

    Category 1 is to identify those market participants that are larger and

    have significant experience in the swap markets. To ensure that the

    rule effectively selects for these entities, and in response to

    commenters, the Commission has raised the threshold number of swaps

    from a trailing average of 20 swaps per month over the previous twelve

    months, to a trailing average of 200 swaps per month over the previous

    twelve months. The Commission, however, believes that

    [[Page 44452]]

    further criteria restricting the swaps that are included against that

    count would create incremental administrative and operational costs

    that do not justify the resulting benefit, and therefore has not placed

    further restrictions on the types of swaps that count against the

    threshold. However, per commenters' request for clarification, the

    Commission is clarifying that the average monthly threshold of swaps

    applies to new swaps that the entity enters into, and it does not apply

    to novations, amendments, or partial tear-ups.

    ACLI maintains that there is diversity among buy-side participants

    in their use of swaps, and expresses concern that Active Funds may not

    be able to effectively represent diverse buy-side interests, and those

    of insurance companies in particular. ACLI, however, does not describe

    or quantify specific costs that it believes would result from this

    circumstance.\44\ The Commission acknowledges that buy-side market

    participants are diverse and may have specific needs reflecting

    concerns or interests unique to individual industries or even

    individual entities. However, the Commission also notes that the fact

    of certain differences among firms does not exclude the possibility of

    remaining similarities. Further, it believes that realizing the

    benefits provided by some buy-side representation in Category 1 is

    preferable to a scenario in which these benefits are foregone by

    removing Active Funds from Category 1 for required clearing

    implementation. Moreover, in the absence of any input as to how

    dissimilarities may specifically impact the compliance implementation

    process, the apparent solution to ACLI's concern would be to include

    insurance companies in Category 1 to assure representation of their

    interests earlier in the implementation process. While any Category 2

    Entity or any other entity may elect to comply sooner than the schedule

    requires (and are encouraged by the Commission to do so), the

    Commission finds no basis to believe that the benefits of requiring all

    insurance companies to participate in Category 1 warrant the additional

    costs that such an approach would create for them.

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

    \44\ See ACLI letter.

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

    MFA expresses concern that questions related to the term ``Active

    Fund'' could create an additional burden for fund operations and

    Commission staff, and proposed that all private funds be placed in

    Category 2 in order to eliminate this burden.\45\ MFA, however, does

    not specify what these questions are, nor the cost to funds associated

    with addressing them. In the absence of more specific information about

    the nature of the potential questions and their associated costs, the

    Commission has insufficient basis to conclude that costs to clarify

    Active Fund issues--either for fund operators or itself--are likely to

    be significant. Accordingly, it believes that the benefits of early-

    stage, buy-side representation warrant retention of the Category 1

    Active-Fund component.

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

    \45\ See MFA letter.

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

    Some commenters express concern about the definition of the term

    Third-Party Subaccounts. They maintain that the Third-Party Subaccount

    category should include any managed accounts, regardless of the level

    of authority granted in the advisory agreement to enter into trading

    agreements, on grounds that the operational and contractual challenges

    for moving swaps related to these accounts into clearing will be much

    the same regardless of whether the accounts' investment management

    agreements have ``specific approval'' requirements.\46\ Similarly, some

    commenters advocate in favor of including all ERISA plans in Category 3

    given their expectations that (1) Category 2 entities will bear more

    ``start-up'' costs related to required clearing than those in Category

    3, and (2) putting some ERISA plans in Category 2 and others in

    Category 3 will make overlays more difficult and costly.\47\

    Conversely, AIMA specifically states that making all funds Category 3

    Entities is not a suitable approach because it would eliminate buy-side

    representation during the early stages of implementation, and,

    consequently, urges the Commission not to adopt this approach.\48\

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

    \46\ See e.g., letters from ICI and AII.

    \47\ See CIEBA letter.

    \48\ See AIMA letter.

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

    Furthermore, AIMA and FSR asserted that some Third-Party

    Subaccounts may be ``private funds'' as defined in the Investment

    Advisers Act of 1940 that would otherwise qualify as Active Funds; AIMA

    expresses concern that allowing such funds 270 days to comply with

    clearing requirements could provide them a competitive advantage

    relative to other Active Funds that are not Third-Party Subaccounts for

    the period of time between the compliance dates for Categories 1 and 3.

    To level this playing field, AIMA proposes placing all Active Funds in

    Category 1, regardless of whether the funds also meet the criteria for

    a Third-Party Subaccount. In support of this proposition, AIMA opines

    that large institutional managers of large numbers of Third-Party

    Subaccounts are likely to have sufficient resources to make the

    transition within the 90 days required of Category 1 Entities.

    The Commission recognizes that some managed funds that do not

    require third party sign-off for clearing agreements, nevertheless, may

    choose to involve their clients in negotiation of relevant documents,

    and that some costs may result from placing some managed funds and

    ERISA plans in Category 2 and others in Category 3. After considering

    the alternatives posed by commenters, the Commission has modified the

    definition of Third-Party Subaccount to include managed accounts for

    which the investment manager is responsible for clearing documentation,

    regardless of whether the investment manager has explicit execution

    authority. In addition, the Commission has determined not to include

    ERISA plans in Category 2. The Commission has made these changes

    despite the fact that commenters do not attempt to quantify the costs

    associated with these provisions, nor do they recognize that such costs

    must be considered against the costs of further delaying required

    clearing implementation by a number of managed funds and ERISA plans. A

    fundamental premise of the Dodd-Frank Act is that central clearing

    minimizes risk to counterparties and the financial system as a whole;

    therefore, further delaying implementation of one or more groups of

    market participants creates costs associated with prolonged exposure of

    the financial system to a greater number of un-cleared swaps.

    Nonetheless, the Commission believes it appropriate to permit certain

    market participants an additional 90 days to come into compliance with

    the clearing requirement based on the comments received.

    Schedule Increments

    Some commenters express the opinion that 90, 180, and 270 days is

    sufficient for Category 1, 2, and 3 Entities, respectively, to comply

    with Clearing Requirement determinations.\49\ Several other commenters,

    however, expressed concern that the additional time provided in this

    rule may not be sufficient for some entities to comply.\50\ In that

    vein, commenters state that the

    [[Page 44453]]

    schedules may not be sufficient for contract negotiations to be

    completed,\51\ that pressing timelines could undermine the ability of

    some entities to negotiate effectively,\52\ and that rapid compliance

    may lead to the creation of industry standards that are not fair or

    prudent.\53\ Some commenters also express concern that entities in

    Categories 2 and 3 may not be able to find vendors able to provide

    sufficient support to meet the deadlines effectively.\54\

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

    \49\ See e.g., letters from Better Markets and MFA. MFA

    qualifies its support, stating that certain additional rules should

    be adopted prior to the schedule becoming effective, and also

    requests changes to the entities included in each category, but

    still generally supports the 90-, 180-, and 270-day implementation

    schedule.

    \50\ See e.g., letters from AII, CIEBA, ICI, FIA/ISDA/SIFMA, and

    FSR.

    \51\ See e.g., ACLI letter.

    \52\ See letters from ACLI, AII, and CIEBA.

    \53\ See letters from ACLI and ICI.

    \54\ See letters from ACLI, CDEU, CIEBA, COPE, and EEI. COPE and

    EEI specifically requested that the Commission determine whether

    ``off the shelf'' software is available to meet the needs of

    entities that do not yet have necessary technology. Further

    conversation clarified that both were concerned about technologies

    that extend beyond those directly related to Clearing Requirements

    established by the Act.

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

    It is impossible to quantify the costs and benefits of one

    particular schedule phase-in increment relative to another--e.g., 90

    days to comply versus 110--and the permutations of such an exercise

    would be endless, even if possible. Similarly, as discussed above,

    whether the schedule included in this adopting release mitigates costs

    to a greater degree than other increments the Commission might have

    adopted as an alternative to immediate implementation of required

    clearing (the result in the absence of this rule) is also a question

    that cannot be resolved with precision. In light of these limitations,

    however, the Commission has drawn upon its historical experience

    monitoring clearing, as well as its consideration of the qualitative

    feedback offered by market participants, in determining to incorporate

    the 90-, 180-, and 270-day benchmark features within the schedule

    adopted in this release. In so doing, the Commission believes that it

    has selected a reasonable schedule that is appropriate and well-suited

    to mitigate compliance pressures for market participants, and fairly

    accommodate the various competing interests involved.

    As is stated above, the Commission recognizes that extending the

    compliance schedule for one or more entities will reduce compliance

    costs for market participants in a number of different ways, but will

    also increase the amount of time during which market participants and

    the public do not benefit from the protections provided by mandatory

    clearing.

    Scheduling Discretion

    Some commenters support the Commission's retention of discretion to

    override the schedule in this release to require immediate clearing

    when it believes that the benefits do not justify the associated

    costs.\55\ These commenters note that over time market participants

    will gain experience to enable swifter compliance with later Clearing

    Requirement determinations, and maintain that, over time, the

    compliance schedules will not be warranted for Clearing Requirement

    determinations for new types, groups, or categories of swaps within an

    asset class that are already subject to a prior Clearing

    Requirement.\56\ Other commenters, however, support application of the

    schedule to all Clearing Requirement determinations in order to reduce

    uncertainty and facilitate orderly transitions to compliance.\57\

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

    \55\ See letters from Barnard and MFA.

    \56\ See letters from Barnard and MFA.

    \57\ See letters from FHLB and ICI.

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

    As discussed below, the Commission believes that the challenges of

    compliance are likely to vary depending on whether previous Clearing

    Requirement determinations have been made for other swaps in the same

    class, how long previous Clearing Requirement determinations for swaps

    in that class have been in place, the similarities between the swaps

    addressed by a determination and swaps subject to previous

    determinations, and a number of other factors. Therefore, the

    Commission believes that the tradeoff between the costs and benefits of

    more rapid compliance will vary as well. Where Clearing Requirement

    determinations pertain to swaps that have important points of

    similarity with swaps already required to be cleared, it is likely that

    the costs associated with more rapid compliance will be significantly

    less, and therefore the balance will shift in favor of a shorter

    compliance deadline than would be allowed under the schedule contained

    in this rule. Also, by including the applicable compliance schedule

    within its public notifications of a proposed Clearing Requirement

    determination, the Commission will mitigate uncertainty costs that

    could result.

    G. Consideration of Section 15(a) Factors

    (1) Protection of Market Participants and the Public

    Category 1 includes, among others, SDs as well as MSPs and Active

    Funds. If SDs were not able to comply immediately with a Clearing

    Requirement determination, and were not given additional time to

    comply, they could choose to withdraw from the market as they work

    toward compliance. Such withdrawal would create lost opportunities for

    them as they fail to capture business that they would have otherwise

    conducted during that period. If MSPs or Active Funds choose to

    withdraw from the market while they work to come into compliance, it

    could become more costly for them to either effectively create or hedge

    certain exposures, which could also prompt them to leave certain risks

    un-hedged that they would otherwise mitigate through the use of swaps.

    By giving Category 1 Entities an additional 90 days to comply with

    Clearing Requirement determinations, the schedule contained in this

    adopting release reduces the likelihood of these entities withdrawing

    from the swap markets while they work toward compliance; this, in turn,

    reduces the probability that these Category 1 Entities will bear the

    potential costs of un-hedged risk exposure.

    Moreover, the Commission believes that SDs are an important source

    of liquidity for swap market participants. If SDs withdraw from the

    market while they work toward compliance, it could negatively impact

    swap liquidity, increasing costs for market participants forced to

    hedge certain risks through less efficient means (or not at all) for a

    period of time. The costs of not hedging certain risks would be borne

    not only by the firms that choose such an approach, but by the public

    in the form of increased counterparty risk throughout the financial

    system. Again, by providing additional time for SDs to comply with

    Clearing Requirement determinations, the schedule in the adopting

    release facilitates an orderly transition and reduces the likelihood

    that the costs associated with SDs withdrawing from the market for a

    period of time would materialize. The Commission considered this

    benefit in light of the cost associated with delayed compliance among

    Category 1 Entities and believes that an appropriate balance has been

    struck.

    The Commission also anticipates that the staggered compliance

    schedule contained in this rule will, to some extent, enable Category 2

    and 3 Entities to adopt technological, legal, and operational standards

    developed by Category 1 Entities. To the extent that this occurs, it

    will reduce the number of entities that are working in parallel to

    develop solutions to the same problems by allowing Category 2 and 3

    Entities some time to wait for Category 1 Entities and vendors to

    develop viable solutions to technological, legal, and operational

    challenges. Some of those solutions are likely to be proprietary, while

    others

    [[Page 44454]]

    will likely relate to non-proprietary standards that must be shared in

    order to be effective. Both types of advances can reduce costs for

    Category 2 and 3 Entities. In the case of non-proprietary standards,

    Category 2 and 3 entities will benefit from the opportunity to adopt

    them without having to invest in their development. In the case of

    proprietary solutions, some of them are likely to be owned by vendors

    marketing them to multiple market participants, thereby spreading the

    development costs among their clients. Each of these consequences is

    likely to reduce overall development costs for the industry, and

    development costs for Category 2 and 3 Entities, in particular.\58\

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

    \58\ As indicated in the NPRM, to the extent that Category 1

    Entities bear a larger portion of the industry wide ``start-up'' or

    development costs, the Commission believes this is appropriate since

    they are likely to be among the most active participants in these

    markets.

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

    In weighing the tradeoff between shorter versus longer compliance

    timelines, the Commission believes Category 2 Entities are likely to be

    less well-resourced and less active in these markets. Therefore the

    dynamic between more or less rapid compliance tips in favor of

    providing additional time for these entities. As stated above, by

    providing 180 days, it becomes more likely that Category 2 Entities

    will be able to draw from lessons learned and standards established by

    Category 1 Entities. It also increases the likelihood that where

    Category 2 Entities will depend on vendors for help developing and

    implementing necessary technology, legal agreements, and operational

    patterns, they will not have to compete as directly with Category 1

    Entities for those resources.

    The Commission believes that entities with Third-Party Subaccounts

    have an additional challenge of transitioning hundreds (or in some

    cases, thousands) of subaccounts into compliance with Clearing

    Requirement determinations, which may require formalizing new

    agreements with each of their customers, and educating their customers

    about how the Clearing Requirement will impact costs and operations. In

    the Commission's view, this additional challenge justifies additional

    time for compliance beyond what is allowed for Category 2 Entities.\59\

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

    \59\ As stated in the NPRM, Category 2 and 3 Entities that want

    to come into compliance sooner than the 180- and 270-day deadlines

    are allowed, and encouraged, to do so.

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

    As described above, the Commission recognizes that delaying

    implementation creates some additional costs in the form of delayed

    protections that central clearing of swaps would otherwise provide--

    standardized and reduced counterparty risk for swaps that are required

    to be cleared, and associated reductions in the overall level of

    systemic risk. However, the Commission believes that this approach

    appropriately balances the tradeoff by requiring firms that are likely

    to be the most active in these markets to comply first and allowing

    additional time for those whose positions are less likely to pose

    significant risk to the financial system as a whole.

    (2) Efficiency, Competitiveness, and Financial Integrity of Futures

    Markets

    As suggested above, Category 1 Entities are likely to establish

    technological, legal, and operational standards that will influence or

    be adopted by Category 2 and 3 Entities. This will (1) serve to reduce

    development costs that Category 2 and 3 Entities otherwise would face,

    (2) focus responsibility for shaping new platforms and standards on

    those firms that possess greater cleared swap experience, and (3)

    support the likelihood that new platforms and standards will reflect

    current best practices. Each of these elements promotes the efficiency

    and integrity of the markets. Moreover, by reducing the number of

    entities necessarily working in parallel to develop such standards, and

    allowing Category 2 and 3 Entities to learn from and build on the

    solutions developed by Category 1 Entities, the phased schedule

    contained in this adopting release holds the potential to foster

    compatibility and interoperability, which reduces the cost and

    complexity of interconnectedness.

    The phased schedule as adopted also will promote an implementation

    plan in which similar entities (i.e., those that usually compete with

    one another) generally have the same compliance timelines, thereby

    protecting competition during the transition period. One commenter

    states, ``A phased approach to compliance will allow the Commission to

    balance its goal of obtaining adequate representation at each stage of

    the regulatory roll-out with the goal of avoiding anti-competitive

    concerns.'' \60\

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    \60\ See ICI letter.

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    That said, however, the Commission also has to balance the goal of

    maintaining a level playing field with other priorities. In particular,

    the Commission deems it important to ensure representation of both buy

    and sell side firms in the earliest stages of compliance. Moreover, the

    Commission believes that, in certain circumstances, variance in

    compliance burden among competitors warrants placing them in different

    implementation categories. Some competitive consequences may result

    from the need to balance these various priorities. The Commission

    believes, however, that it has built sufficient flexibility into the

    phased schedule to mitigate such consequences; specifically, the

    schedule preserves entities' ability to respond to competitive

    incentives to move into clearing voluntarily prior to the date required

    by the compliance schedule. The Commission believes that providing

    flexibility to allow expression of competitive market incentives is

    preferable to the alternative of imposing a more compressed compliance

    schedule for purposes of maintaining a level playing field. As

    discussed above, a shorter schedule could also increase the likelihood

    that industry standards established during the implementation period

    could create and perpetuate undesirable competitive dynamics. In sum,

    the Commission anticipates that any temporary impacts on competitive

    dynamics created by the phased implementation approach it is adopting

    are likely to be less costly than an approach that increases the

    likelihood of sustained competitive disparities, and therefore has

    chosen not to shorten the compliance schedule as a remedy to address

    the risk of competitive advantages that may be conferred on market

    participants that have later compliance dates.

    As discussed above, for the 90-, 180-, and 270-day periods that

    Clearing Requirements are delayed, the markets are exposed to the risks

    that the Clearing Requirements would mitigate. However, the Commission

    has considered this cost for the limited delay durations prescribed in

    light of the benefits--reduced implementation costs, greater degrees of

    compatibility and interoperability, and lessened risk of market

    disturbances from the withdrawal of entities that are not able to

    comply immediately--and considers the tradeoff reflected in the rules

    warranted.

    (3) Price Discovery

    Neither the Commission nor commenters have identified consequences

    for price discovery that are expected to result from this rule.

    (4) Sound Risk Management Practices

    An orderly transition for swaps subject to a Clearing Requirement

    determination promotes sounder risk management practices, particularly

    during the transition period. As mentioned above, in the absence of the

    [[Page 44455]]

    schedule provided in this rule, some entities might exit swap markets

    while taking steps to come into compliance. This result could reduce

    liquidity, particularly if the withdrawing entities are SDs. Reduced

    liquidity likely would increase the cost of using swaps to manage risk

    by increasing spreads, and make it more difficult for entities to enter

    and exit positions in a timely manner. It could also prompt some

    entities to maintain exposures that they would otherwise use swaps to

    mitigate, which would elevate the risk profile of those entities and

    the level of risk that their counterparties bear as a consequence. By

    providing a timetable for orderly transition, this rule encourages

    continued participation in the swap markets and use of swaps for risk

    mitigation purposes during the transition.

    Clearing Requirement delay does prolong existing costs associated

    with not having counterparty credit risk monitored and managed

    effectively by a DCO. More prompt implementation of Clearing

    Requirements would have the benefit of preventing losses from

    accumulating over time through the settlement of variation margin

    between a DCO's clearing members each day. The settlement of variation

    margin each day (and in some cases, multiple times per day) reduces the

    size of exposures a clearinghouse faces should one of its

    counterparties default, and the mechanisms that a clearinghouse has to

    ensure its own solvency reduce the probability that it would default on

    obligations to clearing members. Moreover, more prompt implementation

    also promotes the use of initial margin as a performance bond against

    potential future losses such that if a party fails to meet its

    obligation to pay variation margin, resulting in a default, the DCO may

    use the defaulting party's initial margin to cover most or all of any

    loss based on the need to replace the open position. The Commission

    believes, however, that (1) it has tailored the rule to limit the

    degree, and thereby these costs attributable to, clearing

    implementation delay and (2) the benefits afforded by the schedule's

    operation when the Commission elects to use it warrant the costs of the

    tailored implementation delay.

    (5) Other Public Interest Considerations

    The schedule allows market participants to comply with the

    requirements of the Dodd-Frank Act and provides a sound basis for

    achieving the overarching Dodd-Frank Act goals of reducing counterparty

    risk and promoting stability of the financial system.

    IV. Related Matters

    A. Regulatory Flexibility Act

    The Regulatory Flexibility Act (RFA) requires that agencies

    consider whether the rules they propose will have a significant

    economic impact on a substantial number of small entities and, if so,

    provide a regulatory flexibility analysis respecting the impact.\61\ As

    stated in the NPRM, the subject of this rulemaking provides a

    compliance schedule for a new statutory requirement, section 2(h)(1)(A)

    of the CEA, and does not itself impose significant new regulatory

    requirements.\62\ Accordingly, the Chairman, on behalf of the

    Commission, certified pursuant to 5 U.S.C. 605(b) that the proposed

    rule would not have a significant economic impact on a substantial

    number of small entities. The Commission then invited public comment on

    this determination.

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

    \61\ 5 U.S.C. 601 et seq.

    \62\ 76 FR 58192-58193 (Sept. 20, 2011).

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

    FSR comments that the NPRM failed to evaluate the impact of the

    proposed compliance schedule for the Clearing Requirement on a

    substantial number of small entities. FSR argued that small entities

    may have to bear a more significant burden than larger entities in

    establishing clearing arrangements with FCMs because larger entities

    will be able to enter into such arrangements first.

    In response, the Commission points out that the compliance schedule

    for the Clearing Requirement will affect only eligible contract

    participants (ECPs). Pursuant to section 2(e) of the CEA, only ECPs may

    enter into swaps, unless the swap is listed on a DCM. The Clearing

    Requirement will affect only ECPs because all persons that are not ECPs

    are required to execute their swaps on a DCM, and all contracts

    executed on a DCM must be cleared by a DCO, as required by statute and

    regulation; not by operation of any Clearing Requirement.

    The Commission has previously determined that ECPs are not small

    entities for purposes of the RFA.\63\ However, in their comment letter,

    the Joint Associations assert that certain members of the National

    Rural Electric Cooperative Association (NRECA) may both be ECPs under

    the CEA and small businesses under the RFA. These members of NRECA, as

    the Commission understands, have been determined to be small entities

    by the Small Business Administration (SBA) because they are ``primarily

    engaged in the generation, transmission, and/or distribution of

    electric energy for sale and [their] total electric output for the

    preceding fiscal year did not exceed 4 million megawatt hours.'' \64\

    Although the Joint Associations do not provide details on whether or

    how the NRECA members that have been determined to be small entities

    use the types of swaps that will be subject to the Clearing

    Requirement, the Joint Associations do state that NRECA members

    ``engage in swaps to hedge commercial risk.'' \65\ Because the NRECA

    members that have been determined to be small entities would be using

    swaps to hedge commercial risk, the Commission expects that they would

    be able to use the end-user exception from the Clearing Requirement and

    therefore would not be affected to any significant extent by the

    Clearing Requirement.

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    \63\ See 66 FR 20740, 20743 (Apr. 25, 2001).

    \64\ Small Business Administration, Table of Small Business Size

    Standards, Nov. 5, 2010.

    \65\ See Joint Associations' comment letter, at 2. The letter

    also suggests that NRECA members are not financial entities. See

    id., at note 5, and at 5 (the associations' members ``are not

    financial companies'').

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

    Thus, because nearly all of the ECPs that may be subject to the

    Clearing Requirement are not small entities, and because the few ECPs

    that have been determined by the SBA to be small entities are unlikely

    to be subject to the Clearing Requirement, the Chairman, on behalf of

    the Commission, hereby certifies pursuant to 5 U.S.C. 605(b) that the

    rule herein creating the compliance schedule for the Clearing

    Requirement will not have a significant economic impact on a

    substantial number of small entities.

    B. Paperwork Reduction Act

    The Paperwork Reduction Act (PRA) \66\ imposes certain requirements

    on federal agencies (including the Commission) in connection with

    conducting or sponsoring any collection of information as defined by

    the PRA. As stated in the NPRM, this rulemaking will not require a new

    collection of information from any persons or entities.\67\

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    \66\ 44 U.S.C. 3507(d).

    \67\ 76 FR 58186, 58193 (Sept. 20, 2011).

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    V. List of Subjects

    List of Subjects in 17 CFR Part 50

    Business and industry, Clearing, Swaps.

    In consideration of the foregoing, and pursuant to the authority in

    the Commodity Exchange Act, as amended, and in particular section 2(h)

    of the Act, the Commission hereby adopts an amendment to Chapter I of

    Title 17 of the Code of Federal Regulation by adding a new part 50 as

    follows:

    [[Page 44456]]

    PART 50--CLEARING REQUIREMENT

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

    1376.

    Sec. 50.25 Clearing requirement compliance schedule.

    (a) Definitions. For the purposes of this paragraph:

    Active Fund means any private fund as defined in section 202(a) of

    the Investment Advisers Act of 1940, that is not a third-party

    subaccount and that executes 200 or more swaps per month based on a

    monthly average over the 12 months preceding the Commission issuing a

    clearing requirement determination under section 2(h)(2) of the Act.

    Category 1 Entity means a swap dealer, a security-based swap

    dealer; a major swap participant; a major security-based swap

    participant; or an active fund.

    Category 2 Entity means a commodity pool; a private fund as defined

    in section 202(a) of the Investment Advisers Act of 1940 other than an

    active fund; or a person predominantly engaged in activities that are

    in the business of banking, or in activities that are financial in

    nature as defined in section 4(k) of the Bank Holding Company Act of

    1956, provided that, in each case, the entity is not a third-party

    subaccount.

    Third-party Subaccount means an account that is managed by an

    investment manager that is independent of and unaffiliated with the

    account's beneficial owner or sponsor, and is responsible for the

    documentation necessary for the account's beneficial owner to clear

    swaps.

    (b) Upon issuing a clearing requirement determination under section

    2(h)(2) of the Act, the Commission may determine, based on the group,

    category, type, or class of swaps subject to such determination, that

    the following schedule for compliance with the requirements of section

    2(h)(1)(A) of the Act shall apply:

    (1) A swap between a Category 1 Entity and another Category 1

    Entity, or any other entity that desires to clear the transaction, must

    comply with the requirements of section 2(h)(1)(A) of the Act no later

    than ninety (90) days from the date of publication of such clearing

    requirement determination in the Federal Register.

    (2) A swap between a Category 2 Entity and a Category 1 Entity,

    another Category 2 Entity, or any other entity that desires to clear

    the transaction, must comply with the requirements of section

    2(h)(1)(A) of the Act no later than one hundred and eighty (180) days

    from the date of publication of such clearing requirement determination

    in the Federal Register.

    (3) All other swaps for which neither of the parties to the swap is

    eligible to claim the exception from the clearing requirement set forth

    in section 2(h)(7) of the Act and Sec. 39.6, must comply with the

    requirements of section 2(h)(1)(A) of the Act no later than two hundred

    and seventy (270) days from the date of publication of such clearing

    requirement determination in the Federal Register.

    (c) Nothing in this rule shall be construed to prohibit any person

    from voluntarily complying with the requirements of section 2(h)(1)(A)

    of the Act sooner than the implementation schedule provided under

    paragraph (b).

    Issued in Washington, DC, on July 24, 2012, by the Commission.

    Sauntia Warfield,

    Assistant Secretary of the Commission.

    Appendices to Swap Transaction Compliance and Implementation

    Schedule: Clearing Requirement under Section 2(h) of the CEA--

    Commission Voting Summary and Statements of Commissioners

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

    Federal Regulations.

    Appendix 1--Commission Voting Summary

    On this matter, Chairman Gensler and Commissioners Sommers,

    Chilton, O'Malia and Wetjen voted in the affirmative; no

    Commissioner voted in the negative.

    Appendix 1--Statement of Chairman Gary Gensler

    I support the final rule to establish a schedule to phase in

    compliance with the clearing requirement provisions in the Dodd-

    Frank Wall Street Reform and Consumer Protection Act.

    The rule gives market participants an adequate amount of time to

    comply and helps facilitate an orderly transition to the new

    clearing requirements for the swaps market. The rule provides

    greater clarity to market participants regarding the timeframe for

    bringing their swaps into compliance with the clearing requirement.

    [FR Doc. 2012-18383 Filed 7-27-12; 8:45 am]

    BILLING CODE 6351-01-P

    Last Updated: July 30, 2012