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2012-29211

  • Federal Register, Volume 77 Issue 240 (Thursday, December 13, 2012)[Federal Register Volume 77, Number 240 (Thursday, December 13, 2012)]

    [Rules and Regulations]

    [Pages 74283-74339]

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

    [FR Doc No: 2012-29211]

    [[Page 74283]]

    Vol. 77

    Thursday,

    No. 240

    December 13, 2012

    Part II

    Commodity Futures Trading Commission

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    17 CFR Parts 39 and 50

    Clearing Requirement Determination Under Section 2(h) of the CEA; Final

    Rule

    Federal Register / Vol. 77 , No. 240 / Thursday, December 13, 2012 /

    Rules and Regulations

    [[Page 74284]]

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    COMMODITY FUTURES TRADING COMMISSION

    17 CFR Parts 39 and 50

    RIN 3038-AD86

    Clearing Requirement Determination 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 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 regulations require that certain

    classes of credit default swaps (CDS) and interest rate swaps,

    described herein, be cleared by a derivatives clearing organization

    (DCO) registered with the Commission. The Commission also is adopting

    regulations to prevent evasion of the clearing requirement and related

    provisions.

    DATES: The rules will become effective February 11, 2013. Specific

    compliance dates are discussed in the supplementary information.

    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 Erik Remmler, Associate Director,

    202-418-7630, eremmler@cftc.gov, Division of Clearing and Risk, Camden

    Nunery, Economist, 202-418-5723, cnunery@cftc.gov, Office of the Chief

    Economist, Commodity Futures Trading Commission, Three Lafayette

    Centre, 1155 21st Street NW., Washington, DC 20581.

    SUPPLEMENTARY INFORMATION:

    Table of Contents

    I. Background

    A. Clearing Requirement Proposal

    B. Financial Crisis

    C. Central Role of Clearing in the Dodd-Frank Act

    D. G-20 and International Commitments on Clearing

    E. Overview of Section 2(h) and Sec. 39.5

    F. Submissions From DCOs

    II. Comments on the Notice of Proposed Rulemaking

    A. Overview of Comments Received

    B. Generally Applicable Comments

    C. Credit Default Swaps

    D. Determination Analysis for Credit Default Swaps

    E. Interest Rate Swaps

    F. Determination Analysis for Interest Rate Swaps

    III. Final Rule

    A. Regulation 50.1: Definitions

    B. Regulation 50.2: Treatment of Swaps Subject to a Clearing

    Requirement

    C. Regulation 50.3: Notice to the Public

    D. Regulation 50.4: Classes of Swaps Required To Be Cleared

    E. Regulation 50.5: Clearing Transition Rules

    F. Regulation 50.6: Delegation of Authority

    G. Regulation 50.10: Prevention of Evasion of the Clearing

    Requirement and Abuse of an Exception or Exemption to the Clearing

    Requirement

    IV. Implementation

    V. Cost Benefit Considerations

    A. Statutory and Regulatory Background

    B. Overview of Swap Clearing

    C. Consideration of the Costs and Benefits of the Commission's

    Action

    D. Consideration of Alternative Swap Classes for Clearing

    Determination

    E. Section 15(a) Factors

    VI. Related Matters

    A. Regulatory Flexibility Act

    B. Paperwork Reduction Act

    I. Background

    A. Clearing Requirement Proposal

    On August 7, 2012, the Commission published a notice of proposed

    rulemaking (NPRM) to establish a clearing requirement under new section

    2(h)(1)(A) of the CEA, as provided for under section 723 of Title VII

    of the Dodd-Frank Act.\1\ The Commission proposed that swaps meeting

    the specifications identified in two classes of CDS and four classes of

    interest rate swaps, and available for clearing by an eligible DCO,

    would be required to be cleared. The Commission also proposed rules

    related to the prevention of evasion of the clearing requirement and

    prevention of abuse of an exception or exemption to the clearing

    requirement. The Commission is hereby adopting Sec. Sec. 50.1-50.6 and

    Sec. 50.10, subject to the changes discussed below.

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    \1\ Clearing Requirement Determination Under Section 2(h) of the

    CEA; Proposed Rule, 77 FR 47170 (Aug. 7, 2012).

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    B. Financial Crisis

    In the fall of 2008, a series of large financial institution

    failures triggered a financial and economic crisis that threatened to

    freeze U.S. and global credit markets. As a result of these failures,

    unprecedented governmental intervention was required to ensure the

    stability of the U.S. financial system.\2\ These failures revealed the

    vulnerability of the U.S. financial system and economy to widespread

    systemic risk resulting from, among other things, poor risk management

    practices of financial firms and the lack of supervisory oversight for

    a financial institution as a whole.\3\

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    \2\ On October 3, 2008, President Bush signed the Emergency

    Economic Stabilization Act of 2008, which was principally designed

    to allow the U.S. Department of the Treasury and other government

    agencies to take action to restore liquidity and stability to the

    U.S. financial system (e.g., the Troubled Asset Relief Program--also

    known as TARP--under which the U.S. Department of the Treasury was

    authorized to purchase up to $700 billion of troubled assets that

    weighed down the balance sheets of U.S. financial institutions). See

    Public Law 110-343, 122 Stat. 3765 (2008).

    \3\ See Financial Crisis Inquiry Commission, ``The Financial

    Crisis Inquiry Report: Final Report of the National Commission on

    the Causes of the Financial and Economic Crisis in the United

    States,'' Jan. 2011, at xxviii, available at http://www.gpo.gov/fdsys/pkg/GPO-FCIC/pdf/GPO-FCIC.pdf.

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    The financial crisis also illustrated the significant risks that an

    uncleared, over-the-counter (OTC) derivatives market can pose to the

    financial system. As the Financial Crisis Inquiry Commission explained:

    The scale and nature of the [OTC] derivatives market created

    significant systemic risk throughout the financial system and helped

    fuel the panic in the fall of 2008: millions of contracts in this

    opaque and deregulated market created interconnections among a vast

    web of financial institutions through counterparty credit risk, thus

    exposing the system to a contagion of spreading losses and

    defaults.\4\

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    \4\ See id. at 386.

    Certain OTC derivatives, such as CDS, played a prominent role

    during the crisis. According to a white paper by the U.S. Department of

    the Treasury, ``the sheer volume of these [CDS] contracts overwhelmed

    some firms that had promised to provide payment of the CDS and left

    institutions with losses that they believed they had been protected

    against.'' \5\ In particular, AIG reportedly issued uncleared CDS

    transactions covering more than $440 billion in bonds, leaving it with

    obligations that it could not cover as a result of changed market

    conditions.\6\ As a result of AIG's CDS exposure, the Federal

    government bailed out the firm with over $180 billion of taxpayer money

    in order to prevent AIG's failure and a possible contagion event in the

    broader economy.\7\

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    \5\ Financial Regulatory Reform: A New Foundation, June 2009,

    available at http://www.treasury.gov/initiatives/Documents/FinalReport_web.pdf and cited in S. Rep. 111-176 at 29-30 (Apr. 30,

    2010).

    \6\ Adam Davidson, ``How AIG fell apart,'' Reuters, Sept. 18,

    2008, available at http://www.reuters.com/article/2008/09/18/us-how-aig-fell-apart-idUSMAR85972720080918.

    \7\ Hugh Son, ``AIG's Trustees Shun `Shadow Board,' Seek

    Directors,'' Bloomberg, May 13, 2009, available at http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aaog3i4yUopo&refer=us.

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    More broadly, the President's Working Group (PWG) on Financial

    Markets noted shortcomings in the OTC

    [[Page 74285]]

    derivative markets as a whole during the crisis. The PWG identified the

    need for an improved integrated operational structure supporting OTC

    derivatives, specifically highlighting the need for an enhanced ability

    to manage counterparty risk through ``netting and collateral agreements

    by promoting portfolio reconciliation and accurate valuation of

    trades.'' \8\ These issues were exposed in part by the surge in

    collateral required between counterparties during 2008, when the

    International Swaps and Derivatives Association (ISDA) reported an 86%

    increase in the collateral in use for OTC derivatives, indicating not

    only the increase in risk, but also circumstances in which positions

    may not have been collateralized.\9\

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    \8\ The President's Working Group on Financial Markets, ``Policy

    Statements on Financial Market Developments,'' Mar. 2008, available

    at http://www.treasury.gov/resource-center/fin-mkts/Documents/pwgpolicystatemktturmoil_03122008.pdf.

    \9\ ISDA, ISDA Margin Survey, 2009, available at http://www.isda.org/c_and_a/pdf/ISDA-Margin-Survey-2009.pdf.

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    With only limited checks on the amount of risk that a market

    participant could incur, great uncertainty was created among market

    participants. A market participant did not know the extent of its

    counterparty's exposure, whether its counterparty was appropriately

    hedged, or if its counterparty was dangerously exposed to adverse

    market movements. Without central clearing, a market participant bore

    the risk that its counterparty would not fulfill its payment

    obligations pursuant to a swap's terms (counterparty credit risk). As

    the financial crisis deepened, this risk made market participants wary

    of trading with each other. As a result, markets quickly became

    illiquid and trading volumes plummeted. The dramatic increase in ``TED

    spreads'' evidenced this mistrust.\10\ These spreads increased from a

    long-term average of approximately 30 basis points to 464 basis

    points.\11\

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    \10\ The TED spread measures the difference in yield between

    three-month Eurodollars as represented by London Interbank Offered

    Rate (LIBOR), and three-month Treasury Bills. LIBOR contains credit

    risk while T-bills do not. As the spread got larger, it meant that

    lenders demanded more return to compensate for credit risk than they

    would need if they loaned the money to the U.S. Department of the

    Treasury without any credit risk.

    \11\ The U.S. Financial Crisis: Credit Crunch and Yield Spreads,

    by James R. Barth et al., page 5, available at http://apeaweb.org/confer/bei08/papers/blp.pdf.

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    The failure to adequately collateralize the risk exposures posed by

    OTC derivatives, along with the contagion effects of the vast web of

    counterparty credit risk, led many to conclude that OTC derivatives

    should be centrally cleared. For instance, in 2008, the Federal Reserve

    Bank of New York (FRBNY) began encouraging market participants to

    establish a central counterparty to clear CDS.\12\ For several years

    prior, the FRBNY had led a targeted effort to enhance operational

    efficiency and performance in the OTC derivatives market by increasing

    automation in processing and by promoting sound back office practices,

    such as timely confirmation of trades and portfolio reconciliation.

    Beginning with CDS in 2008, the FRBNY and other primary supervisors of

    OTC derivatives dealers increasingly focused on central clearing as a

    means of mitigating counterparty credit risk and lowering systemic risk

    to the markets as a whole. Both regulators and market participants

    alike recognized that risk exposures would have been monitored,

    measured, and collateralized through the process of central clearing.

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    \12\ See Federal Reserve Bank of New York, Press Release, ``New

    York Fed Welcomes Further Industry Commitments on Over-the-Counter

    Derivatives,'' Oct. 31, 2008, available at http://www.newyorkfed.org/newsevents/news/markets/2008/an081031.html, which

    references documents prepared by market participants describing the

    importance of clearing. See also Ciara Linnane and Karen Brettell,

    ``NY Federal Reserve pushes for central CDS counterparty,'' Reuters,

    Oct. 6, 2008, available at http://www.reuters.com/article/2008/10/06/cds-regulation-idUSN0655208920081006.

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    C. Central Role of Clearing in the Dodd-Frank Act

    Recognizing the peril that the U.S. financial system faced during

    the financial crisis, Congress and the President came together to pass

    the Dodd-Frank Act in 2010. Title VII of the Dodd-Frank Act establishes

    a comprehensive new regulatory framework for swaps, and the requirement

    that swaps be cleared by DCOs is one of the cornerstones of that

    reform. The CEA, as amended by Title VII, now requires a swap: (1) To

    be cleared through a DCO if the Commission has determined that the

    swap, or group, category, type, or class of swap, is required to be

    cleared, unless an exception to the clearing requirement applies; (2)

    to be reported to a swap data repository (SDR) or the Commission; and

    (3) if the swap is subject to a clearing requirement, to be executed on

    a designated contract market (DCM) or swap execution facility (SEF),

    unless no DCM or SEF has made the swap available to trade.\13\

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    \13\ The Commission has proposed rules that would establish a

    separate process for determining whether a swap has been made

    ``available to trade'' by a DCM or SEF. Those rules, and any

    determinations made under those rules, will be finalized separately

    from the clearing requirements discussed herein. See Process for a

    Designated Contract Market or Swap Execution Facility to Make a Swap

    Available to Trade Under Section 2(h)(8) of the Commodity Exchange

    Act, 76 FR 77728 (Dec. 14, 2011).

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    Clearing is at the heart of the Dodd-Frank financial reform.

    According to the Senate Report: \14\

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    \14\ S. Rep. 111-176, at 32 (April 30, 2010). See also Letter

    from Senators Christopher Dodd and Blanche Lincoln to Congressmen

    Barney Frank and Collin Peterson (June 30, 2010) (``Congress

    determined that clearing is at the heart of reform--bringing

    transactions and counterparties into a robust, conservative, and

    transparent risk management framework.'').

    As a key element of reducing systemic risk and protecting

    taxpayers in the future, protections must include comprehensive

    regulation and rules for how the OTC derivatives market operates.

    Increasing the use of central clearinghouses, exchanges, appropriate

    margining, capital requirements, and reporting will provide

    safeguards for American taxpayers and the financial system as a

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    whole.

    The Commission believes that a clearing requirement will reduce

    counterparty credit risk and provide an organized mechanism for

    collateralizing the risk exposures posed by swaps. According to the

    Senate Report: \15\

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    \15\ S. Rep. 111-176, at 33.

    With appropriate collateral and margin requirements, a central

    clearing organization can substantially reduce counterparty risk and

    provide an organized mechanism for clearing transactions. * * *

    While large losses are to be expected in derivatives trading, if

    those positions are fully margined there will be no loss to

    counterparties and the overall financial system and none of the

    uncertainty about potential exposures that contributed to the panic

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    in 2008.

    Notably, Congress did not focus on just one asset class, such as CDS;

    rather, Congress determined that all swaps that a DCO plans to accept

    for clearing must be submitted to the Commission for a determination as

    to whether or not those swaps are required to be cleared pursuant to

    section 2(h)(2)(D) of the CEA.

    D. G-20 and International Commitments on Clearing

    The financial crisis generated international consensus on the need

    to strengthen financial regulation by improving transparency,

    mitigating systemic risk, and protecting against market abuse. As a

    result of the widespread recognition that transactions in the OTC

    derivatives market increased risk and uncertainty in the global economy

    and became a significant contributor to the financial crisis, a series

    of policy initiatives were undertaken to better regulate the financial

    markets.

    [[Page 74286]]

    In September 2009, leaders of the Group of 20 (G-20)--whose

    membership includes the United States, the European Union, and 18 other

    countries--agreed that: (1) OTC derivatives contracts should be

    reported to trade repositories; (2) all standardized OTC derivatives

    contracts should be cleared through central counterparties and traded

    on exchanges or electronic trading platforms, where appropriate, by the

    end of 2012; and (3) non-centrally cleared contracts should be subject

    to higher capital requirements.

    In June 2010, the G-20 leaders reaffirmed their commitment to

    achieve these goals. In its October 2010 report on Implementing OTC

    Derivatives Market Reforms (the October 2010 Report), the Financial

    Stability Board (FSB) made 21 recommendations addressing practical

    issues that authorities may encounter in implementing the G-20 leaders'

    commitments.\16\ The G-20 leaders again reaffirmed their commitments at

    the November 2011 Summit, including the end-2012 deadline. The FSB has

    issued three implementation progress reports. The most recent report

    urged jurisdictions to push forward aggressively to meet the G-20 end-

    2012 deadline in as many reform areas as possible. On mandatory

    clearing, the report observed that ``[j]urisdictions now have much of

    the information they requested in order to make informed decisions on

    the appropriate legislation and regulations to achieve the end-2012

    commitment to centrally clear all standardised OTC derivatives.'' \17\

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    \16\ See ``Implementing OTC Derivatives Market Reforms,''

    Financial Stability Board, Oct. 25, 2010, available at http://www.financialstabilityboard.org/publications/r_101025.pdf.

    \17\ OTC Derivatives Working Group, ``OTC Derivatives Market

    Reforms: Third Progress Report on Implementation,'' Financial

    Stability Board, June 15, 2012, available at http://www.financialstabilityboard.org/publications/r_120615.pdf.

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    Specifically with regard to required clearing, the Technical

    Committee of the International Organization of Securities Commissions

    (IOSCO) has published a final report, Requirements for Mandatory

    Clearing, outlining recommendations that regulators should follow to

    carry out the G-20's goal of requiring standardized swaps to be

    cleared.\18\

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    \18\ IOSCO's report, published in February 2012, is available at

    https://www.iosco.org/library/pubdocs/pdf/IOSCOPD374.pdf.

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    Nations around the world have been preparing for the move to

    mandatory clearing. For example, the Japanese Financial Services

    Authority (JFSA) has proposed requiring certain financial institutions

    to clear yen-denominated interest rate swaps that reference LIBOR and

    CDS that reference the Japanese iTraxx indices by the end of 2012.

    After that, the requirement will be expanded to other entities engaging

    in these swaps. In addition, the JFSA is considering expanding its

    mandatory clearing coverage to include U.S. dollar- and euro-

    denominated interest rate swaps, as well as yen-denominated interest

    rate swaps referencing TIBOR. The JFSA also will consider mandating

    single-name CDS referencing Japanese reference entities, and index and

    single-name CDS on North American and European reference entities.

    The Monetary Authority of Singapore (MAS) released a consultation

    paper addressing mandatory clearing on February 13, 2012. Based on a

    preliminary review MAS expects Singapore dollar interest rate swaps,

    U.S. dollar interest rate swaps, and Asian currency non-deliverable

    forwards to meet its proposed mandatory clearing criteria. Additional

    swaps will be considered for mandatory clearing via clearinghouse

    submission or upon the review of MAS.

    The Securities and Futures Commission and Hong Kong Monetary

    Authority jointly released a consultation paper addressing mandatory

    clearing on October 17, 2011. This consultation plan described a phased

    implementation approach where clearing requirements will initially

    cover standardized interest rate swaps and non-deliverable forwards.

    Hong Kong regulators have said they will consider extending the

    mandatory clearing requirements in subsequent phases. In July, the Hong

    Kong regulators published consultation conclusions and stated that the

    precise mandatory clearing obligations would be set out in subsidiary

    legislation which they will be consulting on in the fourth quarter of

    2012.

    On April 18, 2012, the Australian Council of Financial Regulators

    published a consultation on a number of OTC derivatives, including

    mandatory clearing. The Council of Financial Regulators is developing

    advice for the government which is expected to adopt legislation by

    end-2012.

    Finally, in the European Union, specific clearing determinations

    have yet to be made. However, the European Markets Infrastructure

    Regulation (EMIR) provides that contracts become subject to the

    clearing obligation through either a ``bottom up'' approach or a ``top

    down'' approach. The ``bottom up'' approach is where a national

    authority authorizes a central counterparty (CCP) to clear certain

    classes of OTC derivatives. The ``top down'' approach is where the

    European Securities and Markets Authority (ESMA) identifies classes of

    OTC derivatives which should be subject to the clearing obligation but

    for which no CCP is authorized to clear. Based on this framework, ESMA

    has the authority to make clearing determinations for classes of OTC

    derivative contracts.

    With the adoption of these final rules, the Commission is taking a

    critical step toward meeting the G-20 commitment and fulfilling the

    requirements of the Dodd-Frank Act. The Commission has consulted with

    authorities from around the globe to ensure that our efforts are as

    coordinated as possible.

    E. Overview of Section 2(h) and Sec. 39.5

    The Commission promulgated Sec. 39.5 of its regulations to

    implement procedural aspects of section 2(h) of the CEA.\19\ Regulation

    39.5 establishes procedures for: (1) Determining the eligibility of a

    DCO to clear swaps; (2) the submission of swaps by a DCO to the

    Commission for a clearing requirement determination; (3) Commission

    initiated reviews of swaps; and (4) the staying of a clearing

    requirement.

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    \19\ See 76 FR 44464 (July 26, 2011); 17 CFR 39.5.

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    The determinations and rules adopted in this release implement the

    clearing requirement under section 2(h) of the CEA for certain swaps

    and require that those swaps must be submitted for clearing to

    Commission-registered DCOs. Under section 2(h)(1)(A), ``it shall be

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

    such swap for clearing to a [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.'' \20\

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    \20\ See section 2(h) of the CEA. The Commission also may

    conduct a Commission-initiated review of swaps for required

    clearing. Section 2(h)(2)(A)(i) of the CEA requires the Commission

    on an ongoing basis to ``review each swap, or any group, category,

    type, or class of swaps to make a determination as to whether the

    swap, category, type or class of swaps should be required to be

    cleared.''

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    A clearing requirement determination may be initiated by a swap

    submission. Section 2(h)(2)(B)(i) of the CEA requires a DCO to ``submit

    to the Commission each swap, or any group, category, type or class of

    swaps that it plans to accept for clearing, and provide notice to its

    members of the submission.'' In addition under section 2(h)(2)(B)(ii)

    of the CEA, ``[a]ny swap or group, category, type, or class of swaps

    listed for clearing by a [DCO] as of the date of enactment shall be

    considered submitted to the Commission.''

    [[Page 74287]]

    F. Submissions from DCOs

    On February 1, 2012, Commission staff sent a letter requesting that

    DCOs submit all swaps that they were accepting for clearing as of that

    date, pursuant to Sec. 39.5 of the Commission's regulations.\21\ The

    Commission received submissions relating to CDS and interest rate swaps

    from: The International Derivatives Clearinghouse Group (IDCH) \22\ on

    February 17, 2012; the CME Group (CME), ICE Clear Credit, and ICE Clear

    Europe, each dated February 22, 2012; and a submission from

    LCH.Clearnet Limited (LCH) on February 24, 2012.\23\

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    \21\ The letter made it clear that DCOs should submit both pre-

    enactment swaps and swaps for which DCOs have initiated clearing

    since enactment of the Dodd-Frank Act. Pre-enactment swaps refer to

    those swaps that DCOs were accepting for clearing as of July 21,

    2010, the date of enactment of the Dodd-Frank Act.

    \22\ As discussed in detail below, IDCH has been purchased by

    LCH.Clearnet Group.

    \23\ Other swaps submissions were received from Kansas City

    Board of Trade (KCBT) and the Natural Gas Exchange (NGX). KCBT and

    NGX do not accept any CDS or interest rate swaps for clearing.

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    The clearing requirement determinations and rules adopted in this

    release cover certain CDS and interest rate swaps currently being

    cleared by a DCO. The Commission intends subsequently to consider other

    swaps submitted by DCOs, such as agricultural, energy, and equity

    indices.

    As stated in the NPRM, the decision to focus on CDS and interest

    rate swaps in the initial clearing requirement determinations is a

    function of both the market importance of these swaps and the fact that

    they already are widely cleared. In order to move the largest number of

    swaps to required clearing in its initial determinations, the

    Commission believes that it is prudent to focus on those swaps that

    have the highest market shares and, accordingly, the biggest market

    impact. Further, for these swaps there is already a blueprint for

    clearing and appropriate risk management. CDS and interest rate swaps

    fit these considerations and therefore are well suited for required

    clearing consideration.\24\

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    \24\ The Commission will consider all other swaps submitted

    under Sec. 39.5(b) as soon as possible after this determination is

    published. These other swaps include certain CDS that were submitted

    to the Commission after the initial February 2012 submissions

    discussed above. If the Commission determines that additional swaps

    should be required to be cleared, such determination likely will be

    proposed as a new class under Sec. 50.4.

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    Notably, market participants recommended that the Commission take

    this approach, and comments received on the NPRM supported this

    approach as well.\25\ In addition, interest rate swaps account for

    about $500 trillion of the $650 trillion global OTC swaps market, in

    notional dollars--the highest market share of any class of swaps.\26\

    LCH claims to clear about $302 trillion of those--meaning that, in

    notional terms, LCH clears approximately 60% of the interest rate swap

    market.\27\ While CDS indices do not have as prominent a market share

    as interest rate swaps, CDS indices are capable of having a sizeable

    market impact, as they did during the 2008 financial crisis. Overall,

    the CDS marketplace has almost $29 trillion in notional outstanding

    across both single and multi-name products.\28\ CDS on standardized

    indices accounts for about $10 trillion of the global OTC market in

    notional dollar amount outstanding.\29\ Since March 2009, the ICE Clear

    Credit and ICE Clear Europe have combined to clear over $30 trillion in

    gross notional for all CDS.\30\ Because of the market shares and market

    impacts of these swaps, and because these swaps are currently being

    cleared, the Commission decided to review CDS and interest rate swaps

    in its initial clearing requirement determinations. The Commission

    recognizes that while this is an appropriate basis for the initial

    determinations, swap clearing is likely to evolve and clearing

    requirement determinations made at later times may be based on a

    variety of other factors beyond the extent to which the swaps in

    question are already being cleared.

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    \25\ See, e.g., letters from the CME Group (CME), the Futures

    Industry Association (FIA), the Managed Funds Association (MFA), and

    Americans for Financial Reform (AFR).

    \26\ Bank of International Settlements (BIS) data, December

    2011, available at http://www.bis.org/statistics/otcder/dt1920a.pdf.

    \27\ Id.; LCH data.

    \28\ BIS data, December 2011, available at http://www.bis.org/statistics/otcder/dt1920a.pdf.

    \29\ Id.

    \30\ ICE Clear Credit data, as of the April 26, 2012 clearing

    cycle.

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    II. Comments on the Notice of Proposed Rulemaking

    The Commission received 29 comments during the 30-day public

    comment period following publication of the NPRM, and four additional

    comments after the comment period closed. The Commission considered

    each of these 33 comments in formulating the final regulations.\31\

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    \31\ Comment letters received in response to the NPRM may be

    found on the Commission's Web site at http://comments.cftc.gov/PublicComments/CommentList.aspx?id=1252.

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    The Chairman and Commissioners, as well as Commission staff,

    participated in numerous meetings with clearinghouses, market

    participants, trade associations, public interest groups, and other

    interested parties. In addition, the Commission has consulted with

    other U.S. financial regulators including: (i) The Securities and

    Exchange Commission (SEC); (ii) the Board of Governors of the Federal

    Reserve System; (iii) the Office of the Comptroller of the Currency;

    and (iv) the Federal Deposit Insurance Corporation (FDIC). Staff from

    each of these agencies has had the opportunity to provide oral and/or

    written comments to this adopting release, and the final regulations

    incorporate elements of the comments provided.

    The Commission is mindful of the benefits of harmonizing its

    regulatory framework with that of its counterparts in foreign

    countries. The Commission has therefore monitored global advisory,

    legislative, and regulatory proposals, and has consulted with foreign

    regulators in developing the final regulations.

    A. Overview of Comments Received

    None of the 33 comments received expressed outright opposition to

    the Commission's clearing requirement proposal.\32\ Indeed, 22 of the

    comment letters strongly supported the Commission's proposal and urged

    the Commission to finalize its proposal promptly.\33\ These comments

    also supported the Commission's analysis under the five-factor

    statutory test, and agreed with the Commission's conclusion that swaps

    within the four proposed classes of interest rate swaps and the two

    proposed classes of CDS were appropriate for required clearing.\34\ All

    three DCOs clearing the swaps subject to the final rules expressed

    strong support for the proposal and agreed with the overall approach

    taken by the Commission.\35\

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

    \32\ An unsigned comment submitted on September 4, 2012,

    questioned the need for additional regulation as a general matter.

    \33\ See letters from Futures Industry Association Principle

    Traders Group (FIA PTG), Arbor Research and Trading, LLC, R.J.

    O'Brien & Associates, Svenokur, LLC, Chris Barnard, CRT Capital

    Group (Robert Gorham), LLC, DRW Trading Group, Javelin, The Swaps

    and Derivatives Market Association (SDMA), Knight Capital Americas

    LLC, Bart Sokol (CRT Capital Group), Jefferies & Company, Inc.,

    MarketAxess, Eris Exchange, Coherence Capital Partners LLC, Citadel,

    Americans for Financial Reform (AFR), D.E. Shaw Group,

    AllianceBernstein, LCH.Clearnet Group Limited (LCH), CME Group Inc.

    (CME), and IntercontinentalExchange, Inc. (ICE).

    \34\ See, e.g., letter from Citadel (reviewing each of the five

    statutory factors and supporting the Commission's analysis).

    \35\ CME applauded the Commission's decision to require classes

    of swaps be cleared rather than take a product-by-product approach.

    CME also commended the decision not to propose classes of swaps on a

    DCO-by-DCO basis.

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

    However, a number of commenters requested that the Commission make

    specific modifications to the proposed

    [[Page 74288]]

    rules,\36\ and, in several instances, commenters requested

    clarification of various points.\37\ A number of commenters requested

    that the Commission delay implementation of the clearing requirement

    until certain milestones are met.\38\ Each of these comments is

    discussed in detail below.

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

    \36\ See, e.g., letter from ISDA (requesting changes to the

    delegation provisions of proposed Sec. 50.6).

    \37\ See, e.g., letter from The Financial Services Roundtable

    (FSR) (requesting that the Commission clarify the meaning of

    ``conditional notional amount'').

    \38\ See, e.g., letter from ISDA (requesting that no

    determination take effect until there is ``a further determination

    that a product has an adequate clearing history to support a finding

    of operational readiness to clear by DCOs and market

    participants''), and letter from Vanguard (requesting that the

    Commission delay mandatory clearing until new rules for segregation

    of customer funds and swap positions are fully operational and

    capable of being tested for three months).

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

    The Futures Industry Association (FIA) expressed concern about the

    30-day comment period providing sufficient time to comment on the

    proposal, and recommended that the Commission provide a longer comment

    period for future proposals.\39\ The Commission is cognizant of the

    importance of affording the public sufficient time to comment on

    important proposals. However, given the CEA's requirement that the

    Commission make its clearing requirement determinations within 90 days,

    in most instances, providing a 30-day comment period will be

    appropriate. In fact, some commenters stressed the importance of

    completing the determination process in an efficient manner. As R.J.

    O'Brien noted in its comment letter, implementing the clearing mandate

    as soon as possible ``will improve the financial industry's credibility

    and show the rest of the world we are serious about improving the

    financial safety of our markets.'' Providing for a longer comment

    period likely would impede the Commission's ability to meet the 90-day

    statutory deadline for completing the determination process.

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

    \39\ FIA specifically mentioned its inability to respond to

    questions asked in the NPRM with regard to competitiveness, which it

    viewed as important to the Commission's analysis of competitiveness

    under one of the five statutory factions. See Sections II.D and II.F

    below.

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

    Lastly, two commenters encouraged the Commission to issue proposed

    determinations for energy, agricultural, and equity swaps as soon as

    possible.\40\ As required under the CEA, the Commission will continue

    to review swap submissions received from DCOs for purposes of the

    clearing requirement in as timely a manner as possible.

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

    \40\ See letters from AFR and Chris Barnard.

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

    B. Generally Applicable Comments

    A number of comments are equally applicable to both the CDS and

    interest rate swap proposals. While most of these issues are discussed

    in Section III below, certain threshold comments are addressed at the

    outset.

    i. Submission of Swaps Required To Be Cleared and Failures to Clear

    CME sought clarification that market participants do not have to

    clear those swaps that fall within a class of swaps under Sec. 50.4,

    but for which no DCO provides clearing or for which the DCO provides

    clearing to only a limited number of market participants. Other

    commenters expressed similar concerns about not requiring clearing

    where no DCO offers customer clearing.\41\ Freddie Mac requested

    clarification regarding the legal status of a swap that is submitted

    for clearing to a DCO, but fails to clear.

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

    \41\ See Section II.D for a discussion of iTraxx and the

    availability of client clearing.

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

    The Commission confirms that if no DCO clears a swap that falls

    within a class of swaps under Sec. 50.4, then the clearing requirement

    does not apply to that swap. In essence, it is a two-step process to

    determine whether the clearing requirement applies to a particular

    swap. First, a market participant must determine whether its swap falls

    within one of the classes under Sec. 50.4. Then, if the swap falls

    within one of the classes, the market participant must determine if any

    of the eligible DCOs clear that swap. The second step requires market

    participants to determine if all the product specifications required

    under the DCO's rules are met. If no eligible DCO will accept the swap

    for clearing because there is a different product specification, then

    the swap is not required to be cleared. Market participants need not

    submit swaps to a DCO if they know that the DCO does not clear that

    particular swap.\42\

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

    \42\ The rule text of Sec. 50.2(a) has been modified to clarify

    this two-step process.

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

    In response to Freddie Mac's request for clarification, if

    counterparties submit their swap to a DCO for clearing and the swap

    fails to clear because it contains a term or terms that prevent any

    eligible DCO from clearing the swap, then the swap is not subject to

    the Commission's clearing requirement. On the other hand, if the swap

    fails to clear because one or both of the counterparties have not met

    the DCO's or their clearing members' credit requirements,\43\ then the

    swap remains subject to the clearing requirement and must be cleared as

    soon as technologically practicable after the counterparties learn of

    the credit issue. The Commission notes that section 739 of the Dodd-

    Frank Act amended section 22(a)(4)(B) of the CEA to provide that,

    regarding contract enforcement between two eligible counterparties,

    ``[n]o agreement, contract, or transaction between eligible contract

    participants or persons reasonably believed to be eligible contract

    participants shall be void, voidable, or unenforceable * * * under this

    section or any other provision of Federal or State law, based solely on

    the failure of the agreement, contract, or transaction * * * to be

    cleared in accordance with section 2(h)(1).'' Accordingly, a swap that

    fails to clear because of credit issues may not be voided by either

    eligible counterparty solely for the failure of the swap to be cleared

    in accordance with section 2(h)(1), but the basis for the failure to

    clear must be addressed by the counterparties and they must promptly

    resubmit the swap for clearing.

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

    \43\ It is the Commission's understanding that clearing failures

    generally arise under two circumstances: (1) Failure of the swap to

    meet the product specifications required by the DCO; or (2) a credit

    issue with one or both of the counterparties to the swap. Generally

    speaking, identification of a product specification problem can be

    identified extremely quickly.

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

    With regard to clearing that is not available to all market

    participants, the Commission will not require a swap to be cleared

    unless clearing is generally available to all types of market

    participants.\44\

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

    \44\ See Section II.D for a discussion of iTraxx and the

    availability of client clearing.

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

    ii. Adequacy of DCO Clearing History and Commission Review

    ISDA raised a general issue regarding whether the clearing

    requirement determination for CDS and interest rate swaps properly

    differentiates between swaps that a DCO currently clears and those that

    are not currently cleared by a DCO. ISDA expressed concern about

    delegating to the Director of the Division of Clearing and Risk the

    authority to determine whether newly-cleared swaps fall within a

    previously-established class. ISDA's specific comments and

    recommendations are discussed, and in part adopted, in Section III

    below. However, ISDA's general recommendation is that the Commission

    not impose a clearing requirement until there is ``a further

    determination that a product has an adequate clearing history to

    support a finding of operational readiness to clear by DCOs and market

    participants.'' Specifically, ISDA requests that each product have been

    actually cleared by a DCO and exhibit

    [[Page 74289]]

    non-zero open interest (for both inter-dealer and customer clearing) on

    each day during a six-month period prior to the effective date of the

    clearing requirement determination.

    In contrast with ISDA's comments, the three DCOs eligible to clear

    swaps within the classes under proposed Sec. 50.4 praised the

    Commission for taking the class-based approach rather than a product-

    by-product approach.\45\ In addition, CME and ICE both endorsed the

    Commission's decision not to limit applicability of the clearing

    requirement to individual DCOs.

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

    \45\ Many other commenters also agreed with this approach. See,

    e.g., TriOptima and Citadel.

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

    The Commission observes that ISDA's recommendation that each DCO

    demonstrate non-zero open interest for six months may be inconsistent

    with section 2(h)(2) of the CEA, which requires each DCO to submit to

    the Commission all swaps that ``it plans to accept for clearing.'' The

    use of the phrase ``plans to accept'' indicates that Congress intended

    for the Commission to review swap submissions prior to a DCO's

    commencing clearing operations for those swaps. Under these

    circumstances, the DCO would not be able to demonstrate open interest.

    In addition, adopting ISDA's suggestion could pose a significant

    deterrent to competition among DCOs insofar as DCOs seeking to offer

    swaps for required clearing would have to wait until they attract open

    interest and retain it for six months before they would be on a level

    playing field with incumbent DCOs.

    The Commission believes that it can address ISDA's concerns about

    DCO product expansion and risk management through its ongoing

    supervision and risk surveillance programs.\46\ In addition, under

    Sec. 39.5(a)(1) the Commission can review the presumption of

    eligibility for any DCO offering new swaps falling into a class that it

    is already clearing, and under Sec. 39.5(a)(2), the Commission must

    review the eligibility of any DCO that wishes to clear a swap that is

    not within a class already being cleared by that DCO.\47\ The many

    benefits of a class-based approach are discussed with regard to both

    CDS and interest rate swaps below.

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

    \46\ See discussion of the Commission's DCO examination and risk

    surveillance programs in the NPRM, 77 FR at 47173-74.

    \47\ In its comment letter, Freddie Mac questioned how the

    Commission would review a proposal from a DCO to clear swaps that

    are required to be cleared under Sec. 50.4. In addition to its

    general authority to ensure compliance with the core principles, the

    Commission has authority to review a DCO's eligibility to clear

    swaps subject to a clearing requirement at any time under Sec.

    39.5(a).

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

    iii. Customer Segregation for Swaps

    Under section 2(h)(2)(D)(ii)(V) of the CEA, in making a clearing

    requirement determination, the Commission must take into account the

    existence of reasonable legal certainty in the event of the insolvency

    of the relevant DCO or one or more of its clearing members with regard

    to the treatment of customer and swap counterparty positions, funds,

    and property.\48\ Several commenters raised general concerns about

    customer segregation for cleared swaps.

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

    \48\ This factor is discussed further in Sections II.D and II.F

    below.

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

    Vanguard recommended that the Commission should not implement

    mandatory clearing for any swaps until the Commission's final swap

    customer segregation rules under the legally segregated, operationally

    commingled (LSOC) model are fully operational and capable of being

    tested for at least three months prior to mandatory clearing.

    The Securities Industry and Financial Markets Association's Asset

    Management Group (SIFMA AMG) expressed similar concerns about

    unresolved issues concerning LSOC rules and the operational readiness

    of futures commission merchants (FCMs) and DCOs to comply with those

    rules. SIFMA AMG requested clarification of certain matters related to

    the LSOC model and requests that the Commission issue new rules to

    require FCMs to issue reports as frequently as technologically

    feasible, require DCOs to take all steps necessary to ensure reported

    information is accurate, and require DCOs to complete margin

    calculations as frequently as technologically feasible. SIFMA AMG

    recommended that the Commission implement a three-month testing period

    for LSOC rule implementation after the Commission and the market have

    completed their ongoing rule clarification efforts.

    Both Vanguard and SIFMA AMG requested that all customer margin,

    including excess margin above the amount required by the DCO, be

    protected from fellow-customer risk.

    ISDA noted that the commodity broker liquidation provisions under

    the U.S. bankruptcy code and the Commission's Part 190 regulations have

    never been applied to a DCO. In addition, ISDA stated that the Orderly

    Liquidation Authority under Title II of the Dodd-Frank Act has never

    been applied to any entity. For clearinghouses located in the United

    Kingdom, ISDA observed that the Commission is relying on legal

    opinions, noting the lack of practical experience with DCO insolvency

    in the United Kingdom. In light of the absence of practical experience

    with DCO insolvency, ISDA recommended that the Commission study the

    issue with the goal of documenting uncertainties and proposing

    solutions.

    In response to these comments, the Commission observes that the

    compliance date for LSOC was November 13, 2012. The Commission worked

    with market participants to ensure that compliance by that date was

    accomplished \49\ For reasons discussed below, the compliance schedule

    for this first clearing requirement will commence on March 11,

    2013.\50\ Accordingly, as requested by SIFMA AMG, parties in the first

    compliance category \51\ will have more than 3 months of experience

    under the LSOC rules prior to required clearing taking effect. Those

    parties in the second and third categories will have over 6 and 9

    months of testing prior to required clearing, respectively.\52\ During

    this time, the Commission will continue to work with market

    participants to resolve matters that require clarification regarding

    LSOC.

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

    \49\ The Commission notes that under Sec. 22.13 a DCO may,

    subject to certain conditions contained therein, accept cleared

    swaps customer collateral in excess of the amount required by the

    DCO. Acceptance of this excess collateral is entirely at the

    election of the DCO. Thus, the timing of resolution of any issues

    that may arise as a result of the optional acceptance of such

    collateral is separate and apart from the November 13th compliance

    date for implementation of the regulatory requirements set forth in

    the Part 22 rules.

    \50\ See Section IV for a complete discussion of compliance

    dates.

    \51\ Under the compliance schedule for required clearing, Sec.

    50.25, Category 1 Entities are swap dealers, security-based swap

    dealers, major swap participants, major security-based swap

    participants, and active funds. This category must come in

    compliance with the clearing requirement by March 11, 2013.

    \52\ Category 2 Entities are commodity pools, private funds, and

    persons predominantly engaged in activities that are in the business

    of banking, or in activities that are financial in nature according

    to section 4(k) of the Bank Holding Company Act, provided that such

    participants are not third-party subaccounts. Category 2 Entities

    must comply with the clearing requirement by June 10, 2013, for all

    swaps entered into on or after that date. Category 3 Entities are

    all other counterparties not electing an exception for a swap under

    section 2(h)(7), including third-party subaccounts and ERISA plans.

    Category 3 Entities must comply with the clearing requirement by

    September 9, 2013, for all swaps entered into on or after that date.

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

    Moreover, in response to requests for enhanced LSOC protections,

    the Commission understands that the industry is working toward a

    February implementation date for DCO rules regarding acceptance of

    excess collateral. The Commission recognizes

    [[Page 74290]]

    that this issue is of particular concern to third-party subaccounts

    that will be required to begin clearing swaps executed on or after

    September 9, 2013. Given the industry's February goal, the Commission

    believes that issues regarding the acceptance of excess collateral will

    be resolved before the beginning of September.

    In response to ISDA's request that the Commission conduct a study

    regarding insolvencies of DCOs and clearing members, the Commission

    observes that its staff have actively participated in, and taken

    leading roles in, a number of international efforts related to

    clearinghouse and clearing member insolvency, including an important

    cross-border study regarding insolvency regimes.\53\ In addition, the

    Commission and other U.S. authorities, including the FDIC, have been

    engaged, and continue to engage, in regulatory coordination and

    cooperation, related to insolvencies under Title II.

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

    \53\ See, e.g., ``Survey of Regimes for the Protection,

    Distribution, and/or Transfer of Client Assets'' (Technical

    Committee of the International Organization of Securities

    Commissions, March, 2011); ``Consultative Report on the Recovery and

    Resolution of Financial Market Infrastructures'' (Committee on

    Payment and Settlement Systems and the International Organization of

    Securities Commissions, July, 2012). Staff are also actively

    participating in further efforts in these contexts by the

    International Organization of Securities Commissions and the

    Resolution Steering Group of the Financial Stability Board.

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

    C. Credit Default Swaps

    i. DCO Submissions

    Pursuant to Sec. 39.5, the Commission received filings with

    respect to CDS cleared by CME, ICE Clear Credit, and ICE Clear Europe,

    each a registered DCO.\54\ The CME and ICE Clear Credit submissions

    included the CDS that each clears on North American corporate indices,

    covering various tenors and series.\55\ The ICE Clear Europe submission

    included, among other swaps, the CDS contracts on European corporate

    indices that they clear, with information on each of the different

    tenors and series. Each of the submissions contained information

    relating to the five statutory factors set forth in section 2(h)(2)(D)

    of the CEA and other information required under Sec. 39.5.

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

    \54\ In the case of CME and ICE Clear Europe, the submissions

    also included other swaps beyond those in the CDS and interest rate

    swap categories. These submissions, including a description of the

    specific swaps covered, are available on the Commission's Web site

    at: http://sirt.cftc.gov/sirt/sirt.aspx?Topic=ClearingOrganizationProducts.

    \55\ The Commission has received subsequent submissions from CME

    and ICE Clear Credit relating to CDS. In particular, CME submitted a

    filing with regard to the current series of each of the CDX.NA.IG

    and CDX.NA.HY (Series 19). ICE Clear Credit made filings with regard

    to the clearing of the 3-year tenor of the CDX.HY Series 15 and the

    clearing of the CDX.EM indices. With the exception of the CDX.EM

    submission, upon which the Commission has not yet begun the

    determination process, the substance of each of the other

    submissions was addressed in both the proposed clearing

    determination and the final clearing determination set forth herein.

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

    CME, ICE Clear Credit, and ICE Clear Europe provided notice of

    their Sec. 39.5 swap submissions to their members by posting their

    submissions on their respective Web sites.\56\ The submissions also are

    published on the Commission's Web site.\57\

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

    \56\ Available at http://www.cmegroup.com/market-regulation/rule-filings.html and https://www.theice.com/publicdocs/regulatory_filings/ICEClearCredit_022212.pdf. ICE Clear Europe did not provide

    a link to its relevant Web page.

    \57\ See http://sirt.cftc.gov/sirt/sirt.aspx?Topic=ClearingOrganizationProducts.

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

    Regulation 39.5(b)(3)(viii) also directs a DCO's submission to

    include a summary of any views on the submission expressed by members.

    CME's submission did not address this. In their submissions, ICE Clear

    Credit and ICE Clear Europe stated that neither has solicited nor

    received any comments to date and will notify the Commission of any

    such comments. The Commission did not receive any additional feedback

    from DCOs beyond the information included in comment letters posted on

    the Commission's Web site.

    The CDS cleared by CME, ICE Clear Credit, and ICE Clear Europe that

    were submitted to the Commission are standardized contracts providing

    credit protection on an untranched basis, meaning that settlement is

    not limited to a specific range of losses upon the occurrence of credit

    events among the reference entities included within an index. Besides

    single-name CDS, untranched CDS on indices are the only type of CDS

    being cleared by these DCOs. Other swaps, such as credit index

    tranches, options, and first- or Nth-to-default baskets on these

    indices, are not currently cleared.

    CME and ICE Clear Credit each clear CDS on indices administered by

    Markit. The Markit CDX family of indices is the standard North American

    credit default swap family of indices, with the primary corporate

    indices being the CDX North American Investment Grade (consisting of

    125 investment grade corporate reference entities) (CDX.NA.IG) and the

    CDX North American High Yield (consisting of 100 high yield corporate

    reference entities) (CDX.NA.HY). The standard currency for CDS on these

    indices is the U.S. dollar.

    CME offers the CDX.NA.IG at the 3-, 5-, 7- and 10-year tenors for

    Series 9 and each subsequent series, to the extent that those contracts

    that have not reached their termination date.\58\ CME also offers the

    CDX.NA.HY at the 5-year tenor for Series 11, and each subsequent

    series. ICE Clear Credit offers the CDX.NA.IG Series 8, and each

    subsequent series of that index that is still outstanding, at the 3-,

    5-, 7- and 10-year tenors.\59\ ICE Clear Credit also offers the

    CDX.NA.IG. Series 8 to Series 10, at the 7-year tenor. For the high

    yield index, ICE Clear Credit clears all series from the current series

    through the CDX.NA.HY Series 9 at the 5-year tenor.\60\ Each of these

    cleared CDX.NA contracts is denominated in U.S. dollars.

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

    \58\ As administrator of these indices, Markit reviews the

    composition of underlying reference entities in the indices every

    six months. Once Markit establishes the constituents to be included

    within the indices, a new series of the respective index is created.

    The most recent series is identified as the ``on-the-run'' series,

    with all older series being identified as ``off-the-run.''

    Additionally, each time one of the reference entities within an

    index suffers a credit event, a new version of an existing series of

    the index is created. In addition to the series and version

    variations that may exist on the index, the parties can choose the

    tenor of the CDS on a given index. While the 5-year tenor is the

    most common, and therefore most liquid, other standard tenors may

    include the 1-, 2-, 3-, 7-, and 10-year.

    \59\ ICE Clear Credit began clearing the 3- and 7-year tenors on

    the CDX.NA.IG after its initial Sec. 39.5 submission of February

    22, 2012.

    \60\ ICE Clear Credit also made a Sec. 39.5 submission with

    regard to the 3-year tenor of CDX.NA.HY, Series 15. The Commission

    is not including this contract within the clearing determination at

    this time.

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

    ICE Clear Europe made a submission covering the index CDS that it

    clears. As with CME's and ICE Clear Credit's submissions, the contracts

    that ICE Clear Europe clears are based on Markit indices with corporate

    reference entities, though in this case, the entities are based in

    Europe. ICE Clear Europe clears euro-denominated contracts referencing

    the three primary indices: iTraxx Europe (covering 125 European

    investment grade corporate reference entities); the iTraxx Europe

    Crossover (covering 50 European high yield reference entities); and the

    iTraxx Europe High Volatility (a 30-entity subset of the European

    investment grade index).

    For the iTraxx Europe and Crossover, ICE Clear Europe clears

    outstanding contracts in the Series 7 and 8, respectively, through the

    current series. For the High Volatility index, ICE Clear Europe clears

    outstanding contracts in the Series 9 through the current series. In

    terms of tenors, ICE Clear Europe clears the 5-year tenor for all

    swaps, as well as the 10-year tenor for the iTraxx Europe index.

    [[Page 74291]]

    Based upon those portions of the CME, ICE Clear Credit, and ICE

    Clear Europe swap submissions relating to the CDS contracts discussed

    above, as well as the analysis conducted by the Commission pursuant to

    Sec. 39.5(b) and set forth below, the Commission has reviewed the

    following classes of swaps for purposes of the clearing requirement

    determination.

    ii. Identification of CDS Specifications

    Under Sec. 39.5, the decision of the Commission to require that a

    group, category, type, or class of swaps be required to be cleared is

    informed by a number of factors. As an initial matter, the Commission

    has looked to the DCOs' submissions with regard to the swaps they

    currently clear. After analyzing the key attributes of the swaps

    submitted, the Commission proposed establishing two classes of CDS to

    be subject to the clearing requirement and, pursuant to this final

    rulemaking, is finalizing those classes as proposed. The first class is

    based on the untranched indices covering North American corporate

    credits, the CDX.NA.IG and the CDX.NA.HY. The second class is based on

    the untranched indices covering European corporate credits, the iTraxx

    Europe, the iTraxx Europe Crossover, and the iTraxx Europe High

    Volatility. Given the different markets that the CDS indices cover, the

    different standard currencies, and other logistical differences in how

    the CDS markets and documentation work, the Commission believes this is

    an appropriate basis for creating these two classes.

    The following table sets forth the specific specifications of each

    class:

    Table 1

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

    North American Untranched CDS

    Specification Indices Class

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

    1. Reference Entities............. Corporate.

    2. Region......................... North America.

    3. Indices........................ CDX.NA.IG.

    CDX.NA.HY.

    4. Tenor.......................... CDX.NA.IG: 3Y, 5Y, 7Y, 10Y.

    CDX.NA.HY: 5Y.

    5. Applicable Series.............. CDX.NA.IG 3Y: Series 15 and all

    subsequent Series, up to and

    including the current Series.

    CDX.NA.IG 5Y: Series 11 and all

    subsequent Series, up to and

    including the current Series.

    CDX.NA.IG 7Y: Series 8 and all

    subsequent Series, up to and

    including the current Series.

    CDX.NA.IG 10Y: Series 8 and all

    subsequent Series, up to and

    including the current Series.

    CDX.NA.HY 5Y: Series 11 and all

    subsequent Series, up to and

    including the current Series.

    6. Tranched....................... No.

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

    Specification European Untranched CDS Indices

    Class

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

    1. Reference Entities............. Corporate.

    2. Region......................... Europe.

    3. Indices........................ iTraxx Europe.

    iTraxx Europe Crossover.

    iTraxx Europe HiVol.

    4. Tenor.......................... iTraxx Europe: 5Y, 10Y.

    iTraxx Europe Crossover: 5Y.

    iTraxx Europe HiVol: 5Y.

    5. Applicable Series.............. iTraxx Europe 5Y: Series 10 and all

    subsequent Series, up to and

    including the current Series.

    iTraxx Europe 10Y: Series 7 and all

    subsequent Series, up to and

    including the current Series.

    iTraxx Europe Crossover 5Y: Series

    10 and all subsequent Series, up to

    and including the current Series.

    iTraxx Europe HiVol 5Y: Series 10

    and all subsequent Series, up to

    and including the current Series.

    6. Tranched....................... No.

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

    The Commission believes that indices based on other types of

    entities would be viewed as a separate class and would be subject to a

    separate determination by the Commission. For example, given the

    differences that exist with regard to volumes and risk management of

    indices based on sovereign issuers, as opposed to corporate issuers, it

    is likely that such CDS would represent their own class of swaps.

    Similarly, to the extent indices from other regions were submitted by a

    DCO, it is likely that the Commission would take the view that they are

    part of their own class of swaps as well.

    The Commission believes it appropriate to define the classes of

    swaps as untranched CDS contracts referencing Markit's broad-based

    corporate indices. These corporate indices have the most net notional

    outstanding, the most trading volumes, and the best available pricing.

    The risk management frameworks for the corporate index swaps are the

    most well-established, and have the most available data in terms of CDS

    spreads and corporate default studies for analysis of the underlying

    constituents of the indices. Agreements based on these indices also are

    widely accepted and use standardized terms.\61\

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

    \61\ To the extent other vendors successfully develop similar

    indices, the Commission would conduct the analysis required by Sec.

    39.5, either on its own initiative or based on a DCO submission. If

    based on that analysis the Commission issued a clearing requirement

    determination, it is likely that such indices would be considered to

    be part of an existing class of CDS that are required to be cleared.

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

    Both of the CDS classes presented herein assume that the relevant

    CDS agreement will use the standardized terms established by Markit/

    ISDA with regard to the specific index and be denominated in a currency

    that is accepted for clearing by DCOs. To the extent that a CDS

    agreement on an index listed within the classification is not accepted

    for clearing by any DCO because it uses non-standard terms or is

    denominated in a currency that makes it ineligible for clearing, that

    CDS is not subject to the requirement that it be cleared,

    notwithstanding that the CDS is based on such index.

    Also as proposed, this clearing determination is limited to only

    those series of the referenced indices that are currently being

    cleared.\62\ Further, to the

    [[Page 74292]]

    extent that any swap on a CDS index is of a tenor such that it is

    scheduled to terminate prior to July 1, 2013, such a swap is not part

    of this clearing determination. Given the implementation periods

    provided for under Sec. 50.25, discussed below in Section IV, the

    Commission does not want to create a situation where certain market

    participants will be required to clear a contract based upon their

    status under the implementation provisions, but other parties will

    never be required to clear that same contract before its scheduled

    termination.

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

    \62\ As discussed in further detail below, the clearing

    requirement does not require existing swaps in the older series to

    be cleared. The requirement is prospective, only requiring newly

    executed swaps in these older series to be cleared.

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

    Similarly, the classes only include those tenors of contracts which

    are currently being cleared. AFR commented that both the 1- and 2-year

    tenors of the CDX.NA.IG should be included in the clearing requirement

    determination, citing concerns that if market participants shift to

    these shorter tenors, that shift would undermine a clearing requirement

    that included only longer tenors. Because no DCO clears the 1- or 2-

    year tenor of CDX.NA.IG, the Commission has decided to include within

    today's clearing determination only those tenors of the CDX.NA.IG that

    were proposed. The Commission will monitor the market's use of shorter

    tenors. To the extent that the market generates significant volumes of

    such shorter tenors of CDX.NA.IG, the Commission would expect that one

    or more DCOs will begin offering those tenors for clearing.

    If no DCO were to offer these swaps for clearing, the Commission

    has the authority to commence a Commission-initiated review under

    section 2(h)(2)(A)(i) of the CEA to determine whether the swaps should

    be required to be cleared. Under section 2(h)(4), to the extent that

    the Commission finds that a particular swap or group, category, type,

    or class of swaps would otherwise be subject to mandatory clearing but

    no DCO has listed the swap, group, category, type, or class of swaps

    for clearing, the Commission shall (i) investigate the relevant facts

    and circumstances; (ii) issue a public report containing the results of

    the investigation within 30 days; and (iii) take such actions as the

    Commissions determines to be necessary and in the public interest,

    which may include requiring the retaining of adequate margin or capital

    by parties to the swap.

    The clearing requirement determination will also cover each new

    series of these indices that is created every six months. The

    Commission believes this will provide certainty to the market, as

    opposed to awaiting a new determination for each new series.\63\

    Recognizing that there may be changes to indices and their

    constituents,\64\ the Commission will analyze each new series to ensure

    that the indices should continue to be included within the existing

    class of swaps subject to a clearing determination. To the extent that

    the new series raises issues, such as a DCO's ability to risk manage

    the contracts, the Commission can issue a stay of the clearing

    requirement for that series under Sec. 39.5(d). No commenter raised

    any questions regarding new series.

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

    \63\ The timing of announcement of index constituents would make

    it impossible for the Commission to analyze the index and issue a

    clearing determination on the roll date, given the timeframes

    imposed on the Commission by Sec. 39.5.

    \64\ See Financial Times, ``CDS Market--Markit's Weird

    Selection,'' September 27, 2012, discussing the inclusion of

    constituents (CIT, Calpine, and Charter Communications) in the

    latest series of the CDX.NA.HY that do not have actively traded CDS

    contracts.

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

    As proposed, the Commission has decided that the classes be limited

    to untranched CDS on the aforementioned indices. With these untranched

    CDS, the contract covers the entire index loss distribution of the

    index, and settlement is not linked to a specified number of defaults.

    Tranched swaps, first- or ``Nth'' to-default, options, or any other

    product variations on these indices are excluded from these classes.

    These other swaps based on the indices, such as tranches, have very

    different profiles in terms of the Sec. 39.5 analysis. Besides very

    different notional and trading volumes, the risk management processes

    and operations may be significantly different. The Commission believes

    it appropriate to exclude tranched swaps, and other variations on the

    indices, from the classes of swaps set forth herein. Such swaps, if

    accepted by DCOs and submitted for Commission review, likely would be

    viewed as a separate class or as separate classes.

    AFR notes that market participants can use tranched CDS on the

    indices to replicate contracts and portfolios that would otherwise be

    subject to a clearing requirement. The Commission recognizes this

    concern and will continue to monitor activity in tranched CDS indices,

    as well as how the development of risk management processes at DCOs

    could allow for the clearing of those products. Today's clearing

    determination does not foreclose the possibility that tranched products

    may be subject to another clearing determination in the future.

    D. Determination Analysis for Credit Default Swaps

    Section 2(h)(2)(D)(i) of the CEA requires the Commission to review

    whether a swap submission under section 2(h)(2)(B) is consistent with

    section 5b(c)(2) of the CEA (DCO core principles). Section

    2(h)(2)(D)(ii) of the CEA also requires the Commission to consider five

    factors in a determination based on swap submission: (1) The existence

    of significant outstanding notional exposures, trading liquidity, and

    adequate pricing data; (2) the availability of rule framework,

    capacity, operational expertise and resources, and credit support

    infrastructure to clear the contract on terms that are consistent with

    the material terms and trading conventions on which the contract is

    then traded; (3) the effect on the mitigation of systemic risk, taking

    into account the size of the market for such contract and the resources

    of the DCO available to clear the contract; (4) the effect on

    competition, including appropriate fees and charges applied to

    clearing; and (5) the existence of reasonable legal certainty in the

    event of the insolvency of the relevant DCO or one or more of its

    clearing members with regard to the treatment of customer and swap

    counterparty positions, funds, and property.\65\

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

    \65\ ISDA highlighted the possibility that a CDS index subject

    to a clearing requirement determination could undergo such

    significant changes to its underlying constituents during its

    lifecycle that such an index would no longer be considered a broad-

    based index, subject to the Commission's jurisdiction. The

    Commission notes that the indices subject to the clearing

    requirement determinations discussed herein contain a minimum of 30

    constituents of equal weighting, limiting the likelihood of such

    scenario. Nonetheless, in the event of such a scenario, the

    Commission could review the determination, and if appropriate, stay

    the determination under Sec. 39.5(d) with regard to the index and/

    or series so impacted.

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

    i. Consistency With Core Principles for Derivatives Clearing

    Organizations

    Section 2(h)(2)(D)(i) of the CEA requires the Commission to review

    whether a submission is consistent with the core principles for DCOs.

    Each of the DCO submissions relating to CDS provided data to support

    the Commission's analysis of the five factors under section 2(h)(2)(D)

    of the CEA. The Commission also was able to call upon independent

    analysis conducted with regard to the CDS market, as well as its

    knowledge and reviews of the registered DCOs' operations and risk

    management processes, covering topics such as product selection

    criteria, pricing sources, participant eligibility, and other relevant

    rules. The discussion of all of these factors is set forth below.

    [[Page 74293]]

    The swaps submitted by CME, ICE Clear Credit, and ICE Clear Europe

    pursuant to Sec. 39.5(b) are currently being cleared by those

    organizations. As discussed above, the risk management, rules, and

    operations used by each DCO to clear these swaps are subject to review

    by the Commission's risk management, legal, and examinations staff on

    an on-going basis.

    Additionally, each of the DCOs has established procedures to review

    any new swaps it may consider offering for clearing. Before the indices

    referenced herein were accepted for clearing by any of the DCOs, they

    were subject to review by the risk management functions of those

    organizations. Such analysis generally focuses on the DCO's ability to

    risk manage positions in the prospective swaps and on any specific

    operational issues that may arise from the clearing of such swaps. In

    the case of the former, this involves ensuring that adequate pricing

    data is available, both historically and on a ``going forward'' basis,

    such that a margining methodology could be established, back-tested,

    and used on an on-going basis. Operational issues may include analysis

    of additional contract terms for new swaps that may require different

    settlement procedures. Each of the contracts submitted by CME, ICE

    Clear Credit, and ICE Clear Europe and discussed herein has undergone

    an internal review process by the respective DCO and found to be within

    their product eligibility standards.

    In their submissions, CME and ICE Clear Credit enclosed their risk

    management procedures. In its submission, ICE Clear Europe references

    its risk management procedures, which it had previously submitted to

    the Commission in connection with its application to register as a DCO.

    As part of its risk management and examination functions, the

    Commission reviews each DCO's risk management procedures, including its

    margining methodologies.

    ICE Clear Credit uses a multi-factor model to margin the CDX.NA.IG

    and CDX.NA.HY indices, as well as the single-name CDS it clears. The

    margining methodology is designed to capture the risk of movements in

    credit spreads, liquidation costs, jump-to-default risk for those names

    on which credit protection has been sold, large position concentration

    risks, interest rate sensitivity, and basis risk associated with

    offsetting index derived single names and opposite ``outright'' single

    names. These factors are similarly used by ICE Clear Europe to

    calculate the margining requirements for their iTraxx swap listings and

    the underlying single-name constituents.

    CME's CDS model also weighs a number of factors to calculate the

    initial margin for a portfolio of CDS positions. These include macro-

    economic risk factors, such as movements associated with systematic

    risk resulting in large shifts in credit spreads across a portfolio,

    shifts in credit spreads based on tenors, and changes in relative

    spreads between investment grade and high yield spreads. Additional

    factors include specific sector risks, the idiosyncratic risk of

    extreme moves in particular reference entities, and the liquidity risk

    associated with unwinding the portfolio. In all cases, the

    methodologies are designed to protect against any 5-day move in the

    value of the given CDS portfolio, with a 99% confidence level.

    In addition to initial margin, each of the DCOs collects variation

    margin on a daily basis to capture changes in the mark-to-market value

    of the positions. To do this, the DCOs calculate end-of-day settlement

    prices using clearing members' price submissions for cleared swaps.

    Each of the DCOs maintains processes for ensuring the quality of

    clearing member price submissions, including the ability to compel

    trades at quoted prices on a random basis and to enforce fines on

    incomplete or incorrect submissions. ICE Clear Credit and ICE Clear

    Europe also use Markit services for CDX and iTraxx price submissions.

    CME uses other third-party data providers for pricing support as

    necessary on its cleared CDS products.

    As part of their rule frameworks, each of these three DCOs also

    maintains participant eligibility requirements. On April 20, 2012, CME

    filed its amended rule concerning CDS Clearing Member Obligations and

    Qualifications (Rule 8H04). Pursuant to the amended rule, published to

    comply with Commission Regulation 39.12(a)(2), a CDS clearing member

    would have to maintain at least $50 million of capital. The amended

    rule would also require a CDS clearing member's minimum capital

    requirement to be ``scalable'' to the risks it poses. Furthermore, CME

    already has client clearing available for its CDS index contracts.

    Similarly, on March 23, 2012, ICE Clear Credit filed its amended

    Rule 201(b) to incorporate the $50 million minimum capital requirement

    for clearing members. ICE Clear Europe has adopted similar rules to

    comply with Sec. 39.12(a)(2). ICE Clear Credit also has client

    clearing available for its CDX index contracts.

    In addition to the CDS indices discussed above, ICE Clear Credit

    and ICE Clear Europe offer single-name CDS for clearing.\66\ As part of

    their margining methodology, they are seeking approval to offer

    portfolio margining for the single-name CDS and the CDS indices co-

    mingled as a single portfolio.\67\ Given that the single-name reference

    entities will likely also be constituents of a given index within a

    portfolio, the Commission generally believes that such portfolio

    margining initiatives are consistent with the sound risk management

    policies for DCOs that are required under Sec. 39.13(g)(4). Moreover,

    DCOs such as ICE Clear Credit already use margining methodologies that

    provide for appropriate portfolio margining treatment with regard to

    clearing members' proprietary positions.\68\ The Commission is

    committed to working toward establishing similar portfolio margining

    programs for DCOs clearing customer positions in CDS indices and

    single-name CDS.\69\ Specifically, the Commission anticipates

    addressing ICE's portfolio margining petitions for CDS in the near

    term.

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

    \66\ Such single-name CDS are defined as ``security-based

    swaps'' under section 721(a) of the Dodd-Frank Act.

    \67\ See ICE Clear Credit's petitions to the Commission and SEC,

    dated October 4, 2011. The petition to the Commission is available

    at http://www.cftc.gov/stellent/groups/public/@rulesandproducts/documents/ifdocs/iceclearcredit100411public.pdf. See also ICE Clear

    Europe's petition available at http://www.cftc.gov/stellent/groups/public/@requestsandactions/documents/ifdocs/icecleareurope4dfrequest.pdf.

    \68\ See ICE Clear Credit's certification to the Commission,

    dated as of November 25, 2011. The certification is available at

    http://www.cftc.gov/stellent/groups/public/@rulesandproducts/documents/ifdocs/rul112511icecc001.pdf.

    \69\ A discussion of comments concerning portfolio margining is

    included below.

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

    Based upon the Commission's on-going reviews of DCOs' risk

    management frameworks and clearing rules, and its annual examinations

    of the DCOs, the Commission believes that the submissions of CME, ICE

    Clear Credit, and ICE Clear Europe are consistent with section 5b(c)(2)

    of the CEA and the related Commission regulations. In analyzing the CDS

    products submissions discussed herein, the Commission does not believe

    that a clearing determination with regard to the specified CDS products

    would be inconsistent with CME, ICE Clear Credit, or ICE Clear Europe's

    continued ability to maintain such compliance with the DCO core

    principles set forth in Part 39 of the Commission's regulations.

    [[Page 74294]]

    ii. Consideration of the Five Statutory Factors for Clearing

    Requirement Determinations

    a. Outstanding Notional Exposures, Trading Liquidity, and Adequate

    Pricing Data

    Section 2(h)(2)(D)(ii)(I) of the CEA requires the Commission to

    take into account the existence of outstanding notional exposures,

    trading liquidity, and adequate pricing data.

    The most recent BIS study \70\ found that, as of December 2011, the

    size of the overall CDS marketplace exceeded $28.6 trillion in notional

    amount outstanding. Of that amount, $11.8 trillion was in multi-name

    CDS agreements. Within this sub-category of CDS, CDS on indices

    accounted for more than 89% of the total notional amount outstanding,

    with over $10 trillion in notional outstanding. Overall, CDS on index

    products account for 37% of all notional amounts of CDS contracts

    outstanding.

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

    \70\ See BIS data, available at http://www.bis.org/statistics/otcder/dt1920a.pdf.

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

    The predominant provider of CDS indices is Markit. Markit offers

    indices covering corporate and sovereign entities, among others, in the

    United States, Europe, and Asia. Recent Markit data shows daily

    transaction volumes of 1,559 transactions using its licensed family of

    CDX indices, and 1,828 daily transactions in its European iTraxx

    indices.\71\ Further, it shows a rolling month gross notional amount of

    $745 billion in gross notional amount for the CDX family of indices and

    [euro]680 billion for the iTraxx family. Nearly all of the CDX

    contracts and volumes come from indices that are subject to the

    clearing requirement determination. With regard to the European iTraxx,

    more than 80% of those daily contract volumes and 84% of the daily

    gross notional volumes come from the iTraxx investment grade and high

    yield indices contemplated by the clearing requirement determination.

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

    \71\ Based on data published on www.markit.com as of September

    27, 2012.

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

    One point highlighted by this data, however, is the declining

    trading liquidity in the off-the-run series that can occur. Of the

    volumes noted by Markit, nearly 60% was in the current on-the-run

    series, as compared to all other outstanding series combined.\72\ The

    submissions of ICE Clear Credit, ICE Clear Europe, and CME also note

    the decline in average weekly gross notional amounts and contracts for

    benchmark tenors for off-the-run indices. The decline however can be

    more precipitous among older off-the-run indices. While many market

    factors can contribute to the actual volumes for a specific off-the-run

    contract, subject to certain exceptions, the trend is generally toward

    lower volumes.\73\

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

    \72\ The term ``on-the-run'' refers to current series of an

    index, while older series are referred to ``off-the-run.'' Each six

    months when a new series is created (or ``rolls'' using market

    terminology), the new series is considered the ``on-the-run'' index,

    and all others are considered ``off-the-run.''

    \73\ The current ``on-the-run'' series tend to have the most

    liquidity, while the older ``off-the-run'' series tend to have less

    liquidity, as many investors exit positions in an existing series

    and enter new positions in the new series when it becomes available

    (i.e., they ``roll'' their positions to the new series) thereby

    increasing liquidity in the ``on-the-run'' series.

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

    Set forth below is a table of data taken from DTCC as of November

    7, 2012, highlighting the net notional amounts and outstanding CDS

    index contracts, across all tenors, for each index and series included

    in this clearing determination.\74\

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

    \74\ Data from November 7, 2012, available at www.dtcc.com. In

    2006, DTCC began providing warehouse services for confirmed CDS

    trades through its Trade Information Warehouse (TIW). With the

    commitment of global market participants in 2009 to ensure that all

    OTC derivatives trades are recorded by a central repository, TIW has

    become a global repository for all CDS trades. With all major market

    participants submitting their trades to the TIW, it is estimated

    that 98% of all CDS trades are included within the warehouse, making

    it the primary source of CDS transaction data.

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

    [[Page 74295]]

    [GRAPHIC] [TIFF OMITTED] TR13DE12.000

    Notwithstanding the declining volumes that occur when an index is

    no longer on-the-run, the Commission does not believe that is

    sufficient reason to exclude the older series from the classes of CDS

    that are subject to the clearing requirement. As the DTCC data

    indicates, there are still significant volumes and outstanding notional

    amounts in each of these series.\75\ From the perspective of the DCO,

    the risk management of the older series of swaps should not provide

    significant additional challenges. With the significant notional and

    contract volumes still outstanding according to DTCC, many clearing

    members already have these positions on their books and are meeting

    their risk management requirements, even in the face of declining

    trading volumes. While the volumes may decline, the data included in

    the submissions indicates that volume still does exist, and parties

    should be able to trade these CDS indices as necessary. Additionally,

    as discussed further below, the clearing requirement would apply only

    to new swaps executed in the off-the-run indices.

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

    \75\ The Commission is monitoring volumes in the on-the-run

    iTraxx Europe HiVol. With the newest roll of the indices occurring

    on September 20, 2012, this index has yet to show significant

    volumes in the latest series based on DTCC data. The Commission will

    continue to monitor these volumes and take action as appropriate.

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

    Both AFR and ISDA specifically supported the inclusion of ``off-

    the-run'' CDS indices in the clearing determination. AFR noted that

    without including those indices, the market might enter into such swaps

    so as to avoid the clearing requirement. In addition, ISDA expressed

    concern about the potential negative impact on the relative liquidity

    between cleared and uncleared CDS swaps should a clearing requirement

    cease to apply during the lifecycle of the CDS.

    Given the contract and notional volumes listed above, there is

    adequate data available on pricing. The pricing for the CDS on these

    indices is fairly consistent across clearinghouses. The DCOs generally

    require a clearing member with open interest in a particular index to

    provide a price on that index for end-of-day settlement purposes. After

    applying a process to remove clear outliers, a composite price is

    calculated using the remaining prices. To ensure the integrity of the

    submissions, clearing members' prices may be ``actionable,'' meaning

    that they may form the basis of an actual trade that the member will be

    forced to enter. DCOs also have compliance programs that may result in

    fines for clearing members that fail to submit accurate pricing data.

    Beyond clearing member submissions, there are a number of third-

    party vendors that provide pricing services on these swaps. Third-party

    vendors typically source their data from a broader range of dealers.

    The data includes both direct contributions as well as feeds to

    automated trading

    [[Page 74296]]

    systems. This data is reviewed for outliers and aggregated for

    distribution.

    b. Availability of Rule Framework, Capacity, Operational Expertise and

    Resources, and Credit Support Infrastructure

    Section 2(h)(2)(D)(ii)(II) of the CEA requires the Commission to

    take into account the availability of rule framework, capacity,

    operational expertise and resources, and credit support infrastructure

    to clear the contract on terms that are consistent with the material

    terms and trading conventions on which the contract is then traded. The

    Commission has determined that this factor is satisfied by each of CME,

    ICE Clear Credit, and ICE Clear Europe.

    CME, ICE Clear Credit, and ICE Clear Europe, respectively,

    currently are clearing the swaps each submitted under Sec. 39.5. They

    have developed respective rule frameworks, capacity, operational

    expertise and resources, and credit support infrastructure to clear the

    contracts on terms that are consistent with the material terms and

    trading conventions on which the contracts currently are trading. The

    Commission believes that these are scalable and that CME, ICE Clear

    Credit, and ICE Clear Europe would be able to risk manage the

    additional swaps that might be submitted due to the clearing

    requirement determination.

    Following the financial crisis, the major market participants

    committed in 2009 to the substantial reforms to the OTC derivatives

    markets.\76\ Among the commitments from CDS dealers and buy side

    participants was to actively engage with central counterparties to

    broaden the range of cleared swaps and market participants. These

    changes were in addition to those generated through organizations like

    ISDA and their protocols standardizing CDS. For broadly traded swaps

    like the CDS indices, the ultimate impact of these initiatives was

    operational platforms,\77\ rule frameworks, and other infrastructure

    initiatives that replicated the uncleared market and supported the move

    of these CDS to a centrally cleared environment. In this way, the CDS

    clearing services offered by DCOs, including CME, ICE Clear Credit, and

    ICE Clear Europe, were designed to be cleared in a manner that is

    consistent with the material terms and trading conventions of a

    bilateral, uncleared market.

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

    \76\ See the June 2, 2009 letter to The Honorable William C.

    Dudley, President of the Federal Reserve Bank of New York, available

    at http://www.newyorkfed.org/newsevents/news/markets/2009/060209letter.pdf.

    \77\ In its comment letter supporting the NPRM, MarketAxess

    Holdings Inc. (MarketAxess) noted that the electronic trading

    platform it operates supports the trading of CDX and iTraxx

    products. MarketAxess stated that it intends to apply for

    registration as a SEF once the Commission issues related final

    rules.

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

    In addition, CME, ICE Clear Credit, and ICE Clear Europe are

    registered DCOs. To be registered as such, CME, ICE Clear Credit, and

    ICE Clear Europe have, on an on-going basis, demonstrated to the

    Commission that they are each in compliance with the DCO core

    principles set forth in the CEA and Commission regulations, as

    discussed above. As a general matter, any DCO that does not have the

    rule framework, capacity, operational expertise and resources, and

    credit support infrastructure to clear the swaps that are subject to

    required clearing is not in compliance with the core principles or the

    Commission regulations promulgating these principles.

    Commenters raised issues with regard to the operational

    capabilities of clearinghouses to manage the clearing of iTraxx for

    customers. Commenters such as ISDA, FIA, MFA, and D.E. Shaw all

    highlighted the fact that no registered DCO currently offers customer

    clearing for iTraxx. Besides the lack of approved customer clearing of

    the iTraxx indices at any DCO, the commenters noted substantive

    concerns about the ability of clearinghouses to manage the

    ``restructuring'' credit event applicable to iTraxx (and certain other

    CDS indices) in the context of customer clearing. For the CDX.NA.IG and

    CDX.NA.HY indices, credit events are limited to a ``failure to pay'' or

    the bankruptcy of the companies included in the index. A credit event

    results in the removal of the defaulted constitute from the index, with

    the protection seller settling the amounts owed to the protection buyer

    with regard to that individual constituent. The standardized terms of

    the iTraxx, however, also include ``restructuring'' as a credit event.

    When a restructuring event occurs with regard to an index constituent,

    the impacted company is removed from the index by the creation of a

    single-name CDS referencing that entity. The protection buyer and

    seller have the option to continue that single-name CDS or to settle

    the contract with regard to the restructured credit.

    ISDA, MFA, and FIA note that this process raises issues for DCOs.

    Specifically highlighted were those situations where a DCO does not, in

    fact, already offer clearing of the single-name CDS that is subject to

    the restructuring event. To the extent that the SEC or foreign

    regulator prohibits the DCO from clearing a particular single-name CDS,

    a process would need to be developed to address such circumstances.

    Similarly, the customer account in which the new single-name CDS would

    be held, in the absence of portfolio margining, would need to be

    addressed. MFA comments that the approval of portfolio margining

    petitions would remove much of the complexity of the ``spin-off'' of

    the single-name CDS from the iTraxx indices. Given the inclusion of the

    iTraxx within the clearing determination, MFA states that the petitions

    need to be approved so that the new single-name CDS can be held within

    the cleared swap account and margined with the iTraxx index CDS.

    Finally, the commenters believe that DCOs need to demonstrate that

    their customer clearing platforms are technologically viable and

    sufficiently tested before a clearing determination with regard to the

    iTraxx indices is finalized. For these reasons, these commenters

    believe a delay in the implementation of a clearing requirement for the

    iTraxx indices would be appropriate until such time as customer

    clearing platforms have been established, the necessary regulatory

    approvals have been granted and operational testing has been conducted

    for an appropriate period of time. In MFA's view the delay should be 60

    to 90 days, and in ISDA's view, the testing period should consist of

    voluntary client clearing for at least 90 days.

    On the other hand, ICE supports the Commission's inclusion of

    iTraxx CDS indices within its clearing requirement determination. ICE

    states that ICE Clear Europe has already begun the process of pursuing

    regulatory approval for client clearing of iTraxx, and indicates that

    ICE Clear Credit will do the same.\78\

    [[Page 74297]]

    While recognizing that the standard credit events under the iTraxx add

    some complexity relative to the CDX indices, ICE notes that it has

    worked with market participants and DTCC to develop industry-wide

    solutions to the ``restructuring'' event. Further, ICE states that ICE

    Clear Credit has already implemented applicable parts of this solution

    with regard to the clearing of the CDX.EM CDS index of emerging market

    sovereign constituents.\79\ ICE claims that any additional processes

    necessary with regard to clearing iTraxx index CDS are being addressed

    currently by the industry, and will not present any insurmountable

    challenges.

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

    \78\ ICE Clear Europe's submission, pursuant to Commission

    Regulation 40.6, amending its rulebook to accommodate client

    clearing is available on the Commission's Web site at: http://www.cftc.gov/stellent/groups/public/@rulesandproducts/documents/ifdocs/rul091312iclreu001.pdf. ICE Clear Europe is registered as a

    recognized clearing house with the United Kingdom's Financial

    Services Authority (U.K. FSA) and requires approval from the U.K.

    FSA to offer iTraxx clearing to customers. ICE Clear Credit's

    submission with regard to iTraxx clearing for both proprietary and

    customer accounts is available on the Commission's Web site at

    http://www.cftc.gov/stellent/groups/public/@rulesandproducts/documents/ifdocs/rul092812icc001.pdf. To the extent that ICE Clear

    Credit successfully launches iTraxx clearing, it would address

    ISDA's concern with regard to the Commission issuing a clearing

    determination for swaps that cannot be cleared at a U.S.-based DCO.

    It should be noted, however, that the Commission does not believe a

    DCO clearing a particular swap needs to be based in the U.S. for the

    Commission to find a swap subject to a clearing determination, to

    the extent that swap satisfies the factors required by statute and

    regulation to be included in the Commission's analysis.

    \79\ It is not clear, however, the extent to which clearing

    members are in fact offering customer clearing of the CDX.EM indices

    cleared by ICE Clear Credit.

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

    Citadel also commented that they did not believe that there were

    any substantive reasons why the iTraxx index CDS should not be required

    to be cleared. The ``restructuring'' credit event and the spinning out

    of a newly cleared single-name CDS do not, in Citadel's view, present

    any new issues to market participants. Further, because DCOs already

    offer clearing on the iTraxx on a dealer-to-dealer basis, they have the

    necessary processes upon which to build out the client clearing

    platform. Citadel also states that even if the ICE Clear Credit's and

    ICE Clear Europe's petitions to the SEC for portfolio margining were

    not approved generally,\80\ limited exemptions may be available for the

    single names associated with the spun-off single name. Citadel does

    agree with other commenters that to the extent that client clearing

    cannot be offered with sufficient lead time to allow for proper

    operational testing, a delay may be appropriate in implementing a

    clearing requirement for the iTraxx indices. Citadel believes 60 days

    voluntary customer clearing should be sufficient for such testing.

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

    \80\ It should be noted that the Commission strongly supports

    the petitions for the portfolio margining of single-name CDS and CDS

    indices. The Commission believes that all customers should be able

    to benefit from the reasonable application of portfolio margining,

    and that the benefits thereof should not just be available to the

    proprietary positions in the house accounts of clearing members.

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

    The Commission believes that the introduction of client clearing

    must occur before any clearing determination could become effective

    with regard to the iTraxx indices, or any other CDS indices that the

    Commission may consider.\81\ The Commission agrees with all commenters

    that subject to resolution of all operational issues surrounding client

    clearing of the iTraxx indices, specifically the iTraxx Europe,

    Crossover, and High Volatility, these indices are appropriate for

    inclusion in a clearing requirement. The Commission is encouraged by

    the work currently being done by the DCOs, by other regulators, and by

    the market as a whole, to establish client clearing in the near term.

    The Commission recognizes that additional time may be necessary to

    allow for the DCOs to obtain the necessary regulatory approvals and

    design a workable framework for dealing with the issues presented by

    the client clearing of the iTraxx indices, before the clearing of this

    class of indices can be required of market participants.

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

    \81\ The Commission agrees with the comments of MFA that the

    availability of client clearing should be considered when making

    clearing determinations. Consequently, DCOs accepting, or planning

    to accept, swaps for clearing should make client clearing available

    in compliance with Commission regulations. In the absence of such

    client clearing, the Commission will delay compliance with required

    clearing of iTraxx indices.

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

    As part of this clearing requirement determination, the Commission

    is including the iTraxx class of CDS, as proposed. The Commission

    believes that the compliance schedule outlined in Section IV below

    should provide adequate time for market participants to resolve the

    outstanding issues with regard to client clearing of the iTraxx

    indices. Under this schedule, the requirement for market participants

    to begin clearing would commence on March 11, 2013, for swaps entered

    into on or after that date between Category 1 Entities. Category 2

    Entities would be required to clear swaps beginning on June 10, 2013,

    for swaps entered into on or after that date, and Category 3 Entities

    would be required to clear swaps beginning on September 9, 2013, for

    swaps entered into on or after that date. However, if no DCO has begun

    offering client clearing for iTraxx by February 11, 2013, then

    compliance with the required clearing of iTraxx will commence sixty

    days after the date on which iTraxx is first offered for client

    clearing by an eligible DCO.

    If an eligible DCO offers client clearing for iTraxx on or before

    September 9, 2013, the following phased implementation schedule will

    apply: Category 1 Entities would be required to clear iTraxx indices

    entered into on or after the date 60 days after the date on which

    iTraxx is first offered for client clearing by an eligible DCO;

    Category 2 Entities would be required to clear iTraxx entered into on

    or after the date 150 days after the date on which iTraxx is first

    offered for client clearing by an eligible DCO; and Category 3 Entities

    would be required to clear iTraxx entered into on or after the date 240

    days after the date on which iTraxx is first offered for client

    clearing by an eligible DCO. There will be no phasing of compliance if

    an eligible DCO offers client clearing for iTraxx after September 9,

    2013. Rather, all three categories of market participants will be

    expected to come into compliance by 60 days after the date on which

    iTraxx is first offered for client clearing by an eligible DCO.

    c. Effect on the Mitigation of Systemic Risk

    Section 2(h)(2)(D)(ii)(III) of the CEA requires the Commission to

    take into account a clearing requirement's effect on the mitigation of

    systemic risk, taking into account the size of the market for the

    contract subject to the clearing requirement and the resources of the

    DCOs clearing the contract. The Commission agrees with the Sec. 39.5

    swap submissions of CME, ICE Clear Credit, and ICE Clear Europe that

    requiring certain classes of CDS to be cleared would reduce systemic

    risk in this sector of the swaps market. As CME noted, the 2008

    financial crisis demonstrated the potential for systemic risk arising

    from the interconnectedness of OTC derivatives market participants and

    the limited transparency of bilateral, i.e., uncleared, counterparty

    relationships. According to the Quarterly Report (Second Quarter 2012)

    on Bank Trading and Derivatives Activities of the Office of the

    Comptroller of the Currency (OCC Report),\82\ CDS index products

    account for a significant percentage of the notional value of swaps

    positions held by financial institutions. According to ICE Clear

    Credit, the CDS indices it offers for clearing are among the most

    actively traded swaps with the largest pre-clearing outstanding

    positions, and ICE Clear Credit's clearing members are among the most

    active market participants. ICE Clear Credit also noted that its

    clearing members clear a significant portion of their clearing-eligible

    portfolio.

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

    \82\ Available at http://occ.treas.gov/topics/capital-markets/financial-markets/trading/derivatives/dq212.pdf.

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

    Clearing the CDS indices subject to this determination will reduce

    systemic risk in the following ways: mitigating counterparty credit

    risk because the DCO would become the buyer to every seller of CDS

    indices subject to this determination and vice-versa; providing

    counterparties with daily mark-to-market valuations and exchange of

    [[Page 74298]]

    variation margin pursuant to a risk management framework set by the DCO

    and reviewed by the Commission's Division of Clearing and Risk; posting

    initial margin with the DCO in order to cover potential future

    exposures in the event of a default; achieving multilateral netting,

    which substantially reduces the number and notional amount of

    outstanding bilateral positions; reducing swap counterparties'

    operational burden by consolidating collateral management and cash

    flows; and eliminating the need for novations or tear-ups because

    clearing members may offset opposing positions.

    As discussed in the NPRM, the DCOs collect substantial amounts of

    collateral in the form of initial margin and guaranty fund

    contributions to cover potential losses on CDS portfolios. The

    methodologies for calculating these amounts are based on covering 5-day

    price movements on a portfolio with a 99% confidence level for initial

    margin, and longer liquidation periods and higher confidence levels

    under ``extreme but plausible'' conditions in the case of guaranty fund

    requirements. Beyond these financial resources, the clearinghouses have

    in place established risk monitoring processes, system safeguards, and

    default management procedures, which are subject to testing and review,

    to address potential systemic shocks to the financial markets.

    AFR specifically supported the Commission's analysis on the

    mitigation of systemic risk with regard to the CDS clearing

    determination.\83\ ISDA commented generally that the Commission's

    analysis of this factor should have addressed the centralization of

    risk at DCOs as a result of the determinations, and the new capital,

    collateral, and disclosure requirements that have decreased risk in

    uncleared swaps.\84\ The Commission believes its analysis of other

    factors did in fact focus on the management of risk at DCOs and their

    ability to manage the risks associated with the untranched CDS indices

    included within the determination. In connection with future

    determinations, the Commission will continue to take those issues

    raised by ISDA into consideration.

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

    \83\ Other commenters such as Citadel generally agreed with the

    Commission's analysis of the reduction of systemic risk for both the

    interest rates and CDS determinations.

    \84\ See Section II.F for further discussion of this comment.

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

    d. Effect on Competition

    Section 2(h)(2)(D)(ii)(IV) of the CEA requires the Commission to

    take into account the effect on competition, including appropriate fees

    and charges applied to clearing. Of particular concern to the

    Commission is whether this determination would harm competition by

    creating, enhancing, or entrenching market power in an affected product

    or service market, or facilitating the exercise of market power.\85\

    Under U.S. Department of Justice guidelines, market power is viewed as

    the ability ``to raise price [including clearing fees and charges],

    reduce output, diminish innovation, or otherwise harm customers as a

    result of diminished competitive constraints or incentives.'' \86\

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

    \85\ See U.S. Department of Justice and the Federal Trade

    Commission, Horizontal Merger Guidelines [hereinafter ``Horizontal

    Merger Guidelines''] at Sec. 1 (Aug. 19, 2010), available at http://www.justice.gov/atr/public/guidelines/hmg-2010.pdf.

    \86\ Id.; see also U.S. Department of Justice (DOJ) and the

    Federal Trade Commission (FTC), Antitrust Guidelines for

    Collaborations Among Competitors at Sec. 1.2 (April 2000),

    available at http://www.ftc.gov/os/2000/04/ftcdojguidelines.pdf

    (``The central question is whether the relevant agreement likely

    harms competition by increasing the ability or incentive profitably

    to raise price above or reduce output, quality, service, or

    innovation below what likely would prevail in the absence of the

    relevant agreement'').

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

    In the NPRM, the Commission identified the following putative

    product and service markets as potentially affected by this clearing

    determination: a DCO service market encompassing those clearinghouses

    that currently (or with relative ease in the future could) clear the

    CDS subject to this determination, and a CDS product market or markets

    encompassing the CDS that are subject to this determination.\87\

    Without defining the precise contours of these markets at this

    time,\88\ the Commission recognizes that, depending on the interplay of

    several factors, this clearing determination potentially could impact

    competition within the affected markets. Of particular importance to

    whether any impact is, overall, positive or negative, is: (1) Whether

    the demand for these clearing services and swaps is sufficiently

    elastic that a small but significant increase above competitive levels

    would prove unprofitable because users of the CDS products and DCO

    clearing services would substitute other products/clearing services co-

    existing in the same market(s), and (2) the potential for new entry

    into these markets. The availability of substitute products/clearing

    services to compete with those encompassed by this determination, and

    the likelihood of timely, sufficient new entry in the event prices do

    increase above competitive levels, each operate independently to

    constrain anticompetitive behavior.

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

    \87\ Included among these could be a separate product market for

    CDS indices licensing. AFR stated that this factor should not focus

    on Markit as an index provider, but rather on clearing entities. For

    purposes of its consideration of this factor, the Commission

    believes its analysis appropriately covers competition as it relates

    to clearinghouses, as well as to other market participants.

    \88\ The federal antitrust agencies, the DOJ and FTC, use the

    ``hypothetical monopolist test'' as a tool for defining antitrust

    markets for competition analysis purposes. The test ``identif[ies] a

    set of products that are reasonably interchangeable with a

    product,'' and thus deemed to reside in the same relevant antitrust

    product or service market. ``[T]he test requires that a hypothetical

    profit-maximizing firm, not subject to price regulation, that was

    the only present and future seller of those products (`hypothetical

    monopolist') likely would impose at least a small but significant

    and non-transitory increase in price (`SSNIP') on at least one

    product in the market.'' In most cases, a SSNIP of five percent is

    posited. If consumers would respond to the hypothesized SSNIP by

    substituting alternatives to a significant degree to render it

    unprofitable, those alternative products/services are included

    within the relevant market. This methodological exercise is repeated

    until it has been determined that consumers have no further

    interchangeable products/services available to them. Horizontal

    Merger Guidelines at Sec. 4.1.

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

    The Commission recognized in the NPRM that, depending on the

    interplay of several factors, the clearing requirement potentially

    could impact competition within the affected market and discussed

    various factors that could impact that market.

    In response to the Commission's recognition of the fact that

    currently no DCO clears CDS indices licensed by any provider other than

    Markit, Markit commented that it did not believe the determination

    would foreclose or materially impact competition in the CDS products,

    including licensing. Markit noted that its open licensing policy

    encourages competition among DCOs, SEFs, market makers, and others.

    Markit further commented that, given the costs associated with

    clearing, CDS indices that are not subject to a determination may be at

    a competitive advantage, including those that may be established by

    other index providers.

    In support of the NPRM, Citadel stated that the clearing

    requirement will have a strong positive impact on competition in the

    swap market and the market for clearing services. Citadel noted that

    central clearing will remove a significant barrier to entry for

    alternative swap market liquidity providers and will enable smaller

    entities to compete on more equal terms because central clearing

    eliminates the consideration of counterparty credit risk from the

    selection of execution counterparties. Citadel further commented that

    buy-side market participants will benefit from a wider range of

    potential execution counterparties and asserted that this increased

    competition yields benefits to market participants including narrower

    bid-ask spreads, improved access to best

    [[Page 74299]]

    execution, and increased market depth and liquidity, all of which

    facilitate the emergence of an all-to-all market with electronic and/or

    anonymous execution. Citadel also commented that substitution of the

    DCO for the bilateral counterparty decouples execution from post-trade

    processing and settlement.\89\ Finally, Citadel commented that the

    certainty as to when the first clearing requirement will begin gives

    DCOs and FCMs the confidence to invest in their client clearing

    offerings, and to compete actively for buy-side business both on the

    quality and efficiency of their services as well as on price.

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

    \89\ The Commission observes that issues regarding the bundling

    of clearing services and execution are beyond the scope of this

    rulemaking. See generally Swap Dealer and Major Swap Participant

    Recordkeeping, Reporting, and Duties Rules; Futures Commission

    Merchant and Introducing Broker Conflicts of Interest Rules; and

    Chief Compliance Officer Rules for Swap Dealers, Major Swap

    Participants, and Futures Commission Merchants, 77 FR 20128, 20154-

    55 (Apr. 3, 2012) (discussing the application of Sec. 1.71(d)(2)).

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

    While FIA commented that the NPRM included a full discussion of the

    potential competitive impact of the clearing proposal, as discussed

    above, FIA indicated that it was unable to conduct the analysis it

    believes would be necessary to respond to the Commission's questions in

    the NPRM within the 30-day comment period provided.

    In response to FIA's comment, as discussed above, the Commission

    notes that the 30-day public comment period was necessary for the

    Commission to adhere to the CEA's 90-day determination process.

    Moreover, while FIA indicated that it would like more time to conduct

    further analysis of competitive issues for future determinations, FIA

    did not identify any specific concerns about the competitiveness issue

    analysis that could materially change the Commission's determination if

    such additional information were made available to the Commission. The

    comments provided by Markit and Citadel are consistent with the NPRM's

    conclusion that the clearing requirement potentially could impact

    competition within the affected market, but both commenters go on to

    assert that such an impact would not be negative. Accordingly, the

    Commission believes that its consideration of competitiveness as

    described in the NPRM is sufficient for purposes of finalizing the

    clearing requirement rule.

    e. Legal Certainty in the Event of the Insolvency

    Section 2(h)(2)(D)(ii)(V) of the CEA requires the Commission to

    take into account the existence of reasonable legal certainty in the

    event of the insolvency of the relevant DCO or one or more of its

    clearing members with regard to the treatment of customer and swap

    counterparty positions, funds, and property. The Commission proposed

    this clearing requirement based on its view that there is reasonable

    legal certainty with regard to the treatment of customer and swap

    counterparty positions, funds, and property in connection with cleared

    swaps, namely the CDS indices subject to this determination, in the

    event of the insolvency of the relevant DCO (CME, ICE Clear Credit, or

    ICE Clear Europe) or one or more of the DCO's clearing members.

    In the case of a clearing member insolvency at CME or ICE Clear

    Credit, subchapter IV of Chapter 7 of the U.S. Bankruptcy Code (11

    U.S.C. 761-767) and Part 190 of the Commission's regulations would

    govern the treatment of customer positions.\90\ Pursuant to section

    4d(f) of the CEA, a clearing member accepting funds from a customer to

    margin a cleared swap, must be a registered FCM. Pursuant to 11 U.S.C.

    761-767 and Part 190 of the Commission's regulations, the customer's

    CDS positions, carried by the insolvent FCM, would be deemed

    ``commodity contracts.'' \91\ As a result, neither a clearing member's

    bankruptcy nor any order of a bankruptcy court could prevent either CME

    or ICE Clear Credit from closing out/liquidating such positions.\92\

    However, customers of clearing members would have priority over all

    other claimants with respect to customer funds that had been held by

    the defaulting clearing member to margin swaps, such as the customers'

    positions in CDS indices subject to this determination.\93\ Customer

    funds would be distributed to swaps customers, including CDS customers,

    in accordance with Commission regulations and section 766(h) of the

    Bankruptcy Code. Moreover, the Bankruptcy Code and the Commission's

    rules thereunder (in particular 11 U.S.C. 764(b) and 17 CFR 190.06)

    permit the transfer of customer positions and collateral to solvent

    clearing members.

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

    \90\ The Commission observes that an FCM or DCO also may be

    subject to resolution under Title II of the Dodd-Frank Act to the

    extent it would qualify as covered financial company (as defined in

    section 201(a)(8) of the Dodd-Frank Act).

    \91\ If an FCM is also registered as a broker-dealer, certain

    issues related to its insolvency proceeding would also be governed

    by the Securities Investor Protection Act.

    \92\ See 11 U.S.C. 556 (``The contractual right of a commodity

    broker [which term would include a DCO or FCM] * * * to cause the

    liquidation, termination or acceleration of a commodity contract * *

    * shall not be stayed, avoided, or otherwise limited by operation of

    any provision of [the Bankruptcy Code] or by order of a court in any

    proceeding under [the Bankruptcy Code].'').

    \93\ See 11 U.S.C. 766(h).

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

    Similarly, 11 U.S.C. 761-767 and Part 190 would govern the

    bankruptcy of a DCO, in conjunction with DCO rules providing for the

    termination of outstanding contracts and/or return of remaining

    clearing member and customer property to clearing members.

    With regard to ICE Clear Europe, the Commission understands that

    the default of a clearing member of ICE Clear Europe would be governed

    by the rules of that DCO. ICE Clear Europe, a DCO based in the United

    Kingdom, has represented that under English law its rules would

    supersede English insolvency laws. Under its rules, ICE Clear Europe

    would be permitted to close out and/or transfer positions of a

    defaulting clearing member that is an FCM pursuant to the U.S.

    Bankruptcy Code and Part 190 of the Commission's regulations. According

    to ICE Clear Europe's submission, the insolvency of ICE Clear Europe

    itself would be governed by both English insolvency law and Part 190.

    ICE Clear Europe has obtained legal opinions that support the

    existence of such legal certainty in relation to the protection of

    customer and swap counterparty positions, funds, and property in the

    event of the insolvency of one or more of its clearing members. In

    addition, ICE Clear Europe has obtained a legal opinion from U.S.

    counsel regarding compliance with the protections afforded to FCM

    customers under New York law.

    In response to the NPRM, Citadel commented that it agreed with the

    Commission's analysis that reasonable certainty exists in the event of

    an insolvency of a DCO or one or more DCO members. As discussed above,

    the Commission received three comments related to customer segregation.

    In essence, Vanguard and SIFMA AMG recommend that the Commission delay

    implementation of the clearing requirement until three months after the

    LSOC model is implemented, clarified, and perhaps supplemented with

    additional rulemaking. ISDA requests that the Commission further study

    the issue of insolvency for DCOs.

    As stated above, the Commission believes that the concerns of

    Vanguard and SIFMA AMG are largely addressed by the delayed

    implementation timeframe for this determination. With regard to ISDA's

    request, as discussed above, the Commission is actively engaging in

    efforts to study and prepare for potential scenarios involving

    [[Page 74300]]

    clearinghouse and clearing member insolvency.

    iii. Conclusions Regarding the Five Statutory Factors and Clearing

    Requirement Determination

    Based on the foregoing discussion and analysis, the Commission has

    taken into account each of the five factors provided for under section

    2(h)(2)(D)(ii) of the CEA. Based on these considerations, and having

    reviewed the relevant DCOs' submissions for consistency with section

    5b(c)(2) of the CEA, the Commission is determining that the two classes

    of CDS identified in Sec. 50.4(b) are required to be cleared.

    E. Interest Rate Swaps

    i. Introduction

    Interest rate swaps are agreements wherein counterparties agree to

    exchange payments based on a series of cash flows over a specified

    period of time typically calculated using two different rates

    multiplied by a notional amount. The BIS estimated that, as of December

    2011, over $500 trillion in notional amount of single currency interest

    rate swaps were outstanding representing 75% to 80% of the total

    estimated notional amount of derivatives outstanding.\94\ Based on

    these factors and on the swap submissions received under Sec. 39.5(b),

    the Commission believes that interest rate swaps represent a

    substantial portion of the swaps market and warrant consideration by

    the Commission for required clearing.

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

    \94\ BIS, OTC Derivatives Market Activity as of December 2011,

    Table 1, available at http://www.bis.org/statistics/otcder/dt1920a.pdf. The BIS data provides the broadest market-wide

    estimates of interest rate swap activity available to the

    Commission.

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

    The Commission's proposal for interest rate swaps was presented in

    two parts. The first part, Section II.E of the NPRM, discussed the

    Commission's rationale for determining how to classify and define the

    interest rate swaps identified in the DCO submissions (IRS submissions)

    to be considered for the clearing requirement. The second part, Section

    II.F, presented the Commission's consideration of the IRS submissions

    in accordance with section 2(h)(2)(D) of the CEA. This final release

    follows the same basic two-part structure. In each part, the discussion

    in the NPRM preamble for the corresponding part is summarized. Comments

    received from the public are summarized where appropriate together with

    the Commission's consideration of the comments.

    ii. DCO Submissions

    The Commission received submissions from three registered DCOs

    eligible to clear interest rate swaps: LCH.Clearnet Limited (LCH), the

    clearing division of the Chicago Mercantile Exchange Inc. (CME), and

    International Derivatives Clearinghouse, LLC (IDCH).\95\ On August 14,

    2012, LCH acquired IDCH and changed the name of IDCH to LCH.Clearnet

    LLC (LCH.LLC). LCH.LLC has submitted a request to the CFTC for approval

    of changes to its DCO rules that would result in LCH.LLC clearing the

    same interest rate swaps that LCH clears. As noted in the NPRM, IDCH

    had no cleared swap positions. Accordingly, the change in ownership of

    IDCH would not change the Commission's proposal in terms of swap class

    assessments or volume and liquidity considerations. The proposed

    clearing requirement rule is not DCO specific. Upon approval of

    LCH.LLC's application for its DCO rule changes, LCH.LLC would become a

    U.S.-domiciled DCO capable of accepting the full range of interest rate

    swap products contemplated in the proposal.\96\

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

    \95\ The IRS submissions received by the Commission are

    available at http://www.cftc.gov/IndustryOversight/IndustryFilings/index.htm. Submission materials marked by the submitting DCO for

    confidential treatment pursuant to Sec. Sec. 39.5(b)(5) and

    145.9(d) are not available for public review.

    \96\ IDCH was eligible under Sec. 39.5 to clear interest rate

    swaps. When LCH.LLC assumed IDCH's DCO license, LCH.LLC was deemed

    eligible to clear interest rate swaps as well.

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

    The following table summarizes the interest rate swap classes and

    relevant specifications that each DCO identified in its IRS submission.

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

    \97\ LCH.LLC (formerly IDCH) has applied to the Commission for

    DCO rule change approvals that would effectively implement clearing

    of the same interest rate swaps that LCH now clears. LCH.LLC is not

    accepting interest rate swaps for clearing until such time as it

    launches under its new clearing rules. Accordingly, IDCH's product

    list that was included in the NPRM has been removed from the

    summary.

    \98\ Subsequent to its original submission, CME has added

    clearing of OIS for USD, EUR, GBP, and JPY.

    \99\ In this final rule, currencies are identified either by

    their full name or by the three letter ISO currency designation for

    the currency.

    Table 3--Interest Rate Swap Submissions Summary \97\

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

    LCH CME

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

    Swap Classes................ Fixed-to-floating, basis, Fixed-to-

    forward rate agreements floating.\98\

    (FRAs), overnight index

    swaps (OIS)..

    Currencies \99\............. USD, EUR, GBP, JPY, AUD, USD, EUR, GBP,

    CAD, CHF, SEK, CZK, DKK, JPY, CAD, and

    HKD, HUF, NOK, NZD, PLN, CHF.

    SGD, ZAR.

    Rate Indexes................ For Fixed-to-floating, USD-LIBOR, CAD-

    basis, FRAs: LIBOR in BA, CHF-LIBOR,

    seven currencies, BBR- GBP-LIBOR, JPY-

    BBSW, BA-CDOR, PRIBOR, LIBOR, and

    CIBOR-DKNA13, CIBOR2- EURIBOR.

    DKNA13, EURIBOR-

    Telerate, EURIBOR-

    Reuters, HIBOR-HIBOR,

    HIBOR-HKAB, HIBOR-ISDC,

    BUBOR-Reuters, NIBOR,

    BBR-FRA, BBR-Telerate,

    PLN-WIBOR, PLZ-WIBOR,

    STIBOR, SOR-Reuters,

    JIBAR.

    For OIS: FEDFUNDS, SONIA,

    EONIA, TOIS.

    Maximum Stated Termination For Fixed-to-floating and USD, EUR, and

    Dates. basis: USD, EUR, and GBP GBP out to 50

    out to 50 years, AUD, years, and

    CAD, CHF, SEK and JPY CAD, JPY, and

    out to 30 years and the CHF out to 30

    remaining nine years.

    currencies out to 10

    years..

    For OIS and FRAs: USD,

    EUR, GBP, and CHF out to

    two years.

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

    iii. Interest Rate Swap Market Conventions and Risk Management

    The NPRM described how interest rate swaps present a wide range of

    variable product classes and product specifications within each class.

    Notwithstanding the large variety of contracts, there are commonalities

    that make it possible to categorize interest rate swaps for clearing,

    pricing, and risk purposes. Firstly, the vast majority of interest rate

    swaps use the ISDA definitions and contract conventions that allow

    market participants to agree quickly on common terms for each

    transaction. In fact, the DCOs clearing interest rate swaps all use

    ISDA definitions in their product specifications.

    Secondly, counterparties enter into swaps to achieve particular

    economic

    [[Page 74301]]

    results. While the results desired may differ in small ways depending

    on each counterparty's specific circumstances and goals, there are

    certain common swap conventions that are used to identify and achieve

    commonly desired economic results when entering into interest rate

    swaps. For example, a party that is trying to hedge variable interest

    rate risk may enter into a fixed rate to floating rate swap, or a party

    that is seeking to fix interest rates for periods in the future may

    enter into a forward rate agreement.

    The IRS submissions identified commonly known classes of swaps that

    they clear including: fixed rate to floating rate swaps, that are

    sometimes referred to as plain vanilla swaps (fixed-to-floating swaps);

    floating rate to floating rate swaps, also referred to as basis swaps

    (basis swaps); overnight index swaps (OIS); and forward rate agreements

    (FRAs).\100\ These class terms are also being used in industry efforts

    to develop a taxonomy for interest rate swaps.\101\

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

    \100\ These are sometimes also referred to as ``types,''

    ``categories,'' or ``groups.'' For purposes of the clearing

    requirement determination, the Commission uses the term ``class,''

    in order to be consistent with the approach taken by the European

    Securities and Markets Authority (ESMA) in its Discussion Paper,

    ``Draft Technical Standards for the Regulation on OTC Derivatives,

    CCPs, and Trade Repositories,'' (Feb. 16, 2012), available at http://www.esma.europa.eu/system/files/2012-95.pdf. It is also noted that

    other categorizations are sometimes used for certain purposes.

    However, these four classes are common terms used by the DCOs and

    are common terms used in industry taxonomies.

    \101\ See, e.g., ISDA Swap Taxonomies, available at http://www2.isda.org/identifiers-and-otc-taxonomies/; Financial Products

    Markup Language, available at http://www.fpml.org/; and Federal

    Reserve Bank of New York Staff Reports, ``An Analysis of OTC

    Interest Rate Derivatives Transactions: Implications for Public

    Reporting'' (March 2012) at 3, available at http://www.newyorkfed.org/research/staff_reports/sr557.pdf.

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

    Furthermore, within these general classes, certain specifications

    are essential for defining the economic result and the value of the

    swap. Each of the IRS submissions naturally used these common

    specifications when identifying the swaps that the DCO clears. Within

    each of those specifications, there are common terms used by the DCOs

    and markets, which allows for further classification of the full range

    of interest rate swaps that are executed. Accordingly, as described in

    the NPRM, while there are a wide variety of interest rate swaps when

    taking into account all possible contract specifications, certain

    specifications are commonly used by the DCOs and market participants.

    This allows for the identification of classes of swaps and primary

    specifications within each class.

    The DCOs also risk manage and set margins for interest rate swaps

    on a portfolio basis rather than on a transaction- or product-specific

    basis. In other words, the DCOs analyze the cumulative risk of a

    party's portfolio. By looking at risk on a portfolio basis, the DCOs

    effectively take into account how swaps with different attributes, such

    as underlying currency, stated termination dates, underlying floating

    rate indexes, swap classes, etc., are correlated and thus can offset

    risk across attributes. This is possible because, although individual

    transactions may have unique contract terms, given the commonalities of

    transactions as discussed above, swap portfolios can be risk managed on

    a cumulative value basis taking into account correlations among the

    cleared swaps. Consequently, DCOs can be expected to fairly rapidly,

    and efficiently manage the risk of portfolios of interest rate swaps

    within and across classes in a default scenario through a small number

    of large hedging transactions that hedge large numbers of similarly

    correlated positions held by the defaulting party.\102\ As such,

    liquidity for specific, individual swaps is not the focus of DCOs from

    a risk management perspective. Rather, liquidity is viewed as a

    function of whether a portfolio of swaps has common specifications that

    are determinative of the economics of the swaps in the portfolio such

    that a DCO can price and risk manage the portfolio through block

    hedging and auctions in a default situation.\103\

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

    \102\ After putting on these hedging positions, the DCO has the

    time needed to address any residual risk of the defaulted portfolio

    through auctioning off the defaulted portfolio together with the

    hedging transactions.

    \103\ See 77 FR at 47188 and LCH IRS submission, at 4

    (discussing LCH's management of the Lehman Brothers' bankruptcy in

    September 2008, where upon Lehman's default, LCH needed to risk

    manage a portfolio of approximately 66,000 interest rate swaps,

    which it hedged with approximately 100 new swap trades in less than

    five days and only used approximately 35% of the initial margin

    Lehman had posted).

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

    iv. Interest Rate Swap Classification for Clearing Requirement

    Determinations

    Section 2(h)(2)(A) of the CEA provides that the Commission ``shall

    review each swap, or any group, category, type, or class of swaps to

    make a determination as to whether'' any thereof shall be required to

    be cleared. In reviewing the IRS submissions, the Commission considered

    in the NPRM whether its clearing requirement determination should

    address individual swaps, or categories, types, classes, or other

    groups of swaps.

    Based on the market conventions as discussed above, and the DCO

    recommendations in the IRS submissions, the Commission proposed a

    clearing requirement for four classes of interest rate swaps: Fixed-to-

    floating swaps, basis swaps, OIS, and FRAs. At the time the IRS

    submissions were submitted to the Commission, LCH offered all four

    classes for clearing, as did IDCH, and CME offered one of them for

    clearing. Subsequent to the publication of the NPRM, CME has added

    clearing of OIS, and has stated publicly that it intends to add

    clearing of basis swaps and FRAs in the near future. In addition, upon

    launch of LCH.LLC, it is expected that LCH.LLC will begin clearing the

    same swaps cleared by LCH that are included in the swap classes

    designated by the Commission.

    These four classes represent a substantial portion of the interest

    rate swap market. The following table provides an indication of the

    outstanding positions in each class.

    Table 4--Interest Rate Swaps Notional and Trade Count by Class \104\

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

    Notional amount Gross notional Total trade count

    Swap class (USD BNs) percent of total Total trade count percent of total

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

    Fixed-to-Floating................... 299,818 60 3,239,092 75

    FRA................................. 67,145 13 202,888 5

    OIS................................. 43,634 9 109,704 3

    Basis............................... 27,593 5 119,683 3

    Other \105\......................... 65,689 13 617,637 14

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

    [[Page 74302]]

    Total........................... 503,879 100 4,289,004 100

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

    \104\ TriOptima data, as of March 16, 2012. See Section II.F below for a description of the TriOptima data. The

    TriOptima data provided information on nine other classes of swaps, none of which is included in the IRS

    submissions.

    \105\ In the NPRM, the total notional amount for the ``Other'' category was incorrectly listed as $132,162

    billion as a result of inadvertently including the FRA amounts in the ``Other'' category. Correcting this

    error also resulted in changes to the ``Gross Notional Percent of Total'' column. These corrections do not

    change the Commission's analysis in the NPRM. The fact that the four classes of interest rate swaps included

    in the clearing requirement represent a larger proportion of the total notional amount of interest rate swaps

    outstanding is consistent with Congressional intent to mitigate systemic risk by implementing clearing of

    swaps as discussed in the NPRM. See 77 FR 47171.

    For purposes of the clearing requirement determination, the

    Commission developed the following class definitions based on

    information provided by the submitting DCOs and market conventions.

    1. ``Fixed-to-floating swap'': A swap in which the payment or

    payments owed for one leg of the swap is calculated using a fixed rate

    and the payment or payments owed for the other leg are calculated using

    a floating rate.

    2. ``Floating-to-floating swap'' or ``basis swap'': A swap in which

    the payments for both legs are calculated using floating rates.

    3. ``Forward Rate Agreement'' or ``FRA'': A swap in which payments

    are exchanged on a pre-determined date for a single specified period

    and one leg of the swap is calculated using a fixed rate and the other

    leg is calculated using a floating rate that is set on a pre-determined

    date.

    4. ``Overnight indexed swap'' or ``OIS'': A swap for which one leg

    of the swap is calculated using a fixed rate and the other leg is

    calculated using a floating rate based on a daily overnight rate.

    As described in the NPRM, the LCH and CME IRS submissions addressed

    issues of classification for purposes of the interest rate swap

    clearing requirement. In its submission, LCH discussed the

    classification of interest rate swaps and recommended establishing

    clearing requirements for classes of interest rate swaps. In effect,

    LCH recommended the use of a set of basic product specifications to

    identify and describe each class of swaps subject to the clearing

    requirement. CME recommended a clearing determination for all non-

    option interest rate swaps denominated in a currency cleared by any

    qualified DCO.

    As an alternative, the Commission considered whether to establish

    clearing requirements on a product-by-product basis. The Commission

    noted in the NPRM that such a determination would need to identify the

    multitude of specifications of each product that would be subject to

    the clearing requirement. In this regard, LCH stated in its IRS

    submission that the clearing requirement ``would be sub-optimal for the

    overall market if participants are forced to read pages of rules to

    decipher whether or not a swap is required to be cleared, or to have to

    make complex and time consuming decisions at the point of execution.''

    \106\ A class-based approach would allow market participants to

    determine quickly as a threshold matter whether they might need to

    submit a swap to a DCO for clearing by checking initially whether the

    swap has the basic specifications that define each class subject to the

    clearing requirement.\107\

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

    \106\ LCH IRS submission, at 6.

    \107\ In addition, as noted by LCH, in its IRS submission, a

    product-by-product requirement may be evaded more easily because the

    specifications of a particular swap contract would need to match the

    specifications of each product subject to a clearing requirement.

    The clearing requirement could be evaded by adding, deleting, or

    modifying one or more of the contract's specifications, including

    minor specifications that have little or no impact on the economics

    of the swap. By using a class-based approach that allows for ranges

    of contract specifications established by the DCOs within each

    class, the Commission is reducing the potential for evasion in

    accordance with section 2(h)(4)(A) of the CEA, which directs the

    Commission to prescribe rules necessary to prevent evasion of the

    clearing requirements.

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

    A product-by-product designation also would be difficult to

    administer because the Commission would be required to consider each

    and every product submitted. On the other hand, designating classes of

    interest rate swaps for the clearing requirement provides a cost

    effective, workable method for the Commission to review variations in

    new swap products that DCOs will submit for clearing determinations on

    a going forward basis without undertaking a full Commission review of

    each and every swap to determine if those variations are consistent

    with the five factors the Commission is directed to consider under

    section 2(h)(2)(D) of the CEA. For such swaps, as described in greater

    detail below in Section III.F, the Commission proposed delegating to

    the Director of the Division of Clearing and Risk, with the

    consultation of the General Counsel, the authority to confirm whether

    the swap fits within the identified class and is therefore subject to

    the clearing requirement.

    After consideration of the issues summarized above, the Commission

    proposed in the NPRM to follow the general approach recommended by LCH

    and CME of establishing the clearing requirement for classes of

    interest rate swaps, rather than for individual swap products.

    v. Interest Rate Swap Specifications

    In the NPRM, after consideration of the appropriateness of

    classifying interest rate swaps, the Commission analyzed the IRS

    submissions and proposed to set out the parameters of the four classes

    of interest rate swaps submitted by using the following affirmative

    specifications for each class: (i) Currency in which the notional and

    payment amounts are specified; (ii) rates referenced for each leg of

    the swap; and (iii) stated termination date of the swap. The Commission

    further proposed three ``negative'' or ``limiting'' specifications for

    each class: (i) No optionality (as specified by the DCOs); (ii) no dual

    currencies; and (iii) no conditional notional amounts.\108\

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

    \108\ The term ``conditional notional amount'' refers to

    notional amounts that can change over the term of a swap based on a

    condition established by the parties upon execution such that the

    notional amount of the swap is not a known number or schedule of

    numbers, but may change based on the occurrence of some future

    event. This term does not include what are commonly referred to as

    ``amortizing'' or ``roller coaster'' notional amounts for which the

    notional amount changes over the term of the swap based on a

    schedule of notional amounts known at the time the swap is executed.

    Furthermore, it would not include a swap containing early

    termination events or other terms that could result in an early

    termination of the swap if a DCO clears the swap with those terms.

    The Commission discusses this definition and comments received on it

    below.

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

    The Commission proposed the three affirmative specifications

    because they are fundamental specifications used in the swap market to

    determine the economic result of a swap transaction. Counterparties

    enter into swaps to achieve particular economic results. For

    [[Page 74303]]

    example, counterparties may enter into interest rate swaps to hedge an

    economic risk, to facilitate a purchase, or to take a view on the

    future direction of an interest rate. The counterparties enter into a

    swap that they believe will best achieve their desired economic result

    at a reasonable cost.

    As noted in the NPRM, the IRS submissions identified four different

    classes of swap contracts that are being cleared at this time: fixed-

    to-floating swaps, basis swaps, OIS, and FRAs. These classes of

    interest rate swaps reflect industry categorization and allow

    counterparties to achieve a particular economic result. For example, a

    fixed-to-floating swap may be used by a counterparty to hedge interest

    rate risk related to bonds it has issued or which it owns.

    All three DCO submitters identified currency as a specification for

    distinguishing swaps that are subject to clearing. A swap that requires

    calculation or payment in a currency different than the currency of the

    related underlying purposes of the swap would introduce currency

    risk.\109\ Thus, the currency designated for the swap is a basic factor

    in pricing the swap and achieving the economic results of the swap

    desired by each party.

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

    \109\ For example, parties seeking to hedge interest rate risk

    in connection with bonds or to invest funds using swaps are more

    likely to enter into swaps that designate the same currency in which

    the bonds are payable or that the funds to be invested are held.

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

    Furthermore, the swaps listed by all three DCOs in their IRS

    submissions all identified the interest rates used for each leg of the

    swap as a basic term that defines the swap. The rates are basic

    determinants of the economic value of each stream of payments of an

    interest rate swap.

    Finally, the stated termination date, or maturity, of a swap is a

    basic specification for establishing the value of a swap transaction

    because interest rate swaps are based on an exchange of payments over a

    specified period of time ending on the stated termination date. The

    value of a swap at any one point in time depends in part on the value

    of each payment stream over the remaining life of the swap. For

    example, if a party wants to hedge variable interest rate risk for

    bonds it has issued that mature in ten years, it will generally enter

    into a swap with a stated termination date that matches the final

    maturity date of the bonds being hedged.\110\ To terminate the swap

    prior to such date would result in only a partial hedge and to execute

    a swap with a stated termination date that is later than the final bond

    maturity date would simply create exposed rate risk during the extended

    period beyond the final maturity date of the bonds.

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

    \110\ Although hedging an economic risk expected to remain

    outstanding for, say, ten years with a matching ten year swap may

    generally be the most efficient and precise approach, the Commission

    recognizes that parties may achieve a similar result by using swaps

    with different stated termination dates. However, such substitution

    generally provides a less precise hedge.

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

    As noted above, the Commission also considered in the NPRM whether

    there are product specifications that the Commission should explicitly

    exclude from the initial clearing requirement determination. In this

    regard, the Commission considered swaps with optionality, multiple

    currency swaps, and swaps with conditional notional amounts. The

    Commission proposed that these three specifications should be included

    as so-called ``negative'' or ``limiting'' specifications.

    By using the three affirmative specifications and three limiting

    specifications to further identify the swaps within each class that are

    subject to the clearing requirement, counterparties contemplating

    entering into a swap can determine quickly as a threshold matter

    whether the particular swap may be subject to a clearing requirement.

    If the swap is in a specified class and has the six specifications, the

    parties will know that they need to verify whether a DCO will clear

    that particular swap. This will reduce the burden on swap

    counterparties related to determining whether a particular swap may be

    subject to the clearing requirement.

    The Commission also considered in the NPRM whether to define

    classes of swaps on the basis of other product specifications. Other

    potential specifications are numerous because of the nearly limitless

    alternative interest rate swaps that are theoretically possible. In the

    NPRM, the Commission summarized its consideration by breaking down

    alternative specifications into two general categories: Specifications

    that are commonly used to address mechanical issues for most swaps, and

    specifications that are less common and address idiosyncratic issues

    related to the particular needs of a counterparty. The Commission noted

    that certain specifications are specifically identified for most swap

    transactions, but asserted that many such specifications are not,

    generally speaking, fundamental to determining the economic result the

    parties are trying to achieve. For example, the day count fraction

    selected affects calculation periods and therefore the amounts payable

    for each payment period. The parties, and the DCOs, can make mechanical

    adjustments to period pricing at the time a swap is cleared based on

    the day count fraction alternative selected by the parties and the day

    count fraction does not drive the overall economic result the parties

    are trying to achieve or substantially differentiate the pricing and

    risk management of the swap relative to other swaps in the same class

    and having the same basic class defining specifications.

    Furthermore, as noted in the NPRM, DCOs can provide clearing for

    the standard alternatives of each of these specifications without

    affecting risk management. Using the same day count fraction example,

    LCH will accept U.S. dollar-LIBOR trades for clearing with nine

    alternative day count fractions based on the common day count fractions

    used in the market.\111\ While this specification, and other

    specifications of this kind, may affect the amounts owed on a swap,

    they can be accounted for mechanically in the payment amount

    calculations and do not change the basic substantive economic result

    the parties want to achieve.

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

    \111\ Each DCO identifies the standard term or range of terms it

    will accept for each specification. Accordingly, swap counterparties

    can review the DCO's product specifications to determine whether a

    swap will satisfy the DCO's requirements for these specifications.

    Additionally, CME has developed, and LCH has committed to developing

    by the time the clearing requirement must be complied with in

    accordance with the Commission's implementation schedule, product

    screening mechanisms by which parties can determine whether the DCO

    will clear a particular swap. As discussed in greater detail

    throughout this release, if counterparties want to enter into a swap

    that is in a class subject to required clearing and no DCO will

    clear the swap because it has other specifications that no DCO will

    accept, then the parties can still enter into that transaction on an

    uncleared basis.

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

    Regarding the latter, idiosyncratic specifications, examples

    include special representations added to address particular legal

    issues, unique termination events, special fees, and conditions tied to

    events specific to the parties. None of the DCOs clear interest rate

    swaps with terms in the second group. Accordingly, such specifications

    are not included in the classes of swaps subject to the clearing

    requirement proposed by this rule, and the Commission considered only

    the first group of more common specifications that are identified by

    the submitting DCOs in their product specifications.

    In short, the Commission recognizes that these other specifications

    may have an effect on the economic result to be

    [[Page 74304]]

    achieved with the swap.\112\ However, counterparties and DCOs may

    account for the effects of such specifications with adjustments to

    other specifications or in the price of the swap. Furthermore, DCOs

    account for various alternatives or range of alternatives for these

    terms without impairing risk management. Finally, as described above in

    more detail, including these specifications in the description of the

    swaps subject to a clearing requirement could increase the burden on

    counterparties when checking whether a swap may be subject to required

    clearing. Accordingly, the Commission has determined not to include

    other, non-class defining specifications in the swap class definition.

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

    \112\ LCH recommended in its submission that floating rate tenor

    (also known as frequency) also be a class level specification and

    the Commission acknowledges that floating rate tenor can, in some

    cases, be a fundamental specification for achieving the economic

    benefits of an interest rate swap. However, it is the Commission's

    view that floating rate tenor is more akin to the other non-class

    specifications in that it is not fundamental to all economic results

    that may be considered by parties when contemplating a swap and it

    is a specification for which the DCOs can fairly easily offer all of

    the standard tenors that parties may consider.

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

    vi. General Comments Received Regarding the Specifications

    Determination

    Numerous commenters expressed support for including the

    Commission's four interest rate swap classes and six class

    specifications in the clearing requirement and were of the view that

    the classes satisfy the five statutory factors the Commission is

    required to consider for the clearing requirement determination.\113\

    CME expressed support for the class-based approach in the rulemaking

    rather than swap-by-swap and stated that the Commission ``struck an

    appropriate balance for the initial slate of classes subject to the

    requirement.'' LCH commented that the six swap specifications selected

    are consistent with its recommendation in its IRS submission and

    reaffirmed the reasons cited in the NPRM for using these

    specifications.

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

    \113\ AllianceBernstein, R.J. O'Brien, Citadel, Eris Exchange,

    CME, FIA, D.E. Shaw, Arbor Research, LCH, Knight Capital, Jefferies,

    Coherence Capital, CRT Capital, Javelin Capital, SDMA, Chris

    Barnard, and Svenokur.

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

    Citadel agreed with the Commission's class-based approach rather

    than a product-by-product based approach. Citadel stated that the class

    designation approach ``reflects the risk management approach utilized

    across the industry, and most importantly by DCOs'' to determine margin

    levels and other safeguards and is therefore the starting point for the

    approved classes. Citadel further noted that different tenors or series

    of the same instruments, while displaying different characteristics,

    can be priced both based on market activity and by reference to more

    liquid contracts of the same instruments and are risk managed with the

    same risk management frameworks. Finally, Citadel expressed concern

    that not including products that otherwise share essential

    characteristics as swaps that are otherwise required to be cleared and

    that can be priced with reference to cleared swaps could risk the

    development of separate markets that avoid the clearing requirement.

    AFR noted that the interest rate swap classes selected properly

    reflect the risk profile of the interest rate swap market and will

    avoid uncertainty and complexity for the Commission and market

    participants. AFR also noted that details of product specifications

    such as slightly different tenors, are largely irrelevant, especially

    in the interest rate market and stated that any suggestion of a

    product-by-product approach should be interpreted as a tactic to delay

    implementation. Furthermore, AFR encouraged the Commission to designate

    swap classes to include low volume swaps that can be risk managed in

    ways that high-volume swaps in the class are risk managed. AFR's

    concern is that if the low-volume swaps are not included, they could be

    used to avoid the clearing requirement by replicating the swaps that

    are required to be cleared with the low-volume swaps. Citadel's and

    AFR's comments are consistent with the Commission's rationale for

    establishing the four classes of swaps and the six specifications for

    each class on which the Commission based its consideration of the five

    factors set forth in section 2(h)(2)(D)(ii) of the CEA. As noted in the

    NPRM, the Commission is directed under the CEA to make its

    determination for ``each swap, or any group, category, type, or class

    of swaps.'' The Commission first needed to establish the classes and

    class-defining specifications to which would then consider using the

    five statutory factors.

    ISDA commented that the Commission should not use what ISDA

    characterized as a newly-articulated standard for choosing the swap

    class-defining specifications based on whether they are ``fundamental

    to determining the economic result that parties are trying to

    achieve.'' ISDA expressed concern with what it characterized as a

    standard that it is not grounded in the five statutory factors of

    section 2(h)(2)(D)(ii) of the CEA and will fail to discriminate between

    swaps that may differ in terms of the five factors. Furthermore, in

    ISDA's view, the fundamental economic result depends on facts and

    circumstances of each transaction and the parties.

    The phrase ``fundamental to determining the economic result that

    parties are trying to achieve'' used by the Commission in the NPRM does

    not establish a new standard or replace the statutory five factor

    determination required by the CEA. Rather, the Commission used this

    phrase to describe one of several reasons for establishing which

    product specifications to use in defining each class to which the

    statutory five factor analysis was then applied. The phrase was used in

    the context of identifying the primary product specifications the

    submitting DCOs and the market use to value or price swaps within a

    class. As described at length in Section II.D of the NPRM, in

    establishing the swap classes to be considered, the Commission looked

    at how DCOs grouped the cleared interest rate swaps by certain defining

    types and specifications, how markets trade and view the products as

    classes, and how swaps that share certain common specifications can be

    priced and risk managed together as a class. The Commission's analysis

    for establishing the classes to be considered was not based on any new

    standard. Rather, the aforementioned phrase summarizes one element of

    the Commission's analysis of how to define the classes to be considered

    under the five factors established in the CEA.

    Furthermore, the five factor statutory analysis was separately

    undertaken for each class. For the reasons stated in defining the

    classes and class specifications, the Commission believes that the

    swaps within each class are sufficiently similar to apply the statutory

    analysis to each class. As noted above, many commenters agreed with

    this conclusion.

    Finally, regarding ISDA's view that the fundamental economic result

    depends on facts and circumstances of each transaction and the parties,

    the Commission recognizes that individual swap counterparties may have

    highly specific economic results they are trying to achieve with a swap

    and accordingly set the terms of the swap to achieve those specific

    results. However, the Commission's use of the phrase in the NPRM can be

    more clearly understood in context. The Commission was addressing

    whether certain specifications, other than the six specifications used

    to define each class, should be considered to be class-defining

    specifications. The Commission noted that certain specifications

    ``affect the value of the swap in a mechanical way, they are not,

    [[Page 74305]]

    generally speaking, fundamental to determining the economic result.''

    The Commission provided an example of how other specifications may

    affect the amounts payable on a swap on each payment date, but when

    valuing a swap for pricing and risk management purposes, together with

    other swaps within a class, these other specifications can be accounted

    for by making price adjustments off a standard price curve and

    therefore do not change the basic pricing economics of the swap to an

    extent that would necessitate classifying the swap separately from

    other swaps defined by the six specifications identified by the

    Commission.

    ISDA further commented that, although an overly intricate set of

    product specifications would impose burdens on the market, broad class

    designations impose greater burdens by creating the need for filtering

    products that a DCO will accept for clearing from the designated class.

    In ISDA's view, the Commission's statement in the NPRM that DCOs and

    vendors are ``likely'' to develop screening tools acknowledges the

    issue, but does not provide a solution. ISDA recommended that limiting

    clearing to swaps with prior clearing history supplemented by an

    advance DCO notice process would strike a reasonable balance.

    In response, the Commission notes that the identification of the

    four interest rate swap classes and the parameters for the six

    specifications within each class provides a fairly detailed and easy to

    use initial screening mechanism for market participants to determine

    whether a particular swap needs to be submitted for clearing. If a

    market participant determines that a swap falls into a class under

    Sec. 50.4, then the party will need to take reasonable efforts to

    determine whether any eligible DCO will accept the swap for

    clearing.\114\ The Commission noted in the NPRM that the DCOs or other

    vendors would likely develop screening tools for this purpose. The

    Commission further notes that each DCO and its members and the FCMs who

    clear through the DCO, in effect, already have the capability through

    their own onboarding processes and transaction affirmation platforms to

    screen swap transactions nearly instantaneously to determine whether

    the transactions will be accepted by the DCO. While those systems alone

    should be able to serve as a screening mechanism sufficient to allow

    for compliance with the clearing requirement, the Commission encourages

    the DCOs to create a tool to provide all market participants with the

    ability to independently screen potential swap transactions quickly and

    easily. CME commented that it already has a tool to screen particular

    swaps for eligibility. LCH stated in its comments that while the

    current information on its Web site is designed for dealer use, LCH is

    committed to revising the information to be easily understandable by

    all counterparties.

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

    \114\ See Section III.B for a discussion of the reasonable

    efforts standard in this context.

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

    Furthermore, the Commission does not agree that ISDA's proposal to

    limit the determination to swaps with prior clearing history would ease

    the screening process. DCOs, particularly LCH, already have prior

    clearing history for swaps with tens of thousands of different product

    specification combinations.\115\ Accordingly, even if the Commission

    adopted such an approach, the result would have the problems that a

    product-by-product approach would have, as acknowledged by ISDA. Also,

    the Commission agrees that an appropriate DCO notice framework will

    facilitate product screening and addresses this comment in Section III

    below.

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

    \115\ See, e.g., http://www.swapclear.com/why/ (stating that

    since 1999, LCH has cleared more than 2.2 million OTC interest rate

    swaps, $329 trillion notional, and compressed more than $145

    trillion (as of September 2012)).

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

    In addition, ISDA expressed concern that the discussion of

    specifications that are not included in the six class-specific

    specifications identified by the Commission could be read as a

    directive to abandon such other specifications to the extent they are

    not included in the swaps DCOs will accept for clearing. ISDA requested

    confirmation that footnote 97 of the NPRM (revised as footnote 111 in

    this final release) establishes that if a DCO does not accept a swap

    because the swap contains terms that the DCO does not clear, then

    entering into the swap as an uncleared transaction is permissible. ISDA

    further requested that the Commission state that entering into a swap

    that is not accepted for clearing does not raise a presumption of

    evasion.

    Similarly, Freddie Mac also expressed concern that the discussion

    of fundamental specifications and ``mechanical specifications'' may

    signal the Commission's judgment that parties are required to clear

    swaps that have sufficiently close substitutes. Freddie Mac requested

    that the Commission clarify the treatment of swaps that no DCO will

    clear and that parties may enter into uncleared swaps within a

    designated class if a DCO will not accept the swap provided that the

    variation in specifications is for a legitimate business purpose.

    Freddie Mac noted that section 2(h)(1)(A) of the CEA refers to an

    obligation to ``submit'' the swap for clearing rather than requiring

    that a swap must be successfully cleared. Freddie Mac expressed concern

    that failure to clarify this issue would lead to uncertainty as to the

    legality of uncleared swaps and that executing swap dealers or other

    market participants could use that uncertainty to insist on contractual

    rights to have the option to terminate a swap that fails to clear.

    The Commission confirms that the discussion of the class-defining

    swap specifications and other specifications served only to explain the

    Commission's differentiation between the class specifications and other

    specifications market participants use. The Commission is not requiring

    parties to take affirmative steps to substitute a clearable swap for an

    unclearable swap within a designated class.\116\

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

    \116\ See Sections II and III for further discussion of this

    issue.

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

    Regarding issues of what constitutes evasion of the clearing

    requirement when using a close substitute swap that is not cleared by a

    DCO and ISDA's request regarding a presumption regarding evasion of the

    clearing requirement, this issue, along with other evasion and abuse

    issues, are addressed in Section III.G of this release.

    With respect to the ``negative specifications,'' AFR commented that

    some of these specifications, such as dual currency and optionality,

    are composites of two derivatives including a basic interest rate swap

    that may be subject to the clearing requirement and that market

    participants should be required to clear components of such swaps that

    can be cleared to prevent evasion.

    This initial determination is based on the IRS submissions and

    because none of them include swaps that have the negative

    specifications, the Commission believes it is beneficial for swap

    market participants to expressly exclude those specifications so that

    parties that execute swaps with those specifications will know

    definitively that they are not subject to the clearing requirement.

    While the Commission is sensitive to concerns that the clearing

    requirement could be evaded by adding negative specifications to a swap

    to make it non-clearable, no data or other information is available at

    this time to indicate that compound swaps are being used for evasion.

    If the Commission observes such behavior or otherwise becomes aware

    that is occurring, it will consider

    [[Page 74306]]

    taking appropriate action under its authority provided in the CEA.

    The FSR requested clarification regarding the conditional notional

    amount specification. The FSR interpreted footnote 93 of the NPRM

    (footnote 108 of this adopting release) to mean that interest rate

    swaps entered into in connection with loans to hedge interest rate risk

    (the notional amounts of which are tied at all times to the outstanding

    principal amount of the loan) would not be subject to the clearing

    requirement if the principal amount of the loan would foreseeably vary

    over its term in an unscheduled or unpredictable manner.\117\ The FSR

    used the examples of a swap used to hedge a construction loan, where

    the loan would be drawn over time based on the needs of the

    construction project, and without a fixed draw schedule, or a swap

    entered into in connection with a revolving credit agreement or a

    credit agreement that permits voluntary prepayments. The FSR noted that

    such adjustment may be implemented through a partial termination event,

    permitting or requiring the lender/swap provider to reduce the

    outstanding notional amount of the swap so as to protect both the

    customer and the lender/swap provider from over-hedging.

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

    \117\ In a similar vein, ISDA commented that exclusions from the

    clearing requirements should be available if a party enters into one

    swap to hedge another swap and the hedge would no longer be

    functional if one trade of the pair would be cleared and the other

    not. Section 2(h)(7) of the CEA is clear with respect to this issue,

    and provides that only certain non-financial entities may elect not

    to clear certain swaps that hedge or mitigate commercial risk of the

    entity. The CEA does not extend this election to financial entities.

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

    In response to the FSR, the Commission clarifies that a

    ``conditional notional amount'' is a specification included in the swap

    at the time of execution that provides that the notional amount will

    change during the stated term of the swap in an unscheduled manner upon

    the occurrence of defined events or conditions. There are two elements

    to such a specification: First, the change in notional amount must be

    triggered by a defined event or condition, and second, the change must

    not be clearly predictable at the time the swap is executed.

    Accordingly, the two examples provided by the FSR might be swaps that

    have a conditional notional amount if the swaps include specifications

    or terms that provide for a change in notional amount triggered by an

    event tied to the hedged loan or credit line and the specific timing of

    that event is not sufficiently foreseeable or predictable when the swap

    is entered into such that the swap notional amount change could have

    been scheduled in advance. For example, a swap in which the parties

    agree that the notional amount will automatically be reduced upon a

    draw on a related construction loan identified in the swap or a

    prepayment of a loan identified in the swap would qualify as a swap

    with a conditional notional amount.

    However, the Commission notes that such a specification would not

    qualify if the reduction in the notional amount is voluntary. In this

    regard, a voluntary partial or full termination right is not an

    indication of a conditional notional amount. A party to a cleared swap

    can affect the same result as exercising a voluntary termination right

    at any time by entering into an equal and offsetting cleared swap.

    Clearing eliminates bilateral counterparty credit risk and therefore

    entering into an offsetting swap that is cleared with any party has the

    same effect as terminating the original swap. Accordingly, including a

    voluntary termination right in a swap that otherwise would be clearable

    and is subject to the clearing requirement serves no economic purpose

    that would distinguish the swap from other swaps in the class that are

    required to be cleared.

    As noted in the beginning of this Section II.E, the preceding

    analysis identified the classes of interest rate swaps and

    specifications within the classes to be considered by the Commission in

    the clearing requirement determination. In the following section in the

    NPRM, as summarized in this final release, the Commission took into

    account the statutory provisions under section 2(h)(2)(D) of the CEA

    with respect to the four classes of interest rate swaps and, within

    each class, the six identified product specifications.

    F. Proposed Determination Analysis for Interest Rate Swaps

    i. Consistency With Core Principles for Derivatives Clearing

    Organizations

    As noted above, section 2(h)(2)(D)(i) of the CEA requires the

    Commission to review whether a swap submission is consistent with the

    core principles for DCOs in making a clearing determination. As

    discussed in the NPRM, LCH and CME already clear all swaps identified

    in their respective IRS submissions and therefore each is subject to

    the Commission's review and surveillance procedures summarized in the

    NPRM. Accordingly, LCH and CME already are required to comply with the

    core principles set forth in section 5b(c)(2) of the CEA with respect

    to the swaps being considered by the Commission for the clearing

    requirement. The Commission further described in the NPRM its

    activities as a regulator to monitor and effect ongoing compliance with

    the core principles applicable to DCOs including periodic examinations

    and daily risk surveillance. Further, the Commission stated that the

    Commission does not believe that subjecting any of the interest rate

    swaps identified in the IRS submissions to a clearing requirement would

    alter compliance by the respective DCOs with the core principles.

    Based upon the Commission's ongoing reviews of DCOs' risk

    management frameworks and clearing rules, and its annual examinations

    of the DCOs, the Commission believes that the submissions of LCH and

    CME are consistent with section 5b(c)(2) if the CEA and the related

    Commission regulations. In analyzing the IRS submissions discussed

    herein, the Commission does not believe that a clearing requirement

    with regard to the specified interest rate swap classes would be

    inconsistent with LCH or CME's continued ability to maintain such

    compliance with the DCO core principles set forth in part 39 of the

    Commission's regulations.

    ii. Consideration of the Five Statutory Factors for Clearing

    Requirement Determinations

    Section 2(h)(2)(D)(ii) of the CEA identifies five factors the

    Commission shall consider in making a clearing requirement

    determination. The process for submission and review of swaps for a

    clearing requirement determination is further detailed in Sec. 39.5 of

    the Commission's regulations. This section summarizes the Commission's

    consideration the four classes of swaps identified in the preceding

    section under the statutory five factors in the context of the process

    established by regulation.

    a. Outstanding Notional Exposures, Trading Liquidity, and Adequate

    Pricing Data

    Section 2(h)(2)(D)(ii)(I) of the CEA requires the Commission to

    take into account the existence of outstanding notional exposures,

    trading liquidity, and adequate pricing data. In the NPRM, the

    Commission considered available market data and LCH cleared swap

    information. Unlike CDS for which substantially all of the trading data

    has been collected in one place, there is no single data source for

    notional exposures and trading liquidity for the

    [[Page 74307]]

    entire interest rate swap market.\118\ However, the Commission

    considered several sources of data on the interest rate swap market

    that collectively provides the information the Commission needs to make

    a clearing requirement determination. As described in the NPRM, the

    data sources that the Commission considered include: general estimates

    published by the Bank for International Settlements (BIS data); market

    data published weekly by TriOptima (TriOptima data) covering swap trade

    information submitted voluntarily by 14 large derivatives dealers (G14

    Dealers); trade-by-trade data provided voluntarily by the G14 Dealers

    to the OTC Derivatives Supervisors Group for a three month period

    between June and August 2010 (ODSG data); and trade-by-trade data for

    swaps cleared by LCH for the first calendar quarter of 2012 (LCH

    data).\119\

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

    \118\ See Bank of England, ``Thoughts on Determining Central

    Clearing Eligibility of OTC Derivatives,'' Financial Stability Paper

    No. 14, March 2012, at 11, available at http://www.bankofengland.co.uk/publications/Documents/fsr/fs_paper14.pdf.

    \119\ All DCOs were required to begin providing daily position

    data to the Commission as of November 8, 2012. CME's available data

    was considered too limited to provide any indication of the complete

    interest rate swap market. Because LCH clears a large portion of the

    swap products it offers clearing for (based on available

    information, LCH claims to have cleared approximately 50 to 90

    percent of the dealer open interest in the different interest rate

    swap products that it clears), its data provides some indication of

    the possible notional exposures and liquidity in the products

    submitted by LCH that the Commission considered. Given the

    limitations on other available data, the Commission believes it is

    useful to consider the LCH data along with the market-wide BIS data,

    ODSG data, and TriOptima data.

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

    The NPRM explained in detail that each data source used has a

    number of limitations that are important to understand when considering

    the data. The Commission incorporates the discussion of those

    limitations found in the NPRM into this final release.

    For this determination, the Commission only considered the swaps

    identified in the IRS submissions. Accordingly, where possible, the

    Commission presented and discussed only the data for swaps identified

    in the submissions. The analysis of interest rate swap data in the NPRM

    was presented based on the four swap classes and the class

    specifications. This information was used by the Commission to

    determine whether there exists significant outstanding notional

    amounts, trading liquidity, and pricing data to include each class and

    specification identified in the IRS submissions.

    For purposes of this final release, the Commission is incorporating

    the data tables in the NPRM by reference and the considerations and

    conclusions drawn by the Commission following review of the data is

    summarized below.\120\ Readers are encouraged to refer to the NPRM to

    review the data presented. None of the comments received in response to

    the NPRM raised issues with the data analyzed in the NPRM.

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

    \120\ The ODSG data has not been updated since 2010. The BIS

    data that was available when the NPRM was published was from the

    second half of 2011 and the TriOptima and LCH data used was from the

    first quarter of 2012. The BIS has not published updated data as of

    this writing. TriOptima stopped publishing the interest rate swap

    data in April, 2012. DTCC began collecting similar data at that time

    and is now provisionally registered by the Commission as a SDR. The

    Commission has reviewed data from DTCC and LCH and confirmed that

    the recent data available is consistent with the data used in the

    NPRM to develop the interest rate swap clearing requirement rule,

    taking into consideration normal changes in market activity.

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

    1. Interest Rate Swap Class

    In the NPRM, the Commission considered data relevant to the

    different interest rate swap classes included in the IRS submissions.

    The BIS data provided certain big picture information. It indicated

    that interest rate swaps in total constituted nearly 80% of the

    derivatives market and interest rate swap notional amounts generally

    increased for all three kinds of swaps between 2008 and 2011 with total

    interest rate swap notional amounts reported growing by about 15%

    during that period. Additionally, all three classes of swaps identified

    by the BIS data have substantial notional amounts outstanding. As of

    December 2011, FRAs had about $50.5 trillion outstanding, optional

    swaps had about $51 trillion outstanding, and other interest rate swaps

    had about $403 trillion outstanding. Given this information, the

    Commission concluded that none of the kinds of swaps identified by the

    BIS should be eliminated from consideration by the Commission for a

    clearing requirement based on the BIS data alone. However, the BIS data

    did not provide enough detail to reach further conclusions regarding

    the swaps identified in the IRS submissions.

    The TriOptima data and the ODSG data sets were used to identify

    notional amounts and trade counts for all four classes of swaps

    identified in the IRS submissions. Trading liquidity as an indication

    of how effectively DCOs can risk manage a portfolio of swaps can be

    evidenced in several ways. The data available for this purpose included

    total notional amount outstanding, total number of swaps outstanding,

    and the average number of transactions over a given period of time.

    The TriOptima data showed that all four classes have significant

    outstanding notional amounts with basis swaps being the lowest at about

    $27.6 trillion and the highest being fixed-to-floating swaps at $288.8

    trillion. Total trade counts for each type were also significant with

    the lowest being 109,704 for OIS and the highest being fixed-to-

    floating swaps at 3,239,092.

    The average number of swap trades per week for each class of swaps

    was evidenced by the ODSG data. According to the ODSG data set, basis

    swaps were traded at the lowest frequency compared to the other three

    classes at 240 times on average each week during the ODSG data period.

    Because the ODSG data is from the summer of 2010 and gross notional

    amounts and trading activity in interest rate swaps have both increased

    generally, the Commission believes that trading activity has likely

    increased for all classes since the ODSG data was collected.

    The LCH data generally confirmed the assessment of market-wide

    data. There is substantial outstanding notional volumes and trade

    liquidity for each of the four classes already being cleared at LCH.

    LCH cleared the following percentage of each class of swap as

    reported by TriOptima: \121\

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

    \121\ Percentages are calculated based on total notional amount

    cleared by LCH divided by total notional outstanding as reported by

    TriOptima. The TriOptima data is used because it is the most current

    data set that provides data broken out according to the classes

    being cleared.

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

    75% of the Fixed-to-Floating swaps,

    41% of FRAs,\122\

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

    \122\ LCH started clearing FRAs in December 2011 and cleared

    volumes have increased significantly each month since the start

    date. As of March 31, 2012, the date for which the data was

    presented in the NPRM, LCH had a total notional amount outstanding

    of cleared FRAs of $27.7 trillion. As of October 15, 2012, that

    amount had increased to $58.6 trillion.

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

    84% of OIS, and

    41% of Basis Swaps.

    Accordingly, a substantial portion of each class is already being

    cleared voluntarily.

    Swap Class Conclusion

    The Commission concluded in the NPRM that the four classes of swaps

    currently being cleared have significant outstanding notional amounts

    and trading liquidity. The Commission further noted that a substantial

    percentage of each of the four classes was already being cleared.

    A number of commenters commented that the four interest rate swap

    classes are cleared in material volumes at this

    [[Page 74308]]

    time and expressed support for including the four interest rate swap

    classes in the clearing requirement designation based on the data

    available.\123\ Citadel agreed with the Commission's conclusion that

    the data presented in the NPRM demonstrate substantial outstanding

    notional exposures and a high level of trading liquidity in the

    relevant classes of swaps. Citadel commented that liquidity, for

    purposes of the clearing requirement, should be determined on grounds

    other than trading activity alone. Specifically, market depth can be

    evidenced by the number of dealers quoting two-way markets in a

    product, and the notional sizes of the quoted bids and offers, is also

    a liquidity indicator. Citadel noted that multiple dealers regularly

    quote two-way markets in the swaps covered by the proposed rule in

    meaningful sizes through a variety of mediums, including in periods of

    market stress, and therefore it believes there is ample trading

    liquidity to support a clearing requirement for the classes designated.

    For the reasons described above, the Commission reaffirms the

    aforementioned conclusions provided in the NRPM regarding the classes

    of interest rate swaps proposed in the NPRM for required clearing.

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

    \123\ See letters from FIA PTG, Arbor Research and Trading, LLC,

    R.J. O'Brien, Svenokur, LLC, Chris Barnard, CRT Capital Group

    (Robert Gorham), LLC, DRW Trading Group, Javelin, SDMA, Knight

    Capital Americas LLC, Bart Sokol (CRT Capital Group), Jefferies &

    Company, Inc., MarketAxess, Eris Exchange, Coherence Capital

    Partners LLC, Citadel, AFR, D.E. Shaw Group, AllianceBernstein, LCH,

    CME, and ICE.

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

    2. Currency

    As discussed above in Section II.E, the currency in which the

    notional and payment amounts are specified is a primary product

    specification and all four data sources provide interest rate swap data

    by currency.

    The BIS data addressed seven of the seventeen currencies identified

    in the submissions individually. All seven currencies had substantial

    outstanding notional amounts as of December 2011, ranging from nearly

    $5.4 trillion for the Swiss franc to about $185 trillion in euro. For

    all currencies, the outstanding notional amounts were higher at the end

    of the most recent three-year period as compared to the beginning of

    the period.

    The Commission believes that the BIS data supports the conclusion

    that there exists significant outstanding notional amounts in each

    currency identified in the BIS data and that there is no indication

    that notional amounts in those currencies are decreasing at a rate that

    would warrant elimination of those currencies from consideration for a

    clearing requirement.

    The TriOptima data showed that total outstanding notional amounts

    as of March 16, 2012, ranged from $400 billion for Czech koruna to over

    $176 trillion notional amount for euro.\124\ While there may be

    sufficient outstanding notional amounts in all seventeen currencies,

    the Commission noted in the NPRM that there is a clear demarcation

    between the four currencies with the highest outstanding notional

    amounts: euro, U.S. dollar, British pound, and yen, and all other

    currencies. The four top currencies ranged from about 9% to 36% of the

    total notional amount of all interest rate swaps outstanding and 11% to

    33% of the total number of swap trades. The remaining currencies ranged

    from about 2% down to 0.1% of the total notional amount traded and 3%

    down to 0.2% of total number of trades. In fact, the four major

    currencies accounted for about 93% of the total notional amount

    outstanding in the TriOptima data set.

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

    \124\ TriOptima data, as of March 16, 2012.

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

    The ODSG data provided an indication of trading liquidity in terms

    of average weekly notional amount traded and number of new trades

    completed during the period covered by the data set. Of the four major

    currencies, Japanese yen had the lowest weekly average notional at $323

    billion and the British pound had the lowest average number of trades

    each week at 1,233.

    The TriOptima data provided an overall, more current view of trades

    outstanding, which provides a broader picture of the trading potential

    for each currency for purposes of DCO risk management. As of March 16,

    2012, all but one of the seventeen currencies had outstanding trade

    counts in excess of 14,000 with the exception being the Danish krone at

    6,849. Again, the four highest currencies by trade count: euro, U.S.

    dollar, British pound, and yen, accounted for about 85% of the total

    number of trades recorded and outstanding at the time the data was

    collected.

    The LCH data showed that the relative notional amount and number of

    swaps in each currency cleared is generally correlated with the

    notional amount and number of swaps of each currency reported by the

    more general market data sets. As a percentage of the total notional

    amount outstanding as reported by TriOptima, LCH cleared the following

    percentages: \125\

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

    \125\ The TriOptima data is used for this calculation because it

    is the most current data set that provides data broken out according

    to the classes currently being cleared.

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

    66% of euro,

    61% of U.S. dollars,

    58% of British pounds,

    59% of Japanese yen, and

    42% of other currencies.

    Of the interest rate swaps identifying U.S. dollars, euro, British

    pounds or yen as the applicable currency, significantly more than half

    were already being cleared by LCH. While the level of clearing of other

    currencies was, on a combined basis reasonably high at 42%, the

    Commission noted the level is noticeably lower than the percentage of

    swaps being cleared for the top four currencies.

    Currency Specification Conclusion

    The Commission concluded in the NPRM that all of the data sets

    demonstrate the existence of significant outstanding notional amounts

    and trading liquidity in the seventeen currencies identified in the IRS

    submissions. However, the Commission noted that swaps using the four

    currencies with the highest outstanding notional amounts and trade

    frequency: euro, U.S. dollar, British pound, and yen, account for an

    outsized portion of both notional amounts outstanding and trading

    volumes. Furthermore, the Commission noted that these four currencies

    are already being cleared more than the other currencies generally.

    While it is important that this determination include a substantial

    portion of the interest rate swaps traded to have a substantive,

    beneficial impact on systemic risk, the Commission also recognized that

    the final rule is the Commission's first swap clearing requirement

    determination. As noted in the phased implementation rules for the

    clearing requirement, the Commission believes that introducing too much

    required clearing too quickly could unnecessarily increase the burden

    of the clearing requirement on market participants. In recognition of

    these considerations, the Commission determined in the NPRM to focus

    the remainder of this initial clearing requirement determination

    analysis on swaps referencing the four most heavily traded currencies.

    The Commission noted that the decision not to include the other

    thirteen currencies at this time does not limit the Commission's

    authority to reconsider required clearing of those currencies in the

    future.

    [[Page 74309]]

    LCH commented that it supports the Commission's decision to

    initially limit the interest rate swap clearing determination to swaps

    with USD, EUR, GBP, and JPY as the underlying currency, and recommended

    that the Commission propose mandatory clearing of swaps in the other 13

    currencies identified in the IRS submission after the initial phase of

    the clearing requirement is well-established. LCH stated that there is

    ample volume and liquidity in swaps denominated in those currencies to

    support a clearing requirement determination and that it would be

    beneficial for the market if the Commission would clarify whether and/

    or when it plans to make clearing of swaps denominated in other

    currencies mandatory.

    The Commission reaffirms the conclusions in its proposed

    determination to limit the interest rate swap clearing determination to

    interest rate swaps with USD, EUR, GBP, and JPY as the underlying

    currency, at this time. In response to LCH, the Commission reiterates

    that not including interest rate swaps in the other 13 currencies in

    this determination in no way forestalls the Commission from initiating

    a new clearing requirement determination for interest rate swaps in

    those currencies. The decision not to include them at this time was

    based on the fact that this is the initial clearing requirement

    determination and the Commission is mindful that market participants

    will be undertaking significant activity to implement compliance for

    the first time. Accordingly, the Commission has effectively delayed

    consideration of these currencies so that the market will have time to

    adapt to mandatory clearing of interest rate swaps in the four primary

    currencies, with the expectation that thereafter, the additional

    currencies can be added fairly easily. The Commission expects to

    initiate a clearing determination for interest rate swaps in the 13

    currencies at some time in 2013.

    3. Floating Rate Index Referenced

    The ODSG data and LCH data provided an indication of the rate

    indices used on a transaction-by-transaction basis. Rate indexes are

    currency specific. The ODSG data showed minimal activity for the EUR-

    LIBOR index with about $1 billion of notional amount and five trades

    made for the three month period in 2010 that the ODSG data covers. EUR-

    LIBOR does not appear on the LCH data table because, although swaps

    referencing that index can be cleared at LCH, LCH had no open interest

    for that index as of March 31, 2012. Given the minimal notional amounts

    and trade liquidity for the EUR-LIBOR index, the Commission determined

    in the NPRM not to include EUR-LIBOR under the clearing requirement.

    The other rate indexes all showed significant notional amounts and

    trading liquidity. The rates with the least activity, the U.S. dollar

    Fedfund index and British pound-LIBOR index, each have over one

    trillion dollars in notional outstanding already cleared at LCH and $93

    billion and $82 billion in notional amount, respectively, were cleared

    per week on average. In terms of number of trades cleared at LCH, swaps

    referencing Fedfunds were cleared on average 116 times per week and

    swaps referencing British pound-LIBOR were cleared 888 times per week

    on average. All of the other indices cleared have similar or

    substantially higher numbers of trades and notional amounts cleared.

    In the NPRM, the Commission noted that the rate indexes used for

    over-the-counter interest rate swaps reference not only the generic

    index, but a reference definition for the index such as the ISDA

    definition or Reuters definition. While the Commission recognized the

    importance of these reference definitions for each swap contract, the

    Commission concluded that such definitions are not relevant for

    purposes of the clearing requirement determination. Furthermore, if the

    parties to a swap identify a specific reference definition for an

    index, they need only confirm whether any eligible DCO accepts that

    reference definition. If none do, then the swap in question is not

    accepted for clearing and it is not subject to the clearing

    requirement.

    Rate Index Specification Conclusion

    The Commission concluded in the NPRM that with the exception of the

    EURO-LIBOR index, swaps using all of the rate indexes identified in the

    IRS submissions have significant outstanding notional amounts and

    trading liquidity and that significant notional amounts of swaps using

    these rate indexes are already cleared by DCOs.

    The Commission received no comments on the rate index specification

    determination, and confirming its conclusions regarding the rate index

    specifications identified in the NPRM.

    4. Stated Termination Dates

    Stated termination date (sometimes referred to as ``maturities'')

    data is often presented by aggregating stated termination dates for

    swaps into specified term periods or ``buckets.'' The IRS submissions

    showed that the DCOs have been clearing interest rate swaps with final

    termination dates out to at least ten years for all seventeen

    currencies noted above and out to 50 years for some classes and

    currencies.

    Stated termination dates can fall on any day of the year. Given

    this continuum of termination dates, the DCOs have indicated that they

    manage the cleared swap portfolio risk using a swap curve.\126\ Swap

    curves are also used by market participants to price interest rate

    swaps. By pricing swaps in this way, the economic results of an

    interest rate swap can be fairly closely approximated, and therefore

    hedged, using two or more other swaps with different maturities

    principally by matching the weighted average duration of those swaps

    with the duration of the swap being hedged.\127\ In the same manner, a

    large portfolio of interest rate swaps can be hedged fairly closely

    with a small number of hedging swaps that have the same duration as the

    entire portfolio or subsets of related swaps within the portfolio. In

    effect, for DCO risk management purposes, the termination dates of

    interest rate swaps are assessed based on how they affect the overall

    duration aspects of the portfolio of swaps cleared.\128\ Accordingly,

    the primary determination with respect to the stated termination date

    specification is, for each class and currency, at what point, if any,

    along the continuum of swap maturities does the notional outstanding

    and trading liquidity become insufficient to structure the swap curve

    effectively for DCO risk management purposes.

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

    \126\ The ``swap curve'' is the term generally used by market

    participants for interest rate swap pricing and is similar to, and

    is sometimes established, in part, based on, ``yield curves'' used

    for pricing bonds.

    \127\ Other factors, such as convexity, may also be taken into

    account in determining the appropriate hedge ratio between the

    initial swap and the other swaps used to hedge its exposure.

    \128\ For further discussion of the use of portfolio risk

    management by DCOs, see the discussion of interest rate swap market

    conventions and risk management in Section II.E above.

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

    The TriOptima data provided sufficient detail to discern notional

    amounts and trade counts only for each swap class. The ODSG data

    provided sufficient detail to discern notional amounts and trade counts

    only for each currency. The LCH data provided enough detail for both

    swap class and currency.

    The TriOptima data and LCH data summarized in the NPRM showed that

    for fixed-to-floating swaps and basis swaps, there was significant

    outstanding notional amounts and number of trades for all maturity

    buckets being cleared.

    [[Page 74310]]

    For FRAs, the TriOptima data showed a steep drop off after two

    years, although in the two to five year bucket, there is still over $1

    trillion dollars of outstanding notional amount and 1,646 trades. The

    LCH data showed substantial outstanding notional amounts of FRAs out to

    two years and none thereafter. The IRS submissions provide that the

    DCOs do not clear FRAs with payment dates beyond three years.

    Accordingly, the Commission need not consider FRAs with maturities

    beyond three years until such time as a DCO submits such swaps for

    clearing.

    For OIS, the TriOptima data showed notional amounts for all

    maturity buckets, but the drop off was steep beyond two years. After

    ten years, outstanding notional amounts drop below $100 billion for

    each maturity bucket. The LCH data showed no outstanding notional

    amounts cleared beyond two years. The IRS submissions provide that the

    DCOs do not accept for clearing OIS swaps beyond two years.

    Accordingly, the Commission did not consider OIS swaps beyond two years

    in this clearing requirement determination.

    The ODSG data and LCH data presented in the NPRM showed notional

    amounts traded for maturity buckets by currency. There were traded and

    cleared notional amounts for euro, U.S. dollars, and British pounds out

    to the 30 to 50 year bucket and for yen out to the twenty to thirty

    year bucket. The LCH data confirms that substantial notional amounts of

    swaps in euro, U.S. dollars, and British pounds are being cleared out

    to 50 years and yen out to 30 years.

    Stated Termination Date Specification Conclusion

    For the classes of swaps considered by the Commission in the NPRM,

    the TriOptima data showed that there were significant outstanding

    notional amounts and number of trades out to 50 years for fixed-to-

    floating swaps and basis swaps, out to 10 years or more for OIS, and

    out to 2 years for FRAs. With respect to currencies, the ODSG data and

    LCH data show significant outstanding notional amounts and number of

    trades in swaps out to 50 years for U.S. dollars, euro, and British

    pounds and out to 30 years for yen.

    Citadel noted that different tenors of the same instruments, while

    displaying incrementally different characteristics, are priceable both

    based on market activity and also with reference to more liquid or on-

    the-run (or, as the case may be, already cleared) transactions of the

    same instruments, and are risk managed using the same risk management

    frameworks. Accordingly, swaps within a designated class with

    incrementally different tenors do not require a new review that would

    incur excessive delay. For the aforementioned reasons, the Commission

    confirming its conclusions regarding required clearing for interest

    rate swaps with the stated termination date specifications as proposed

    in the NPRM.

    5. Adequate Pricing Data

    In the NPRM, the Commission took into account the adequacy of the

    pricing data for the four classes of interest rate swaps. LCH stated in

    its IRS submission that there is adequate pricing data for risk and

    default management. It explained that its risk and default management

    is based on the following factors under normal and stressed conditions:

    Outstanding notional, by maturity bucket and currency;

    Number of participants with live open positions, by

    maturity bucket and currency;

    Notional throughput of the market, by maturity bucket and

    currency;

    Size tradable that would not adjust the market price, by

    maturity bucket;

    Number of potential direct clearing members clearing the

    products that are part of the mutualized default fund and default

    management process;

    Interplay between on-the-run and off-the-run contracts;

    and

    Product messaging components and structure.

    LCH carries out a fire drill of its default management procedures

    and readiness twice a year. According to LCH, the fire drill presents

    an opportunity to further benchmark market liquidity and behavior and

    for models and assumptions to be recalibrated based on practitioner

    input. LCH also tests liquidity assumptions from the outset when

    developing clearing capabilities for a new product and thereafter, on a

    daily basis. This testing informs how LCH develops and modifies its

    risk management framework to provide adequate risk coverage in

    compliance with the core principles applicable to DCOs. Based on this

    framework, LCH contends that there is adequate pricing data for the

    swaps offered for clearing.

    CME represented in its IRS submission that its interest rate swap

    valuations are fully transparent and rely on pricing inputs obtained

    from wire service feeds. Further, CME uses conventional pricing

    methodologies, including OIS discounting, to produce its zero coupon

    curve off of which cleared swaps of all stated termination dates are

    priced. In addition, customers are provided with direct access to daily

    reports showing curve inputs, daily discount factors, and valuations

    for each cleared swap position.

    It is also worth noting that those interest rate swaps that are the

    subject of this proposal are capable of being priced off of deep and

    liquid debt markets. Because of the stability of access to pricing data

    from these markets, the pricing data for non-exotic interest rate swaps

    that are currently being cleared is generally viewed as non-

    controversial.

    In response to the NPRM, Citadel commented that its experience

    regarding trading liquidity further lead it to conclude that there is

    sufficient data in the market for DCOs to perform required pricing and

    risk management of the classes of swaps included in the proposed rule.

    Finally, Citadel commented that access to reliable pricing data will

    only improve over time as the Dodd-Frank rules promoting transparency

    are implemented. No other comments were received on this factor.

    Based on consideration of the existence of significant outstanding

    notional exposures, trading liquidity, and adequate pricing data, as

    described in the NPRM, the Commission is reaffirming in this release

    its decision to include interest rate swaps with the following

    specifications in the clearing requirement rule and to consider the

    other four factors identified in section 2(h)(2)(D) of the CEA with

    respect to these swaps.

    Table 5--Interest Rate Swap Determination

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

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

    Specification Fixed-to-floating swap class

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

    1. Currency..................... U.S. Dollar (USD). Euro (EUR)........ Sterling (GBP).... Yen (JPY).

    2. Floating Rate Indexes........ LIBOR............. EURIBOR........... LIBOR............. LIBOR.

    3. Stated Termination Date Range 28 days to 50 28 days to 50 28 days to 50 28 days to 30

    years. years. years. years.

    4. Optionality.................. No................ No................ No................ No.

    5. Dual Currencies.............. No................ No................ No................ No.

    [[Page 74311]]

    6. Conditional Notional Amounts. No................ No................ No................ No.

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

    Specification Basis Swap Class

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

    1. Currency..................... U.S. Dollar (USD). Euro (EUR)........ Sterling (GBP).... Yen (JPY).

    2. Floating Rate Indexes........ LIBOR............. EURIBOR........... LIBOR............. LIBOR.

    3. Stated Termination Date Range 28 days to 50 28 days to 50 28 days to 50 28 days to 30

    years. years. years. years.

    4. Optionality.................. No................ No................ No................ No.

    5. Dual Currencies.............. No................ No................ No................ No.

    6. Conditional Notional Amounts. No................ No................ No................ No.

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

    Specification Forward Rate Agreement Class

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

    1. Currency..................... U.S. Dollar (USD). Euro (EUR)........ Sterling (GBP).... Yen (JPY).

    2. Floating Rate Indexes........ LIBOR............. EURIBOR........... LIBOR............. LIBOR.

    3. Stated Termination Date Range 3 days to 3 years. 3 days to 3 years. 3 days to 3 years. 3 days to 3 years.

    4. Optionality.................. No................ No................ No................ No.

    5. Dual Currencies.............. No................ No................ No................ No.

    6. Conditional Notional Amounts. No................ No................ No................ No.

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

    Specification Overnight Index Swap Class

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

    1. Currency..................... U.S. Dollar (USD). Euro (EUR)........ Sterling (GBP).

    2. Floating Rate Indexes........ FedFunds.......... EONIA............. SONIA.

    3. Stated Termination Date Range 7 days to 2 years. 7 days to 2 years. 7 days to 2 years.

    4. Optionality.................. No................ No................ No.

    5. Dual Currencies.............. No................ No................ No.

    6. Conditional Notional Amounts. No................ No................ No.

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

    b. Availability of Rule Framework, Capacity, Operational Expertise and

    Resources, and Credit Support Infrastructure

    Section 2(h)(2)(D)(ii)(II) of the CEA requires the Commission to

    take into account the availability of rule framework, capacity,

    operational expertise and resources, and credit support infrastructure

    to clear the proposed classes of swaps on terms that are consistent

    with the material terms and trading conventions on which they are now

    traded. The Commission stated in the NPRM that it believed that LCH and

    CME,\129\ have developed rule frameworks, capacity, operational

    expertise and resources, and credit support infrastructure to clear the

    interest rate swaps they currently clear on terms that are consistent

    with the material terms and trading conventions on which those swaps

    are being traded. The Commission noted that LCH already clears more

    than half the global interest rate swaps in the four proposed classes

    of the clearing requirement and that CME also already cleared the more

    commonly traded swaps under this clearing requirement proposal. The

    Commission further notes that CME has recently added, or has stated

    publicly that it intends to add by the end of 2012, swaps in all four

    classes and at least the four currencies included in the final rule.

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

    \129\ IDCH was also included in this discussion in the NPRM.

    However, as discussed above, IDCH has been acquired by LCH and is

    now LCH.LLC and its rules and product offering are being revised to

    be substantially the same as LCH's. Accordingly, the rule

    frameworks, capacity, operational expertise and resources, and

    credit support infrastructure for IDCH is not discussed in this

    final release, but is being assessed by the Commission as part of

    LCH.LLC's request for approval of its rulebook and risk management

    framework revisions.

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

    The Commission also noted that the DCOs each developed their

    interest rate swap clearing offerings in conjunction with market

    participants and in response to the specific needs of the marketplace.

    In this manner, the clearing services of each DCO are designed to be

    consistent with the material terms and trading conventions of a

    bilateral, uncleared market.

    LCH submitted that it has the capability and expertise to manage

    the risks inherent in the current book of interest rate swaps cleared

    and the increased volume that the clearing requirement could generate

    for all of its currently clearable products. LCH has developed

    operational models, controls, and risk algorithms to ensure that it can

    process trades, and is capable of calculating the level of risk it has

    with any counterparty--both direct clearing members and their

    customers.

    CME's IRS submission cited to its rule books to demonstrate the

    availability of rule framework, capacity, operational expertise and

    resources, and credit support infrastructure to clear qualified,

    interest rate swap contracts on terms that are consistent with the

    material terms and trading conventions on which the contracts are then

    traded.

    After considering the information provided by the DCOs in the IRS

    submissions and the nature and extent of clearing already undertaken by

    the DCOs of existing bilateral swaps, the Commission concluded in the

    NPRM that there is available rule framework, capacity, operations

    expertise and resources, and credit support infrastructure consistent

    with the material terms and trading conventions on which the swaps

    included in the four interest rate swap classes are designated.

    Citadel commented that the fact that all swaps included in the four

    interest rate swap classes are being cleared in material volumes

    provides clear evidence that there is the rule framework, capacity,

    operational expertise and resources, and credit support infrastructure

    necessary to clear each of the swaps that are included in the

    Commission's determination. Further, Citadel stated that because

    registered DCOs are required to be in compliance on an on-going basis

    with the DCO core principles in the CEA, they ``by definition'' have

    demonstrated that they satisfy this factor. In addition, Citadel noted

    that the DCOs have been preparing for and anticipating increased

    volumes as a result of the clearing requirement since the enactment of

    the Dodd-Frank Act, if not earlier. Also, under the Commission's

    implementation rule,\130\ there is a 270-

    [[Page 74312]]

    day period provided to allow DCOs, customers, FCMs, and all others

    engaged in the clearing process to test and ramp up customer clearing

    volumes voluntarily, and be in position to manage full production

    clearing volumes during the phase-in of the clearing requirement.

    Citadel stated that it believed the DCOs and FCMs are well prepared for

    a surge in clearing volumes and have the framework, capacity,

    expertise, resources and infrastructure to support it in a safe and

    sound manner and that Citadel's own experience in commencing voluntary

    clearing of swaps confirms its observations.

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

    \130\ 77 FR at 44441-44456.

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

    For the reasons described above, and as discussed in the NPRM, the

    Commission reaffirms that there is available rule framework, capacity,

    operations expertise and resources, and credit support infrastructure

    consistent with the material terms and trading conventions on which the

    swaps included in the four interest rate swap classes are designated.

    c. Effect on the Mitigation of Systemic Risk

    Section 2(h)(2)(D)(ii)(III) of the CEA requires the Commission to

    consider the effect on the mitigation of systemic risk, taking into

    account the size of the market for such contract and the resources of

    the DCO available to clear the contract. CME, LCH, and IDCH stated in

    their IRS submissions that subjecting interest rate swaps to central

    clearing would help mitigate systemic risk. As stated above in the

    analysis of interest rate swap market data, the Commission believes

    that the market for these swaps is significant and mitigating

    counterparty risk through clearing likely would reduce systemic risk in

    the swap market and the financial system as a whole.

    According to LCH's IRS submission, if all clearable swaps are

    required to be cleared, the inevitable result will be a less disparate

    marketplace from a systemic risk perspective. CME submits that the 2008

    financial crisis demonstrated the potential for systemic risk arising

    from the interconnectedness of OTC derivatives market participants and

    that centralized clearing will reduce systemic risk.

    IDCH stated in its IRS submission that, given the tremendous size

    of the interest rate derivatives market, the potential mitigation of

    systemic risk through centralized clearing of interest rate swaps is

    significant. IDCH asserted that clearing such swaps brings the risk

    mitigation and collateral and operational efficiency afforded to

    cleared and exchange-traded futures contracts to bilaterally negotiated

    OTC interest rate derivatives. The submission of interest rate swaps

    for clearing affords the parties the credit, risk management, capital,

    and operational benefits of central counterparty clearing of such

    transactions, and facilitates collateral efficiency. Cleared swaps

    allow market participants to free up counterparty credit lines that

    would otherwise be committed to open bilateral contracts. Additionally,

    according to IDCH, an efficient system for centralized clearing allows

    parties to mitigate the risk of a bilateral OTC derivative. Instead of

    holding offsetting positions with different counterparties and being

    exposed to the risk of each counterparty, a party may enter into an

    economically offsetting position that is cleared. Although the

    positions are not offset, the initial margin requirement will be

    reduced to close to zero. To eliminate risk without using centralized

    clearing, the party must enter into a tear-up agreement with the

    counterparty, or enter into a novation.

    While the clearing requirement would remove a large portion of the

    interconnectedness of current OTC markets that leads to systemic risk,

    the Commission noted in the NPRM that central clearing concentrates

    risk in a handful of entities. However, the Commission observed that

    central clearing was developed and designed to handle such

    concentration of risk. LCH has extensive experience risk managing very

    large volumes of interest rate swaps. Based on available data, it is

    believed that about half of all interest rate swaps transacted are

    cleared by LCH. CME submitted that it has the necessary resources

    available to clear the swaps that are the subject of its submission.

    The Commission notes that CME or its predecessors have cleared futures

    since 1898 and is the largest futures clearinghouse in the world. CME

    has not defaulted during that time.

    Accordingly, the Commission stated in the NPRM, and reaffirms in

    this release that it believes that LCH and CME have the resources

    needed to clear the interest rate swaps included in its determination

    and to manage the risk posed by clearing interest rate swaps that are

    required to be cleared. In addition, the Commission believes that the

    central clearing of the interest rate swaps that are the subject of

    this determination and final rule would serve to mitigate counterparty

    credit risk thereby having a positive effect on reducing systemic risk.

    In support of the Commission's determination regarding systemic

    risk, Citadel commented that the transition from an interconnected

    network of bilateral derivatives exposures to central clearing in

    regulated clearing houses will mitigate systemic risk. In support of

    this assertion, Citadel cited a New York Federal Reserve Board staff

    paper \131\ and noted that central clearing stands as a pillar of the

    Dodd-Frank Act. Citadel explained that central clearing eliminates the

    prospect of firms becoming too interconnected to fail by virtue of

    their bilateral swap positions and ensures that sufficient margin is

    reserved against each side of each swap, while further mitigating any

    default event through mutualization funds, clearing member obligations,

    and the additional financial safeguards of the regulated DCO.

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

    \131\ See, e.g., Policy Perspectives on OTC Derivatives Market

    Infrastructure by Duffie, Li, and Lubke (March 2010), available at

    http://www.newyorkfed.org/research/staff_reports/sr424.pdf.

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

    Citadel further asserted that the Commission's determination takes

    the decisive step, long anticipated and prepared for by the market, of

    making mandatory central clearing of the most liquid and standardized

    swaps a reality. Citadel went on to express confidence that the

    transition to required clearing of liquid swaps will support and

    incentivize the expansion of the cleared product set, because it will

    be more economically efficient for market participants to hold as much

    of their portfolios as possible in a single margined basket at a DCO.

    Citadel concluded that the Commission's clearing requirement rule thus

    provides the certainty needed for market participants to transition

    more of their swap portfolios from bilateral to cleared trades, thereby

    reducing or eliminating bilateral counterparty credit risk, and by

    extension, systemic risk.

    By contrast, ISDA commented on how mandatory clearing may

    centralize risk in DCOs and questioned the risk-mitigating aspects of

    central clearing as contrasted with the new regulatory regime for

    uncleared swaps. ISDA also questioned the Commission's assertion that

    central clearing was designed to address the concentration of risk. In

    response to ISDA's comment, the Commission observes that while the

    regime for bilateral, uncleared swaps will be greatly improved after

    full implementation of the Dodd-Frank Act reforms, central clearing

    provides for certain risk management features that cannot be replicated

    on a bilateral basis. To name just one critical distinction, a

    clearinghouse addresses the tail risk of open positions through

    mutualization. Each clearing member must contribute to a default fund

    that protects the system as a whole.

    [[Page 74313]]

    d. Effect on Competition

    Section 2(h)(2)(D)(ii)(IV) of the CEA requires the Commission to

    take into account the effect on competition, including appropriate fees

    and charges applied to clearing. Of particular concern to the

    Commission is whether the determination would harm competition by

    creating, enhancing, or entrenching market power in an affected product

    or service market, or facilitating the exercise of market power. Market

    power is viewed as the ability to raise price, including clearing fees

    and charges, reduce output, diminish innovation, or otherwise harm

    customers as a result of diminished competitive constraints or

    incentives.\132\

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

    \132\ See Section II.D above for a more detailed discussion of

    these issues.

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

    In the NPRM, the Commission identified one putative service market

    as potentially affected by this proposed clearing determination: a DCO

    service market encompassing those clearinghouses that currently (or

    with relative ease in the future could) clear the interest rate swaps

    subject to this proposal. The Commission recognized that, depending on

    the interplay of several factors, the clearing requirement potentially

    could impact competition within the affected market and discussed

    various factors that could impact that market.

    As discussed above, in support of the NPRM, Citadel stated that the

    clearing requirement will have a strong positive impact on competition

    in the swap market and the market for clearing services. Citadel noted

    that central clearing will remove a significant barrier to entry for

    alternative swap market liquidity providers and will enable smaller

    entities to compete on more equal terms because central clearing

    eliminates the consideration of counterparty credit risk from the

    selection of execution counterparties. Citadel further commented that

    buy-side market participants will benefit from a wider range of

    potential execution counterparties and asserted that this increased

    competition yields benefits to market participants including narrower

    bid-ask spreads, improved access to best execution, and increased

    market depth and liquidity, all of which establish a prerequisite for

    the emergence of an all-to-all market with electronic and/or anonymous

    execution. Citadel also commented that substitution of the DCO for the

    bilateral counterparty decouples execution from post-trade processing

    and settlement. Finally, Citadel commented that the certainty as to

    when the first clearing requirement will begin gives DCOs and FCMs the

    confidence to invest in their client clearing offerings, and to compete

    actively for buy-side business both on the quality and efficiency of

    their services as well as on price.

    FIA commented that the NPRM included a full discussion of the

    potential competitive impact of the clearing proposal. However, as

    discussed above, FIA indicated that it was unable to conduct the

    analysis it believes would be necessary to respond to the Commission's

    questions in the NPRM within the 30-day comment period provided.

    In response to FIA's comment, the Commission notes that the 30-day

    public comment period was necessary for the Commission to adhere to the

    CEA's 90-day determination process. Moreover, while FIA indicated that

    it would like more time to conduct further analysis of competitive

    issues for future determinations, FIA did not identify any specific

    concerns about the competitiveness issue analysis that could materially

    change the Commission's determination if such additional information

    were made available to the Commission. The comments provided by Citadel

    are consistent with the NPRM's conclusion that the clearing requirement

    potentially could impact competition within the affected market, but go

    on to assert that such an impact would not be negative. Accordingly,

    the Commission believes that its consideration of competitiveness as

    described in the NPRM is sufficient for purposes of finalizing the

    clearing requirement rule.

    e. Legal Certainty in the Event of the Insolvency

    Section 2(h)(2)(D)(ii)(V) of the CEA requires the Commission to

    take into account the existence of reasonable legal certainty in the

    event of the insolvency of the relevant DCO or one or more of its

    clearing members with regard to the treatment of customer and swap

    counterparty positions, funds, and property. The Commission's proposal

    was based on its view that there is reasonable legal certainty with

    regard to the treatment of customer and swap counterparty positions,

    funds, and property in connection with cleared swaps, namely the

    interest rate swaps subject to the proposal, in the event of the

    insolvency of the relevant DCO or one or more of the DCO's clearing

    members.

    In the case of a clearing member insolvency at CME or IDCH (now,

    LCH.LLC), i.e., DCOs subject to the bankruptcy laws of the United

    States, subchapter IV of Chapter 7 of the U.S. Bankruptcy Code (11

    U.S.C. 761-767) and Part 190 of the Commission's regulations would

    govern the treatment of customer positions.\133\ Pursuant to section

    4d(f) of the CEA, a clearing member accepting funds from a customer to

    margin a cleared swap, must be a registered FCM. Pursuant to 11 U.S.C.

    761-767 and Part 190 of the Commission's regulations, the customer's

    interest rate swap positions, carried by the insolvent FCM, would be

    deemed ``commodity contracts.'' \134\ As a result, neither a clearing

    member's bankruptcy nor any order of a bankruptcy court could prevent a

    United States domiciled DCO from closing out/liquidating such

    positions.\135\ However, customers of clearing members would have

    priority over all other claimants with respect to customer funds that

    had been held by the defaulting clearing member to margin swaps, such

    as the interest rate swaps included in the clearing determination.\136\

    Customer funds would be distributed to swap customers, including

    interest rate swap customers, in accordance with Commission regulations

    and section 766(h) of the Bankruptcy Code. Moreover, the Bankruptcy

    Code and the Commission's rules thereunder (in particular 11 U.S.C.

    764(b) and 17 CFR 190.06) permit the transfer of customer positions and

    collateral to solvent clearing members.

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

    \133\ The Commission observes that an FCM or DCO also may be

    subject to resolution under Title II of the Dodd-Frank Act to the

    extent it would qualify as covered financial company (as defined in

    section 201(a)(8) of the Dodd-Frank Act).

    \134\ If an FCM is also registered as a broker-dealer, certain

    issues related to its insolvency proceeding would also be governed

    by the Securities Investor Protection Act.

    \135\ See 11 U.S.C. 556 (``The contractual right of a commodity

    broker [which term would include a DCO or FCM] * * * to cause the

    liquidation, termination or acceleration of a commodity contract * *

    * shall not be stayed, avoided, or otherwise limited by operation of

    any provision of [the Bankruptcy Code] or by order of a court in any

    proceeding under [the Bankruptcy Code]'').

    \136\ See 11 U.S.C. 766(h).

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

    Similarly, 11 U.S.C. 761-767 and Part 190 would govern the

    bankruptcy of a DCO, in conjunction with DCO rules providing for the

    termination of outstanding contracts and/or return of remaining

    clearing member and customer property to clearing members.

    With regard to LCH, the Commission understands that the default of

    a clearing member of LCH would be governed by the rules of that DCO.

    LCH, a DCO based in the United Kingdom, has represented that under

    English law its rules would supersede English insolvency laws. Under

    its rules, LCH would be permitted to close out and/or transfer

    positions of a defaulting clearing member that is an FCM

    [[Page 74314]]

    pursuant to the U.S. Bankruptcy Code and Part 190 of the Commission's

    regulations. According to LCH's submission, the insolvency of LCH

    itself would be governed by both English insolvency law and Part 190.

    LCH has obtained legal opinions that support the existence of such

    legal certainty in relation to the protection of customer and swap

    counterparty positions, funds, and property in the event of the

    insolvency of one or more of its clearing members. In addition, LCH has

    obtained a legal opinion from U.S. counsel regarding compliance with

    the protections afforded to FCM customers under New York law.

    In response to the NPRM, Citadel commented that it agreed with the

    Commission's analysis that reasonable certainty exists in the event of

    an insolvency of a DCO or one or more DCO members. As discussed above,

    the Commission received three comments related to customer segregation.

    In essence, Vanguard and SIFMA AMG recommend that the Commission delay

    implementation of the clearing requirement until three months after the

    LSOC model is implemented, clarified, and perhaps supplemented with

    additional rulemaking. ISDA requests that the Commission further study

    the issue of insolvency for DCOs.

    As stated above, the Commission believes that the concerns of

    Vanguard and SIFMA AMG are largely addressed by the delayed

    implementation timeframe for this determination. With regard to ISDA's

    request, as discussed above, the Commission is actively engaging in

    efforts to study and prepare for potential scenarios involving

    clearinghouse and clearing member insolvency.

    iii. Conclusions Regarding the Five Statutory Factors and Clearing

    Requirement Determination

    In the foregoing discussion and analysis, the Commission has taken

    into account each of the five factors provided for under section

    2(h)(2)(D)(ii) of the CEA for the interest rate swap classes that are

    the subject of this determination. Based on these considerations, and

    having reviewed the relevant DCOs' submissions for consistency with

    section 5b(c)(2) of the CEA, the Commission is determining that the

    four classes of interest rate swaps identified in Sec. 50.4(a) are

    required to be cleared.

    III. Final Rules

    The Commission is adopting the following rules under section

    2(h)(2), as well as its authority under sections 5b(c)(2)(L) and 8a(5)

    of the CEA. In issuing a determination regarding whether a swap or

    class of swaps is required to be cleared, ``the Commission may require

    such terms and conditions to the requirement as the Commission

    determines to be appropriate.'' \137\

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

    \137\ Section 2(h)(2)(D)(iii) of the CEA.

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

    A. Regulation 50.1: Definitions

    As proposed, Sec. 50.1 set forth two defined terms: ``business

    day'' and ``day of execution.'' The definition of business day excluded

    Saturdays, Sundays, and legal holidays. The definition of ``day of

    execution'' served as a means of addressing situations where executing

    counterparties are located in different time zones. It was intended to

    avoid difficulties associated with end-of-day trading by deeming swaps

    executed after 4:00 p.m., or on a day other than a business day, to

    have been executed on the immediately succeeding business day. The

    Commission recognized that market participants should not be required

    to maintain back-office operations 24 hours a day or 7 days a week in

    order to meet the proposed deadline for submitting swaps that are

    required to be cleared to a DCO. The Commission also was attempting to

    be sensitive to possible concerns about timeframes that may discourage

    trade execution late in the day. To account for time-zone issues, the

    ``day of execution'' was defined to be the calendar day of the party to

    the swap that ends latest, giving the parties the maximum amount of

    time to submit their swaps to a DCO while still requiring such

    submission on a same-day basis.

    The Commission received two comments on these definitions. LCH

    commended the Commission for including flexibility on the timing of

    swap submission for those swaps executed late in the day, but requested

    that the Commission clarify that DCOs can continue to accept swaps for

    clearing late in the day. In response to this request, the Commission

    confirms that the 4:00 p.m. cut off for same-day submission to a DCO is

    intended to give market participants flexibility and respond to

    concerns about counterparties in different time zones. This definition

    should not be interpreted as a prohibition on late-day submission of

    swaps to DCOs or as impeding DCO's ability to accept such swaps.

    FIA observed an apparent conflict between the proposed definitions

    of ``business day'' and ``day of execution'' and regulation

    23.506(b).\138\ As with LCH, FIA's concern focused on the ability of

    DCOs to expand their business hours. As explained above, the

    definitions do not proscribe a DCO's ability to set business hours.

    Accordingly, the Commission is adopting the definitions as proposed.

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

    \138\ This regulation directs swap dealers and major swap

    participants to submit swaps subject to the clearing requirement to

    a DCO as soon as technologically practicable after execution, but no

    later than the close of business on the day of execution. See 17 CFR

    23.506(b), 77 FR 21278, 21307 (Apr. 9, 2012). To the extent that a

    swap dealer or major swap participant is subject to both Sec.

    23.506(b) and Sec. 50.2(a), the entity should comply with Sec.

    23.506(b) when its counterparty is another swap dealer or major swap

    participant, but if the swap is between a swap dealer and a non-swap

    dealer, then the non-swap dealer counterparty can elect to follow

    the timing requirements of Sec. 50.2(a) or Sec. 23.506(b).

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

    B. Regulation 50.2: Treatment of Swaps Subject to a Clearing

    Requirement

    As proposed, Sec. 50.2(a) required all persons, other than those

    who elect the exception in accordance with Sec. 39.6 (now Sec.

    50.50),\139\ to submit a swap that is part of the class described in

    Sec. 50.4 for clearing by a DCO as soon as technologically practicable

    and no later than the end of the day of execution. The objective of

    this provision was to ensure that swaps subject to a clearing

    requirement are submitted to DCOs for clearing in a timely manner.

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

    \139\ The Commission is recodifying Sec. 39.6 as Sec. 50.50 so

    that market participants are able to locate all rules related to the

    clearing requirement in one part of the Code of Federal Regulations.

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

    ISDA recommended that the Commission clarify the rule text to

    recognize that non-clearing members are deemed to have met the

    requirements of Sec. 50.2 once they submit the swap to their FCM

    clearing member. ISDA also requested that the Commission recognize that

    in some cross-border transactions clearing members will not necessarily

    be FCMs. Similarly, ISDA asked that there be an exclusion for foreign

    governments and governmental entities as set forth in the end-user

    exception final rulemaking. Lastly, ISDA asked that there be an

    exception in the rule for system outages and force majeure events.

    In response to ISDA's first comment, the Commission is modifying

    the rule text by adding new paragraph (c) to clarify that submission of

    a swap to an FCM or a DCO clearing member is sufficient to meet the

    timeliness requirements of the rule. For U.S. customers, this will mean

    submission to a registered FCM. For cross-border transactions, the

    Commission recognizes that submission of the swap may be to a non-FCM

    clearing member when the customer is not a U.S. person.\140\

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

    \140\ If the person submitting the swap is a customer, as Sec.

    1.3(k) defines that term, then only a registered FCM may accept that

    swap for clearing, even if the customer seeks to clear the swap on a

    DCO located outside of the U.S.

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    [[Page 74315]]

    With regard to foreign governments and governmental entities, the

    Commission reiterates the position taken in the end-user exception

    rulemaking that ``foreign governments, foreign central banks, and

    international financial institutions should not be subject to Section

    2(h)(1) of the CEA.'' \141\ Finally, the Commission declines to include

    an explicit exception for unforeseen outages and other events. The

    Commission recognizes that these situations may occur and has adopted

    rules relating to system safeguards and disaster recovery for market

    infrastructures \142\ and market participants.\143\ However, none of

    the straight-through-processing rules adopted by the Commission

    included carve-outs for system outages or force majeure events,\144\

    and the Commission does not believe it is necessary to include such

    provisions in this rule. In the case of serious market-wide

    disruptions, the Commission would take this mitigating fact into

    account in reviewing compliance with Sec. 50.2.

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

    \141\ See End-User Exception to the Clearing Requirement for

    Swaps, 77 FR 42560, 42562 (July 19, 2012).

    \142\ See, e.g., Derivatives Clearing Organization General

    Provisions and Core Principles, 76 FR 69334, 69443-69444 (Nov. 8,

    2011) (adopting Sec. 39.18 relating to system safeguards).

    \143\ See Swap Dealer and Major Swap Participant Recordkeeping,

    Reporting, and Duties Rules, 77 FR 20128, 20208-20209 (Apr. 3, 2012)

    (adopting Sec. 23.603 relating to business continuity and disaster

    recovery).

    \144\ Customer Clearing Documentation, Timing of Acceptance for

    Clearing, and Clearing Member Risk Management, 77 FR 21278, 21307

    (Apr. 9, 2012).

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

    Additionally, in an effort to clarify that a market participant

    does not have to submit a swap that falls within the Sec. 50.4

    classes, but that the entity knows are not offered for clearing by any

    DCO because the swap contains specifications that are not accepted for

    clearing, the Commission is modifying the text of Sec. 50.2 to include

    a reference to ``eligible'' DCOs that offer such swaps for clearing.

    Proposed Sec. 50.2(b) would require persons subject to Sec.

    50.2(a) to undertake reasonable efforts to determine whether a swap is

    required to be cleared. In the NPRM, the Commission indicated that it

    would consider such reasonable efforts to include checking the

    Commission's Web site or the DCO's Web site for verification of whether

    a swap is required to be cleared, or consulting third-party service

    providers for such verification.

    CME commented on the Commission's observation in the NPRM that DCOs

    could design and develop systems that will enable market participants

    and trading platforms to check whether or not their swap is subject to

    a clearing requirement and be provided with an answer within seconds

    (or faster). CME stated that its platform already provides market

    participants with a tool to screen a particular swap for eligibility

    for clearing upon submission to CME. The Commission recognizes that

    this technological capability will be beneficial to market

    participants, particularly pre-execution, and is necessary to ensure

    timely clearing of swaps subject to the clearing requirement.

    Freddie Mac observed that Sec. 50.2(a) and (b) could be

    interpreted to require two different standards of care: strict

    liability for the former and a reasonable inquiry standard for the

    latter. In response to Freddie Mac's comment, the Commission clarifies

    that Sec. 50.2(a) establishes a requirement regarding the timely

    submission of swaps to DCOs. It is a bright-line standard, but it is

    not intended to introduce a new scienter requirement regarding

    submission for clearing beyond that provided for in the statute.\145\

    With regard to Sec. 50.2(b), the Commission's objective was to afford

    market participants clarity about what efforts they must expend in

    determining whether their swaps are required to be cleared. In the

    absence of some central screening mechanism available to all market

    participants for the purpose of immediately determining whether any

    eligible DCO offers a particular swap for clearing,\146\ the Commission

    believes it appropriate to provide clarity regarding what constitutes

    reasonable search or verification efforts.\147\

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

    \145\ See Section III.G for further discussion regarding

    scienter.

    \146\ See discussion in Section II.E regarding LCH's and CME's

    efforts to provide such a screening mechanism.

    \147\ The Commission notes that it will consider whether

    verification efforts are reasonable in light of all the facts and

    circumstances of a market participant's particular situation.

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

    C. Regulation 50.3: Notice to the Public

    The Commission proposed Sec. 50.3(a) to require each DCO to post

    on its Web site a list of all swaps that it will accept for clearing

    and clearly indicate which of those swaps the Commission has determined

    are required to be cleared pursuant to part 50 of the Commission's

    regulations and section 2(h)(1) of the CEA.

    ISDA commented that DCOs should provide swap information, including

    product specifications, in a manner that is easy to access and use.

    ISDA also called upon DCOs to provide at least one-month's advance

    notice for new swaps that they plan to accept for clearing and to

    provide a description of the margin methodology used in clearing the

    swap. The Commission agrees that DCOs should provide information in a

    manner that is easy to use and accessible to the public. Regulation

    Sec. 50.3(b) builds upon the requirements of Sec. 39.21(c)(1), which

    requires each DCO to disclose publicly information concerning the terms

    and conditions of each contract, agreement, and transaction cleared and

    settled by the DCO. The Commission also welcomes ISDA's suggestion that

    DCOs voluntarily provide advance notice of new swaps that they plan to

    clear and make relevant information regarding their margining

    methodologies available.\148\

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

    \148\ 17 CFR 39.21 requires that DCOs provide market

    participants with ``sufficient information to enable the market

    participants to identify and evaluate accurately the risks and costs

    associated with using the services'' of the DCO.

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

    LCH commented that it is committed to revising the information on

    its Web site so that it is provided in a format that is easily

    understandable by all swaps counterparties, including customers.

    Regulation Sec. 50.3(b) requires the Commission to post on its Web

    site a list of those swaps it has determined are required to be cleared

    and all DCOs that are eligible to clear such classes of swaps. No

    comments were received on this provision. The Commission is adopting

    the rule as proposed in order to provide market participants with

    sufficient notice regarding which swaps are subject to a clearing

    requirement. For clarification, the Commission will include on its Web

    site any swaps that it has determined through delegated authority under

    Sec. 50.6 fall within a class of swaps described in Sec. 50.4.

    D. Regulation 50.4: Classes of Swaps Required To Be Cleared

    As discussed at length above, proposed Sec. 50.4 set forth the

    classes of interest rate swaps and CDS that the Commission proposed for

    required clearing. Proposed Sec. 50.4(a) included a table listing

    those types of interest rate swaps the Commission would require to be

    cleared, and proposed Sec. 50.4(b) included a table listing those

    types of CDS indices the Commission would require to be cleared.

    ISDA recommended that the Commission clarify that the stated

    termination date ranges in Sec. 50.4(a) be applied only at trade

    inception for purposes of determining whether the swap is required to

    be cleared. The Commission confirms ISDA's

    [[Page 74316]]

    understanding of the stated termination date range applying only at

    trade inception or upon an ownership event change, as discussed in

    detail below.

    As discussed above, the Commission is adopting Sec. 50.4(a) and

    (b). The Commission believes that this format provides market

    participants with a clear understanding of which swaps are required to

    be cleared. By using basic specifications to identify the swaps subject

    to the clearing requirement, counterparties contemplating entering into

    a swap can determine quickly as a threshold matter whether or not the

    particular swap may be subject to a clearing requirement. If the swap

    has the basic specifications of a class of swaps determined to be

    subject to a clearing requirement, the parties will know that they need

    to verify whether an eligible DCO will clear that particular swap. This

    will reduce the burden on swap counterparties related to determining

    whether a particular swap may be subject to the clearing requirement.

    i. Disentangling Complex Swaps

    TriOptima commented that the complete swap must be assessed against

    the clearing requirement and parties should not be required to

    disentangle non-clearable swaps in order to clear the clearable

    components. The Commission confirms TriOptima's view regarding those

    swaps that may have components that can be cleared, but would require

    disentangling the clearable part of the swap. Adherence to the clearing

    requirement does not require market participants to structure their

    swaps in a particular manner or disentangle swaps that serve legitimate

    business purposes.\149\

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

    \149\ See discussion below regarding Sec. 50.10 and the evasion

    and abuse standards.

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

    ii. Swaptions and Extendible Swaps

    In response to the Commission's inquiry in the NPRM regarding how

    to treat a swap that becomes effective upon the exercise of a swaption,

    ISDA suggested that the resulting swap should only be required to be

    cleared if the underlying swap and the counterparties to the swap were

    subject to a clearing requirement at the time that the swaption was

    executed. ISDA also commented that the same approach should apply to

    extendible swaps, i.e., a swap for which a party has the option to

    extend the term of the swap. ISDA reasoned that the parties to a

    swaption or an extendible swap would not have taken into account the

    cost of clearing the resultant swap if they negotiated the price of the

    option before a clearing requirement was applicable to the underlying

    swap or extended swap. LCH similarly commented that a swaption entered

    into before a clearing requirement is applicable to the underlying swap

    would not have been priced with an expectation that the swap created on

    exercise would be cleared. For this reason, LCH also stated that an

    underlying swap of a swaption should be subject to an applicable

    clearing requirement only if the swaption was entered into after the

    clearing requirement applicable to the underlying swap becomes

    effective.

    The Commission agrees that the cost of clearing may not be

    reflected in the pricing of the swaption or extendible swap if the

    clearing requirement for the underlying swap or the extendable swap

    arises after the execution of the swaption or extendible swap. The

    Commission is thus clarifying that the clearing requirement only

    applies to swaps resulting from the exercise of a swaption or

    extendible swap extension if the clearing requirement would have been

    applicable to the underlying swap or the extended swap at the time the

    counterparties executed the swaption or extendible swap.

    iii. Ownership Event Changes

    In the NPRM, the Commission asked whether it should clarify that

    the clearing requirement applies to all new swaps and changes in the

    ownership of a swap, including assignment, novation, exchange,

    transfer, or conveyance. ISDA responded that a swap that is not subject

    to the clearing requirement at the time it is executed should not

    become subject to it upon an ownership event change unless the parties

    can agree on pricing and other terms necessary to reflect the costs of

    clearing and until the swap can be transitioned from uncleared to

    cleared with accuracy.\150\

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

    \150\ Aside from a general assertion about the challenges of

    selecting a DCO for clearing, ISDA did not elaborate on its implied

    assertion that swaps subject to ownership changes may be difficult

    to transition to clearing accurately.

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

    As the Commission acknowledged above, the cost of clearing may not

    be reflected in the pricing of a swap if the clearing requirement

    arises after the execution of that swap. However, unlike with the

    exercise of a swaption, typically, the original counterparties to a

    swap that is assigned, novated, exchanged, transferred, or conveyed,

    along with the new party in ownership, each have an opportunity to

    revisit the terms of the original swap and account for new costs.\151\

    While there may be cost implications for the remaining party when its

    counterparty changes, these cost implications can arise for any number

    of foreseeable or unforeseeable reasons,\152\ and if the remaining

    party is concerned about potential cost implications resulting from a

    change of its counterparty, it would be able to protect itself through

    the terms of the swap, such as including consent rights or required

    price adjustments upon such an event.\153\ The Commission is concerned

    that if such swaps are not treated as new swaps for the purposes of the

    clearing requirement, it could be creating incentives to ``trade''

    historical swaps through the assignment, novation, exchange, transfer,

    or conveyance processes to avoid required clearing. Accordingly, for

    purposes of this rule, a change in ownership of a swap would subject

    the swap to required clearing under section 2(h)(1) of the CEA in the

    same manner and to the same extent as a newly executed swap.

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

    \151\ Going forward, prior to or at the time of ownership

    change, parties will have to account for any additional costs of

    clearing.

    \152\ For example, an ownership change for a bilateral swap may

    have foreseeable or unforeseeable credit or tax implications for the

    remaining party.

    \153\ The Commission observes that the ISDA Master Agreement

    used for most bilateral swaps requires the prior written consent of

    the remaining party for any transfer of the agreement other than for

    certain limited transfers of payments upon default or upon a merger,

    acquisition, or transfer of all assets.

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

    Furthermore, for swaps executed after the clearing requirement is

    in place, the Commission also believes it is important to clarify that

    a change in ownership may result in a requirement to clear. For

    example, a financial entity and an end user under section 2(h)(7) of

    the CEA enter into a swap that is not required to be cleared, and later

    if the end user transfers its ownership interest in the swap to another

    party that is a financial entity not eligible to claim an exception

    under section 2(h)(7), then the swap would be required to be cleared if

    the other prerequisites to the requirement exist.

    E. Regulation 50.5: Clearing Transition Rules

    As proposed, Sec. 50.5 would codify section 2(h)(6) of the CEA.

    Under proposed Sec. 50.5(a), swaps that are part of a class described

    in Sec. 50.4 but were entered into before the enactment of the Dodd-

    Frank Act would be exempt from clearing so long as the swap is reported

    to an SDR pursuant to Sec. 44.02 and section 2(h)(5)(A) of the CEA.

    Similarly, under proposed Sec. 50.5(b), swaps entered

    [[Page 74317]]

    into after the enactment of the Dodd-Frank Act but before the

    application of the clearing requirement would be exempt from the

    clearing requirement if reported pursuant to Sec. 44.03 and section

    2(h)(5)(B) of the Act.

    LCH suggested that the Commission change the citations in Sec.

    50.5(a) from Sec. 44.02 to Sec. 46.3, and in Sec. 50.5(b) from Sec.

    44.03 to Sec. 45.3 for swaps entered after the enactment of the Dodd-

    Frank Act but prior to the compliance date for reporting to an SDR and

    to Sec. 45.3 for swaps entered into after the compliance date for SDR

    reporting but prior to the application of a clearing requirement. The

    Commission agrees with LCH and is modifying the rule to provide more

    accurate cross references to parts 45 and 46. In addition, under Sec.

    50.5(b), the Commission cross references Sec. 46.3 or Sec. 45.3, as

    appropriate, because until April 2013, certain market participants may

    properly rely on Sec. 46.3 for reporting swaps executed after the

    enactment of the Dodd-Frank Act.

    F. Regulation 50.6: Delegation of Authority

    Under proposed Sec. 50.6(a), the Commission would delegate to the

    Director of the Division of Clearing and Risk, or the Director's

    designee, with the consultation of the General Counsel or the General

    Counsel's designee, the authority to determine whether a swap falls

    within a class of swaps described in Sec. 50.4 and to communicate such

    a determination to the relevant DCOs.

    ICE supported the Commission's proposal and agreed that this

    approach would allow DCOs to add new swaps in a timely and efficient

    manner and rely on the DCOs' risk management processes and governance

    for adding new products to an existing class. Citadel also supported

    the proposed delegation provision based on the view that the Commission

    carefully oversees DCO risk management and it is beneficial to move

    products into clearing without excessive delay. LCH generally supported

    the Commission's proposal, but requested confirmation that if the DCO

    makes a material change to an existing type of swap, the Commission

    would follow the full clearing requirement determination process.

    By contrast, ISDA objected to proposed Sec. 50.6 based on a

    concern that the Commission would be delegating the clearing

    determination for DCO product expansions to the DCOs themselves, which

    would contradict the requirement that the Commission review each DCO

    submission under section 2(h)(2)(B)(iii)(II) of the CEA. Based on the

    breadth of the swaps classes under Sec. 50.4, ISDA commented that DCOs

    will be able to add new swaps under the clearing requirement without

    review by the Commission under the five statutory factors. ISDA

    recommended that the delegation provision be supplemented to include

    (1) a requirement that new DCO product offerings raise no materially

    different considerations regarding the Commission's determination; (2)

    a public comment period; and (3) a compliance phase-in period of 90

    days.

    In response to LCH's request for clarification, the Commission

    confirms that if a DCO makes a material change to an existing type of

    swap, the Commission would follow the full clearing requirement

    determination process. Under the example provided by LCH--extending the

    tenor of swaps clearing--the DCO's change would require a change to the

    rule text under Sec. 50.4, which would require Commission action.

    In response to ISDA's comments, the Commission observes that the

    proposed delegation provision was not intended to displace Commission

    review under section 2(h)(2)(B)(iii)(II) of the CEA. With respect to

    swaps within the classes identified in Sec. 50.4 that are already

    being cleared by at least one DCO, the delegation provision will

    facilitate other DCOs' ability to offer new swaps for required clearing

    so long as those swaps fall within one of the classes previously

    established by the Commission. With respect to swaps that meet the

    specifications identified in Sec. 50.4, but have not been previously

    offered for clearing by any DCO, the Commission agrees with ISDA that

    the delegation is limited to those swaps that are consistent with the

    prior determination. For instance, if a new swap falls within a class

    under Sec. 50.4, but clearing the swap requires that DCOs adopt a new

    margining methodology or pricing methodology, the Commission would

    subject that swap to a new clearing requirement determination

    process.\154\ Accordingly, the Commission is modifying the rule to

    limit the delegation authority to those instances where the newly

    submitted swap falls within the class under Sec. 50.4 and is

    consistent with the Commission's clearing requirement determination for

    that class of swaps. In addition, the Commission is modifying the rule

    to require that the Director of the Division of Clearing and Risk

    notify the Commission prior to exercising any authority delegated under

    Sec. 50.6.

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

    \154\ Without this delegation process a new swap that falls

    within a class under Sec. 50.4 could have automatically been

    included in the clearing requirement without review. The delegation

    provision provides a check on that process.

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

    The Commission declines to adopt ISDA's other recommendations.

    Provided that inclusion of the new swaps under Sec. 50.4 is consistent

    with the Commission's previous clearing requirement determination,

    there is no need for an additional public comment period beyond that

    provided for as part of the initial clearing requirement determination

    process. Moreover, under the CEA and Commission regulation, any

    counterparty to a swap can apply for a stay of the clearing

    requirement.\155\ This stay provision would serve to notify the

    Commission of objections to inclusion of a particular swap in a

    previously-defined class. In addition, the Commission does not believe

    that an additional phase-in period is necessary. Provided that

    including the new swap is consistent with the prior determination, the

    compliance phasing for the original class will afford sufficient time

    for operational and systems implementation. If such time had not been

    sufficient, the Director of the Division of Clearing and Risk could

    submit the matter to the Commission for its consideration, or the

    Commission could itself exercise the delegated authority, under Sec.

    50.6(b).

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

    \155\ See section 2(h)(3) of the CEA and regulation 39.5(d).

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

    G. Regulation 50.10: Prevention of Evasion of the Clearing Requirement

    and Abuse of an Exception or Exemption to the Clearing Requirement

    The Commission proposed Sec. 50.10 under the rulemaking authority

    in sections 2(h)(4)(A), 2(h)(7)(F), and 8a(5) of the CEA. Proposed

    Sec. 50.10 would prohibit evasions of the requirements of section 2(h)

    of the CEA and abuse of any exemption or exception to the requirements

    of section 2(h), including the end-user exception or any other

    exception or exemption that the Commission may provide by rule,

    regulation, or order.\156\

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

    \156\ As noted in the proposing release, the Commission

    preliminarily viewed evasion of the clearing requirement and abuse

    of an exemption or exception to the clearing requirement, including

    the end-user exception, to be related concepts and are informed by

    new enforcement authority under the Dodd-Frank Act, which added new

    sections 6(e)(4)-(5), and 9(a)(6), to the CEA. See Proposed Clearing

    Requirement Determination, 77 FR 47170, 47207 (Aug. 7, 2012).

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

    Proposed Sec. 50.10(a) would make it unlawful for any person to

    knowingly or recklessly evade, participate in, or facilitate an evasion

    of any of the requirements of section 2(h).\157\ This

    [[Page 74318]]

    would apply to any requirement under section 2(h) of the CEA or any

    Commission rule or regulation promulgated thereunder.\158\ In the

    proposing release, the Commission noted, however, that section

    2(h)(1)(A) of the CEA provides that it ``shall be unlawful for any

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

    clearing'' to a DCO if the swap is required to be cleared. Unlike the

    knowing or reckless standard under proposed Sec. 50.10(a), section

    2(h)(1)(A) imposes a non-scienter standard on swap market

    participants.\159\

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

    \157\ Proposed Sec. 50.10(a) was informed by and consistent

    with section 6(e)(4) and (5) of the CEA, which states that any DCO,

    swap dealer, or major swap participant that ``knowingly or

    recklessly evades or participates in or facilitates an evasion of

    the requirements of section 2(h) shall be liable for a civil

    monetary penalty in twice the amount otherwise available for a

    violation of section 2(h).''

    \158\ These requirements include the clearing requirement under

    section 2(h)(1), reporting of data under section 2(h)(5), and the

    trade execution requirement under section 2(h)(8), among other

    requirements. For example, it would be a violation of proposed Sec.

    50.10(a) for a SEF to knowingly or recklessly evade or participate

    in or facilitate an evasion of the trade execution requirement under

    section 2(h)(8).

    \159\ Any person engaged in a swap that would be required to be

    cleared under section 2(h) and Part 50 of the Commission's

    Regulations, and such person did not submit the swap for clearing,

    absent an exemption or exception, would be subject to a Commission

    enforcement action regardless of whether the person knowingly or

    recklessly failed to submit the swap for clearing.

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

    Proposed Sec. 50.10(b) would make it unlawful for any person to

    abuse the end-user exception to the clearing requirement as provided

    under section 2(h)(7) of the CEA and Sec. 39.6 (now Sec. 50.50).\160\

    The proposing release stated that an abuse of the end-user exception to

    the clearing requirement may also, depending on the facts and

    circumstances, be an evasion of the requirements of section 2(h). The

    Commission's preliminary view was informed by section 9(a)(6) of the

    CEA, which cross-references both the prevention of evasion authority in

    section 2(h)(4) and prevention of abuse to the exception to the

    clearing requirement in section 2(h)(7)(F).\161\ Thus, the Commission

    proposed to interpret a violation of section 9(a)(6) of the CEA to also

    be a violation of proposed Sec. 50.10(b).

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

    \160\ See End-User Exception to the Clearing Requirement for

    Swaps, 77 FR 42560 (July 19, 2012).

    \161\ Proposed Sec. 50.10(b) is adopted under the authority in

    both section 2(h)(4)(A) and section 2(h)(7)(F).

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

    Proposed Sec. 50.10(c) would make it unlawful for any person to

    abuse any exemption or exception to the requirements of section 2(h) of

    the CEA, including any exemption or exception, as the Commission may

    provide by rule, regulation, or order.\162\

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

    \162\ This provision was informed by the Dodd-Frank Act

    amendments in section 2(h)(4)(A) to prescribe rules necessary to

    prevent evasions of the clearing requirements; section 2(h)(7)(F) to

    prescribe rules necessary to prevent abuse of the exceptions to the

    clearing requirements; and the Commission's general rulemaking

    authority in section 8a(5) to promulgate rules that, in the judgment

    of the Commission, are reasonably necessary to accomplish any

    purposes of the CEA.

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

    In the preamble to the NPRM, the Commission proposed to adopt a

    ``principles-based'' approach to applying proposed Sec. 50.10 and

    declined to provide a bright-line test of non-evasive or abusive

    conduct, because such an approach may be a roadmap for engaging in

    evasive or abusive conduct or activities. The Commission, however, did

    propose additional guidance to provide clarity to market participants.

    The Commission proposed to determine on a case-by-case basis in light

    of all the relevant facts and circumstances, whether particular

    transactions or other activities constitute a violation of Sec. 50.10.

    Similar to its approach in the final rules further defining the term

    ``swap'' (the ``Product Definition Rules''), the Commission proposed

    that it would not consider transactions or other activities structured

    in a manner solely motivated by a legitimate business purpose to

    constitute evasion or abuse.\163\

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

    \163\ The Commission's discussion of Sec. 50.10 is similar to

    its approach for the anti-evasion rules Sec. Sec. 1.3(xxx)(6) and

    1.6 that it recently adopted in a joint final rulemaking with the

    Securities and Exchange Commission. See Further Definition of

    ``Swap,'' ``Security-Based Swap,'' and ``Security-Based Swap

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

    Recordkeeping, 77 FR 48208, 48350-48354 (Aug. 13, 2012).

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

    i. In General

    Four commenters discussed different aspects of proposed Sec.

    50.10, including the standard of intent that proposed Sec. 50.10

    requires and the proposed legitimate business purpose guidance. After

    considering the comments as discussed more fully below, the Commission

    has determined that Sec. 50.10 is necessary to prevent evasion of the

    requirements of section 2(h) and abuses of any exemption or exception

    to the requirements of section 2(h). Therefore, the Commission is

    adopting Sec. 50.10 as proposed, but the Commission is providing

    additional interpretive guidance regarding Sec. 50.10 as set out

    below.

    ii. Standard of Intent

    Two commenters discussed the relevant standard of intent for

    proposed Sec. 50.10. ISDA commented that Sec. 50.10(a), (b), and (c)

    should be governed by a single standard of intent. ISDA noted that

    proposed Sec. 50.10(a) would make it unlawful for any person to

    ``knowingly or recklessly'' evade the requirements of section 2(h);

    whereas, proposed Sec. 50.10(b) and (c) would make it unlawful to

    ``abuse'' exceptions or exemptions to the requirements of section 2(h).

    ISDA requested the Commission clarify that all three provisions are

    subject to a scienter standard.

    FreddieMac commented that the statutory ``knowing or reckless''

    standard for evasion indicates that Congress intended that parties to a

    swap should be deemed in compliance with the clearing requirement at

    least where they have submitted a swap for clearing in good faith and

    have a reasonable expectation of clearing.

    In consideration of the comments, the Commission clarifies that it

    interprets the ``knowingly or recklessly'' standard in Sec. 50.10(a)

    to be the same as the ``abuse'' standard in Sec. 50.10(b) and (c). The

    Commission believes that a ``knowingly or recklessly'' standard is

    consistent with and an appropriate standard of intent for any ``abuse''

    of any exemption or exception to the requirements of section 2(h).

    Additionally, the purpose of Sec. 50.10 is to prevent evasion of the

    requirements under section 2(h) or to prevent an abuse of an exception

    or exemption to the requirements under section 2(h). Therefore, the

    Commission confirms that it would not constitute a violation of Sec.

    50.10 where a party submits a swap for clearing in good faith and the

    party has a reasonable expectation of clearing.

    iii. Legitimate Business Purpose

    Four commenters discussed the proposed guidance on what constitutes

    a legitimate business purpose. TriOptima supported the proposed

    principles-based approach to prevent evasion and the proposed guidance.

    TriOptima also requested the Commission clarify that activities and

    transactions carried out for the purpose of reducing counterparty

    credit risk constitute a legitimate business purpose.

    FreddieMac commented that the proposing release creates ambiguity

    as to the circumstances in which a swap is required to be submitted for

    clearing. In particular, FreddieMac commented that the NPRM appears to

    represent the Commission's view that swaps that differ in regard to

    ``mechanical'' terms may be sufficiently close substitutes such that

    parties may be required to use such a ``substitute swap'' (where one is

    available) that is subject to a clearing

    [[Page 74319]]

    requirement.\164\ FreddieMac asserted that the Commission should not

    pre-judge when a swap that is required to be cleared is a close

    substitute for a swap that is not subject to a clearing requirement.

    Furthermore, FreddieMac commented that the Commission should clarify

    that a swap that would otherwise be required to be cleared but for a

    variation in one or more material contract terms should not also be

    required to be submitted for clearing, provided that such variation of

    the terms is for legitimate business purposes.

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

    \164\ See NRPM at 47191, fn. 97 (discussing a category of

    interest rate swap specifications ``that are commonly used to

    address mechanical issues'').

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

    In response to the proposed guidance, ISDA asserted that the

    Commission did not clearly respond to its comment to the Product

    Definition Rules that variations based on considerations of the costs

    and burdens of regulation should be considered to have a legitimate

    business purpose.\165\ ISDA requested the Commission clarify that if a

    business has a choice, in the absence of fraud, deceit, or unlawful

    activity, of entering into an uncleared swap, rather than a cleared

    swap, ``because [the uncleared swap] is cheaper, or free of unwanted

    aspects of clearing or trading, then that choice should be identified

    by the Commission as legitimate.'' ISDA also asserted that presence of

    fraud, deceit, or unlawful activity is a proper prerequisite to evasion

    or abuse violations. Furthermore, ISDA argued that market participants

    will be subject to constant uncertainty when structuring and

    transacting in markets that offer legitimate alternatives if the

    proposal were adopted.

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

    \165\ See Product Definition Rules, 77 FR at 48302, fn. 1052.

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

    The Commission is guided by the central role that clearing plays

    under the Dodd-Frank Act. As noted in the proposing release, ``the

    requirement that swaps be cleared by DCOs is one of the cornerstones of

    that reform.'' \166\ But even given the importance of central clearing

    as a means to mitigate counterparty credit risk, reduce systemic risk,

    and protect U.S. taxpayers, the Commission accepts that a person may

    have legitimate business purposes for entering into swaps that are not

    subject to the clearing requirement.

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

    \166\ NPRM at 47171.

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

    In that regard, commenters requested that the Commission confirm

    that considering the costs and burdens of regulation, or reduction of

    counterparty credit risk, are legitimate business purposes. As stated

    in the proposing release, the Commission will not provide a bright-line

    test of non-evasive or abusive conduct because such an approach may be

    a roadmap for engaging in evasive or abusive conduct or

    activities.\167\ The Commission expects, however, that a person acting

    for legitimate business purposes will naturally weigh many costs and

    benefits associated with different transactions, including different

    swap classes and swap specifications that may or may not be subject to

    the clearing requirement. Therefore, the Commission clarifies that a

    person's specific consideration of, for example, costs or regulatory

    burdens, including the avoidance thereof, is not, in and of itself,

    dispositive that the person is acting without a legitimate business

    purpose in a particular case.\168\ The Commission will view legitimate

    business purpose considerations on a case-by-case basis in conjunction

    with all other relevant facts and circumstances.

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

    \167\ NPRM at 47207.

    \168\ Examples described in the guidance are illustrative and

    not exhaustive of the conduct or activities that could be considered

    evasive or abusive. In considering whether conduct or activities is

    evasive or abusive, the Commission will consider the facts and

    circumstances of each situation.

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

    In the context of the clearing requirement and Sec. 50.10(a),

    however, the Commission does not believe it would be sufficient to

    satisfy the legitimate business purpose test where a person's principal

    purpose of entering into a swap that is not subject to the clearing

    requirement is to circumvent the costs of clearing.\169\ Circumventing

    the costs of clearing may be a consideration, but cannot be the

    principal consideration in order to satisfy the legitimate business

    purpose test. The Commission notes ISDA's comment regarding evasion,

    and the Commission has determined that to permit such an outcome would

    create an exception that would swallow the rule and could render the

    central clearing objectives and benefits under the Dodd-Frank Act

    meaningless. Moreover, section 2(h)(4)(A) requires the Commission

    prescribe the rules that the Commission determines ``to be necessary to

    prevent evasions of the mandatory clearing requirements,'' \170\ which

    evinces Congress's concern that evasion of the clearing requirement

    would undermine a central purpose of the Dodd-Frank Act. As noted

    above, the Commission determines that the proposed rules are necessary

    to prevent evasions of the mandatory clearing requirements, and is

    therefore adopting them.

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

    \169\ ISDA also requested clarification that avoiding ``unwanted

    aspects of clearing or trading'' should be considered to be a

    legitimate business purpose. ISDA did not specify what it means by

    ``unwanted aspects,'' nor did it explain how avoiding aspects of

    clearing or trading could be distinguished from evasion.

    Accordingly, the Commission is declining to include this concept as

    part of its guidance regarding legitimate business purposes.

    \170\ Section 2(h)(4)(A) of the CEA, 7 U.S.C. 2(h)(4)(A).

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

    Furthermore, the Commission believes that this standard will not

    subject market participants to significant uncertainty, and the

    benefits of central clearing will outweigh the costs and burdens of any

    such uncertainty. In response to Freddie Mac's comment regarding the

    Commission discussion of ``mechanical'' specifications in the NPRM,

    that discussion served only to explain the Commission's decision not to

    include those specifications in the set of class-defining

    specifications identified by the Commission for its class-based

    clearing requirement determination. The Commission is not pre-judging

    whether a swap that contains non class-defining specifications that are

    not accepted by a DCO would constitute evasion. The Commission

    recognizes that including such specifications in a swap could serve a

    legitimate business purpose if, for example, such specifications would

    legitimately result in a more accurate hedge of a business risk. In

    keeping with the Commission's guidance that it will use a principles-

    based approach, assessing whether any particular swap that includes

    such terms would constitute evasion will be done on a case-by-case

    basis in light of all the relevant facts and circumstances.

    Finally, the Commission declines to adopt ISDA's suggestion that

    the presence of fraud, deceit, or other unlawful activity is a

    prerequisite to establishing a violation of evasion or abuse under

    Sec. 50.10. Although it is likely that fraud, deceit, or unlawful

    activity will be present where knowing or reckless evasion or abuse has

    occurred, the Commission does not believe that these factors are

    prerequisites to a violation of Sec. 50.10. Rather, the presence or

    absence of fraud, deceit, or unlawful activity is one circumstance the

    Commission will consider when evaluating a person's conduct or

    activities.

    IV. Implementation

    The Commission proposed to require compliance with the clearing

    requirement for the classes of swaps identified in proposed Sec. 50.4

    according to the compliance schedule contained in

    [[Page 74320]]

    Sec. 50.25.\171\ Under this schedule, compliance with the clearing

    requirement would be phased by type of market participant entering into

    a swap subject to the clearing requirement.

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

    \171\ 17 CFR 50.25, Swap Transaction Compliance and

    Implementation Schedule: Clearing Requirement Under Section 2(h) of

    the CEA, 77 FR 44441 (July 30, 2012). Regulation 50.25 defines the

    terms Category 1 Entity and Category 2 Entity; this release uses the

    term Category 3 Entity to refer to counterparties to swaps falling

    under Sec. 50.25(b)(3).

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

    The Commission received no comments specifically addressing the use

    of Sec. 50.25. Vanguard recommended that the Commission should not

    implement mandatory clearing for any swaps until market participants

    have time to negotiate and execute all necessary documentation.

    Vanguard recommended the Commission delay compliance with the clearing

    requirement until six months after August 29, 2012, the date on which

    ISDA and FIA published a standard form of the futures agreement

    addendum for cleared swaps, i.e., February 28, 2013. SIFMA AMG also

    expressed concern about legal documentation and negotiations taking

    many months, and the difficulty buy-side clients face in finding FCMs

    to clear for them. SIFMA AMG also recommended the clearing requirement

    be delayed for six months.

    In response to Vanguard's and SIFMA AMG's comments and light of the

    circumstances discussed below, compliance with the clearing requirement

    will not be required for any swaps until March 11, 2013. This extension

    of at least 6 months beyond publication of the FIA-ISDA clearing

    addendum applies to all market participants and addresses Vanguard's

    and SIFMA AMG's concerns about documentation. The Commission accounted

    for precisely this type of documentation issue in its adoption of Sec.

    50.25. Accordingly, Category 2 Entities and Category 3 Entities have 90

    and 180 days beyond March 11, 2013, to come into compliance with the

    new clearing requirement, which is well beyond the six months from

    August 29, 2012, as requested by Vanguard and SIFMA AMG. The Commission

    also notes that any market participant may petition for relief under

    Sec. 140.99 if that entity is unable to find an FCM to clear its swaps

    or if it needs additional time to complete requisite

    documentation.\172\

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

    \172\ 17 CFR 140.99 sets for the process for addressing requests

    for exemptive, no-action, and interpretative letters.

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

    On September 10, 2012, the Commission clarified the timing of its

    swap dealer registration rules. The swap dealer registration

    regulations go into effect on October 12, 2012, and entities that have

    more than the de minimis level of dealing (swaps entered into after

    October 12) must register by no later than two months after the end of

    the month in which they surpass the de minimis level. By way of

    example, if an entity reaches $8 billion in swap dealing the day after

    October 12, then the entity would have to register within two months

    after the end of October, or by December 31, 2012.

    Given that swap dealers will not be required to register until the

    end of the year, and in light of requests for clarification regarding

    the application of Sec. 50.25, the Commission is clarifying that swaps

    executed prior to specific compliance dates set forth below are not

    subject to the clearing requirement.

    To promote certainty for market participants, the Commission is

    setting specific dates for compliance. Accordingly, the requirement for

    Category 1 Entities to begin clearing will commence on Monday, March

    11, 2013, for swaps they enter into on or after that date. Category 2

    Entities are required to clear swaps beginning on Monday, June 10,

    2013, for swaps entered into on or after that date, and Category 3

    Entities would be required to clear swaps beginning on Monday,

    September 9, 2013, for swaps entered into on or after that date.

    For example, no swap executed between two Category 1 Entities prior

    to March 11, 2013, is required to be cleared. In other words, Category

    1 Entities entering into swaps falling within one of the classes

    identified in Sec. 50.4 on or after March 11, 2013, are required to

    clear those swaps. Category 2 Entities must begin clearing swaps

    pursuant to the new clearing requirement on or after June 10, 2013, and

    Category 3 Entities must begin clearing such swaps if they are entered

    into on or after the September 9, 2013.

    The above schedule will apply to compliance with required clearing

    for iTraxx. However, if no DCO has begun offering client clearing for

    iTraxx by February 11, 2013, then compliance with the required clearing

    of iTraxx will commence sixty days after the date on which iTraxx is

    first offered for client clearing by an eligible DCO. If an eligible

    DCO offers client clearing for iTraxx on or before September 9, 2013,

    the following phased implementation schedule will apply: Category 1

    Entities are required to clear iTraxx indices entered into on or after

    the date 60 days after the date on which iTraxx is first offered for

    client clearing by an eligible DCO; Category 2 Entities are required to

    clear iTraxx entered into on or after the date 150 days after the date

    on which iTraxx is first offered for client clearing by an eligible

    DCO; and Category 3 Entities are required to clear iTraxx entered into

    on or after the date 240 days after the date on which iTraxx is first

    offered for client clearing by an eligible DCO. There will be no

    phasing of compliance if an eligible DCO offers client clearing for

    iTraxx after September 9, 2013. Rather, all three categories of market

    participants will be expected to come into compliance by 60 days after

    the date on which iTraxx is first offered for client clearing by an

    eligible DCO.

    This clarification avoids the possibility that Active Funds that

    are included in Category 1 Entities would be required to clear before

    swap dealers, and provides market participants with certainty as to

    when they must begin clearing swaps.

    With regard to Active Funds, in order to promote orderly

    implementation of part 23 and the part 50 rules, both of which refer to

    Active Funds, the Commission is harmonizing the annual calculation

    period for both implementation of part 23's swap trading relationship

    documentation requirements under Sec. 23.504 \173\ and the clearing

    requirement compliance schedule under Sec. 50.25. For purposes of

    implementing Sec. 23.504, the Commission defined an Active Fund, as

    any private fund as defined in section 202(a) of the Investment

    Advisers Act of 1940, that is a 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 adopting release, i.e., September 11,

    2012.\174\ For purposes of Sec. 50.25, the Commission defined Active

    Fund in the same manner except that the monthly average over the 12

    months would be preceding the date of publication of the clearing

    requirement determination in the Federal Register, i.e., whatever date

    this adopting release is published.\175\ Market participants have asked

    the Commission to harmonize these two dates so that there will be one

    self-identified list of Active Funds for purposes of both

    implementation schedules under parts 23 and 50. The Commission agrees

    with this approach and is modifying both compliance schedules to

    require private funds to calculate the number of swaps they enter into

    as a monthly average

    [[Page 74321]]

    over the past 12 months preceding November 1, 2012.

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

    \173\ Confirmation, Portfolio Reconciliation, Portfolio

    Compression, and Swap Trading Relationship Documentation

    Requirements for Swap Dealers and Major Swap Participants, 77 FR

    55904 (Sept. 11, 2012).

    \174\ See 77 FR at 55940.

    \175\ See Swap Transaction Compliance and Implementation

    Schedule: Clearing Requirement Under Section 2(h) of the CEA, 77 FR

    at 44456.

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

    In addition, the Commission clarifies that for purposes of

    calculating the number of swaps a fund executes as a monthly average

    over the 12 months preceding November 1, 2012, for both part 23 and

    part 50, private funds as defined in section 202(a) of the Investment

    Advisers Act of 1940 are not required to include foreign exchange

    swaps, in light of the final determination from the Secretary of the

    Treasury to exempt such swaps from the CEA.\176\

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

    \176\ See http://www.treasury.gov/press-center/press-releases/Documents/11-16-2012%20FX%20Swaps%20Determination%20pdf.pdf

    (finalizing Determinations of Foreign Exchange Swaps and Forwards,

    75 FR 66829 (Oct. 28, 2010)).

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

    Finally, ISDA commented that the inter-affiliate exemption should

    be finalized prior to requiring compliance with the clearing

    requirement. The Commission has proposed its inter-affiliate exemption

    rules \177\ and anticipates that it will finalize those rules prior to

    the aforementioned compliance dates for these clearing requirement

    determinations.

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

    \177\ Clearing Exemption for Swaps Between Certain Affiliated

    Entities, 77 FR 50425 (Aug. 21, 2012).

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

    V. Cost-Benefit Considerations

    A. Statutory and Regulatory Background

    As discussed in the NPRM, and above, certain OTC derivatives, such

    as credit default swaps (CDS) played a prominent role in the financial

    crisis in the fall of 2008, highlighting the risk that opaque OTC

    markets can create for the financial system by linking together

    financial institutions in ways that are not well-understood.\178\ The

    failure to adequately collateralize the risk exposures posed by OTC

    derivatives, along with the contagion effects of the vast web of

    uncollateralized counterparty credit risk, led many to conclude that

    OTC derivatives should be centrally cleared.

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

    \178\ 77 FR 47170 (Aug. 7, 2012). See also Section I.B above.

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

    A fundamental premise of the Dodd-Frank Act is that the use of

    properly functioning central clearing can reduce systemic risk.

    Congress included the statutory clearing requirement in the Dodd-Frank

    amendments to the CEA 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. The clearing

    requirement determinations and regulations contained in this adopting

    release identify certain classes of swaps that are required to be

    cleared pursuant to the Dodd-Frank Act's \179\ clearing requirement

    incorporated within amended section 2(h)(1)(A) of the CEA.\180\

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

    \179\ Dodd-Frank Wall Street Reform and Consumer Protection Act,

    Public Law 111-203, 124 Stat. 1376 (2010).

    \180\ This section states: ``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 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.''

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

    The Commission's regulations establishing the process for the

    review of swaps that are submitted for a mandatory clearing

    determination are found in Part 39 of the Commission's regulations.

    Regulation 39.5 provides an outline for the Commission's review of

    swaps for required clearing.\181\ Regulation 39.5 requires the

    Commission to review all swaps submitted by DCOs or those swaps that

    the Commission opts to review on its own initiative.\182\ Under section

    2(h)(2)(D) of the CEA, in reviewing swaps for required clearing, the

    Commission must take into account the following factors: (1)

    Significant outstanding notional exposures, trading liquidity and

    adequate pricing data, (2) the availability of rule framework,

    capacity, operational expertise and credit support infrastructure, (3)

    the effect on the mitigation of systemic risk, (4) the effect on

    competition and (5) the existence of reasonable legal certainty in the

    event of the insolvency of the DCO or one or more of its clearing

    members.\183\ Regulation 39.5 also directs DCOs to provide to the

    Commission other information, such as product specifications,

    participant eligibility standards, pricing sources, risk management

    procedures, a description of the manner in which the DCO has provided

    notice of the submission to its members and any additional information

    requested by the Commission. This information is designed to assist the

    Commission in identifying those swaps that are required to be cleared.

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

    \181\ 76 FR 44464 (July 26, 2011).

    \182\ See Sec. 39.5(b), Sec. 39.5(c). Under section

    2(h)(2)(B)(ii) of the CEA, ``[a]ny swap or group, category, type, or

    class of swaps listed for clearing by a [DCO] as of the date of

    enactment shall be considered submitted to the Commission.''

    \183\ Section 2(h)(2)(D) of the CEA and Sec. 39.5(b)(ii).

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

    On February 1, 2012, Commission staff sent a letter requesting that

    registered DCOs submit all swaps that they were accepting for clearing

    as of that date, pursuant to Sec. 39.5 of the Commission's

    regulations. The Commission received submissions relating to CDS and

    interest rate swaps, as well as agricultural and energy swaps.

    This initial Commission determination addresses certain interest

    rate swaps and CDS, and is the first of a series of determinations that

    the Commission anticipates making as part of a phased approach to

    implementing mandatory clearing. The Commission chose to issue its

    first clearing requirement proposal for interest rate swaps and CDS

    because those swaps represent a significant share of the market in the

    case of interest rate swaps, and pose a unique risk profile in the case

    of CDS. In addition, the market has been clearing both types of swaps

    for some time, and market participants asked that the Commission begin

    with interest rate swaps and CDS. The Commission intends subsequently

    to consider other swaps submitted by DCOs, such as agricultural,

    energy, and equity indices.

    As stated in both the NPRM and above, the decision to initially

    focus on CDS and interest rate swaps from amongst the swaps submitted

    to the Commission for mandatory clearing determinations pursuant to

    section 2(h)(2) is a function of both the market importance of these

    swaps and the fact that they already are widely cleared. In order to

    move the largest number of swaps to required clearing in its initial

    determinations, the Commission believes that it is prudent to focus on

    those swaps that have the highest market shares and market impact.

    Further, for these swaps there is already a blueprint for clearing and

    appropriate risk management. CDS and interest rate swaps fit these

    considerations and therefore are well suited for required clearing

    consideration.\184\ In the discussion that follows, the importance of

    central clearing is explained and highlighted to provide the background

    for the Commission's consideration of the costs and benefits in this

    rulemaking as the Commission exercises its discretion under section

    2(h)(2)(D) of the CEA to determine whether swaps that are submitted for

    a mandatory clearing determination are required to be cleared.

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

    \184\ 77 FR 47172 (August 7, 2012). See also Section I.F above.

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

    B. Overview of Swap Clearing

    The following background discussion provides context for the

    Commission's consideration of the costs and benefits of its clearing

    determinations in this rulemaking.

    [[Page 74322]]

    i. How Clearing Reduces Risk

    When a bilateral swap is cleared, the clearinghouse becomes the

    counterparty to each of the original counterparties to the swap. This

    standardizes counterparty credit risk for the original swap

    participants in that they each bear the same risk--i.e., the 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 the

    original swap participants. 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.

    Given the variety of effective clearinghouse tools to monitor and

    manage counterparty credit risk, the Commission believes that DCOs will

    continue to be some of the most creditworthy counterparties in the swap

    markets. These tools include the contractual right to: (1) Collect

    initial and variation margin associated with outstanding swap

    positions; (2) mark positions to market regularly (usually one or more

    times per day) and issue margin calls whenever the margin in a

    customer's account has dropped below predetermined levels set by the

    DCO; (3) adjust the amount of margin that is required to be held

    against swap positions in light of changing market circumstances, such

    as increased volatility in the underlying; and (4) close out the swap

    positions of a customer that does not meet margin calls within a

    specified period of time.

    Moreover, in the event that a clearing member defaults on their

    obligations to the DCO, the latter has a number of remedies to manage

    associated risks, including transferring the swap positions of the

    defaulted member, and covering any losses that may have accrued with

    the defaulting member's margin and other collateral on deposit. In

    order to transfer the swap positions of a defaulting member and manage

    the risk of those positions while doing so, the DCO has the ability to:

    (1) Hedge the portfolio of positions of the defaulting member to limit

    future losses; (2) partition the portfolio into smaller pieces; (3)

    auction off the pieces of the portfolio, together with their

    corresponding hedges, to other members of the DCO; and (4) allocate any

    remaining positions to members of the DCO. In order to cover the losses

    associated with such a default, the DCO would typically draw from (in

    order): (1) The initial margin posted by the defaulting member; (2) the

    guaranty fund contribution of the defaulting member; (3) the DCO's own

    capital contribution; (4) the guaranty fund contribution of non-

    defaulting members; and (5) an assessment on the non-defaulting

    members. These mutualized risk mitigation capabilities are largely

    unique to clearinghouses, and help to ensure that they remain solvent

    and creditworthy swap counterparties even when dealing with defaults by

    their members or other challenging market circumstances.

    ii. Movement of Swaps Into Clearing

    There is significant evidence that some parts of the OTC swap

    markets (the interest rate swaps and CDS markets in particular) have

    been migrating into clearing over the last number of years in response

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

    clearing requirement. LCH 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.\185\ Data provided to the Commission shows that the notional

    amount of cleared interest rate swaps is approximately $72 trillion as

    of January 2007, and just over $236 trillion in September 2010, an

    increase of 228% in three and a half years.\186\ Together, those facts

    indicate increased demand for LCH clearing services related to interest

    rate swaps, a portion of which preceded the Dodd-Frank Act.\187\ Data

    available through CME and TriOptima indicate similar patterns of

    growing demand for interest rate swap clearing services, although their

    publically available data does not provide a picture of demand prior to

    the passage of the Dodd-Frank Act.\188\

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

    \185\ As a measure of volume, LCH accounts for each swap it

    clears as one trade side, which represents one counterparty to each

    two-sided trade.

    \186\ Data provided to the Commission by LCH. In the context of

    interest rate swaps, the notional amount refers to the specified

    amount on which the exchanged swap payments are calculated. It is a

    nominal amount that is not exchanged between counterparties.

    \187\ See http://www.lchclearnet.com/swaps/volumes/. Since the

    Dodd-Frank Act was passed in July 2010, outstanding trade sides at

    LCH have increased from approximately 1.6 million to 2.3 million in

    September of 2012, an increase of approximately 44%. Indeed, the

    number of new trade sides being submitted for clearing per month

    increased from approximately 55,000 trade sides per month to 150,000

    trade sides per month, an increase of approximately 270%.

    \188\ See http://www.cmegroup.com/trading/interest-rates/cleared-otc/index.html#data and http://www.trioptima.com/repository/historical-reports.html. Notably, CME launched its interest rate

    swap clearing service in the fall of 2010, after the Dodd-Frank Act

    was passed.

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

    In addition to interest rate swap clearing, major CDS market

    participants are clearing their CDS indices and single names in

    significant volumes. As explained above, in 2008, prior to the

    enactment of the Dodd-Frank Act, the Federal Reserve Bank of New York

    (FRBNY) began encouraging market participants to establish a central

    counterparty to clear CDS.\189\ In the past four years CDS clearing has

    grown significantly. As a representation of this growth, CME now has

    initial margin for CDS in excess of $1.8 billion and a guaranty fund of

    approximately $629 million,\190\ and ICE Clear Credit has initial

    margin on deposit for CDS of $10.8 billion and a guaranty fund equal to

    $4.4 billion.\191\ ICE Clear Europe has initial margin for CDS totaling

    $6.8 billion and a guaranty fund of $2.7 billion.\192\

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

    \189\ See Federal Reserve Bank of New York, Press Release, ``New

    York Fed Welcomes Further Industry Commitments on Over-the-Counter

    Derivatives,'' Oct. 31, 2008, available at http://www.newyorkfed.org/newsevents/news/markets/2008/an081031.html, which

    references documents prepared by market participants describing the

    importance of clearing. See also Ciara Linnane and Karen Brettell,

    ``NY Federal Reserve pushes for central CDS counterparty,'' Reuters,

    Oct. 6, 2008.

    \190\ See http://www.cmegroup.com/clearing/cme-clearing-overview/safeguards.html for data regarding CME's guaranty fund,

    posted as of May 10, 2012.

    \191\ See https://www.theice.com/clear_credit.jhtml for data on

    the size of guaranty fund, posted as of May 10, 2012.

    \192\ Id. The data is not adequate to enable the Commission to

    determine how much of the movement into clearing is attributable to

    natural market forces or anticipated requirements under the Dodd-

    Frank Act.

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

    iii. The Clearing Requirement and Role of the Commission

    In the Dodd-Frank Act, Congress directed that clearing shift from a

    voluntary practice to a mandatory practice for certain swaps and gave

    the Commission responsibility for determining which swaps would be

    required to be cleared. Under section 2(h)(2) of the CEA, the

    Commission is required to review each swap, or group, category, type,

    or class of swaps that a DCO clears and submits to the Commission in

    order to determine whether the submitted swaps are required to be

    cleared. In making these clearing determinations and promulgating the

    final rules, the Commission has taken its direction from the statutory

    text and is implementing the statute by determining, in accordance with

    the five factors set forth in the statute, whether swaps submitted to

    the Commission for a mandatory

    [[Page 74323]]

    clearing determination are required to be cleared. As described above,

    the Commission has decided to initially focus on interest rate swaps

    and CDS because of the market importance of these swaps and the fact

    that they already are widely cleared.

    In determining pursuant to section 2(h)(2)(D) whether these

    particular swaps should be required to be cleared, the Commission has

    taken into account the fact that voluntary clearing of swaps has

    increased over the past years (perhaps due in part to anticipation of

    the clearing requirement to be imposed under the Dodd-Frank Act, but

    perhaps due in part to a realization of the benefits of clearing after

    the financial crisis). These industry efforts and the extent to which

    voluntary clearing of swaps has already occurred provide a useful

    reference point for the Commission's consideration of the costs and

    benefits of its actions in determining whether particular swaps should

    be required to be cleared.\193\

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

    \193\ The Commission also recognizes that there might not be a

    linear relationship between the quantity of swaps that are cleared

    (whether measured by number of swaps, the notional value of swaps,

    or some other measure of swap quantity, such as the exposure

    resulting from the swaps) and the costs and benefits resulting from

    clearing. For example, if the Commission were to assume that the

    rule would result in a doubling of the quantity of a certain type of

    swap that is cleared, it would not necessarily be the case that the

    costs and benefits of clearing that type of swap would double.

    Rather, the relationship could be non-linear for a variety of

    reasons (such as variations among the users of that type of swap).

    In fact, it may be reasonable to assume that where the costs of

    clearing are relatively low and the benefits are relatively high,

    market participants already voluntarily clear swaps even in the

    absence of a clearing requirement.

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

    In the discussion that follows, the Commission summarizes and

    evaluates the costs and benefits of the new clearing requirements

    resulting from the Commission's clearing determinations in this

    rulemaking. In the context of this relevant statutory provision and

    ongoing industry initiatives, in the sections that follow, the

    Commission also has considered its clearing determinations in light of

    cost-benefit issues raised by commenters and suggested alternatives.

    In general, the Commission believes that the costs and benefits

    related to the required clearing of the classes of interest rate swaps

    and CDS resulting from this rulemaking are attributable, in part to (1)

    Congress's stated goal of reducing systemic risk by, among other

    things, requiring clearing of swaps and the statutory clearing mandate

    in section 2(h) of the CEA to achieve that objective; and (2) the

    Commission's determination under section 2(h)(2)(D) that these

    particular classes of swaps should be required to be cleared. The

    Commission will discuss the costs and benefits of the overall move from

    voluntary clearing to required clearing for the particular swaps

    subject to this new clearing requirement.\194\ However, in so doing,

    the Commission believes that it is not readily ascertainable whether an

    increased use of clearing following such determinations should be

    attributed to statutory or regulatory requirements that particular

    swaps be required to be cleared, as compared to swap market

    participants' market-based decisions to increase the use clearing to

    reduce risks and costs.\195\

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

    \194\ Embedded in this approach is the assumption that costs and

    benefits of increased clearing prior to the determination is not a

    function of the Dodd-Frank Act or the clearing determination

    contained herein. As stated above, the Commission acknowledges that

    some increases in clearing that have already occurred are likely the

    result of anticipated clearing requirements. However, it is not

    possible to estimate how much of the increases in clearing are the

    result market forces, and how much is a function of expected

    requirements related to clearing. Both factors have likely

    contributed to the increases in clearing that have occurred prior to

    this rule.

    \195\ It is also possible that some market participants would

    respond to the current rule's requirement that certain types of

    swaps be cleared by decreasing their use of such swaps. This

    possibility contributes to the uncertainty regarding how the current

    rule will affect the volume of swaps that are cleared.

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

    C. Consideration of the Costs and Benefits of the Commission's Action

    i. CEA Section 15(a)

    Section 15(a) of the CEA 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

    the following 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. Accordingly, the Commission considers the

    costs and benefits resulting from its discretionary determinations with

    respect to the section 15(a) factors.

    As stated above, the Commission received a total of 33 comment

    letters following the publication of the NPRM, many of which strongly

    supported the proposed regulations. Some commenters generally addressed

    the cost-and-benefit aspect of the current rule; none of them, however,

    provided any quantitative data in response to the Commission's requests

    for comment. In the sections that follow the Commission considers: (1)

    Costs and benefits of required clearing for the classes of swaps

    identified in this adopting release; (2) alternatives contemplated by

    the Commission and the costs and benefits relative to the approach

    adopted herein; (3) the impact of required clearing for swaps under the

    identified classes of swaps in light of the 15(a) factors. The

    Commission also discusses the corresponding comments accordingly.

    ii. Costs and Benefits of Required Clearing Under the Final Rule

    In order to comply with required clearing under this adopting

    release, market participants are likely to face certain startup and

    ongoing costs relating to technology and infrastructure, new or updated

    legal agreements, ongoing fees from service providers, and costs

    related to collateralization of their positions. The per-entity costs

    related to changes in technology, infrastructure, and legal agreements

    are likely to vary widely, depending on each market participant's

    existing technology infrastructure, legal agreements, operations, and

    anticipated needs in each of these areas. For market participants that

    already use clearing services, some of these costs may be expected to

    be lower, while the opposite will likely be true for market

    participants that must begin to use clearing services only because of

    the new clearing requirement. The costs of collateralization, on the

    other hand, are likely to vary depending on a number of factors,

    including whether an entity is subject to capital requirements or not,

    and the differential between the cost of capital for the assets the

    entity uses as collateral, and the returns the entity realizes on those

    assets.

    There are also significant benefits associated with increased

    clearing, including reducing and standardizing counterparty credit

    risk, increased transparency, and easier access to the swap markets.

    These effects together will contribute significantly to the stability

    and efficiency of the financial system. The Commission lacks data to

    quantify these benefits with any degree of precision. The Commission

    notes, however, that the extraordinary financial system turbulence of

    2008 has had profound and long-lasting adverse effects on the economy,

    and therefore reducing systemic risk provides significant, if

    unquantifiable, benefits.\196\ Also, as is the case for the

    [[Page 74324]]

    costs related to clearing, these benefits would be relatively less to

    the extent that market participants are already using clearing in the

    absence of a requirement.

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

    \196\ For example, the PEW Economic Policy Group estimates total

    costs of the acute stage of the crisis for U.S. interests were

    approximately $12.04 trillion, including lost GDP, wages, real

    estate wealth, equity wealth, and fiscal costs. Their estimates

    include $7.4 trillion in losses in the equity markets between June

    2008 and March 2009, but do not include subsequent gains in equity

    markets that restored markets to their mid-2008 levels by the end of

    2009. In addition, their calculations do not include continued

    declines in real estate markets subsequent to March 2009. See Pew

    Economic Policy Group, ``The Cost of the Financial Crisis: The

    Impact of the September 2008 Economic Collapse,'' March 2010. The

    IMF estimated that the cost to the banking sector of the financial

    crisis through 2010 was approximately $2.2 trillion and reported a

    range of estimates for total cost to the taxpayer of GSE bailouts

    that ranged from $160 billion (Office of Management and Budget,

    February 2010) to $500 billion (Barclays Capital, December 2009).

    See IMF, ``Global Financial Stability Report: Responding to the

    Financial Crisis and Measuring Systemic Risks,'' October 2010. Both

    studies acknowledge that the estimates are subject to uncertainties.

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

    a. Technology, Infrastructure, and Legal Costs

    With respect to technology and infrastructure, for market

    participants that already use swap clearing services or trade futures,

    many of the backend requirements for technology and infrastructure that

    supports cleared swaps are likely to be quite similar, and therefore

    necessary changes to those systems are likely to require relatively

    lower costs. Market participants that are not currently using swap

    clearing services or trade futures, however, may need to implement

    appropriate infrastructure and technology to connect with an FCM that

    will clear swaps on their behalf.

    Similarly for legal fees, the costs related to clearing the swaps

    that are subject to this clearing requirement are likely to vary widely

    depending on whether market participants already use clearing services

    or trade futures. For those market participants that have not already

    engaged an FCM, it has been estimated, in response to another

    rulemaking, that smaller financial institutions will spend between

    $2,500 and $25,000 reviewing and negotiating legal agreements when

    establishing a new business relationship with an FCM.\197\ Commenters

    on this rulemaking did not provide data that would enable the

    Commission to determine to what degree these estimates would apply to

    larger entities establishing a relationship with an FCM or to determine

    costs associated with entities that already have established

    relationships with one or more FCMs, but need to revise those

    agreements.\198\ Even accepting the data provided for smaller financial

    institutions, the Commission lacks sufficient data to calculate a

    reasonable estimate of the potential costs that are likely to depend

    significantly on the specific business needs of each entity and

    therefore are expected to vary widely among market participants.

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

    \197\ See comments to End-User Exception to Mandatory Clearing

    of Swaps; Proposed Rule, 75 FR 80747 (Dec. 23, 2011), including

    Chatham Financial letter at 2, available at http://comments.cftc.gov/PublicComments/ViewComment.aspx?id=58077, and

    Webster Bank letter at 3, available at http://comments.cftc.gov/PublicComments/ViewComment.aspx?id=58076.

    \198\ In its letter, FIA stated that it does not collect

    information from its members concerning fees charged for particular

    services, and thus is unable to respond to the Commission's request

    for date regarding FCM fees. No other commenter responded to the

    request for information regarding legal fees.

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

    Citadel commented that the fact that all the interest rate swaps

    and CDS included in the Commission's proposal are already being cleared

    by registered DCOs in material volumes provides clear evidence that

    there is the rule framework, capacity, operational expertise and

    resources, and credit support infrastructure necessary to clear each of

    the swaps that are the subject of the Commission's determination.

    SIFMA AMG and Vanguard expressed concern about legal documentation

    and negotiations taking many months, and recommended the clearing

    requirement be delayed. They also raised doubt about the readiness of

    market participants to comply with the Commission's upcoming swap

    customer segregation rules. Vanguard further stated that it has

    ``serious reservations about the potential impact on cost, liquidity,

    and heightened margin risk which could result from the premature roll-

    out of the clearing mandate.''

    In light of the ``lack of experience and practical know-how''

    related to DCO insolvency, ISDA recommended that the Commission conduct

    a study on insolvency. Citadel, on the other hand, stated that

    reasonable legal certainty exists in the event of an insolvency of a

    DCO or one or more DCO members with regard to the treatment of customer

    and swap counterparty positions, funds, and property.

    Commission Response

    In response to Vanguard and SIFMA AMG's concerns about legal

    documentation and operational readiness, the Commission has clarified

    that compliance with the clearing requirement will not be required for

    any swaps until March 11, 2013, which responds to commenters'

    recommendation that the clearing requirement by delayed for six months

    to allow for documentation. Moreover, Category 2 and Category 3

    entities will have until June 10, 2013, and September 9, 2013,

    respectively, to come into compliance with the new requirement.\199\ In

    response to ISDA's statements regarding insolvency, as explained above,

    Commission staff actively participates in a number of international

    efforts related to clearinghouses and clearing member insolvency, as

    well as in coordination efforts with U.S. authorities.\200\

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

    \199\ See Section IV above, clarifying that compliance for

    Category I, II, and III Entities will apply, respectively, to swaps

    executed on or after March 11, 2013, June 10, 2013, and September 9,

    2013.

    \200\ See Section II.B above.

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

    Additionally, the Commission is exercising the anti-evasion

    rulemaking authority granted to it by the Dodd-Frank Act. In terms of

    legal costs, market participants will be responsible for complying with

    the new anti-evasion requirements. Generally, rule Sec. 50.10 states

    that it is unlawful for any person to knowingly or recklessly evade or

    participate in or facilitate an evasion of the requirements of section

    2(h) of the CEA, to abuse the exception to the clearing requirement as

    provided under section 2(h)(7) of the CEA and Commission rules, or to

    abuse any exemption or exception to the requirements of section 2(h) of

    the CEA, including any exemption or exception as the Commission may

    provide by rule, regulation, or order.

    This rule is expected to help ensure that would-be evaders cannot

    engage in conduct or activities that constitute an evasion of the

    requirements of section 2(h) or an abuse of any exemption or exception

    to such requirements. The Commission also sets forth guidance as to how

    it would determine if such evasion or abuse has occurred, while at the

    same time preserving the Commission's ability to determine, on a case-

    by-case basis, with consideration given to all the facts and

    circumstances, that other types of transactions or activities

    constitute an evasion or abuse under Sec. 50.10.\201\

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

    \201\ The Commission has not adopted a ``bright-line'' standard

    for evasion in order to avoid providing a ``road-map'' for evasion.

    The Commission's discussion of Sec. 50.10 is similar to its

    approach for the anti-evasion rules Sec. Sec. 1.3(xxx)(6) and 1.6

    that it recently adopted in a joint final rulemaking with the

    Securities and Exchange Commission. See Further Definition of

    ``Swap,'' ``Security-Based Swap,'' and ``Security-Based Swap

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

    Recordkeeping, 77 FR 48208, 48350-48354 (Aug. 13, 2012).

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

    The Commission believes that participants in the swap markets

    should have policies and procedures already in place to ensure that

    their employees, affiliates, and agents will refrain from engaging in

    activities, including devising transactions, for the purpose of

    [[Page 74325]]

    evading, or in reckless disregard of, the requirements of section 2(h)

    of the CEA and Commission regulations or to abuse any exemption or

    exception to such requirements. The Commission believes that it will

    not be necessary for firms that currently have adequate compliance

    programs to hire additional staff or significantly upgrade their

    systems to comply with the proposed rule. Firms may, however, incur

    some costs, such as costs associated with training staff on the new

    clearing requirement rules.

    In addition, market participants may incur costs when determining

    whether they are properly relying on a legitimate business purpose. The

    Commission in choosing a principles-based approach rather than a

    bright-line test, recognizes that there may be direct costs and

    indirect costs due to perceived uncertainty related to determining what

    constitutes a legitimate business purpose for entering into swaps that

    are not subject to the clearing requirement. As stated above, the

    Commission will not provide a bright-line test of non-evasive or

    abusive conduct because such an approach may be a roadmap for engaging

    in evasive or abusive conduct or activities. However, the Commission

    has provided guidance above regarding what is meant by certain key

    terms in Sec. 50.10, and the Commission has clarified its belief that

    where a person's principal purpose in entering into a swap that is not

    subject to the clearing requirement is to circumvent the costs of

    clearing, the legitimate business purpose test would not be satisfied.

    The Commission anticipates that this guidance will mitigate costs

    related to determining whether particular conduct or activity could be

    construed as being an evasion of the requirements of section 2(h) or an

    abuse of any exemption or exception to the requirements.\202\

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

    \202\ See above at Section III.G.

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

    b. Ongoing Costs Related to FCMs and Other Service Providers

    In the NPRM, the Commission considered ongoing costs associated

    with fees charged by FCMs that market participants will bear, in

    addition to costs associated with technological and legal

    infrastructure. Regarding fees, DCOs typically charge FCMs an initial

    transaction fee for each of the FCM's customers' interest rate swaps

    that are cleared, as well as an annual maintenance fee for each of

    their customers' open positions. Not including customer-specific and

    volume discounts, the transaction fees for interest rate swaps at the

    CME range from $1 to $24 per million notional amount for interest rate

    swaps and the maintenance fees are $2 per year per million notional

    amount for open positions.\203\ LCH transaction fees for interest rate

    swaps range from $1-$20 per million notional amount, and the

    maintenance fee ranges from $5-$20 per swap per month, depending on the

    number of outstanding swap positions that an entity has with the

    clearinghouse.\204\ For CDS, ICE Clear Credit charges an initial

    transaction fee of $6 per million notional amount. There is no

    maintenance fee charged by ICE for maintaining open CDS positions.\205\

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

    \203\ See CME pricing charts at: http://www.cmegroup.com/trading/cds/files/CDS-Fees.pdf;

    http://www.cmegroup.com/trading/interest-rates/files/CME-IRS-Customer-Fee.pdf;

    and http://www.cmegroup.com/trading/interest-rates/files/CME-IRS-Self-Clearing-Fee.pdf.

    \204\ See LCH pricing for clearing services related to OTC

    interest rate swaps at: http://www.lchclearnet.com/swaps/swapclear_for_clearing_members/fees.asp.

    \205\ See ICE Clear Credit fees for CDS at: https://www.theice.com/publicdocs/clear_credit/circulars/ICEClearCredit%20Fee%20Schedule%20Notice_FINAL.pdf.

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

    FCMs will also bear additional fees with respect to their house

    accounts at the DCO to the extent that they clear more swaps due to the

    clearing requirement. For example, for interest rate swaps that they

    clear through CME, clearing members are charged a transaction fee that

    ranges from $0.75 to $18.00 per million notional, depending on the

    transaction maturity.\206\ Members, however, are not charged annual

    maintenance fees for their open house positions.\207\ For CDS, clearing

    members at ICE Clear Credit are charged $5-6 per transaction per

    million notional and there is no maintenance fee.\208\

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

    \206\ See CME pricing charts.

    \207\ See id.

    \208\ See ICE Clear Credit fees for CDS at: https://www.theice.com/publicdocs/clear_credit/circulars/ICEClearCredit%20Fee%20Schedule%20Notice_FINAL.pdf.

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

    As discussed above, it is difficult to predict precisely how the

    requirement to clear the classes of swaps covered by this new

    requirement will increase the use of swap clearing, as compared to the

    use of clearing that would occur in the absence of the requirement.

    However, the Commission expects that application of the clearing

    requirement to the swaps covered by the new rule will generally

    increase the use of clearing, leading to the ongoing transaction costs

    noted above.

    In addition, the Commission understands that FCM customers that

    only transact in swaps occasionally are typically required to pay a

    monthly or annual fee to each FCM that ranges from $75,000 to $125,000

    per year.\209\ Again, although it is difficult to predict precisely how

    many FCM customers would be subject to such fees based on the clearing

    requirement for CDS and interest rate swaps, the Commission expects

    that some market participants that previously did not use clearing

    would be subject to the requirements of the current rule.

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

    \209\ See letters from Chatham and Webster Bank. The Commission

    is not aware of similar annual fees charged to larger customers. The

    Commission believes that FCMs are more likely to charge such fees to

    smaller customers in order to cover the fixed costs that are not

    likely covered through fees charged on a per-swap basis to customers

    that use swaps less frequently.

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

    In the NPRM, the Commission asked a series of questions related to

    FCM fees and invited comment on the fee information presented. No

    commenter responded to the questions asked or provided any additional

    information with regard to clearing fees. As noted above, FIA raised

    the issue only to explain that it does not collect such information

    from its members.

    c. Costs Related to Collateralization of Cleared Swap Positions

    As mentioned above, market participants that enter into swaps with

    the specifications identified in the classes subject to this adopting

    release will be required to post collateral with their FCM and/or at

    the DCO. The incremental cost of collateral resulting from the

    application of the clearing requirement depends on the extent to which

    such swaps are already being cleared (even in the absence of the

    requirement) or otherwise collateralized bilaterally. The incremental

    cost also depends on whether such swaps are, if not collateralized,

    priced to include implicit contingent liabilities and counterparty

    credit risk born by the counterparty to the swap.

    1. Quantitative Approach Presented in the NPRM

    A conservative approach would be to assume that all the swaps that

    are currently not cleared would be covered by the new clearing

    requirement, and that they are completely uncollateralized, and not

    priced to include implicit contingent liabilities and counterparty

    credit risk born by the counterparty. Under this approach, imposition

    of the clearing requirement for those types of swaps would create

    additional costs due to: (1) The difference between cost of capital and

    returns on that capital for assets posted to meet initial margin for

    the entire term of the swap; and (2) the difference

    [[Page 74326]]

    between cost of capital and returns on that capital for assets paid to

    meet the cost of capital for variation margin to the extent a party is

    ``out of the money'' on each swap. Under the assumptions mentioned

    above, if every interest rate swap and CDS that is not currently

    cleared were moved into clearing, the additional initial margin that

    would need to be posted is approximately $19.2 billion for interest

    rate swaps and $53 billion for CDS.\210\

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

    \210\ The numbers calculated above may either over-estimate or

    under-estimate the amount of additional initial margin that would

    need to be posted under the conservative assumptions stated above.

    For instance, differences in the amount of netting that is possible

    within portfolios currently being cleared versus those not currently

    being cleared could have a significant impact on the amount of

    additional margin that is required to be posted. Other factors such

    as differences in liquidity among swaps currently being cleared and

    those not being cleared could also impact the amount of additional

    margin that is posted.

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

    In the NPRM, the Commission calculated its estimated additional

    initial margin amounts based on the following assumptions. According to

    representations made to the Commission by LCH, they clear approximately

    51% of the interest rate swaps market. The total amount of initial

    margin on deposit at LCH for interest rate swaps is approximately $20

    billion.\211\ Therefore, if all remaining interest rate swaps were

    moved into clearing, approximately $19.2 billion ($20B/0.51-$20B =

    19.2B) would have to be posted in initial margin.

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

    \211\ The total amount of initial margin on deposit at CME for

    interest rate swaps is $5 billion, but for purposes of this

    estimate, the Commission is not including that amount.

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

    Similarly, the initial margin related to CDS currently on deposit

    at CME, ICE Clear Credit, and ICE Clear Europe is approximately $21.4

    billion.\212\ This amount includes initial margin based on both index-

    based CDS and single-name CDS positions. BIS data indicates that

    approximately 36.6% of the CDS market comprises index-based CDS.\213\

    In the NPRM, the Commission noted that if it is assumed that

    approximately 36.6% of the overall portfolio-based CDS margin (i.e.,

    CDS indices and single-name CDS margined together) currently held by

    DCOs for CDS positions is related to index-based CDS, and then add any

    margin held by DCOs attributable solely to index-based CDS, it can be

    estimated that approximately $9.0 billion in margin currently held by

    those DCOs is related to index-based CDS. ISDA data indicates that

    14.5% of the index-based CDS market is currently cleared.\214\

    Therefore, the Commission noted in the NPRM that if the entire index-

    based CDS market moved into clearing, $53 billion ($9.0B/0.145-$9.0 =

    $53B) in initial margin would have to be posted at DCOs.

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

    \212\ The total amount of initial margin on deposit only

    includes those amounts reported to the Commission by registered

    DCOs. Other clearinghouses, such as LCH.Clearnet.SA, clear the

    indices included in the proposed determination, however, the

    relative size of the open interest in the relevant CDS indices is

    substantially smaller than each of the DCOs included in this

    calculation.

    \213\ BIS estimates that the gross notional value of outstanding

    CDS contracts is $28.6 trillion, and that $10.5 trillion of that is

    index related CDS. See BIS data, available at http://www.bis.org/statistics/otcder/dt21.pdf.

    \214\ In the NPRM, the Commission noted that ISDA has estimated

    that 14.5% of the index-based CDS market is currently being cleared,

    whereas the total outstanding notional at CME, ICE Clear Europe, and

    ICE Credit represents approximately 7.5% of the global index-based

    CDS market estimated by BIS. Such a discrepancy would be expected if

    one or more of the following occurred: (1) If ISDA overestimated the

    percentage of the index-based CDS that is currently being cleared;

    (2) if BIS overestimated the size of the global index-based swap

    market; (3) if a significant amount of compression occurs as index-

    based CDS are moved into clearing; and/or (4) if a significant

    portion of the cleared index-based CDS market is held at

    clearinghouses other than CME, ICE Clear Europe, and ICE Clear

    Credit. The Commission noted in the NPRM that it believes that the

    compression of CDS positions moving into clearing is the most likely

    explanation and therefore used the ISDA estimate.

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

    Both of the above estimates assume that additional interest rate

    swaps brought into clearing would have similar margin requirements per

    unit of notional amount to those interest rate swaps that are already

    in clearing, and assumes that additional CDS brought into clearing

    would have similar margin requirements per unit of notional amount to

    those CDS that are already being cleared. These assumptions, in turn,

    assume similar levels of liquidity, compression, netting, and similar

    tenors for the swaps that are currently cleared and those that are not.

    While the Commission recognizes that these factors are unlikely to be

    identical among both groups of products, adequate information to

    quantify the impact of each of these possible differences between the

    two groups of swaps on the amount of additional collateral that would

    have to be posted is not available.

    In any case, the Commission noted that it is probable that the

    estimates in the NPRM significantly overstate the amount of additional

    capital that would be posted for a number of reasons described below.

    First, these estimates are based upon the assumption that every

    interest rate swap and index-based CDS not currently cleared is brought

    into clearing as a result of the Commission's determinations herein.

    However, in this adopting release the Commission has set forth clearing

    requirements only for certain classes of interest rate swaps and CDS,

    and not for all interest rate swaps and CDS. Therefore, there will

    still be certain types of interest rate swaps, such as those related to

    the thirteen additional currencies cleared by LCH, that are not

    required to be cleared. Moreover, the clearing requirement will apply

    only to new swap transactions \215\ whereas market estimates include

    legacy transactions. In addition, these estimates assume that no

    additional voluntary clearing would be taking place in the absence of

    the Commission's determinations. The Commission also observes that, to

    the extent that portfolio margining for products such as CDS is

    expanded to all market participants, it is likely to reduce the

    additional margin that is required. In some instances, these margin

    reductions for well-balanced portfolios could be significant.

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

    \215\ As well as, applying to swaps subject to a change in

    ownership, as explained above in Section III.D.

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

    In addition, non-financial entities entering into swaps for the

    purpose of hedging or mitigating commercial risk are not required to

    use clearing under section 2(h)(7) of the CEA. As a consequence, many

    entities will not be required to clear, even when entering into

    interest rate swaps or CDS that are otherwise required to be cleared.

    Third, some interest rate swaps and CDS involve cross border

    transactions to which the Commission's clearing requirement will not

    apply.\216\ Fourth, collateral is already posted with respect to many

    non-cleared interest rate swaps and CDS. ISDA conducted a recent survey

    which reported that 93.4% of all trades involving credit derivatives,

    and 78.1% of all trades involving fixed income derivatives are subject

    to collateral agreements.\217\ Moreover, although the Commission cannot

    verify the accuracy of the estimate, ISDA estimated that the aggregate

    amount of collateral in circulation in the non-cleared OTC derivatives

    market at the end of 2011 was approximately $3.6 trillion.\218\

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

    \216\ Cross-Border Application of Certain Swaps Provisions in

    the Commodity Exchange Act, 77 FR 41214 (July 12, 2012).

    \217\ See ISDA Margin Survey 2012, at 15, available at http://www2.isda.org/functional-areas/research/surveys/margin-surveys/.

    Although it is unclear exactly how many of the derivatives covered

    by this survey are swaps, it is reasonable to assume that a large

    part of them are.

    \218\ This estimate, however, does not adjust for double

    counting of collateral assets. The same survey reports that as much

    as 91.1% of cash used as collateral and 43.8% of securities used as

    collateral are being reused, and therefore are counted two or more

    times in the ISDA survey. See ISDA Margin Survey 2012, at 20 and 11,

    respectively.

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

    [[Page 74327]]

    2. Comments Received in Response to NPRM Consideration of Costs and

    Benefits

    In the NPRM, the Commission requested comment regarding the total

    amount of additional collateral that would be required due to the

    proposed clearing requirement. In particular, the Commission sought

    quantifiable data and analysis.\219\ No commenter addressed the

    quantitative approach laid out by the Commission in the NPRM. Nor did

    any commenter provide quantifiable data and analysis to support or

    refute such analysis. Citadel stated that the Commission's

    determination is justified on a cost-benefit basis, but did not address

    the costs of collateral directly. FIA noted that the NPRM's cost-

    benefit discussion ``is among the more thoughtful and comprehensive the

    Commission has ever prepared,'' but did not address the costs of

    collateral, fees, or other costs.

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

    \219\ 77 FR at 47214.

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

    3. Additional Research Reviewed by the Commission

    Despite the lack of feedback from commenters regarding the costs of

    collateral, the Commission continued to research market and academic

    literature in the public domain for additional data. The Commission

    identified and obtained two relevant papers. These papers are presented

    as additional informative background regarding the costs of mandatory

    clearing. The Commission has reviewed, but has not been able to verify,

    the conclusions reached in these papers.

    In a recent research note, Morgan Stanley estimated the global

    increase in initial margin for interest rate swaps trades as a result

    of the swap clearing requirements.\220\ Its ``bull case'' figure of $20

    billion is largely consistent with the Commission's estimate of $19.2

    billion in the NPRM calculated above, though its methodology is

    different. Morgan Stanley obtained this figure in several steps. First,

    it considered two main groups of interest rate swaps traders: dealers

    and buy-side investors, which Morgan Stanley believes have interest

    rate swaps with notional values of approximately $339 trillion and $89

    trillion, respectively, outstanding. Next, Morgan Stanley projected

    that the amount of new interest rate swaps that will be cleared as a

    percentage of current notional would be 10% for dealers and 80% for

    buy-side participants, assuming that ``most of the eligible dealer-to-

    dealer trades are already centrally cleared.'' Finally, Morgan Stanley

    multiplied the resulting amount of new interest rate swaps that will be

    cleared for each group of traders by an initial margin to notional

    ratio that they estimated.\221\ Currently, according to Morgan Stanley,

    ``the aggregate dealer initial margin as a percentage of notional

    reported by LCH is approximately 0.005%.'' For dealers, the value of

    0.00005 was therefore chosen as their initial margin to notional ratio.

    For buy-side investors, however, Morgan Stanley scaled up LCH's

    benchmark ratio of 0.00005 by a growth factor of 5 to ``[capture] the

    extent to which buy-side portfolios are less diversified than dealers

    and may enjoy less netting efficiencies.'' Overall, the report argued,

    dealers and buy-side participants should expect their aggregate initial

    margin to increase by $2 billion ($339,000B x 10% x 0.00005 [ap] $2B)

    and $18 billion ($89,000B x 80% x 0.00005 x 5 [ap] $18B), respectively,

    resulting in a total estimate of $20 billion in additional margin for

    the bull case scenario. By scaling up LCH's benchmark ratio by a growth

    factor in the range between 10-20 for each group of investors, Morgan

    Stanley further obtained a ``base case'' figure of $480 billion and a

    ``bear case'' figure of $1.3 trillion. The difference between the

    Commission's estimate and Morgan Stanley's base case figure or bear

    case figure can largely be attributed to the following: the Commission

    used LCH's current overall initial margin to notional ratio in its

    calculations, whereas Morgan Stanley used LCH's current dealer initial

    margin to notional ratio; more importantly, the Commission made the

    simplifying assumption that the initial margin to notional ratio will

    stay more or less constant, whereas Morgan Stanley scaled up its

    benchmark ratio by a growth factor in a range between 10-20 based on

    its ``discussions with clearing and banking industry professionals and

    estimates made by [BIS]'' as well as its internal estimates.\222\

    Putting aside the growth factor effect, it is worth emphasizing that

    Morgan Stanley's estimates refer to the global increase in initial

    margin, which may potentially be much larger than the additional amount

    of initial margin required for those entities under the Commission's

    jurisdiction.

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

    \220\ See Morgan Stanley, Morgan Stanley Research, ``Swap

    Central Clearing: What is the Impact on Collateral?'' (August 2012).

    \221\ This ratio is the initial margin divided by the notional

    outstanding.

    \222\ In particular, Morgan Stanley assumed that ``dealer

    [initial margin] may grow over time due to higher CCP collateral

    requirements and counterparty diversification regulations.''

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

    Also, the Commission notes that in Morgan Stanley's calculations,

    the additional collateral required for buy-side swaps represents the

    vast majority of the additional collateral required in each scenario

    (approximately 95%, 74%, and 81% of the total additional capital

    required for the ``bull case,'' ``base case,'' and ``bear case,''

    respectively). A critical assumption driving each of these calculations

    is that swaps with 80% of the total buy-side notional amount are moved

    into clearing as a result of the mandate. However, the Commission

    believes this assumption may be high in light of the end-user

    exception, which includes an exemption for small financial institutions

    with less than $10 billion in assets.\223\ Adjusting this assumption

    downward would result in dramatic reductions in Morgan Stanley's

    calculations regarding the amount of additional collateral that may be

    required as a result of the mandate.

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

    \223\ See End User Exception to the Clearing Requirement for

    Swaps, 77 FR 42560 (July 19, 2012).

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

    TABB Group has also conducted a study recently that estimated the

    global ``margin shortfall'' (i.e., the additional amount of initial

    margin that will be required) for all OTC swaps due to clearing

    requirements and anticipated margin requirements for uncleared

    swaps.\224\ According to their model, the total amount of margin that

    will be required for both cleared and uncleared swaps is estimated to

    be between $2.9 trillion to $4.1 trillion, depending on the degree of

    netting for each type of traders. Further, they estimate that $1.34

    trillion of margin is already posted for all OTC swaps, leaving an

    additional $1.56-2.76 trillion in margin that would need to be posted

    for all swaps, including both cleared and uncleared positions. The

    table below summarizes TABB Group's margin estimates by trader type.

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

    \224\ See TABB Group, ``The New Global Risk Transfer Market:

    Transformation and the Status Quo,'' (Sept. 2012).

    [[Page 74328]]

    Table 6--Margin Estimates by Trader Type in Billions of U.S. Dollars \225\

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

    Gross

    Gross margin Estimated netting Estimated

    Trader type notional (1.5% of benefit margin

    notional) posted

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

    Dealers with CCP.................................. 248,561 3,728 3,710 (99.5%) 19

    Other Dealers..................................... 305,624 4,584 1,605-2,521 (35-55%) 2,063-2,980

    Financial Institutions............................ 59,964 899 225-405 (25-45%) 495-675

    Non-Financial End Users........................... 33,851 508 76-178 (15-35%) 330-432

    Others............................................ 60,000

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

    Total......................................... ........... ........... ..................... 2,906-4,105

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

    As shown in the table, if the amount for non-financial end-users

    is excluded, then the margin shortfall will be adjusted down to $1.23-

    2.33 trillion. Like the Commission, the TABB Group considered all the

    OTC swaps, some of which are not covered by the clearing requirement.

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

    \225\ Id.

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

    The TABB Group estimates are considerably higher than those of the

    Commission and of Morgan Stanley largely because of different estimates

    about what amount of netting will be possible for swaps not currently

    being cleared, and in particular, for the swaps between dealers that do

    not involve a CCP.

    4. Collateral Costs and Costs of Capital

    Given the increased collateral demands that required clearing of

    interest rate swaps and CDS is likely to bring, there will be

    corresponding demand for capital. To calculate the additional

    collateral cost to market participants, the Commission in the NPRM

    estimated the difference between the cost of capital for the additional

    collateral and the returns on that capital. Although no comments

    discussed this issue in comments on the NPRM, the Commission notes that

    in comments regarding other Commission rules, commenters have sometimes

    taken the view that the difference between the cost and returns on

    capital for funds that are used as collateral is substantial.

    The Commission described a comment on behalf of the Working Group

    of Commercial Energy Firms in the NPRM. In this comment, an economic

    consulting firm, NERA, used an estimate of 13.08% for the pre-tax

    weighted average cost of capital for the firm, and an estimate of 3.49%

    for the pre-tax yield on collateral, for a difference as 9.59% which

    NERA used as the net pre-tax cost of collateral.\226\ However, as noted

    in the NPRM, these estimates use the borrowing costs for the entire

    firm, but only consider the returns on capital for one part of the

    firm, when determining the spread between the two.\227\ The result is

    an over-stated difference, and therefore a higher cost associated with

    collateral than would result if the costs of capital and returns of

    capital were compared on a consistent basis.\228\

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

    \226\ The NERA study is available at http://comments.cftc.gov/PublicComments/ViewComment.aspx?id=50037 and their comments

    defending their cost of capital are available in their letter at

    http://comments.cftc.gov/PublicComments/ViewComment.aspx?id=57015.

    \227\ Moreover, according to Morgan Stanley's research note

    cited above, many dealers and buy-side investors currently hold

    enough unencumbered collateral to meet at least part of the

    incremental initial margin requirements. In other words, each of

    these entities will need to raise only a portion of the additional

    capital required.

    \228\ This aspect of the NERA study has been described in

    greater detail by MIT professors John Parsons and Antonio Mello,

    available at http://bettingthebusiness.com/2012/01/22/phantom-costs-to-the-swap-dealer-designation-and-otc-reform/ and http://bettingthebusiness.com/2012/03/19/nera-doubles-down/.

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

    However, as the Commission noted in the NPRM, this cost is not only

    likely overstated, for the reasons mentioned above, but it also may not

    be a new cost. Rather, it is a displacement of a cost that is embedded

    in uncleared, uncollateralized (or under-collateralized) swaps.

    Entering into a swap is costly for any market participant because of

    the default risk posed by its counterparty, whether the counterparty is

    a DCO, swap dealer, or other market participant. When a market

    participant faces the DCO, the DCO accounts for that counterparty risk

    by requiring collateral to be posted, and the cost of capital for the

    collateral is part of the cost that is necessary in order to maintain

    the swap position. When a market participant faces a dealer or other

    counterparty in an uncleared swap, however, the uncleared swap contains

    an implicit line of credit upon which the market participant

    effectively draws when its swap position is out of the money.

    Counterparties charge for this implicit line of credit in the spread

    they offer on uncollateralized, uncleared swaps. It can be shown that

    the cash flows of an uncollateralized swap (i.e., a swap with an

    implicit line of credit) are, over time, substantially equivalent to

    the cash flows of a collateralized swap with an explicit line of

    credit.\229\ Moreover, because the counterparty credit risk created by

    the implicit line of credit is the same as the counterparty risk that

    would result from an explicit line of credit provided to the same

    market participant, to a first order approximation, the charge for each

    should be the same as well.\230\ This means that the cost of capital

    for additional collateral posted as a consequence of requiring

    uncollateralized swaps to be cleared does not introduce an additional

    cost, but rather takes a cost that is implicit in an uncleared,

    uncollateralized swap and makes it explicit. This observation applies

    to capital costs associated with both initial margin and variation

    margin.

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

    \229\ Antonio S. Mello, and John E. Parsons, ``Margins,

    Liquidity, and the Cost of Hedging,'' MIT Center for Energy and

    Environmental Policy Research, May 2012.

    \230\ See id. at 12; Mello and Parsons state in their paper,

    ``Hedging is costly. But the real source of the cost is not the

    margin posted, but the underlying credit risk that motivates

    counterparties to demand that margin be posted.'' The paper goes on

    to demonstrate that, ``To a first approximation, the cost charged

    for the non-margined swap must be equal to the cost of funding the

    margin account. This follows from the fact that the non-margined

    swap just includes funding of the margin account as an embedded

    feature of the package.'' Id. at 15-16.

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

    The Commission received no comment regarding the costs of

    collateral it presented in the NPRM.

    5. Regulatory Capital Implications

    Another potential impact of the new clearing requirement that the

    Commission described in the NPRM may result from the fact that

    financial institutions are required to hold additional capital with

    respect to their swap positions pursuant to prudential regulatory

    capital requirements. Basel III standards are designed to incentivize

    central clearing of derivatives by applying a lower capital weighting

    to

    [[Page 74329]]

    them than for similar uncleared derivatives positions.\231\ Moreover,

    bilateral margining regulations are currently being developed by the

    Commission and U.S. prudential regulators that will subject uncleared

    swaps entered into by swap dealers and major swap participants to

    increased margin requirements in the near future.\232\ Therefore, the

    Commission expects that, all things being equal, the capital that

    certain financial institutions are required to hold is likely to be

    reduced as a consequence of their increased use of swap clearing.

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

    \231\ See Basel Committee on Banking Supervision reforms--Basel

    III, available at http://www.bis.org/bcbs/basel3/b3summarytable.pdf

    (indicating that Basel III reforms will create capital incentives

    for banks to use central counterparties for derivatives).

    \232\ The Commission's proposed is Margin Requirements for

    Uncleared Swaps for Swap Dealers and Major Swap Participants, 76 FR

    23732 (Apr. 28, 2011); and the U.S. prudential regulators proposed a

    similar requirement, Margin and Capital Requirements for Covered

    Swap Entities, 76 FR 27564 (May 11, 2011).

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

    The Commission received no comment regarding the regulatory capital

    discussion it presented in the NPRM.

    6. Operational Issues Related to Collateralization

    The Commission also discussed in the NPRM the operational costs

    that may result from the collateral requirements that apply to the

    clearing requirement. With uncleared swaps, the Commission noted,

    counterparties may agree not to collect variation margin until certain

    thresholds of exposure are reached, thus reducing or perhaps entirely

    eliminating the need to exchange variation margin as exposure changes.

    DCOs, on the other hand, collect and pay variation margin on a daily

    basis and sometimes more frequently. As a consequence, more required

    clearing may increase certain operational costs associated with moving

    variation margin to and from the DCO. On the other hand, increased

    clearing is also likely to lead to benefits from reduced operational

    costs related to valuation disputes, as parties to cleared swaps agree

    to abide by the DCO's valuation procedures. To the extent that the

    requirement to clear the types of swaps covered by the new clearing

    requirement leads to increased use of clearing, these costs and

    benefits are likely to result.

    The Commission received no comment regarding the operational costs

    of collateral discussion it offered in the NPRM.

    7. Guaranty Fund Contribution as a Collateral Cost

    As explained in the NPRM, increases in clearing as a result of the

    clearing requirement also may result in additional costs for clearing

    members in the form of guaranty fund contributions. However, the

    Commission noted, it may be that increased clearing of swaps would

    decrease guaranty fund contributions for certain clearing members.

    Market participants that currently transact swaps bilaterally, and do

    not clear such swaps, must either become clearing members of an

    eligible DCO or submit such swaps for clearing through an existing

    clearing member of an eligible DCO, once the clearing requirement

    applies to such swaps. A party that chooses to become a clearing member

    of a DCO must make a guaranty fund contribution based on the risk that

    its positions pose to the DCO. A party that chooses to clear swaps

    through an existing clearing member may have a share of the clearing

    member's guaranty fund contribution passed along to it in the form of

    fees. While the addition of new clearing members and new customers for

    existing clearing members may result in existing clearing members

    experiencing an increase in their guaranty fund requirements, it should

    be noted that if (1) new clearing members are not among the two

    clearing members used to calculate the guaranty fund and (2) any new

    customers trading through a clearing member do not increase the size of

    uncollateralized risks at either of the two clearing members used to

    calculate the guaranty fund, all else held constant, existing clearing

    members may experience a decrease in their guaranty fund requirement.

    The Commission received no comment regarding the guaranty fund

    costs discussion it presented in the NPRM.

    d. Benefits of Clearing

    In the NPRM, the Commission also described the benefits of swap

    clearing, which in general, are significant. Thus, to the extent that

    the new clearing requirement for certain classes of interest rate swaps

    and CDS leads to increased use of clearing, these benefits are likely

    to result. As is the case for the costs noted above, it is difficult to

    predict the precise extent to which the use of clearing will increase

    as a result of the new requirement, and therefore the benefits of the

    requirement cannot be precisely quantified. But the Commission believes

    that the benefits of increased clearing resulting from this requirement

    will be significant, because the classes of swaps required to be

    cleared represent a substantial portion of the total swap markets.

    Currently outstanding interest rate swaps and CDS indices represent

    about 77.8% and 1.6%, respectively, of the total global swaps market,

    when measured by notional amount.\233\ As noted above, the new clearing

    requirement requires that only certain classes of interest rate swaps

    and CDS indices be cleared, but such classes likely represent the most

    common swaps within those overall asset classes, and therefore are

    likely to comprise a relatively large portion of those asset classes.

    The Commission reiterates the conclusion stated in the NPRM, which is

    that by requiring these particular swaps to be cleared, the benefits of

    clearing are expected to be realized across a relatively large portion

    of the market.

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

    \233\ BIS data, December 2011, available at http://www.bis.org/statistics/derstats.htm. As explained above, the Commission observes

    that while CDS accounts for a smaller portion of the total swaps

    market, its unique risk profile involving jump-to-default risk

    contributed to the Commission's decision to include it in among the

    first clearing determinations.

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

    The new clearing requirement that swaps within certain classes be

    cleared is expected to increase the number of swaps in which market

    participants will face a DCO, and therefore, will face a highly

    creditworthy counterparty. DCOs are some of the most creditworthy

    counterparties in the swap market because, as explained above, they

    have at their disposal a number of risk management tools that enable

    them to manage counterparty risk effectively. Those tools include

    contractual rights that enable them to use margin to manage current and

    potential future exposure, to close out and transfer defaulting

    positions while minimizing losses that result from such defaults, and

    to protect solvency during the default of one or more members through a

    waterfall of financial resources from which they can draw, as outlined

    above. Also, clearing protects swap customers from the risk of having

    to share losses in the event of the default of another clearing member.

    Under Sec. 50.2(a) of this adopting release, swaps meeting the

    specifications of the classes of swaps that are required to be cleared

    must be submitted to clearing ``as soon as technologically practicable

    after execution, but in any event by the end of the day of execution.''

    \234\ This conforms to the requirements established in the recently

    finalized rule

    [[Page 74330]]

    regarding timing of acceptance for clearing,\235\ which is designed to

    promote rapid submission of these swaps for clearing and reduce the

    unnecessary counterparty risk that can develop between the time of

    execution and submission to clearing.\236\

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

    \234\ See Sec. 50.2(a) (setting for the timeframe for

    submission of swaps to DCOs).

    \235\ See Client Clearing Documentation, Timing of Acceptance

    for Clearing, and Clearing Member Risk Management, 77 FR 21278 (Apr.

    9, 2012).

    \236\ The Commission notes that if a market participant executed

    a swap that is required to be cleared on a SEF or DCM, then that

    market participant will be deemed to have met their obligation to

    submit the swap to a DCO because of the straight-through processing

    rules previously adopted by the Commission.

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

    As it noted in the NPRM, the Commission expects that the

    requirement for rapid submission, processing, and acceptance or

    rejection of swaps for clearing will be beneficial in several respects.

    It is important to note that when two parties enter into a bilateral

    swap with the intention of clearing it, each party bears counterparty

    risk until the swap is cleared. Once the swap is cleared, the

    clearinghouse becomes the counterparty to each of the original parties,

    which minimizes and standardizes counterparty risk.

    Where swaps of the type covered by the new clearing requirement are

    not executed on an exchange, the requirements of Sec. 50.2(a) should

    significantly reduce the amount of time needed to process them.

    Although costs associated with latency-period counterparty credit risk

    cannot be completely eliminated in this context, the rules will reduce

    the need to discriminate among potential counterparties in executing

    off-exchange swaps, as well as the potential costs associated with

    swaps that are rejected from clearing. By reducing the counterparty

    risk that could otherwise develop during the latency period, these

    rules promote a market in which all eligible market participants have

    access to counterparties willing to trade on terms that approximate the

    best available terms in the market. This is likely to improve price

    discovery and promote market integrity.

    Another benefit of the new clearing requirement is the mitigation

    of systemic risk. Counterparty risk readily develops into systemic risk

    in an interconnected financial system especially in times of financial

    stress due to various types of contagion effects.\237\ By ensuring that

    outstanding potential future and current exposures are collateralized

    in a timely fashion for more swaps, this new clearing requirement

    contributes to the mitigation of systemic risk.

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

    \237\ For a comprehensive discussion of the various types of

    contagion effects in times of financial stress, see Brunnermeier,

    M., A. Crocket, C. Goodhart, A. Persaud, and H. Shin: ``The

    Fundamental Principles of Financial Regulation,'' (2009), available

    at http://www.princeton.edu/~markus/research/papers/Geneva11.pdf.

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

    The Commission's consideration of the effect on the mitigation of

    systemic risk is generally supported by comments, which provided

    general observations regarding the mitigation of systemic risk. Citadel

    and Eris Exchange both stated that implementing the clearing

    requirement is a significant milestone toward ``achieving the Dodd-

    Frank Act's objectives of reducing interconnectedness, mitigating

    systemic risk, increasing transparency, and promoting competition in

    the swaps market.'' Freddie Mac commented that it ``supports the

    Commission's goal to reduce systemic risk through central clearing of

    swaps where appropriate.'' On the other hand, ISDA urged the Commission

    to consider the argument that ``clearing involves a greater

    centralization of risk than the over-the counter markets ever did.''

    ISDA also questioned the risk-mitigating aspects of central clearing as

    contrasted with the new regulatory regime for uncleared swaps. In

    response to ISDA's comment, the Commission observes that while the

    regime for bilateral, uncleared swaps will be greatly improved after

    full implementation of the Dodd-Frank Act reforms, central clearing

    provides for certain risk management features that cannot be replicated

    on a bilateral basis. To name just one critical distinction, a

    clearinghouse addresses the tail risk of open positions through

    mutualization. Each clearing member must contribute to a default fund

    that protects the system as a whole. Also, recent experience indicates

    that all DCOs were able to withstand the 2008 financial crisis in a

    relatively sound manner.\238\

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

    \238\ No DCO required government assistance, and all DCOs were

    able to manage their open positions in both swaps and futures. Even

    difficult default situations were handled in an orderly fashion. For

    example, during the Lehman Brothers' bankruptcy in September 2008,

    LCH was able to manage the default of Lehman's significant swap

    portfolio. See 77 FR at 47188 and LCH IRS submission, at 4

    (discussing LCH's management of the Lehman Brothers' bankruptcy in

    September 2008, where upon Lehman's default, LCH needed to risk

    manage a portfolio of approximately 66,000 interest rate swaps,

    which it hedged with approximately 100 new swap trades in less than

    five days and only used approximately 35% of the initial margin

    Lehman had posted).

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

    Regarding competition, Markit stated that the new clearing

    requirement might lower barriers to entry in the index provider market

    ``because new indices would not necessarily be subject to the clearing

    mandate, which can be costly.'' Citadel commented that the framework

    established by the Commission promotes competition among swap dealers,

    as ``counterparty credit risk no longer features as a consideration in

    the selection of executive counterparties.''

    In addition, Sec. 50.10 and related guidance provides market

    participants with a useful framework for behavior under the

    requirements of section 2(h), which will promote the benefits of swap

    clearing without introducing uncertainty regarding market behavior.

    Activity conducted principally for a legitimate business purpose,

    absent other indicia of evasion or abuse, would not constitute a

    violation of Sec. 50.10 as described in the Commission's

    interpretation.

    D. Consideration of Alternative Swap Classes for Clearing

    Determinations

    The Commission's determination to require initially the clearing of

    certain CDS and interest rate swaps is a function of both the market

    importance of these products and the fact that they already are widely

    cleared. In order to move the largest number of swaps to required

    clearing in its initial determination, the Commission continues to

    believe that it is prudent to focus on swaps that are widely used and

    for which there is already a blueprint for clearing and appropriate

    risk management. CDS and interest rate swaps that match these factors

    are therefore well suited for required cleared.

    As noted in the NPRM and discussed above, interest rate swaps with

    a notional amount of $504 trillion are currently outstanding--the

    highest proportion of the $648 trillion global swaps market of any

    class of swaps.\239\ CDS indices with a notional amount of about $10.4

    trillion are currently outstanding.\240\ While CDS indices do not have

    as prominent a share of the entire swaps market as interest rate swaps,

    uncleared CDS is capable of having a sizeable market impact, as it did

    during the 2008 financial crisis. In addition, many of the swaps within

    each of the classes that will now be subject to required clearing are

    already cleared by one or more clearinghouses. LCH claims to clear

    interest rate swaps with a notional amount of about $284 trillion--

    meaning that, in notional terms, LCH represents that they clear just

    over 50% of the interest rate swap market.\241\ The swap market has

    made a smooth transition into clearing CDS on its own initiative. As a

    result, DCOs, FCMs, and many market participants

    [[Page 74331]]

    already have experience clearing the types of swaps that will be

    subject to required clearing. The Commission expects, therefore, that

    DCOs and FCMs are equipped to handle the increases in volume and

    outstanding notional amount in these swaps that is likely to be cleared

    as the result of this rule. Because of the wide use of these swaps and

    their importance to the market, and because these swaps are already

    cleared safely, the Commission continues to believe it is reasonable to

    initially subject certain types of interest rate swaps and CDS to the

    clearing requirement.

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

    \239\ BIS data, June 2011, available at http://www.bis.org/publ/otc_hy1111.pdf.

    \240\ See id.

    \241\ See id.

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

    In reviewing the swap submissions provided by DCOs, the Commission

    decided to classify swaps according to certain key specifications for

    CDS and interest rate swaps. These specifications inform whether a

    particular swap falls within one of the classes of swaps that the

    Commission has determined are required to be cleared. The two classes

    of CDS that are required to be cleared are (1) U.S. dollar-denominated

    CDS covering North America corporate credits and (2) euro-denominated

    CDS referencing European corporate obligations. The four classes of

    interest rate swaps required to be cleared are (1) fixed-to-floating

    swaps, (2) basis swaps, (3) OIS, and (4) FRAs. In formulating each of

    the six classes under this adopting release, the Commission considered

    a number of alternatives.

    Regarding CDS, the Commission outlined three key specifications

    comprising (1) region and nature of reference entity, (2) the nature of

    the CDS itself, and (3) tenor. Each of these specifications will assist

    market participants in determining whether a swap falls within the CDS

    classes of swaps required to be cleared. For the first, a

    distinguishing characteristic is whether the reference entity is in

    North American or European and whether it is one of Markit's CDX.NA.IG,

    CDX.NA.HY, iTraxx Europe, iTraxx Europe Crossover and iTraxx Europe

    High Volatility indices. The second key specification relates to

    whether the CDS is tranched or untranched. The classes that are

    required to be cleared include only untranched CDS where the contract

    covers the entire index loss distribution of the index and settlement

    is not linked to a specified number of defaults. Tranched swaps, first-

    or ``Nth'' to-default, options, or any other product variations on

    these indices are excluded from these classes. Finally, the third key

    specification entails whether a swap falls within a tenor, specific to

    an index, that is required to be cleared. The Commission has determined

    that each of the 3-, 5-, 7-, and 10-year tenors be included within the

    class of swaps subject to the clearing requirement determination for

    CDX.NA.IG; the 5-year tenor be included for CDX.NA.HY; each of the 5-

    and 10-year for iTraxx Europe; the 5-year for iTraxx Europe Crossover;

    and, the 5-year for iTraxx Europe High Volatility. In addition, it

    should be noted that only certain series will be viewed as required to

    be cleared.

    The Commission considered a number of possible alternatives. First,

    the Commission could have used a narrower or broader group of reference

    entities. For example, the Commission has not included the

    CDX.NA.IG.HVOL within the North American swap class, but it considered

    doing so. The Commission concluded that while doing so would have

    increased the number of swaps required to be cleared, there is not

    sufficient liquidity to justify required clearing at this time given

    that the recent series of CDX.NA.IG.HVOL has not been cleared by ICE

    (and is not offered at all by CME).

    Several commenters raised issues regarding the operational

    capabilities of clearinghouses to manage the clearing of iTraxx CDS

    indices for customers.\242\ More specifically, they pointed out that no

    registered DCO currently offers customer clearing for iTraxx and

    expressed concerns about the ability of clearinghouses to manage

    restructuring credit events applicable to iTraxx. On the other hand,

    Citadel and ICE both supported the inclusion of iTraxx CDS indices in

    the clearing requirement. In particular, ICE stated that ICE Clear

    Europe has begun the process of pursuing regulatory approval for

    clearing of iTraxx and that ICE Clear Credit will do the same;

    moreover, ICE said that it has worked closely with market participants

    and DTCC to develop an industry wide solution for processing a

    restructuring credit event.

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

    \242\ ISDA, FIA, MFA, and D.E. Shaw.

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

    Having considered the different views, the Commission is including

    the iTraxx class of CDS as proposed. The Commission believes that the

    uncertainty surrounding the implementation of customer clearing for

    iTraxx will be resolved within the next few months, which will allow

    this standard and liquid class of CDS to be cleared. If no eligible DCO

    offers iTraxx for client clearing, compliance with the required

    clearing of iTraxx will commence sixty days after the date on which

    iTraxx is first offered for client clearing by an eligible DCO.

    The Commission also considered whether it could include tranched

    CDS in the clearing requirement. The Commission recognized in the NPRM

    that there is a significant market for tranched swaps using the

    indices. In these transactions, parties to the CDS contract agree to

    address only a certain range of losses along the entire loss

    distribution curve. Other swaps such as first or ``Nth'' to default

    baskets, and options, also exist on the indices. However, these swaps

    are not being cleared currently and were not submitted by a DCO for

    consideration under Sec. 39.5. As a result, including tranched CDS was

    not a viable alternative for this determination.

    AFR noted that requiring clearing of only untranched CDS indices

    may give rise to arbitrage opportunities, as the payoff properties

    desired from an index can be closely replicated by trading tranches of

    that index. The Commission recognizes this concern and will take into

    account the possibility of arbitrage opportunities in its future

    reviews of tranched CDS for clearing determination.

    Regarding tenor, the Commission could have included more of those

    offered within the classes of swaps required to be cleared. For

    example, the Commission noted in the NPRM that the CDX.NA.IG has 1- and

    2-year tenors and the CDX.NA.HY, has 3-, 7-, and 10-year tenors that

    have not been included among the specified tenors. The iTraxx Europe

    has 3- and 7-year tenors and the Crossover and High Volatility each

    have 3-, 7-, and 10-year tenors that have not been included. In

    addition, the Commission could have included all series of active

    indices. The Commission's concern, regarding both tenors and series, is

    that certain tenors and series have lower liquidity and may be

    difficult for a DCO to adequately risk manage, which is reflected in

    the fact that those tenors and series are not currently cleared by any

    DCO. While including more tenors and series would have increased the

    volume of swaps required to be cleared to some degree, the Commission

    concluded that doing so could raise costs for DCOs and other market

    participants and be less desirable relative to the factors established

    in Sec. 39.5.

    AFR commented that both the 1- and 2-year tenors of the CDX.NA.IG

    should be included in the clearing requirement. It is concerned that

    ``market participants might shift to those tenors to avoid mandatory

    clearing [of the longer tenors].'' The Commission notes that no DCO

    currently clears the 1- or 2-year tenor of CDX.NA.IG, making the

    clearing of either swap infeasible. However, the Commission recognizes

    that requiring mandatory clearing of these shorter tenors may prevent

    [[Page 74332]]

    arbitrage opportunities if they generate sufficient trading volumes in

    the future.

    With regard to interest rate swaps, as mentioned above, the

    Commission is finalizing a clearing requirement for four classes of

    interest rate swaps: Fixed-to-floating swaps, basis swaps, OIS, and

    FRAs. Within those four classes, there are three affirmative

    specifications for each class ((i) Currency in which the notional and

    payment amounts are specified, (ii) rates referenced for each leg of

    the swap, and (iii) stated termination date of the swap). There are

    also three ``negative'' specifications for each class ((i) No

    optionality (as specified by the DCOs); (ii) no dual currencies; and

    (iii) no unknown notional amounts). The Commission considered whether

    to establish clearing requirements on a product-by-product basis. As

    noted in the NPRM, such a determination would need to identify the

    multitude of legal specifications of each product that would be subject

    to the clearing requirement. Although the industry uses standardized

    definitions and conventions, the product descriptions would be lengthy

    and require counterparties to compare all of the legal terms of their

    particular swap against the terms of the many different swaps that

    would be included in a clearing requirement. The Commission continues

    to believe that for interest rate swaps, a product-by-product

    determination would be unnecessarily burdensome for market participants

    in trying to assess whether each swap transaction is subject to the

    requirement. A class-based approach allows market participants to

    determine quickly whether they need to submit their swap to a DCO for

    clearing by checking initially whether the swap has the basic

    specifications that define each class subject to the clearing

    requirement.

    As an alternative to the classes selected, LCH recommended in its

    IRS submission that the Commission use the following specifications to

    classify interest rate swaps for purposes of making a clearing

    determination: (i) Swap class (i.e., what the two legs of the swap are

    (fixed-to-floating, basis, OIS, etc.)); (ii) floating rate definitions

    used; (iii) the currency designated for swap calculations and payments;

    (iv) stated final term of the swap (also known as maturity); (v)

    notional structure over the life of the swap (constant, amortizing,

    roller coaster, etc.); (vi) floating rate frequency; (vii) whether

    optionality is included; and (viii) whether a single currency or more

    than one currency is used for denominating payments and notional

    amount. In its submission, CME recommended a clearing determination for

    all non-option interest rate swaps denominated in a currency cleared by

    any qualified DCO.

    The Commission noted in the NPRM that these alternative

    specifications fall into two general categories: specifications that

    are commonly used to address mechanical issues for most swaps, and

    specifications that are less common and address idiosyncratic issues

    related to the particular needs of a counterparty. Examples of the

    latter are special representations added to address particular legal

    issues, unique termination events, special fees, and conditions tied to

    events specific to the parties. None of the DCOs clear interest rate

    swaps with terms in the second group. While such specifications may

    affect the value of the swap, such specifications are not, generally

    speaking, fundamental to determining the economic result the parties

    are trying to achieve.\243\ The Commission is finalizing the three

    affirmative specifications described above because it believes that

    they are fundamental specifications used by counterparties to determine

    the economic result of a swap transaction for each party.\244\

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

    \243\ As noted in Section II.E above, mechanical specifications

    include characteristics such as floating rate reset tenors,

    reference city for business days, business day convention, and

    others that have some small impact on valuation but that do not

    fundamentally alter the economic consequence of the swap for the

    parties that enter into it.

    \244\ In a comment, ISDA questioned the Commission's description

    of mechanical and idiosyncratic factors. In response, the Commission

    clarified that it is not introducing a new test for interest rate

    swaps, but was merely setting forth and describing relevant class-

    defining specifications. See Section II.D above for a full

    discussion.

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

    The Commission also noted in the NPRM that it could have not

    included the negative specifications for interest rate swaps, which

    would have had the potential effect of including more interest rate

    swaps within the universe of those required to be cleared. However, the

    Commission continues to believe that swaps with optionality (such as

    swaptions or swaps with embedded options), multiple currency swaps, and

    swaps with notional amounts that are not specified at the time of

    execution raise concerns regarding adequate pricing measures and

    consistency across swap contracts. Additionally, at this time, no DCO

    is offering them for clearing.

    Another alternative considered by the Commission and discussed in

    the NPRM was that of stating the clearing requirement in terms of a

    particular type of swap, rather than using broad characteristics to

    describe the type of swaps for which clearing would be required. For

    example, rather than requiring that all interest rate swaps that meet

    the six specifications in Sec. 50.4(a) be cleared, the Commission

    noted in the NPRM that the rule could have specified that only certain

    sub-types of those interest rate swaps--such as all such interest rate

    swaps with a term of five years--are required to be cleared. Such an

    approach might permit the Commission to account for variation in

    liquidity and outstanding notional values among different sub-types of

    swap, and thereby focus the clearing requirement on very particular

    swaps to account for these differences within the same general class.

    Also, generally speaking, limiting the clearing requirement to fewer

    swaps could reduce some costs associated with clearing.

    However, this advantage was weighed against an important

    disadvantage of this approach. A highly focused clearing requirement

    could increase the ability for market participants to replicate the

    economic results of a swap that is required to be cleared by

    substituting a swap not required to be cleared; this greater latitude

    for clearing avoidance, in turn, could increase systemic risk and

    dampen the beneficial effects of clearing noted above.\245\ Under the

    approach proposed by the Commission, all swaps that fall within

    identified classes are covered by the clearing requirement, provided an

    eligible DCO offers the swap for clearing, which reduces the risk of

    such avoidance and the associated reduction of benefits. Moreover,

    stating the clearing requirement in more general terms reduces the

    costs associated with determining whether or not a particular swap is

    subject to the clearing requirement.

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

    \245\ For instance, in the example noted above, swaps with a

    term of five years and one day would not be required to be cleared.

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

    Numerous commenters expressed support for the Commission's

    specifications determination.\246\ CME stated that ``the Commission has

    struck an appropriate balance for the initial slate of classes subject

    to the requirement.'' LCH commented that ``the Commission's decision to

    classify interest rate swaps based on six principle swap specifications

    * * * is sound.'' Citadel stated that the Commission's class

    designation approach ``reflects the risk management approach utilized

    across the industry, and most importantly by DCOs'' to

    [[Page 74333]]

    determine necessary margin and other safeguards.

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

    \246\ AllianceBernstein, R.J. O'Brien, Citadel, Eris Exchange,

    CME, FIA, D.E. Shaw, Arbor Research, LCH, Knight Capital, Jefferies,

    Coherence Capital, CRT Capital, Javelin Capital, SDMA, Chris

    Barnard, and Svenokur.

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

    On the other hand, regarding interest rate swaps, ISDA is concerned

    that the Commission's class-based approach will impose great burdens

    and uncertainties in terms of ``the search efforts needed to filter out

    from among the broad class those specific products that a DCO will

    accept for clearing.'' The Commission notes that ISDA's concern may not

    be justified, as CME already has a platform in place that ``provides

    market participants with a tool to screen a particular swap for

    eligibility for clearing upon submission of the swap to CME.''

    The Commission also considered requiring clearing for all seventeen

    currencies of interest rate swaps that are currently offered for

    clearing, but decided instead to require clearing at this time for

    interest rate swaps in four currencies (EUR, USD, GBP, and JPY). As

    noted in the NPRM, the Commission recognizes that requiring interest

    rate swaps in all seventeen currencies submitted by LCH to be cleared

    would provide the benefit of some incremental reduction in overall

    counterparty, and thus systemic, risk attendant to clearing a greater

    portion of interest rate swaps. However, as noted above, the Commission

    continues to believe that initiating the clearing requirement in a

    measured manner with respect to interest rate swaps in the four

    specified currencies familiar to many market participants is the

    preferable approach at this time because it would give market

    participants an opportunity to identify and address any operational

    challenges related to required clearing. Moreover, the currencies

    included in the required classes constitute approximately 93% of

    cleared interest rate swaps, which suggests that significant reductions

    in counterparty risk and gains in systemic protection will be

    accomplished by limiting the clearing determination to them.\247\

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

    \247\ See Section II.F above for more thorough discussion of the

    data.

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

    LCH supported the Commission's determination, and recommended that

    the Commission propose mandatory clearing of swaps denominated in the

    other 13 currencies once the initial phase of mandatory clearing is

    well-established. LCH stated that there is ``ample volume and liquidity

    in swaps denominated in these currencies to support mandatory

    clearing.'' The Commission will evaluate the benefits of this

    recommendation against the cost burdens in its future determinations.

    Similarly, the Commission considered requiring clearing of all CDS

    that are currently being cleared, but did not propose to include, in

    the initial clearing requirement, certain types of CDS that have a less

    significant role in the current market.\248\

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

    \248\ For instance, the Commission decided not to include

    CDX.NA.IG.HiVol from the proposed determination given the lack of

    volume in the current on-the-run and recent off-the-run series. In

    addition, CME currently does not clear any HiVol contracts, and ICE

    Clear Credit no longer clears the most recent series.

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

    AFR and Chris Barnard both urged the Commission to rapidly

    designate energy, agriculture and equity swaps for mandatory clearing

    as well. The Commission reiterates that it will continue to review swap

    submissions received from DCOs and will issue clearing requirement for

    other classes of swaps so as to realize the benefits of clearing in a

    timely manner.

    E. Section 15(a) Factors

    As noted above, the requirement to clear swaps within the classes

    of swaps covered by this adopting release is expected to result in

    increased use of clearing, although it is difficult to quantify the

    extent of that increase. Thus, this section discusses the expected

    results from an overall increase in the use of swap clearing in terms

    of the factors set forth in section 15(a) of the CEA.

    i. Protection of Market Participants and the Public

    As described above, required clearing of CDS and interest rate

    swaps resulting from this clearing determination is expected to reduce

    counterparty credit risk for market participants that will now be

    required to clear those swaps because they will face the DCO rather

    than another market participant that lacks the full array of risk

    management tools that the DCO has at its disposal. This increase in

    clearing of CDS and interest rate swaps also reduces uncertainty in

    times of market stress because market participants facing a DCO are

    less concerned with the impact of such stress on the solvency of their

    counterparty for cleared trades. Moreover, by reducing uncertainty

    about counterparty solvency for market participants facing a DCO, the

    clearing determinations under this adopting release are likely to

    reduce the risk of contagion if one or more DCO customers or clearing

    members fails during a time of market stress, which creates benefits

    for the public.

    By requiring clearing of swaps within certain classes, all of which

    are already available for clearing, the Commission continues to expect,

    as it stated in the NPRM, that this rule will encourage a smooth

    transition to clearing by creating an opportunity for market

    participants to work out challenges related to required clearing of

    swaps while operating in familiar terrain. More specifically, the DCOs

    will clear an increased volume of swaps that they already understand

    and have experience managing. Similarly, FCMs likely will realize

    increased customer and transaction volume as the result of the

    requirement, but will not have to simultaneously learn how to

    operationalize clearing for new types of swaps. Additionally, the

    experience that current FCMs have with these swaps is likely to benefit

    customers that are new to swap clearing, as the FCM guides them through

    initial process of clearing swaps.\249\

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

    \249\ As discussed in Section II.C and II.E above, DCOs offering

    clearing for CDS and interest rate swaps have established extensive

    risk management practices, which focus on the protection of market

    participants. See also Sections II.D and II.F for a discussion of

    the effect on the mitigation of systemic risk in the CDS market and

    in the interest rate swaps market, as well as the protection of

    market participants during insolvency events at either the clearing

    member or DCO level.

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

    In addition, uncleared swaps subject to collateral agreements can

    be the subject of valuation disputes. These valuation disputes

    sometimes require several months, or longer, to resolve.

    Uncollateralized exposure can grow significantly during that time,

    leaving one of the two parties exposed to counterparty credit risk that

    was intended to be covered through a collateral agreement. DCOs

    eliminate, or reduce, valuation disputes for cleared swaps as well as

    the risk that uncollateralized exposure can develop and accumulate

    during the time when such a dispute would have otherwise occurred, thus

    providing additional protection to market participants that transact in

    swaps subject to required clearing.\250\

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

    \250\ See Sections II.D and II.F above for a further discussion

    of how DCOs obtain adequate pricing data for the CDS and interest

    rate swaps that they clear. Based on this pricing data, valuation

    disputes are minimized, if not eliminated for cleared swaps.

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

    As far as costs are concerned, market participants that do not

    currently have established clearing relationships with an FCM will have

    to set up and maintain such a relationship in order to clear swaps that

    are required to be cleared. As discussed above, market participants

    that conduct a limited number of swaps per year will likely be required

    to pay monthly or annual fees that FCMs charge to maintain both the

    relationship and outstanding swap positions belonging to the customer.

    In addition, the FCM is likely to pass along fees charged by the DCO

    for establishing and maintaining open positions.

    [[Page 74334]]

    ii. Efficiency, Competitiveness, and Financial Integrity of Swap

    Markets

    The Commission continues to expect, as it explained in the NPRM,

    that increased clearing of the CDS and interest rate swaps subject to

    this adopting release is expected to reduce uncertainty regarding

    counterparty credit risk in times of market stress and promote

    liquidity and efficiency during those times. Increased liquidity

    promotes the ability of market participants to limit losses from

    exiting positions effectively when necessary in order to manage risk

    during a time of market stress.

    In addition, to the extent that positions move from facing multiple

    counterparties in the bilateral market to being run through a smaller

    number of clearinghouses, clearing likely facilitates increased

    netting. This netting effect reduces operational risk and may reduce

    the amount of collateral that a party must post or pay in terms of

    initial and variation margin.

    As discussed in Sections II.D and II.F above, in setting forth this

    new clearing requirement, the Commission took into account a number of

    specific factors that relate to the financial integrity of the swap

    markets. Specifically, the NPRM and the discussion above includes an

    assessment of whether the DCOs clearing CDS and interest rate swaps

    have the rule framework, capacity, operational expertise and resources,

    and credit support infrastructure to clear CDS and interest rate swaps

    on terms that are consistent with the material terms and trading

    conventions on which the contract is then traded. The Commission also

    considered the financial resources of DCOs to handle additional

    clearing, as well as the existence of reasonable legal certainty in the

    event of a clearing member or DCO insolvency.\251\

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

    \251\ See Sections II.D and II.F.

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

    As discussed above, bilateral swaps create counterparty risk that

    may lead market participants to discriminate among potential

    counterparties based on their creditworthiness. Such discrimination is

    expensive and time consuming insofar as market participants must

    conduct due diligence in order to evaluate a potential counterparty's

    creditworthiness. Requiring the certain types of swaps subject to this

    clearing determination to be cleared reduces the number of transactions

    for which such due diligence is necessary, thereby contributing to the

    efficiency of the swap markets.

    In setting forth a clearing requirement for both CDS and interest

    rate swaps, the Commission considered the effect on competition,

    including appropriate fees and charges applied to clearing. As

    discussed in more detail in Sections II.D and II.F above, there are a

    number of potential outcomes that may result from required clearing.

    Some of these outcomes may impose costs, such as if a DCO possessed

    market power and exercised that power in a anticompetitive manner, and

    some of the outcomes would be positive, such as if the clearing

    requirement facilitated a stronger entry-opportunity for competitors.

    As far as costs are concerned, the markets for some swaps within

    the classes that are required to be cleared may be less liquid than

    others. All other things being equal, swaps for which the markets are

    less liquid have the potential to develop larger current

    uncollateralized exposures after a default on a cleared position, and

    therefore will require posting of relatively greater amounts of initial

    margin.

    iii. Price Discovery

    As the Commission noted in the NPRM, clearing of CDS and interest

    rate swaps subject to this new clearing requirement is likely to

    encourage better price discovery because it eliminates the importance

    of counterparty creditworthiness in pricing swaps cleared through a

    given DCO. That is, by making the counterparty creditworthiness of all

    swaps of a certain type essentially the same, prices should reflect

    factors related to the terms of the swap, rather than the idiosyncratic

    risk posed by the entities trading it.\252\

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

    \252\ See Chen, K., et al., ``An Analysis of CDS Transactions:

    Implications for Public Reporting,'' September 2011, Federal Reserve

    Bank of New York Staff Reports, at 14, available at http://www.newyorkfed.org/research/staff_reports/sr517.pdf.

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

    As discussed in Sections II.D and II.F above, DCOs obtain adequate

    pricing data for the CDS and interest rate swaps that they clear. Each

    DCO establishes a rule framework for its pricing methodology and

    rigorously tests its pricing models to ensure that the cornerstone of

    its risk management regime is as sound as possible.

    iv. Sound Risk Management Practices

    If a firm enters into swaps to hedge certain positions and then the

    counterparty to those swaps defaults unexpectedly, the firm could be

    left with large outstanding exposures and unhedged positions. As

    explained in the NPRM and stated above, when a swap is cleared, the DCO

    becomes the counterparty facing each of the two original counterparties

    to the swap. This standardizes and reduces counterparty credit risk for

    each of the two original participants. To the extent that a market

    participant's hedges comprise swaps that are required to be cleared,

    the requirement enhances their risk management practices by reducing

    their counterparty risk. Accordingly, for counterparties required to

    clear those CDS and interest rate swaps subject to this requirement,

    risk management will be enhanced.

    In addition, from systemic perspective, required clearing reduces

    the complexity of unwinding/transferring swap positions from large

    entities that default. Procedures for transfer of swap positions and

    mutualization of losses among DCO members are already in place, and the

    Commission continues to anticipate that they are much more likely to

    function in a manner that enables efficient transfer of positions than

    legal processes that apply to uncleared, bilateral swaps.\253\

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

    \253\ As discussed in Sections II.C and II.E above, sound risk

    management practices are critical for all DCOs, especially those

    offering clearing for CDS and interest rate swaps. In the discussion

    above, the Commission considered whether each DCO submission under

    review was consistent with the core principles for DCOs. In

    particular, the Commission considered the DCO submissions in light

    of Core Principle D, which relates to risk management. See also

    Sections II.D and II.F for a discussion of the effect on the

    mitigation of systemic risk in the CDS market and in the interest

    rate swaps market, as well as the protection of market participants

    during insolvency events at either the clearing member or DCO level.

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

    v. Other Public Interest Considerations

    In September 2009, the President and the other leaders of the

    ``G20'' nations met in Pittsburgh and committed to a program of action

    that includes, among other things, central clearing of all standardized

    swaps.\254\ Together, interest rate swaps and CDS represent more than

    75% of the notional amount of outstanding swaps, and therefore,

    requiring the most active, standardized classes of swaps within those

    groups to be cleared represents a significant step toward the

    fulfillment of that commitment.

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

    \254\ A list of the G20 commitments made in Pittsburgh can be

    found at: http://www.g20.utoronto.ca/analysis/commitments-09-pittsburgh.html.

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

    VI. Related Matters

    A. Regulatory Flexibility Act

    The Regulatory Flexibility Act (RFA) requires that agencies

    consider whether the rules they propose will have a

    [[Page 74335]]

    significant economic impact on a substantial number of small entities

    and, if so, provide a regulatory flexibility analysis respecting the

    impact.\255\ As stated in the NPRM, the clearing requirement

    determinations and rules proposed by the Commission will affect only

    eligible contract participants (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.\256\

    Accordingly, the Chairman, on behalf of the Commission, certified

    pursuant to 5 U.S.C. 605(b) that the proposed rules would not have a

    significant economic impact on a substantial number of small entities.

    The Commission then invited public comment on this determination. The

    Commission received no comments.

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

    \255\ See 5 U.S.C. 601 et seq.

    \256\ To the extent that this rulemaking affects DCMs, DCOs, or

    FCMs, the Commission has previously determined that DCMs, DCOs, and

    FCMs are not small entities for purposes of the RFA. See,

    respectively and as indicated, 47 FR 18618, 18619, Apr. 30, 1982

    (DCMs and FCMs); and 66 FR 45604, 45609, Aug. 29, 2001 (DCOs).

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

    The Commission has previously determined that ECPs are not small

    entities for purposes of the RFA.\257\ However, in its proposed

    rulemaking to establish a schedule to phase in compliance with certain

    provisions of the Dodd-Frank Act, including the clearing requirement

    under section 2(h)(1)(A) of the CEA, the Commission received a joint

    comment (Electric Associations Letter) from the Edison Electric

    Institute (EEI), the National Rural Electric Cooperative Association

    (NRECA) and the Electric Power Supply Association (EPSA) asserting that

    certain members of NRECA may both be ECPs under the CEA and small

    businesses under the RFA.\258\ 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.'' \259\

    Although the Electric Associations Letter does not provide details on

    whether or how the NRECA members that have been determined to be small

    entities use the interest rate swaps and CDS that are the subject of

    this rulemaking, the Electric Associations Letter does state that the

    EEI, NRECA, and EPSA members ``engage in swaps to hedge commercial

    risk.'' \260\ 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 this rulemaking.

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

    \257\ See 66 F.R. 20740, 20743 (Apr. 25, 2001).

    \258\ See joint letter from EEI, NRECA, and ESPA, dated Nov. 4,

    2011, (Electric Associations Letter), commenting on Swap Transaction

    Compliance and Implementation Schedule: Clearing and Trade Execution

    Requirements under Section 2(h) of the CEA, 76 FR 58186 (Sept. 20,

    2011).

    \259\ Small Business Administration, Table of Small Business

    Size Standards, Nov. 5, 2010.

    \260\ See Electric Associations Letter, at 2. The letter also

    suggests that EEI, NRECA, and EPSA 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

    proposed 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 CFTC, hereby certifies pursuant to 5 U.S.C. 605(b) that

    the rules herein will not have a significant economic impact on a

    substantial number of small entities.

    B. Paperwork Reduction Act

    The Paperwork Reduction Act (PRA) \261\ 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, Sec. 50.3(a), would

    require each DCO to post on its Web site a list of all swaps that it

    will accept for clearing and clearly indicate which of those swaps the

    Commission has determined are required to be cleared, builds upon the

    requirements of Sec. 39.21(c)(1), which requires each DCO to disclose

    publicly information concerning the terms and conditions of each

    contract, agreement, and transaction cleared and settled by the DCO.

    The Commission received no comments related to PRA. Thus, this

    rulemaking will not require a new collection of information from any

    persons or entities.

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

    \261\ 44 U.S.C. 3507(d).

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

    List of Subjects

    17 CFR Part 39

    Business and industry, Reporting requirements, Swaps.

    17 CFR Part 50

    Business and industry, Clearing, Swaps.

    For the reasons stated in the preamble, amend 17 CFR parts 39 and

    50 as follows:

    PART 39--DERIVATIVES CLEARING ORGANIZATIONS

    0

    1. The authority citation for part 39 continues to read as follows:

    Authority: 7 U.S.C. 2 and 7a-1 as amended by Pub. L. 111-203,

    124 Stat. 1376.

    Sec. 39.6 [Removed and Reserved]

    0

    2. Remove and reserve Sec. 39.6.

    PART 50--CLEARING REQUIREMENT AND RELATED RULES

    0

    3. The authority citation to part 50 is revised to read as follows:

    Authority: 7 U.S.C. 2(h) and 7a-1 as amended by Pub. L. 111-203,

    124 Stat. 1376.

    0

    4. Add subpart A, consisting of Sec. Sec. 50.1 through 50.24 to read

    as follows:

    Subpart A--Definitions and Clearing Requirement

    Sec.

    50.1 Definitions.

    50.2 Treatment of swaps subject to a clearing requirement.

    50.3 Notice to the public.

    50.4 Classes of swaps required to be cleared.

    50.5 Swaps exempt from a clearing requirement.

    50.6 Delegation of authority.

    50.7-50.9 [Reserved]

    50.10 Prevention of evasion of the clearing requirement and abuse of

    an exception or exemption to the clearing requirement.

    50.11-50.24 [Reserved]

    Subpart A--Definitions and Clearing Requirement

    Sec. 50.1 Definitions.

    For the purposes of this part,

    Business day means any day other than a Saturday, Sunday, or legal

    holiday.

    Day of execution means the calendar day of the party to the swap

    that ends latest, provided that if a swap is:

    (1) Entered into after 4:00 p.m. in the location of a party; or

    (2) Entered into on a day that is not a business day in the

    location of a party, then such swap shall be deemed to have been

    entered into by that party on the immediately succeeding business day

    of that party, and the day of execution shall be determined with

    reference to such business day.

    Sec. 50.2 Treatment of swaps subject to a clearing requirement.

    (a) All persons executing a swap that:

    (1) Is not subject to an exception under section 2(h)(7) of the Act

    or Sec. 50.50 of this part; and

    [[Page 74336]]

    (2) Is included in a class of swaps identified in Sec. 50.4 of

    this part, shall submit such swap to any eligible derivatives clearing

    organization that accepts such swap for clearing as soon as

    technologically practicable after execution, but in any event by the

    end of the day of execution.

    (b) Each person subject to the requirements of paragraph (a) of

    this section shall undertake reasonable efforts to verify whether a

    swap is required to be cleared.

    (c) For purposes of paragraph (a) of this section, persons that are

    not clearing members of an eligible derivatives clearing organization

    shall be deemed to have complied with paragraph (a) of this section

    upon submission of such swap to a futures commission merchant or

    clearing member of a derivatives clearing organization, provided that

    submission occurs as soon as technologically practicable after

    execution, but in any event by the end of the day of execution.

    Sec. 50.3 Notice to the public.

    (a) In addition to its obligations under Sec. 39.21(c)(1), each

    derivatives clearing organization shall make publicly available on its

    Web site a list of all swaps that it will accept for clearing and

    identify which swaps on the list are required to be cleared under

    section 2(h)(1) of the Act and this part.

    (b) The Commission shall maintain a current list of all swaps that

    are required to be cleared and all derivatives clearing organizations

    that are eligible to clear such swaps on its Web site.

    Sec. 50.4 Classes of swaps required to be cleared.

    (a) Interest rate swaps. Swaps that have the following

    specifications are required to be cleared under section 2(h)(1) of the

    Act, and shall be cleared pursuant to the rules of any derivatives

    clearing organization eligible to clear such swaps under Sec. 39.5(a)

    of this chapter.

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

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

    Specification Fixed-to-floating swap class

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

    Currency........................ U.S. dollar (USD). Euro (EUR)........ Sterling (GBP).... Yen (JPY).

    Floating Rate Indexes........... LIBOR............. EURIBOR........... LIBOR............. LIBOR.

    Stated Termination Date Range... 28 days to 50 28 days to 50 28 days to 50 28 days to 30

    years. years. years. years.

    Optionality..................... No................ No................ No................ No.

    Dual Currencies................. No................ No................ No................ No.

    Conditional Notional Amounts.... No................ No................ No................ No.

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

    Specification Basis swap class

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

    Currency........................ U.S. dollar (USD). Euro (EUR)........ Sterling (GBP).... Yen (JPY).

    Floating Rate Indexes........... LIBOR............. EURIBOR........... LIBOR............. LIBOR.

    Stated Termination Date Range... 28 days to 50 28 days to 50 28 days to 50 28 days to 30

    years. years. years. years.

    Optionality..................... No................ No................ No................ No.

    Dual Currencies................. No................ No................ No................ No.

    Conditional Notional Amounts.... No................ No................ No................ No.

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

    Specification Forward rate agreement class

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

    Currency........................ U.S. dollar (USD). Euro (EUR)........ Sterling (GBP).... Yen (JPY).

    Floating Rate Indexes........... LIBOR............. EURIBOR........... LIBOR............. LIBOR.

    Stated Termination Date Range... 3 days to 3 years. 3 days to 3 years. 3 days to 3 years. 3 days to 3 years.

    Optionality..................... No................ No................ No................ No.

    Dual Currencies................. No................ No................ No................ No.

    6. Conditional Notional Amounts. No................ No................ No................ No.

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

    Specification Overnight index swap class

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

    Currency........................ U.S. dollar (USD). Euro (EUR)........ Sterling (GBP).

    Floating Rate Indexes........... FedFunds.......... EONIA............. SONIA.

    Stated Termination Date Range... 7 days to 2 years. 7 days to 2 years. 7 days to 2 years.

    Optionality..................... No................ No................ No.

    Dual Currencies................. No................ No................ No.

    Conditional Notional Amounts.... No................ No................ No.

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

    (b) Credit default swaps. Swaps that have the following

    specifications are required to be cleared under section 2(h)(1) of the

    Act, and shall be cleared pursuant to the rules of any derivatives

    clearing organization eligible to clear such swaps under Sec. 39.5(a)

    of this chapter.

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

    Specification North American untranched CDS indices class

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

    Reference Entities............................................... Corporate.

    Region........................................................... North America.

    Indices.......................................................... CDX.NA.IG; CDX.NA.HY.

    Tenor............................................................ CDX.NA.IG: 3Y, 5Y, 7Y, 10Y; CDX.NA.HY: 5Y.

    Applicable Series................................................ CDX.NA.IG 3Y: Series 15 and all subsequent

    Series, up to and including the current

    Series.

    CDX.NA.IG 5Y: Series 11 and all subsequent

    Series, up to and including the current

    Series.

    CDX.NA.IG 7Y: Series 8 and all subsequent

    Series, up to and including the current

    Series.

    CDX.NA.IG 10Y: Series 8 and all subsequent

    Series, up to and including the current

    Series.

    CDX.NA.HY 5Y: Series 11 and all subsequent

    Series, up to and including the current

    Series.

    Tranched......................................................... No.

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

    [[Page 74337]]

    Specification European untranched CDS indices class

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

    Reference Entities............................................... Corporate.

    Region........................................................... Europe.

    Indices.......................................................... iTraxx Europe.

    iTraxx Europe Crossover.

    iTraxx Europe HiVol.

    Tenor............................................................ iTraxx Europe: 5Y, 10Y.

    iTraxx Europe Crossover: 5Y.

    iTraxx Europe HiVol: 5Y.

    Applicable Series................................................ iTraxx Europe 5Y: Series 10 and all

    subsequent Series, up to and including the

    current Series.

    iTraxx Europe 10Y: Series 7 and all

    subsequent Series, up to and including the

    current Series.

    iTraxx Europe Crossover 5Y: Series 10 and all

    subsequent Series, up to and including the

    current Series.

    iTraxx Europe HiVol 5Y: Series 10 and all

    subsequent Series, up to and including the

    current Series.

    Tranched......................................................... No.

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

    Sec. 50.5 Swaps exempt from a clearing requirement.

    (a) Swaps entered into before July 21, 2010 shall be exempt from

    the clearing requirement under Sec. 50.2 of this part if reported to a

    swap data repository pursuant to section 2(h)(5)(A) of the Act and

    Sec. 46.3(a) of this chapter.

    (b) Swaps entered into before the application of the clearing

    requirement for a particular class of swaps under Sec. Sec. 50.2 and

    50.4 of this part shall be exempt from the clearing requirement if

    reported to a swap data repository pursuant to section 2(h)(5)(B) of

    the Act and either Sec. 46.3(a) or Sec. Sec. 45.3 and 45.4 of this

    chapter, as appropriate.

    Sec. 50.6 Delegation of Authority.

    (a) The Commission hereby delegates to the Director of the Division

    of Clearing and Risk or such other employee or employees as the

    Director may designate from time to time, with the consultation of the

    General Counsel or such other employee or employees as the General

    Counsel may designate from time to time, the authority:

    (1) After prior notice to the Commission, to determine whether one

    or more swaps submitted by a derivatives clearing organization under

    Sec. 39.5 falls within a class of swaps as described in Sec. 50.4,

    provided that inclusion of such swaps is consistent with the

    Commission's clearing requirement determination for that class of

    swaps; and

    (2) To notify all relevant derivatives clearing organizations of

    that determination.

    (b) The Director of the Division of Clearing and Risk may submit to

    the Commission for its consideration any matter which has been

    delegated in this section. Nothing in this section prohibits the

    Commission, at its election, from exercising the authority delegated in

    this section.

    Sec. 50.7-50.9 [Reserved].

    Sec. 50.10 Prevention of evasion of the clearing requirement and

    abuse of an exception or exemption to the clearing requirement.

    (a) It shall be unlawful for any person to knowingly or recklessly

    evade or participate in or facilitate an evasion of the requirements of

    section 2(h) of the Act or any Commission rule or regulation

    promulgated thereunder.

    (b) It shall be unlawful for any person to abuse the exception to

    the clearing requirement as provided under section 2(h)(7) of the Act

    or an exception or exemption under this chapter.

    (c) It shall be unlawful for any person to abuse any exemption or

    exception to the requirements of section 2(h) of the Act, including any

    exemption or exception as the Commission may provide by rule,

    regulation, or order.

    0

    5. Designate Sec. 50.25 under new subpart B under the following

    heading and add reserved Sec. Sec. 50.26 through 50.49.

    Subpart B--Compliance Schedule

    Sec.

    50.25 Clearing requirement compliance schedule.

    50.26-50.49 [Reserved]

    0

    6. Add subpart C, consisting of Sec. 50.50, to read as follows:

    Subpart C--Exceptions and Exemptions to Clearing Requirement

    Sec. 50.50 Exceptions to the clearing requirement.

    (a) Non-financial entities. (1) A counterparty to a swap may elect

    the exception to the clearing requirement under section 2(h)(7)(A) of

    the Act if the counterparty:

    (i) Is not a ``financial entity'' as defined in section

    2(h)(7)(C)(i) of the Act;

    (ii) Is using the swap to hedge or mitigate commercial risk as

    provided in paragraph (c) of this section; and

    (iii) Provides, or causes to be provided, the information specified

    in paragraph (b) of this section to a registered swap data repository

    or, if no registered swap data repository is available to receive the

    information from the reporting counterparty, to the Commission. A

    counterparty that satisfies the criteria in this paragraph (a)(1) and

    elects the exception is an ``electing counterparty.''

    (2) If there is more than one electing counterparty to a swap, the

    information specified in paragraph (b) of this section shall be

    provided with respect to each of the electing counterparties.

    (b) Reporting. (1) When a counterparty elects the exception to the

    clearing requirement under section 2(h)(7)(A) of the Act, one of the

    counterparties to the swap (the ``reporting counterparty,'' as

    determined in accordance with Sec. 45.8 of this part) shall provide,

    or cause to be provided, the following information to a registered swap

    data repository or, if no registered swap data repository is available

    to receive the information from the reporting counterparty, to the

    Commission, in the form and manner specified by the Commission:

    (i) Notice of the election of the exception;

    (ii) The identity of the electing counterparty to the swap; and

    (iii) The following information, unless such information has

    previously been provided by the electing counterparty in a current

    annual filing pursuant to paragraph (b)(2) of this section:

    (A) Whether the electing counterparty is a ``financial entity'' as

    defined in section 2(h)(7)(C)(i) of the Act, and if the electing

    counterparty is a financial entity, whether it is:

    (1) Electing the exception in accordance with section

    2(h)(7)(C)(iii) or section 2(h)(7)(D) of the Act; or

    (2) Exempt from the definition of ``financial entity'' as described

    in paragraph (d) of this section;

    [[Page 74338]]

    (B) Whether the swap or swaps for which the electing counterparty

    is electing the exception are used by the electing counterparty to

    hedge or mitigate commercial risk as provided in paragraph (c) of this

    section;

    (C) How the electing counterparty generally meets its financial

    obligations associated with entering into non-cleared swaps by

    identifying one or more of the following categories, as applicable:

    (1) A written credit support agreement;

    (2) Pledged or segregated assets (including posting or receiving

    margin pursuant to a credit support agreement or otherwise);

    (3) A written third-party guarantee;

    (4) The electing counterparty's available financial resources; or

    (5) Means other than those described in paragraphs

    (b)(1)(iii)(C)(1), (2), (3) or (4) of this section; and

    (D) Whether the electing counterparty is an entity that is an

    issuer of securities registered under section 12 of, or is required to

    file reports under section 15(d) of, the Securities Exchange Act of

    1934, and if so:

    (1) The relevant SEC Central Index Key number for that

    counterparty; and

    (2) Whether an appropriate committee of that counterparty's board

    of directors (or equivalent body) has reviewed and approved the

    decision to enter into swaps that are exempt from the requirements of

    sections 2(h)(1) and 2(h)(8) of the Act.

    (2) An entity that qualifies for an exception to the clearing

    requirement under this section may report the information listed in

    paragraph (b)(1)(iii) of this section annually in anticipation of

    electing the exception for one or more swaps. Any such reporting under

    this paragraph shall be effective for purposes of paragraph (b)(1)(iii)

    of this section for swaps entered into by the entity for 365 days

    following the date of such reporting. During such period, the entity

    shall amend such information as necessary to reflect any material

    changes to the information reported.

    (3) Each reporting counterparty shall have a reasonable basis to

    believe that the electing counterparty meets the requirements for an

    exception to the clearing requirement under this section.

    (c) Hedging or mitigating commercial risk. For purposes of section

    2(h)(7)(A)(ii) of the Act and paragraph (b)(1)(iii)(B) of this section,

    a swap is used to hedge or mitigate commercial risk if:

    (1) Such swap:

    (i) Is economically appropriate to the reduction of risks in the

    conduct and management of a commercial enterprise, where the risks

    arise from:

    (A) The potential change in the value of assets that a person owns,

    produces, manufactures, processes, or merchandises or reasonably

    anticipates owning, producing, manufacturing, processing, or

    merchandising in the ordinary course of business of the enterprise;

    (B) The potential change in the value of liabilities that a person

    has incurred or reasonably anticipates incurring in the ordinary course

    of business of the enterprise;

    (C) The potential change in the value of services that a person

    provides, purchases, or reasonably anticipates providing or purchasing

    in the ordinary course of business of the enterprise;

    (D) The potential change in the value of assets, services, inputs,

    products, or commodities that a person owns, produces, manufactures,

    processes, merchandises, leases, or sells, or reasonably anticipates

    owning, producing, manufacturing, processing, merchandising, leasing,

    or selling in the ordinary course of business of the enterprise;

    (E) Any potential change in value related to any of the foregoing

    arising from interest, currency, or foreign exchange rate movements

    associated with such assets, liabilities, services, inputs, products,

    or commodities; or

    (F) Any fluctuation in interest, currency, or foreign exchange rate

    exposures arising from a person's current or anticipated assets or

    liabilities; or

    (ii) Qualifies as bona fide hedging for purposes of an exemption

    from position limits under the Act; or

    (iii) Qualifies for hedging treatment under:

    (A) Financial Accounting Standards Board Accounting Standards

    Codification Topic 815, Derivatives and Hedging (formerly known as

    Statement No. 133); or

    (B) Governmental Accounting Standards Board Statement 53,

    Accounting and Financial Reporting for Derivative Instruments; and

    (2) Such swap is:

    (i) Not used for a purpose that is in the nature of speculation,

    investing, or trading; and

    (ii) Not used to hedge or mitigate the risk of another swap or

    security-based swap position, unless that other position itself is used

    to hedge or mitigate commercial risk as defined by this rule or Sec.

    240.3a67-4 of this title.

    (d) For purposes of section 2(h)(7)(A) of the Act, a person that is

    a ``financial entity'' solely because of section 2(h)(7)(C)(i)(VIII)

    shall be exempt from the definition of ``financial entity'' if such

    person:

    (1) Is organized as a bank, as defined in section 3(a) of the

    Federal Deposit Insurance Act, the deposits of which are insured by the

    Federal Deposit Insurance Corporation; a savings association, as

    defined in section 3(b) of the Federal Deposit Insurance Act, the

    deposits of which are insured by the Federal Deposit Insurance

    Corporation; a farm credit system institution chartered under the Farm

    Credit Act of 1971; or an insured Federal credit union or State-

    chartered credit union under the Federal Credit Union Act; and

    (2) Has total assets of $10,000,000,000 or less on the last day of

    such person's most recent fiscal year.

    Issued in Washington, DC, on November 29, 2012, by the

    Commission.

    Sauntia S. Warfield,

    Assistant Secretary of the Commission.

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

    Federal Regulations: Appendices to Clearing Requirement

    Determination Under Section 2(h) of the CEA--Commission Voting

    Summary and Statement of the Chairman.

    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 2--Statement of Chairman Gary Gensler

    I support the final rule requiring certain interest rate swaps

    and credit default swap (CDS) indices to be cleared, as provided by

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

    Frank Act).

    Central clearing is one of the three major building blocks of

    Dodd-Frank swaps market reform--in addition to promoting market

    transparency and bringing swap dealers under comprehensive

    oversight--and this rule completes the clearing building block.

    Central clearing lowers the risk of the highly interconnected

    financial system. It also democratizes the market by eliminating the

    need for market participants to individually determine counterparty

    credit risk, as now clearinghouses stand between buyers and sellers.

    In a cleared market, more people have access on a level playing

    field.

    Small and medium-sized businesses, banks and asset managers can

    enter the market and trade anonymously and benefit from the market's

    greater competition.

    Clearinghouses have lowered risk for the public and fostered

    competition in the futures markets since the late 19th century.

    Following the 2008 financial crisis, President Obama convened the G-

    20 leaders in Pittsburgh in 2009, and an international

    [[Page 74339]]

    consensus formed that standardized swaps should be cleared by the

    end of 2012.

    The CFTC has already completed a number of significant Dodd-

    Frank reforms laying the foundation of risk management for

    clearinghouses, futures commission merchants and other market

    participants that participate in clearing. Other reforms paving the

    way for this rule include straight-through processing for swaps and

    protections for customer funds.

    This rule, which fulfills President Obama's G-20 commitment on

    clearing, is the last step on the path to required central clearing

    between financial entities. It benefited from significant domestic

    and international consultation. Moving forward, we will work with

    market participants on implementation. I would like to thank my

    fellow Commissioners and the CFTC staff for all of their hard work

    and dedication so that now clearing will be a reality in the swaps

    market.

    For this first set of determinations, the Commission looked to

    swaps that are currently cleared by four derivatives clearing

    organizations (DCOs).

    This set includes standard interest rate swaps in U.S. dollars,

    euros, British pounds and Japanese yen, as well as five CDS indices

    on North American and European corporate names.

    With this rule, swap dealers and the largest hedge funds will be

    required to clear these swaps in March. Compliance would be phased

    in for other market participants through the summer of 2013.

    I believe that the Commission's determination for each class

    satisfies the five factors provided for by Congress in the Dodd-

    Frank Act, including the first factor that addresses outstanding

    exposures, liquidity and pricing data.

    Under the rule, a DCO must post on its Web site a list of all

    swaps it will accept for clearing and must indicate which swaps the

    Commission had determined are required to be cleared. In addition,

    the Commission will post this information on our Web site.

    [FR Doc. 2012-29211 Filed 12-12-12; 8:45 am]

    BILLING CODE 6351-01-P

    Last Updated: December 13, 2012