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2013-12242

  • Federal Register, Volume 78 Issue 107 (Tuesday, June 4, 2013)[Federal Register Volume 78, Number 107 (Tuesday, June 4, 2013)]

    [Rules and Regulations]

    [Pages 33475-33604]

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

    [FR Doc No: 2013-12242]

    [[Page 33475]]

    Vol. 78

    Tuesday,

    No. 107

    June 4, 2013

    Part II

    Commodity Futures Trading Commission

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    17 CFR Part 37

    Core Principles and Other Requirements for Swap Execution Facilities;

    Final Rule

    Federal Register / Vol. 78 , No. 107 / Tuesday, June 4, 2013 / Rules

    and Regulations

    [[Page 33476]]

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    COMMODITY FUTURES TRADING COMMISSION

    17 CFR Part 37

    RIN 3038-AD18

    Core Principles and Other Requirements for Swap Execution

    Facilities

    AGENCY: Commodity Futures Trading Commission.

    ACTION: Final rule.

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    SUMMARY: The Commodity Futures Trading Commission (``Commission'' or

    ``CFTC'') is adopting new rules, guidance, and acceptable practices to

    implement certain statutory provisions enacted by Title VII of the

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

    Act''). The final rules, guidance, and acceptable practices, which

    apply to the registration and operation of a new type of regulated

    entity named a swap execution facility (``SEF''), implement the Dodd-

    Frank Act's new statutory framework that, among other requirements,

    adds a new section 5h to the Commodity Exchange Act (``CEA'' or

    ``Act'') concerning the registration and operation of SEFs, and adds a

    new section 2(h)(8) to the CEA concerning the execution of swaps on

    SEFs.

    DATES: The rules will become effective August 5, 2013, with the

    exception of regulation 37.3(b)(5) (17 CFR 37.3(b)(5)), which shall

    become effective August 5, 2015.

    Compliance date: October 2, 2013, except that: (a) From August 5,

    2013 until October 2, 2014 market participants may comply with the

    minimum market participant requirement in regulation 37.9(a)(3) (17 CFR

    37.9(a)(3)) by transmitting a request for a quote to no less than two

    market participants; and (b) each affected entity shall comply with the

    warning letter requirement in regulation 37.206(f) (17 CFR 37.206(f))

    no later than August 5, 2014.

    FOR FURTHER INFORMATION CONTACT: Amir Zaidi, Special Counsel, 202-418-

    6770, azaidi@cftc.gov, Alexis Hall-Bugg, Special Counsel, 202-418-6711,

    ahallbugg@cftc.gov, or David Van Wagner, Chief Counsel, 202-418-5481,

    dvanwagner@cftc.gov, Division of Market Oversight; Michael Penick,

    Senior Economist, 202-418-5279, mpenick@cftc.gov, or Sayee Srinivasan,

    Research Analyst, 202-418-5309, ssrinivasan@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. Swaps and Title VII of the Dodd-Frank Act

    B. SEF Notice of Proposed Rulemaking

    II. Part 37 of the Commission's Regulations--Final Rules

    A. Adoption of Regulations, Guidance, and Acceptable Practices

    B. General Regulations (Subpart A)

    1. Sec. 37.1--Scope

    2. Sec. 37.2--Applicable Provisions

    3. Sec. 37.3--Requirements for Registration

    4. Sec. 37.4--Procedures for Listing Products and Implementing

    Rules

    5. Sec. 37.5--Information Relating to Swap Execution Facility

    Compliance

    6. Sec. 37.6--Enforceability

    7. Sec. 37.7--Prohibited Use of Data Collected for Regulatory

    Purposes

    8. Sec. 37.8--Boards of Trade Operating Both a Designated

    Contract Market and a Swap Execution Facility

    9. Sec. 37.9--Permitted Execution Methods

    10. Sec. 37.10--Swaps Made Available for Trading

    11. Sec. 37.11--Identification of Non-Cleared Swaps or Swaps

    Not Made Available To Trade

    C. Regulations, Guidance, and Acceptable Practices for

    Compliance With the Core Principles

    1. Subpart B--Core Principle 1 (Compliance With Core Principles)

    2. Subpart C--Core Principle 2 (Compliance With Rules)

    (a) Sec. 37.200--Core Principle 2--Compliance With Rules

    (b) Sec. 37.201--Operation of Swap Execution Facility and

    Compliance With Rules

    (c) Sec. 37.202--Access Requirements

    (d) Sec. 37.203--Rule Enforcement Program

    (e) Sec. 37.204--Regulatory Services Provided by a Third Party

    (f) Sec. 37.205--Audit Trail

    (g) Sec. 37.206--Disciplinary Procedures and Sanctions

    (h) Sec. 37.207--Swaps Subject to Mandatory Clearing

    3. Subpart D--Core Principle 3 (Swaps Not Readily Susceptible to

    Manipulation)

    4. Subpart E--Core Principle 4 (Monitoring of Trading and Trade

    Processing)

    (a) Sec. 37.401--General Requirements

    (b) Sec. 37.402--Additional Requirements for Physical-Delivery

    Swaps

    (c) Sec. 37.403--Additional Requirements for Cash-Settled Swaps

    (d) Sec. 37.404--Ability To Obtain Information

    (e) Sec. 37.405--Risk Controls for Trading

    (f) Sec. 37.406--Trade Reconstruction

    (g) Sec. 37.407--Additional Rules Required

    5. Subpart F--Core Principle 5 (Ability To Obtain Information)

    (a) Sec. 37.501--Establish and Enforce Rules

    (b) Sec. 37.502--Collection of Information

    (c) Sec. 37.503--Provide Information to the Commission

    (d) Sec. 37.504--Information-Sharing Agreements

    6. Subpart G--Core Principle 6 (Position Limits or

    Accountability)

    7. Subpart H--Core Principle 7 (Financial Integrity of

    Transactions)

    (a) Sec. 37.701--Mandatory Clearing

    (b) Sec. 37.702--General Financial Integrity

    (c) Sec. 37.703--Monitoring for Financial Soundness

    8. Subpart I--Core Principle 8 (Emergency Authority)

    (a) Sec. 37.801--Additional Sources for Compliance

    9. Subpart J--Core Principle 9 (Timely Publication of Trading

    Information)

    10. Subpart K--Core Principle 10 (Recordkeeping and Reporting)

    11. Subpart L--Core Principle 11 (Antitrust Considerations)

    12. Subpart M--Core Principle 12 (Conflicts of Interest)

    13. Subpart N--Core Principle 13 (Financial Resources)

    (a) Sec. 37.1301--General Requirements

    (b) Sec. 37.1302--Types of Financial Resources

    (c) Sec. 37.1303--Computation of Financial Resource Requirement

    (d) Sec. 37.1304--Valuation of Financial Resources

    (e) Sec. 37.1305--Liquidity of Financial Resources

    (f) Sec. 37.1306--Reporting Requirements

    14. Subpart O--Core Principle 14 (System Safeguards)

    (a) Sec. 37.1401--Requirements

    15. Subpart P--Core Principle 15 (Designation of Chief

    Compliance Officer)

    (a) Sec. 37.1501--Chief Compliance Officer

    III. Related Matters

    A. Regulatory Flexibility Act

    B. Paperwork Reduction Act

    C. Cost Benefit Considerations

    1. Introduction

    2. SEF Market Structure

    3. Registration

    4. Recordkeeping and Reporting

    5. Compliance

    6. Monitoring and Surveillance

    7. Financial Resources

    8. Emergency Operations and System Safeguards

    IV. List of Commenters

    V. Text of Final Regulations, Guidance, and Acceptable Practices

    I. Background

    A. Swaps and Title VII of the Dodd-Frank Act

    Historically, swaps have traded in over-the-counter (``OTC'')

    markets, rather than on regulated exchanges given their exemption from

    regulation.\1\ The OTC swaps market is less transparent than exchange-

    traded futures and securities markets. This lack of transparency was a

    major contributor to the 2008 financial crisis because regulators and

    market participants lacked visibility to identify and assess the

    implications of swaps market exposures and counterparty

    relationships.\2\ As a result, on July 21,

    [[Page 33477]]

    2010, President Obama signed the Dodd-Frank Act,\3\ which tasked the

    Commission with overseeing a large portion of the U.S. swaps market.

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    \1\ See Commodity Futures Modernization Act of 2000, Public Law

    106-554, 114 Stat. 2763 (2000).

    \2\ See The 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

    (Official Government Edition), at 299, 352, 363-364, 386, 621 n. 56

    (2011), available at http://fcic-static.law.stanford.edu/cdn_media/fcic-reports/fcic_final_report_full.pdf. The Commission has

    acknowledged, however, that the benefits of enhanced market

    transparency are not boundless, particularly in swap markets with

    limited liquidity. See Procedures to Establish Appropriate Minimum

    Block Sizes for Large Notional Off-Facility Swaps and Block Trades,

    77 FR 15460, 15466 (proposed Mar. 15, 2012). In implementing these

    regulations, the Commission has taken into account the benefits and

    concerns related to market transparency.

    \3\ Dodd-Frank Wall Street Reform and Consumer Protection Act,

    Public Law 111-203, 124 Stat. 1376 (2010).

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    Title VII of the Dodd-Frank Act \4\ amended the CEA \5\ to

    establish a comprehensive new regulatory framework for swaps and

    security-based swaps (``SB-swaps''). A key goal of the Dodd-Frank Act

    is to bring greater pre-trade and post-trade transparency to the swaps

    market. Pre-trade transparency with respect to the swaps market refers

    to making information about a swap available to the market, including

    bid (offers to buy) and offer (offers to sell) prices, quantity

    available at those prices, and other relevant information before the

    execution of a transaction. Such transparency lowers costs for

    investors, consumers, and businesses; lowers the risks of the swaps

    market to the economy; and enhances market integrity to protect market

    participants and the public. The Dodd-Frank Act also ensures that a

    broader universe of market participants receive pricing and volume

    information by providing such information upon the completion of every

    swap transaction (i.e., post-trade transparency).\6\ By requiring the

    trading of swaps on SEFs and designated contract markets (``DCMs''),

    all market participants will benefit from viewing the prices of

    available bids and offers and from having access to transparent and

    competitive trading systems or platforms.

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    \4\ Pursuant to section 701 of the Dodd-Frank Act, Title VII may

    be cited as the ``Wall Street Transparency and Accountability Act of

    2010.''

    \5\ 7 U.S.C. 1 et seq.

    \6\ See Financial Stability Board, Implementing OTC Derivatives

    Market Reforms, at 41 (Oct. 25, 2010), available at http://www.financialstabilityboard.org/publications/r_101025.pdf;

    Technical Committee of the International Organization of Securities

    Commissions, Transparency of Structured Finance Products Final

    Report, at 17, 21 (Jul. 2010), available at http://www.iosco.org/library/pubdocs/pdf/IOSCOPD326.pdf.

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    In addition to facilitating greater transparency and trading of

    swaps on SEFs, Title VII of the Dodd-Frank Act establishes a

    comprehensive regulatory framework, including registration, operation,

    and compliance requirements for SEFs.\7\ For example, section 733 of

    the Dodd-Frank Act sets forth a broad registration provision that

    requires any person who operates a facility for the trading of swaps to

    register as a SEF or as a DCM.\8\ In addition, section 721 of the Dodd-

    Frank Act amended the CEA to define SEF as a trading platform where

    multiple participants have the ability to execute swaps by accepting

    bids and offers made by multiple participants in the platform.\9\

    Furthermore, section 723 of the Dodd-Frank Act set forth a trade

    execution requirement, which states that swap transactions subject to

    the clearing requirement must be executed on a DCM or SEF, unless no

    DCM or SEF makes the swap available to trade or for swap transactions

    subject to the clearing exception under CEA section 2(h)(7).\10\

    Section 733 of the Dodd-Frank Act provided that to be registered and

    maintain registration, a SEF must comply with fifteen enumerated core

    principles and any requirement that the Commission may impose by rule

    or regulation.\11\

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    \7\ See CEA section 5h, as enacted by section 733 of the Dodd-

    Frank Act; 7 U.S.C. 7b-3. This regulatory framework includes: (i)

    Registration, operation, and compliance requirements for SEFs and

    (ii) fifteen core principles. Applicants and registered SEFs are

    required to comply with the core principles as a condition of

    obtaining and maintaining their registration as a SEF.

    \8\ CEA section 5h(a)(1), as enacted by section 733 of the Dodd-

    Frank Act; 7 U.S.C. 7b-3(a)(1).

    \9\ CEA section 1a(50), as amended by section 721 of the Dodd-

    Frank Act; 7 U.S.C. 1a(50).

    \10\ CEA section 2(h)(8), as amended by section 723 of the Dodd-

    Frank Act; 7 U.S.C. 2(h)(8).

    \11\ CEA section 5h, as enacted by section 733 of the Dodd-Frank

    Act; 7 U.S.C. 7b-3.

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    B. SEF Notice of Proposed Rulemaking

    The Dodd-Frank Act amended the CEA to provide that, under new

    section 5h, the Commission may in its discretion determine by rule or

    regulation the manner in which SEFs comply with the core

    principles.\12\ In consideration of both the novel nature of SEFs and

    its experience in overseeing DCMs' compliance with core principles, the

    Commission carefully assessed which SEF core principles would benefit

    from regulations, providing legal certainty and clarity to the

    marketplace, and which core principles would benefit from guidance or

    acceptable practices, where flexibility is more appropriate. Based on

    that evaluation, on January 7, 2011, the Commission proposed a

    combination of regulations, guidance, and acceptable practices for the

    registration, oversight, and regulation of SEFs (``SEF NPRM'').\13\

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    \12\ CEA section 5h(f)(1); 7 U.S.C. 7b-3(f)(1).

    \13\ Core Principles and Other Requirements for Swap Execution

    Facilities, 76 FR 1214 (proposed Jan. 7, 2011).

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    The SEF NPRM provided, among other requirements, the following:

    (1) Procedures for temporary and full SEF registration.\14\

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    \14\ Id. at 1238.

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    (2) A minimum trading functionality requirement that all SEFs must

    offer,\15\ which took into account the SEF definition,\16\ the core

    principles applicable to SEFs,\17\ and the goals provided in section

    733 of the Dodd-Frank Act.\18\ The minimum trading functionality

    required a SEF to provide a centralized electronic trading screen upon

    which any market participant can post both executable and non-

    executable bids and offers that are transparent to all other market

    participants of the SEF.\19\ For a trader who has the ability to

    execute against its customer's order or to execute two customers'

    orders against each other, the SEF NPRM also required the trader be

    subject to a 15 second time delay between the entry of those two

    orders.\20\ In addition, the proposal allowed a Request for Quote

    (``RFQ'') System \21\ that operates in conjunction with the SEF's

    minimum trading functionality.\22\ Finally, the SEF NPRM stated that a

    SEF may offer other functionalities in conjunction with the minimum

    trading functionality, as long as those functionalities meet the SEF

    definition and comply with the core principles.\23\

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    \15\ Id. at 1241.

    \16\ CEA section 1a(50); 7 U.S.C. 1a(50).

    \17\ CEA section 5h(f); 7 U.S.C. 7b-3(f).

    \18\ The goals of section 733 of the Dodd-Frank Act are to

    promote the trading of swaps on SEFs and to promote pre-trade price

    transparency in the swaps market. CEA section 5h(e); 7 U.S.C. 7b-

    3(e).

    \19\ Core Principles and Other Requirements for Swap Execution

    Facilities, 76 FR at 1241.

    \20\ Id.

    \21\ Id.

    \22\ By ``in conjunction with the SEF's minimum trading

    functionality,'' the Commission means that the SEF NPRM required a

    SEF to offer the minimum trading functionality, and if that SEF also

    offered an RFQ System, it was required to communicate any bids or

    offers resting on the minimum trading functionality to the RFQ

    requester along with the responsive quotes. See the discussion below

    regarding ``Taken Into Account and Communicated'' Language in the

    RFQ System Definition under Sec. 37.9(a)(1)(ii)--Request for Quote

    System in the preamble for further details.

    \23\ Core Principles and Other Requirements for Swap Execution

    Facilities, 76 FR at 1220.

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    (3) The classification of swap transactions into two categories:

    Required Transactions (i.e., transactions subject to the trade

    execution mandate under section 2(h)(8) of the CEA and not block

    trades) and Permitted Transactions (i.e., transactions not

    [[Page 33478]]

    subject to the clearing and trade execution mandates, illiquid or

    bespoke swaps, or block trades).\24\ Under the SEF NPRM, Required

    Transactions were required to be executed on the minimum trading

    functionality, an Order Book meeting the minimum trading functionality,

    or an RFQ System (in conjunction with the minimum trading

    functionality).\25\ The SEF NPRM also allowed a SEF to provide

    additional methods of execution for Permitted Transactions, including

    Voice-Based Systems.\26\

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    \24\ Id. at 1241.

    \25\ Id.

    \26\ Id.

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    (4) Regulations, guidance, and acceptable practices to implement

    the 15 core principles specified in section 5h(f) of the Act.\27\

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    \27\ Id. at 1241-1253, 1256-1258.

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    The initial comment period for the SEF NPRM ended on March 8, 2011.

    Subsequently, the Commission reopened the comment period until June 3,

    2011, as part of its global extension of comment periods for various

    rulemakings implementing the Dodd-Frank Act.\28\ After the second

    comment period ended, the Commission continued to accept and consider

    late comments, which it did until April 30, 2013.\29\ The Commission

    received approximately 107 comment letters on the SEF NPRM from members

    of the public.\30\ The Chairman and Commissioners, as well as the

    Commission staff, participated in numerous meetings with

    representatives of single dealer platforms, interdealer brokers, DCMs,

    trade associations, OTC market participants, potential SEF applicants,

    and other interested parties.\31\ In addition, the Commission consulted

    with the Securities and Exchange Commission (``SEC'') and international

    regulators on numerous occasions.

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    \28\ Reopening and Extension of Comment Periods for Rulemakings

    Implementing the Dodd-Frank Wall Street Reform and Consumer

    Protection Act, 76 FR 25274 (May 4, 2011). The Commission extended

    the applicable comment periods to provide the public an additional

    opportunity to comment on the proposed new regulatory framework. The

    Commission also opened an additional comment period, which ended on

    June 10, 2011, to provide the public an opportunity to comment on

    the Commission's phased implementation of the Act, as amended,

    including its implementation of section 733 of Dodd-Frank Act. Joint

    Public Roundtable on Issues Related to the Schedule for Implementing

    Final Rules for Swaps and Security-Based Swaps Under the Dodd-Frank

    Wall Street Reform and Consumer Protection Act, 76 FR 23221 (Apr.

    26, 2011).

    \29\ The Commission also held two roundtables touching on issues

    related to the SEF NPRM: (1) ``Available to Trade'' Provision for

    Swap Execution Facilities and Designated Contract Markets; and (2)

    Proposed Regulations Implementing Core Principle 9 for Designated

    Contract Markets. Transcripts are available through the Commission's

    Web site at http://www.cftc.gov/PressRoom/Events/2012Events/index.htm.

    \30\ A list of the full names and abbreviations of commenters to

    the SEF NPRM is included in section IV at the end of this release.

    The Commission notes that many commenters submitted more than one

    comment letter. Additionally, all comment letters that pertain to

    the SEF NPRM, including those from the additional comment periods

    related to implementation of the final Dodd-Frank rules, are

    contained in the SEF rulemaking comment file and are available

    through the Commission's Web site at http://comments.cftc.gov/PublicComments/CommentList.aspx?id=955.

    \31\ Meeting summaries are available through the Commission's

    Web site at http://comments.cftc.gov/PublicComments/CommentList.aspx?id=955.

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    II. Part 37 of the Commission's Regulations--Final Rules

    A. Adoption of Regulations, Guidance, and Acceptable Practices

    In this final rulemaking, the Commission is adopting many of the

    proposed regulations that each SEF must meet in order to comply with

    section 5h of the CEA, both initially upon registration and on an

    ongoing basis, and related guidance, and acceptable practices. As a

    result of the written comments received and dialogue and meetings with

    the public, the Commission has revised or eliminated a number of

    regulations that were proposed in the SEF NPRM, and in a number of

    instances, has codified guidance and/or acceptable practices in lieu of

    the proposed regulations. In determining the scope and content of the

    final SEF regulations, the Commission has carefully considered the

    costs and benefits for each rule with particular attention to the

    public comments. Additionally, the Commission has taken into account

    the concerns raised by commenters regarding the potential effects of

    specific rules on SEFs offering different swap contracts and trading

    systems or platforms and the importance of the statutory differences

    between SEFs and DCMs. The Commission addresses these issues below in

    its discussion of specific rule provisions.

    The Commission also notes that the SEC has proposed rules related

    to security-based SEFs (``SB-SEFs'') as required under section 763 of

    the Dodd-Frank Act (``SB-SEF NPRM'').\32\ Section 712(a) of the Dodd-

    Frank Act states that before commencing any rulemaking regarding swap

    execution facilities, the Commission ``shall consult and coordinate to

    the extent possible with the Securities and Exchange Commission and the

    prudential regulators for the purposes of assuring regulatory

    consistency and comparability . . . .'' \33\ The Commission has also

    received several comments stating that the Commission and the SEC

    should harmonize their rules as much as possible.\34\

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    \32\ Registration and Regulation of Security-Based Swap

    Execution Facilities, 76 FR 10948 (proposed Feb. 28, 2011).

    \33\ 15 U.S.C. 8302(a)(1).

    \34\ Tradeweb Comment Letter at 3-4 (Jun. 3, 2011); Reuters

    Comment Letter 3-4 (Mar. 8, 2011); FSR Comment Letter at 10-11 (Mar.

    8, 2011); WMBAA Comment Letter at 10-11 (Mar. 8, 2011).

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    The Commission has coordinated with the SEC to harmonize the SEF

    and SB-SEF requirements to the extent possible and has taken into

    consideration the comments for greater harmonization between the SEF

    and SB-SEF regulations. However, there may be appropriate differences

    in the approach that each agency may take regarding the regulation of

    SEFs and SB-SEFs. Cognizant of the different products and markets

    regulated by the SEC and the Commission, the SEC recognized in its SB-

    SEF NPRM that there may be differences in the approach that each agency

    may take regarding the regulation of SEFs and SB-SEFs.\35\

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

    \35\ Registration and Regulation of Security-Based Swap

    Execution Facilities, 76 FR at 10950.

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

    Similarly, the Commission is mindful that swaps may also trade on

    DCMs. Thus, in addition to its efforts to coordinate its approach with

    the SB-SEF regulations, the Commission also seeks, where possible, to

    harmonize the final SEF regulations with the DCM regulations in order

    to minimize regulatory differences between SEFs and DCMs in those

    instances where Congress enacted similar core principles for the two

    types of registered entities. In addition, some differences in the

    agencies' regulatory oversight regimes may be attributed to the fact

    that, unlike the SEC that is only responsible for overseeing trading in

    SB-swaps, such as single-name securities and narrow-based security

    indexes, the Commission is charged with the oversight of swaps trading

    over a broad range of asset categories. Consequently, the Commission

    has taken into account the varied characteristics of those underlying

    commodities in formulating the regulatory responsibilities of SEFs.

    In the preamble sections below, the Commission responds to the

    substantive comments submitted in response to the SEF NPRM. The

    Commission reviewed and considered all comments in adopting this final

    rulemaking. Further, the final regulations include a number of

    technical revisions and non-substantive changes to the proposed rule

    text intended to clarify certain provisions, standardize terminology

    [[Page 33479]]

    within this part 37, conform terminology to that used in other parts of

    the Commission's regulations, and more precisely state regulatory

    standards and requirements. For example, a minimum trading

    functionality requirement was in proposed Sec. 37.9, which has been

    moved to the registration section under final Sec. 37.3 to clarify

    that this functionality is required in order to register as a SEF. The

    final regulations will become effective 60 days after their publication

    in the Federal Register.

    B. General Regulations (Subpart A)

    The regulations in this final rulemaking are codified in subparts A

    through P under part 37 of the Commission's regulations. The general

    regulations consisting of Sec. Sec. 37.1 through 37.9 are codified in

    subpart A, and the regulations applicable to each of the 15 core

    principles are codified in subparts B through P, respectively.\36\

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    \36\ Subparts B through P begin with a regulation containing the

    language of the core principle in the Act.

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

    1. Sec. 37.1--Scope

    Proposed Sec. 37.1 provided that part 37 applies to entities that

    are registered SEFs, have been registered SEFs, or are applying to

    become registered SEFs. The proposed rule also stated that part 37 does

    not restrict the eligibility of SEFs to operate under the provisions of

    parts 38 or 49 of this chapter.

    (a) Commission Determination

    The Commission received no comments on this section and is adopting

    the provision as proposed.\37\

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

    \37\ The Commission has removed the phrase ``has been

    registered'' from proposed Sec. 37.1 because a SEF that has been

    registered is the same as a SEF that is registered.

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

    2. Sec. 37.2--Applicable Provisions

    Proposed Sec. 37.2 listed the Commission regulations that, in

    addition to part 37, will be applicable to SEFs, including regulations

    that have been codified and are proposed to be codified upon the

    Commission's finalization of the rulemakings implemented pursuant to

    the Dodd-Frank Act.

    (a) Commission Determination

    Although it received no comments on this section, the Commission is

    revising proposed Sec. 37.2 to generally state that SEFs shall comply

    with, in addition to part 37, all applicable Commission regulations,

    and to only cite those specific provisions whose applicability to SEFs

    may not be apparent. The Commission notes that a separate rulemaking

    adopted conforming changes to existing regulations to clarify the pre-

    Dodd Frank provisions applicable to SEFs.\38\ There are, however,

    certain existing regulations that will apply to SEFs that the separate

    rulemaking did not address. Accordingly, for clarity purposes, the

    Commission is specifically stating that Sec. 1.60 \39\ and part 9 \40\

    of its regulations will apply to SEFs. These revisions will eliminate

    the need for the Commission to continually update Sec. 37.2 when new

    regulations with which SEFs must comply are codified.

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    \38\ Adaptation of Regulations to Incorporate Swaps, 77 FR 66288

    (Nov. 2, 2012). The Commission may promulgate a second phase of

    conforming changes to its regulations once more rules relating to

    swaps are finalized.

    \39\ The term ``contract market'' used in Sec. 1.60 of the

    Commission's regulations should be interpreted to include a SEF for

    purposes of applying the requirements of Sec. 1.60 to a SEF. 17 CFR

    1.60.

    \40\ The term ``exchange'' used in part 9 of the Commission's

    regulations should be interpreted to include a SEF for purposes of

    applying the requirements of part 9 to a SEF. 17 CFR part 9.

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    3. Sec. 37.3--Requirements for Registration \41\

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

    \41\ The Commission is renaming the title of this section from

    ``Requirements for Registration'' to ``Requirements and Procedures

    for Registration'' to provide greater clarity. The Commission is

    also restructuring the order of Sec. 37.3 to provide clarity.

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    Proposed Sec. 37.3 established, among other procedures,

    application procedures for temporary and full registration of new SEFs,

    and procedures for the transfer of a registration. To assist

    prospective SEF applicants, the SEF NPRM included under appendix A to

    part 37 an application form titled Form SEF. Form SEF included

    information that an applicant would be required to provide to the

    Commission in order for the Commission to make a determination

    regarding the applicant's request for SEF registration.

    With respect to which entities must register as a SEF, the SEF NPRM

    stated that in order for an entity to meet the SEF definition and

    satisfy the SEF registration requirements, multiple parties must have

    the ability to execute or trade swaps by accepting bids and offers made

    by multiple participants.\42\ In this regard, the SEF NPRM stated that

    one-to-one voice services and single dealer platforms do not satisfy

    the SEF definition because multiple participants do not have the

    ability to execute or trade swaps with multiple participants.\43\ In

    addition, the SEF NPRM stated that entities that operate exclusively as

    swap processors do not meet the SEF definition and should not be

    required to register.\44\ Although the SEF NPRM stated that the

    registration provision in CEA section 5h(a)(1) could be read to require

    the registration of entities that solely engage in trade

    processing,\45\ it stated that such entities do not meet the SEF

    definition and should not be required to register as SEFs because: (1)

    They do not provide the ability to execute or trade a swap as required

    by the SEF definition; and (2) the SEF definition does not include the

    term ``process.'' \46\

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

    \42\ Core Principles and Other Requirements for Swap Execution

    Facilities, 76 FR at 1219.

    \43\ Id.

    \44\ Id.

    \45\ CEA section 5h(a)(1) states that ``[n]o person may operate

    a facility for the trading or processing of swaps unless the

    facility is registered as a swap execution facility or designated

    contract market. . . .'' 7 U.S.C. 7b-3(a)(1).

    \46\ Core Principles and Other Requirements for Swap Execution

    Facilities, 76 FR at 1219.

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

    The SEF NPRM also noted that CEA section 2(h)(8) requires that

    transactions involving swaps subject to the clearing requirement be

    executed on a DCM or SEF, unless no DCM or SEF makes such swaps

    available to trade or such swaps qualify for the clearing exception

    under CEA section 2(h)(7).\47\ In this regard, the SEF NPRM stated that

    market participants may desire to avail themselves of the benefits of

    trading on SEFs for swaps that are not subject to the CEA section

    2(h)(8) trade execution requirement, but it also acknowledged that such

    swaps are not required to be executed on a SEF or DCM.\48\

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

    \47\ Id. at 1221-22. CEA sections 2(h)(7) and 2(h)(8); 7 U.S.C.

    2(h)(7) and 2(h)(8). See discussion below under Sec. 37.10--Swaps

    Made Available for Trading in the preamble for further details

    regarding this process.

    \48\ Id. at 1222.

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

    (a) Requirements for Registration

    (1) Summary of Comments

    Several commenters asserted that the proposed rule is ambiguous as

    to who must register as a SEF as required under CEA section 5h(a)(1)

    and requested clarification.\49\ For example, UBS stated that the

    Commission should clarify that ``the SEF registration requirement in

    [CEA section 5h(a)(1)] only applies to platforms that meet the SEF

    definition.'' \50\ In addition, Barclays

    [[Page 33480]]

    commented that the language of CEA section 5h(a)(1) should not be read

    broadly to require SEF registration for any platform or system that

    executes or processes swaps to the extent it is deemed to be a

    ``facility'' without considering whether such swaps are or are not

    subject to the CEA section 2(h)(8) trade execution mandate.\51\

    Similarly, Bloomberg noted the broad language under the CEA section

    5h(a)(1) registration requirement, and stated that if Congress intended

    that all swaps be traded on a SEF or DCM, then the trade execution

    mandate under CEA section 2(h)(8) would be unnecessary.\52\ The

    Commission also received comments and specific requests for a

    Commission determination as to whether certain business models or

    services must register as a SEF, including one-to-many platforms, blind

    auction platforms, aggregation services or portals, portfolio

    compression services, risk mitigation services, and swap processing

    services.

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

    \49\ CEA section 5h(a)(1) states that ``[n]o person may operate

    a facility for the trading or processing of swaps unless the

    facility is registered as a swap execution facility or designated

    contract market. . . .'' 7 U.S.C. 7b-3(a)(1). UBS Comment Letter at

    1-2 (May 18, 2012); UBS Comment Letter at 2-3 (Nov. 2, 2011);

    Barclays Comment Letter at 2 (Jun. 3, 2011); Deutsche Comment Letter

    at 6 (Mar. 8, 2011); Bloomberg Comment Letter at 3 (Mar. 8, 2011);

    State Street Comment Letter at 3 (Mar. 8, 2011); CME Comment Letter

    at 8 (Mar. 8, 2011).

    \50\ UBS Comment Letter at 1 (May 18, 2012). The Commission

    notes that UBS submitted 2 comment letters on May 18, 2012.

    \51\ Barclays Comment Letter at 2 (Jun. 3, 2011).

    \52\ Bloomberg Comment Letter at 3 (Mar. 8, 2011).

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

    (i) One-to-Many Systems or Platforms

    AFR opined that single dealer or one-to-many platforms do not meet

    the SEF definition in CEA section 1a(50), which refers to a system in

    which multiple parties have the ability to execute or trade swaps by

    accepting bids or offers from multiple participants.\53\ Similarly,

    IECA stated that SEFs should operate in a way that publicly reveals

    market prices, and that preserving the ``one-to-one'' pricing model of

    existing dealer systems is inconsistent with the SEF definition.\54\

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

    \53\ AFR Comment Letter at 3-4 (Mar. 8, 2011). JP Morgan also

    commented that it agrees with the Commission that a single dealer

    platform cannot qualify as a SEF because it fails to satisfy the

    ``multiple to multiple'' language in the SEF definition. JP Morgan

    Comment Letter at 3 (Mar. 8, 2011).

    \54\ IECA Comment Letter at 3 (May 24, 2011).

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

    (ii) Blind Auction Systems or Platforms

    Nodal commented that a blind auction platform should be able to

    register as a SEF.\55\ Nodal contended that its blind auction platform

    meets the SEF definition because multiple participants have the ability

    to execute swap transactions by accepting bids and offers made by

    multiple participants albeit without the pre-trade posting of bids or

    offers.\56\ Nodal explained that its platform allows participants to

    submit firm bids and offers without the disclosure of the terms of

    those bids and offers to other participants, and that the auction

    algorithmically processes the bids and offers to match participants

    efficiently.\57\ Nodal further explained that auction volume is awarded

    to participants at the same price and at a price equal to or better

    than the participants' auction order.\58\

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

    \55\ Nodal Comment Letter at 2-3 (Jun. 3, 2011); Nodal Comment

    Letter at 2-3 (Mar. 8, 2011). Nodal also expressed support for blind

    auction platforms in its comment letter to the Second Amendment to

    July 14, 2011 Order for Swap Regulation Notice of Proposed

    Amendment, 77 FR 28819 (proposed May 16, 2012).

    \56\ Nodal Comment Letter at 3 (Mar. 8, 2011).

    \57\ Id.

    \58\ Id. at 2.

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

    (iii) Aggregation Services or Portals

    UBS and Bloomberg requested clarification whether aggregator

    services are required to register as SEFs.\59\ UBS stated that an

    aggregator service will provide customers with the ability to access

    the best available liquidity and pricing on multiple SEFs through the

    aggregator's screen so that customers will not have to connect to each

    SEF individually.\60\ UBS stated that an aggregator service should not

    be required to register as a SEF because the transaction is executed on

    the relevant SEF's platform.\61\

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

    \59\ UBS Comment Letter at 1 (May 18, 2012); Meeting with UBS

    dated Mar. 27, 2012; Meeting with Bloomberg dated Jan. 18, 2012. See

    also UBS Comment Letter at 1 (Nov. 2, 2011).

    \60\ Meeting with UBS dated Mar. 27, 2012. See also UBS Comment

    Letter at 1 (Nov. 2, 2011).

    \61\ Meeting with UBS dated Mar. 27, 2012.

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

    (iv) Services Facilitating Portfolio Compression and Risk Mitigation

    Transactions

    Several commenters sought clarification that portfolio compression

    and risk mitigation services are not required to register as SEFs.\62\

    According to TriOptima, its portfolio compression service provides a

    netting mechanism that reduces the outstanding trade count and

    outstanding gross notional value of swaps in participants' portfolios

    by terminating or modifying existing trades.\63\ Specifically,

    TriOptima stated that prospective participants may sign up for a

    scheduled compression cycle and the participants must provide detailed

    data about their respective portfolios and risk tolerances.\64\ Other

    than to update mark-to-market values shortly before the compression

    cycle is run, prospective participants have no further input into the

    compression process, which is entirely controlled by the compression

    algorithm.\65\ On a specified date, TriOptima runs the compression

    cycle, which produces a set of proposed transactions for each

    participant.\66\ The proposed transactions, if effected, would

    terminate or modify participants' existing trades in order to reduce

    the outstanding trade count and outstanding gross notional value of

    swaps in the participants' portfolios.\67\ Each participant receives

    only details of the proposed compression transactions to which it is a

    party, but all of the compression transactions must be accepted in

    order for the particular compression cycle to occur.\68\ If a single

    participant declines to agree to the proposed compression transactions,

    then the entire compression cycle fails and the pre-compression swap

    transactions remain in effect.\69\ TriOptima contended that such

    services do not perform the role of a trade execution venue so they

    should not be regulated as a SEF.\70\

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

    \62\ Meeting with ICAP and TriOptima dated Sep. 6, 2012; Meeting

    with ICAP dated Aug. 29, 2012; Meeting with ICE dated Jul. 25, 2012;

    WMBAA Comment Letter at 3 (Jul. 18, 2011); ICAP Comment Letter at 2

    (Jul. 7, 2011); TriOptima Comment Letter at 1 (Mar. 8, 2011).

    \63\ TriOptima Comment Letter at 2, 4 (Mar. 8, 2011).

    \64\ Id. at 2. The service does not place any constraints on the

    number of positions or risk tolerances of prospective participants.

    Id.

    \65\ Id. at 3.

    \66\ Id.

    \67\ Id.

    \68\ Id.

    \69\ Id.

    \70\ Id.

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

    ICAP stated that its bulk risk mitigation service assists market

    participants in managing their risk exposures by identifying offsetting

    risk requirements and executing new offsetting trades among those

    participants.\71\ Specifically, ICAP stated that its risk mitigation

    service sets the curve and price for all trades based on a survey of

    market making entities, such as banks, or other entities that are

    willing to provide quotes, as well as price quotes on DCMs.\72\ All

    prospective participants in a particular risk mitigation run are first

    shown the curve and prices for transactions along the curve.\73\

    Subsequently, the prospective participants provide ICAP with data about

    any of their positions of their choosing and their acceptable risk

    tolerances.\74\ ICAP then runs a proprietary algorithm, which produces

    a set of proposed transactions for each participant.\75\ The proposed

    transactions, if effected, would result in new trades for the

    participants that enable them to manage their exposures to market,

    credit, or other sources of

    [[Page 33481]]

    risk.\76\ All transactions must be accepted in order for a particular

    risk mitigation run to occur.\77\ If a single participant declines to

    agree to the proposed risk mitigation transactions, then the entire

    risk mitigation run fails and the existing swap transactions remain in

    effect.\78\ While its bulk risk mitigation services result in market

    participants entering into new trades, ICAP commented that such

    services do not meet the SEF definition because they do not permit

    participants to trade in real-time, negotiate price, or initiate

    directional trades.\79\

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

    \71\ Meeting with ICAP dated Aug. 29, 2012; ICAP Comment Letter

    at 1, 4 (Jul. 7, 2011).

    \72\ Meeting with ICAP dated Aug. 29, 2012; ICAP Comment Letter

    at 4 (Jul. 7, 2011).

    \73\ Id.

    \74\ Id. The service does not place any constraints on the

    number of positions or risk tolerances of prospective participants.

    Id.

    \75\ Id.

    \76\ Id.

    \77\ Id.

    \78\ Id.

    \79\ ICAP Comment Letter at 2 (Jan. 16, 2013); ICAP Comment

    Letter at 4 (Jul. 7, 2011).

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

    (v) Swap Processing Services

    In its first comment letter, MarkitSERV agreed with the SEF NPRM

    that entities operating exclusively as swap processors should not have

    to register as SEFs because they only provide post-execution services

    that facilitate clearing and settlement, not services relating to the

    execution of swaps.\80\ However, in a subsequent comment letter, after

    the SEC's proposed rule that would require certain providers of post-

    trade services to register with the SEC as clearing agencies,

    MarkitSERV recommended that the Commission regulate entities that

    perform the confirmation and processing of swaps.\81\ While MarkitSERV

    acknowledged that the SEC's authority under the Securities and Exchange

    Act of 1934 to regulate swap processors as a clearing agency has no

    parallel in the CEA, MarkitSERV recommended that the Commission

    register such entities to avoid unnecessarily inconsistent

    regulations.\82\ MarkitSERV recommended that the Commission require

    swap processors to register as a sub-category of SEFs because CEA

    section 5h(a)(1) references the processing of swaps.\83\

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

    \80\ MarkitSERV Comment Letter at 6 (Mar. 8, 2011).

    \81\ MarkitSERV Comment Letter at 1-2 (Jun. 3, 2011).

    \82\ Id. at 3-4.

    \83\ Id. at 5.

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

    (2) Commission Determination

    In response to commenters' requests for clarification regarding the

    registration requirement, the Commission is clarifying how it

    interprets the broad registration provision in section 5h(a)(1) of the

    Act in coordination with the specific requirements for a SEF's

    structure found in section 1a(50) of the Act and the trade execution

    requirement in section 2(h)(8) of the Act. As noted in the SEF NPRM,

    the Commission views the CEA section 5h(a)(1) registration requirement

    \84\ as applying only to facilities that meet the SEF definition in CEA

    section 1a(50).\85\ Section 1a(50) of the Act defines a SEF as ``a

    trading system or platform in which multiple participants have the

    ability to execute or trade swaps by accepting bids and offers made by

    multiple participants in the facility or system, through any means of

    interstate commerce, including any trading facility, that--(A)

    Facilitates the execution of swaps between persons; and (B) is not a

    designated contract market.'' \86\ Accordingly, the Commission is

    revising proposed Sec. 37.3 to clarify the scope of the registration

    requirement, which states that ``[a]ny person operating a facility that

    offers a trading system or platform in which more than one market

    participant has the ability to execute or trade swaps with more than

    one other market participant on the system or platform shall register

    the facility as a swap execution facility under this part 37 or as a

    designated contract market under part 38 of this chapter.'' \87\

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

    \84\ CEA section 5h(a)(1) states that ``[n]o person may operate

    a facility for the trading or processing of swaps unless the

    facility is registered as a swap execution facility or as a

    designated contract market. . . .'' 7 U.S.C. 7b-3(a)(1).

    \85\ See Core Principles and Other Requirements for Swap

    Execution Facilities, 76 FR at 1219 (explaining that entities that

    operate exclusively as swap processors do not meet the SEF

    definition and should not be required to register as a SEF despite

    the broad language in the CEA section 5h(a)(1) registration

    provision).

    \86\ CEA section 1a(50); 7 U.S.C. 1a(50). The Commission notes

    that the Secretary of the Treasury issued a written determination

    pursuant to CEA sections 1a(47)(E) and 1b that foreign exchange

    swaps and foreign exchange forwards should not be regulated as swaps

    under the CEA, and therefore should be exempted from the definition

    of the term ``swap'' under the CEA. See Determination of Foreign

    Exchange Swaps and Foreign Exchange Forwards Under the Commodity

    Exchange Act, 77 FR 69694 (Nov. 20, 2012). Accordingly, if a

    facility offers a trading system or platform solely for the

    execution or trading of foreign exchange swaps or foreign exchange

    forwards, then the facility would not be required to register as a

    SEF.

    \87\ The Commission is adding this new provision to Sec.

    37.3(a)(1). As a result, proposed Sec. 37.3(a) is adopted as Sec.

    37.3(b), proposed Sec. 37.3(b) is adopted as Sec. 37.3(c),

    proposed Sec. 37.3(c) is adopted as Sec. 37.3(d), proposed Sec.

    37.3(d) is adopted as Sec. 37.3(e), proposed Sec. 37.3(e) is

    adopted as Sec. 37.3(f), and proposed Sec. 37.3(f) is adopted as

    Sec. 37.3(g). The SEF NPRM stated that certain entities such as

    one-to-one voice services and single-dealer platforms do not provide

    the ability for participants to conduct multiple-to-multiple

    execution or trading because they limit the provision of liquidity

    to a single liquidity provider. Core Principles and Other

    Requirements for Swap Execution Facilities, 76 FR at 1219.

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

    The Commission also clarifies that swap transactions that are not

    subject to the CEA section 2(h)(8) trade execution requirement may be

    executed on either a registered SEF (i.e., a facility that meets the

    SEF definition) or an alternative entity that is not required to

    register as a SEF (e.g., see one-to-many system or platform discussion

    below).\88\ This clarification is consistent with the Commission's

    acknowledgement in the SEF NPRM that swap transactions that are not

    subject to the CEA section 2(h)(8) trade execution requirement would

    not have to be executed on a registered SEF.\89\

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

    \88\ The Commission notes that it is not tying the registration

    requirement in CEA section 5h(a)(1) to the trade execution

    requirement in CEA section 2(h)(8), such that only facilities

    trading swaps subject to the trade execution requirement would be

    required to register as a SEF. Therefore, a facility would be

    required to register as a SEF if it operates in a manner that meets

    the SEF definition even though it only executes or trades swaps that

    are not subject to the trade execution mandate. The Commission also

    notes that transactions involving swaps on SEFs that are subject to

    the trade execution mandate are considered to be ``Required

    Transactions'' under part 37 of the Commission's regulations,

    whereas ``Permitted Transactions'' are transactions not involving

    swaps that are subject to the trade execution mandate. As discussed

    further below, the regulatory obligations which pertain to Permitted

    Transactions differ from, and are somewhat less rigorous than, those

    for Required Transactions. See discussion below regarding Permitted

    Transactions under Sec. 37.9(a)(1)(iv)--Required Transactions and

    Sec. 37.9(a)(1)(v)--Permitted Transactions in the preamble. See

    also Process for a Designated Contract Market or Swap Execution

    Facility To Make a Swap Available To Trade, 76 FR 77728 (proposed

    Dec. 14, 2011) (discussing the process by which a swap is determined

    to be subject to the trade execution requirement in CEA section

    2(h)(8)).

    \89\ Core Principles and Other Requirements for Swap Execution

    Facilities, 76 FR at 1222.

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

    The Commission believes that its interpretation of the registration

    provision in CEA section 5h(a)(1) is consistent with the statute and

    helps further the goals provided in CEA section 5h, which are to

    promote the trading of swaps on SEFs and to promote pre-trade price

    transparency in the swaps market. Although the registration provision

    is written in broad language and could be read to require the

    registration of any facility for the trading or processing of swaps,

    the Commission notes that other statutory provisions appear to narrow

    the registration requirement. For example, the CEA section 2(h)(8)

    trade execution requirement and CEA section 5h(d)(2), which states that

    ``[f]or all swaps that are not required to be executed through a swap

    execution facility . . . such trades may be executed through any other

    available means of interstate commerce[,]'' \90\ when read together,

    contemplate alternative entities that are not required to register as

    SEFs and may execute those swaps that are not

    [[Page 33482]]

    required to be executed on a SEF (i.e., those swaps that are not

    subject to the CEA section 2(h)(8) trade execution requirement). The

    Commission is interpreting the CEA section 5h(a)(1) registration

    provision in a manner that is consistent with the SEF definition in CEA

    section 1a(50), the trade execution requirement in CEA section 2(h)(8),

    and CEA section 5h(d)(2), as discussed above.

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

    \90\ CEA section 5h(d)(2); 7 U.S.C. 7b-3(d)(2).

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

    The following discussion is not intended to comprehensively cover

    which entities are required to register as a SEF. Whether a particular

    entity falls within the scope of CEA section 5h(a)(1) depends on all of

    the relevant facts and circumstances of the entity's operations. The

    Commission is mindful that any rule attempting to capture all of the

    possible configurations of facilities that provide for the execution or

    trading of swaps may be or become over-inclusive or under-inclusive in

    light of technological changes and the ever evolving swaps market.\91\

    However, in response to commenters' requests, the Commission is

    providing examples of how it would interpret the CEA section 5h(a)(1)

    registration requirement with respect to certain categories of better

    understood facilities.

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

    \91\ The Commission notes that entities seeking guidance

    concerning their SEF registration obligations may request such

    further guidance from the Division of Market Oversight (``DMO'').

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

    (i) One-to-Many Systems or Platforms

    The Commission continues to believe that a one-to-many system or

    platform on which the sponsoring entity is the counterparty to all swap

    contracts executed through the system or platform would not meet the

    SEF definition in section 1a(50) of the Act and, therefore, would not

    be required to register as a SEF under section 5h(a)(1) of the Act. In

    the Commission's view, such a system or platform does not meet the SEF

    definition because it limits the provision of liquidity to a single

    liquidity provider (i.e., the sponsoring entity). Accordingly, market

    participants do not have the ability to conduct multiple-to-multiple

    execution or trading on such a trading system or platform. The

    Commission notes, however, that transactions in swaps that are subject

    to the trade execution mandate, under CEA section 2(h)(8), must be

    executed on a DCM or SEF and, accordingly, may not be executed on a

    one-to-many system or platform.\92\

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

    \92\ Transactions in swaps that are subject to the clearing

    requirement in CEA section 2(h)(1) and ``made available to trade''

    would be subject to the trade execution requirement. See CEA

    sections 2(h)(1) and 2(h)(8); 7 U.S.C. 2(h)(1) and 2(h)(8). See also

    Process for a Designated Contract Market or Swap Execution Facility

    To Make a Swap Available To Trade, 76 FR 77728 (proposed Dec. 14,

    2011) (discussing the process by which a swap is determined to be

    subject to the trade execution requirement in CEA section 2(h)(8)).

    The trade execution requirement provides an exception to the

    requirement for swap transactions subject to the clearing exception

    under CEA section 2(h)(7).

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

    (ii) Blind Auction Systems or Platforms

    The Commission understands from commenters that a blind auction

    system or platform, as described above, allows market participants to

    submit firm bids and offers without disclosure of the terms of those

    bids and offers to other participants. Such bids and offers are matched

    through a pre-determined algorithm. The Commission believes that an

    entity that provides such a blind auction system or platform would meet

    the SEF definition in CEA section 1a(50) because more than one market

    participant has the ability to execute or trade swaps with more than

    one other market participant on the system or platform. Accordingly, an

    entity that provides such a blind auction system or platform would have

    to register as a SEF under section 5h(a)(1) of the Act.

    (iii) Aggregation Services or Portals

    The Commission understands that certain entities may seek to

    provide their users with the ability to access multiple SEFs and the

    market participants thereon, but do not provide for execution on their

    aggregation services as execution occurs on one of those individual

    SEFs. The Commission believes that an entity that provides such an

    aggregation service would not meet the SEF definition in CEA section

    1a(50) because it is only providing a portal through which its users

    may access multiple SEFs and swaps are not executed or traded through

    the service. Accordingly, an entity that provides such an aggregation

    service or portal would not have to register as a SEF under section

    5h(a)(1) of the Act.\93\ However, the Commission notes that to the

    extent that an aggregation service or portal itself provides a trading

    system or platform whereby more than one market participant has the

    ability to execute or trade swaps with more than one other market

    participant on the system or platform, the aggregation service would be

    required to register as a SEF.\94\

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

    \93\ The Commission notes that footnote 423 below classifies

    aggregator platforms as a type of independent software vendor

    (``ISV''). Therefore, other types of ISVs would not have to register

    as a SEF if they only provide their users with the ability to access

    multiple SEFs, but do not provide for execution or trading of swaps.

    See discussion below regarding ISVs under Sec. 37.202(a)--Impartial

    Access by Members and Market Participants in the preamble.

    \94\ For example, some aggregation services may provide their

    users with a portal to multiple SEFs and also execute swap

    transactions between their multiple users. These services would have

    to register as a SEF under section 5h(a)(1) of the Act. The

    Commission notes that if other types of ISVs provide a system or

    platform whereby more than one participant has the ability to

    execute or trade swaps with more than one other participant on the

    system or platform, then they would also have to register as a SEF

    under section 5h(a)(1) of the Act. See discussion below regarding

    ISVs under Sec. 37.202(a)--Impartial Access by Members and Market

    Participants in the preamble.

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

    (iv) Services Facilitating Portfolio Compression and Risk Mitigation

    Transactions

    The Commission notes that portfolio compression services provide a

    netting mechanism that reduces the outstanding trade count and

    outstanding gross notional value of swaps in two or more swap

    counterparties' portfolios.\95\ To achieve this result, a portfolio

    compression service, for example, may wholly terminate or change the

    notional value of some or all of the swaps submitted by the

    counterparties for inclusion in the portfolio compression exercise and,

    depending on the methodology employed, replace the terminated swaps

    with other swaps whose combined notional value (or some other measure

    of risk) is less than the combined notional value (or some other

    measure of risk) of the terminated swaps in the compression

    exercise.\96\ The swap counterparties' risk profiles are not materially

    changed as a result of the portfolio compression exercise.

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

    \95\ Confirmation, Portfolio Reconciliation, Portfolio

    Compression, and Swap Trading Relationship Documentation

    Requirements for Swap Dealers and Major Swap Participants, 77 FR

    55904, 55932 (Sep. 11, 2012).

    \96\ Id. at 55960.

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

    The Commission does not believe that a portfolio compression

    service, as described above, provides for the execution or trading of

    swap transactions between counterparties because the compression

    service is providing a netting mechanism whereby the outstanding trade

    count and outstanding gross notional value of swaps in two or more swap

    counterparties' portfolios are reduced. Therefore, an entity providing

    such a portfolio compression service would not meet the SEF definition

    in section 1a(50) of the Act and would not have to register as a SEF

    under section 5h(a)(1) of the Act.\97\

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

    \97\ The Commission notes, however, that transactions in swaps

    that are subject to the trade execution mandate, under CEA section

    2(h)(8), must be executed on a DCM or SEF and, accordingly, may not

    be executed on a portfolio compression service (unless no DCM or SEF

    makes the swap available to trade or the swap transaction is

    excepted or exempted from clearing under CEA section 2(h)(7) or as

    otherwise provided by the Commission).

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

    The Commission understands from commenters that certain entities

    provide

    [[Page 33483]]

    risk mitigation services, as described above, that operate to assist

    market participants in managing their exposures to market, credit, and

    other sources of risk. These risk mitigation services may redistribute

    or mitigate market participants' risks, but they do not provide a

    netting mechanism. To redistribute or mitigate risk, a risk mitigation

    service, for example, may allow market participants to identify

    elements of risk in their respective portfolios and to submit

    information about these risks to the service. The risk mitigation

    service may set the prices for all points along the maturity or credit

    curve for all trades and the service's proprietary algorithm produces a

    set of proposed transactions for each participant. If all participants

    accept the proposed transactions, then the new trades are executed.

    In the Commission's view, such an entity would meet the SEF

    definition in CEA section 1a(50) because more than one market

    participant has the ability to execute swaps with more than one other

    market participant on the system or platform.\98\ In response to ICAP's

    comment that such services do not meet the SEF definition because they

    do not permit participants to trade in real-time, negotiate price, or

    initiate directional trades, the Commission notes that the SEF

    definition does not require any of these stated characteristics. As

    noted above, the outcome of a successful risk mitigation run is the

    execution of new trades between multiple participants at prices

    accepted by those multiple participants.

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

    \98\ The Commission also notes that ICAP's Web sites for its

    Reset and ReMatch risk mitigation services support the notion that

    these services are executing trades between counterparties. ICAP's

    Reset Web site states that ``[t]he new RESET matching engine allows

    for unilateral matching with hedging. No longer is it necessary to

    have an offsetting position for each trade to be executed.'' See

    http://www.reset.net/aboutus.php. A press article regarding ReMatch

    states that ``ReMatch addresses the problem of minimal or no exit

    liquidity . . . [by] enabling market participants to exit positions

    that they may otherwise have been unable to.'' See http://www.icap.com/news-events/in-the-news/news/2011/rematch-expands-service-into-us-financials.aspx.

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

    Additionally, the Commission notes that there are alternative

    avenues to managing the same risks that risk mitigation services

    manage, including bringing the risk mitigating orders to the open

    market. For instance, a market participant could assess the various

    risk elements in its portfolio using appropriate tools, and then decide

    on a set of trades to mitigate these risks. The market participant

    could choose to execute these trades through a risk mitigation service,

    a SEF, or a DCM. In fact, in the DCM context, market participants

    execute such risk mitigating trades on the DCM and not through a

    separate non-DCM service. As such, risk mitigation services are

    providing an alternative avenue to execute certain swap transactions

    between counterparties.

    Furthermore, the Commission believes that the confluence of trading

    interests from a diverse range of motivations (e.g., risk mitigating

    and risk taking trades) brings depth to the marketplace and helps to

    build liquid markets. If the Commission did not require these risk

    mitigation services to register as SEFs, then market participants would

    be able to execute certain swap transactions away from the SEF, which

    would hurt liquidity and also the trading of swaps on SEFs. This would

    contradict one of the goals in section 5h of the Act, which is to

    promote the trading of swaps on SEFs.\99\

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

    \99\ CEA section 5h(e); 7 U.S.C. 7b-3(e).

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

    For the reasons mentioned above, the Commission believes that an

    entity that provides such a risk mitigation service would have to

    register as a SEF under section 5h(a)(1) of the Act. However, the

    Commission notes that such entities may not have to register as a SEF

    if they only provide the analytical services that produce the proposed

    risk mitigation transactions and the execution of those transactions

    occurs elsewhere and, in particular, the execution of those

    transactions that are subject to the trade execution mandate occurs on

    a SEF.

    (v) Swap Processing Services

    As noted in the SEF NPRM, entities that solely engage in trade

    processing would not meet the SEF definition in CEA section 1a(50)

    because they do not provide the ability to execute or trade a swap as

    required by the definition. Accordingly, swap processing services would

    not have to register as a SEF under CEA section 5h(a)(1). Consistent

    with this distinction, the Commission declines to create a sub-category

    of SEFs for processing services that would be subject to some limited

    subset of SEF core principles as requested by MarkitSERV.

    Finally, the Commission notes that platforms seeking guidance

    concerning the SEF registration obligations and its application to

    their particular operations may request informal guidance from the

    Division of Market Oversight (``DMO'').

    (b) Sec. 37.9(b)(2)--Minimum Trading Functionality (Final Sec.

    37.3(a)(2))

    To further clarify what functionalities a SEF must provide if it is

    required to register as a SEF, as opposed to what functionalities

    trigger the registration requirement, the Commission is moving proposed

    Sec. 37.9(b)(2) to final Sec. 37.3(a)(2). As discussed in the SEF

    NPRM, an entity that must register as a SEF under CEA section 5h(a)(1)

    must ensure that its operations comply with the minimum trading

    functionality requirement.\100\ The minimum trading functionality

    requirement in proposed Sec. 37.9(b)(2) provided that an applicant

    seeking registration as a SEF must, at a minimum, offer trading

    services to facilitate Required Transactions by providing market

    participants with the ability to post both firm and indicative quotes

    on a centralized electronic screen accessible to all market

    participants who have access to the SEF.

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

    \100\ Core Principles and Other Requirements for Swap Execution

    Facilities, 76 FR at 1219.

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

    (1) Summary of Comments

    Several commenters stated that the minimum trading functionality is

    similar to an order book, which is not required by the SEF

    definition.\101\ In this regard, Commissioner Sommers offered a dissent

    to the SEF NPRM, which was published as Appendix 3 to that notice.\102\

    Commissioner Sommers' dissent asserted that the minimum trading

    functionality requirement is not mandated by the Dodd-Frank Act.\103\

    In addition, Commissioner Sommers' dissent argued for a broader

    interpretation of the terms ``trading system'' and ``platform,'' which

    are included in the statutory SEF definition so that SEFs can offer a

    broader model for executing swaps.\104\ Many commenters also stated

    that the SEF definition only requires that the facility provide

    multiple participants with the ``ability'' to execute or trade swaps by

    accepting bids and offers made by ``multiple participants'' and, thus,

    the definition does not require making bids or offers transparent to

    the entire market but rather to multiple participants.\105\ Better

    Markets commented that the Commission's minimum trading

    [[Page 33484]]

    functionality requirement is an overly broad interpretation of the SEF

    definition because it allows a SEF to be almost any type of system or

    platform.\106\ Therefore, it recommended that the Commission narrowly

    interpret the multiple participant to multiple participant requirement

    so that the scope of acceptable execution methods has rational

    boundaries.\107\

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

    \101\ Reuters Comment Letter at 3-4 (Dec. 12, 2011); Rosen et

    al. Comment Letter at 8-9 (Apr. 5, 2011); WMBAA Comment Letter at 4,

    9 (Mar. 8, 2011); ISDA/SIFMA Comment Letter at 5-6 (Mar. 8, 2011);

    FXall Comment Letter at 4-5 (Mar. 8, 2011). Commissioner Sommers'

    dissent to the SEF NPRM. See Core Principles and Other Requirements

    for Swap Execution Facilities, 76 FR at 1259.

    \102\ Core Principles and Other Requirements for Swap Execution

    Facilities, 76 FR at 1259.

    \103\ Id.

    \104\ Id.

    \105\ Reuters Comment Letter at 3-4 (Dec. 12, 2011); Rosen et

    al. Comment Letter at 8 (Apr. 5, 2011); ISDA/SIFMA Comment Letter at

    5-6 (Mar. 8, 2011); CME Comment Letter at 7-8 (Mar. 8, 2011); FXall

    Comment Letter at 4-5 (Mar. 8, 2011); Barclays Comment Letter at 5

    (Mar. 8, 2011); MarketAxess Comment Letter at 32-33 (Mar. 8, 2011);

    WMBAA Comment Letter at 8 (Mar. 8, 2011).

    \106\ Better Markets Comment Letter at 6-7 (Mar. 8, 2011).

    \107\ Id.

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

    Several commenters expressed concern about the requirement to post

    indicative quotes.\108\ Nodal and other commenters expressed concern

    that indicative quotes could be used for manipulative purposes.\109\

    Tradeweb commented that, under the proposal, SEFs operating an

    anonymous order book system would be required to offer indicative

    quotes due to the minimum trading functionality requirement, which

    would not be suitable for anonymous order book marketplaces.\110\

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

    \108\ Nodal Comment Letter at 3-4 (Mar. 8, 2011); ISDA/SIFMA

    Comment Letter at 6 (Mar. 8, 2011); SIFMA AMG Comment Letter at 9

    (Mar. 8, 2011); ICE Comment Letter at 3 (Mar. 8, 2011); Tradeweb

    Comment Letter at 6 (Mar. 8, 2011).

    \109\ Nodal Comment Letter at 3-4 (Mar. 8, 2011); ISDA/SIFMA

    Comment Letter at 6 (Mar. 8, 2011); SIFMA AMG Comment Letter at 9

    (Mar. 8, 2011); ICE Comment Letter at 3 (Mar. 8, 2011).

    \110\ Tradeweb Comment Letter at 6 (Mar. 8, 2011).

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

    (2) Commission Determination

    The Commission reiterates its view in the SEF NPRM that an entity

    that must register as a SEF under CEA section 5h(a)(1) must ensure that

    its operations comply with the minimum trading functionality

    requirement.\111\ The Commission reaffirms that an acceptable SEF

    system or platform must provide at least a minimum functionality to

    allow market participants the ability to make executable bids and

    offers, and to display them to all other market participants on the

    SEF. The Commission is adopting a revised version of proposed Sec.

    37.9(b)(2), which now requires a SEF to provide an Order Book as

    defined in final Sec. 37.3(a)(3) (i.e., an electronic trading

    facility, a trading facility, or a trading system or platform in which

    all market participants have the ability to enter multiple bids and

    offers, observe or receive bids and offers, and transact on such bids

    and offers) because, as noted by several commenters, the proposed

    minimum trading functionality description is similar to the proposed

    definition of an Order Book.\112\ In response to comments, like the one

    provided by Commissioner Sommers, that an order book is not required by

    the SEF definition, the Commission believes that an Order Book, as

    defined in final Sec. 37.3(a)(3), is consistent with the SEF

    definition and promotes the goals provided in section 733 of the Dodd-

    Frank Act.\113\ This interpretation is also consistent with the SEF

    NPRM, as the Commission noted that it took into account these

    requirements when proposing the minimum trading functionality

    requirement.\114\

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

    \111\ Core Principles and Other Requirements for Swap Execution

    Facilities, 76 FR at 1219.

    \112\ The Commission is renumbering proposed Sec. 37.9(b)(2) to

    Sec. 37.3(a)(2).

    \113\ CEA section 1a(50); 7 U.S.C. 1a(50). In section 5h(e) of

    the Act, Congress provided a ``rule of construction'' to guide the

    Commission's interpretation of certain SEF provisions (stating that

    the goals of section 5h of the Act are to ``promote the trading of

    swaps on [SEFs] and to promote pre-trade price transparency in the

    swaps market''). 7 U.S.C. 7b-3(e).

    \114\ Core Principles and Other Requirements for Swap Execution

    Facilities, 76 FR at 1219.

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

    The Commission notes, however, that the final regulations provide

    SEFs with additional flexibility in the execution methods for Required

    Transactions by allowing SEFs to offer an RFQ System in conjunction

    with an Order Book, as described below, to permit market participants

    to access multiple market participants, but not necessarily the entire

    market.\115\ The Commission also notes that a SEF may petition the

    Commission under Sec. 13.2 of the Commission's regulations to amend

    its regulations to include additional execution methods for Required

    Transactions.\116\ The final regulations further allow a SEF to utilize

    ``any means of interstate commerce'' in providing the execution methods

    in Sec. 37.9(a)(2)(i)(A) or (B) (i.e., an Order Book or an RFQ System

    that operates in conjunction with an Order Book, as described

    below).\117\ The Commission also notes that a SEF may provide any

    method of execution for Permitted Transactions.\118\ By allowing SEFs

    to offer additional methods of execution, and permitting flexible means

    for executing swaps through these methods of execution, as discussed

    below, the Commission is effectuating the Congressional direction to

    allow multiple participants to execute swaps by accepting bids and

    offers made by multiple participants through any means of interstate

    commerce.\119\ The Commission notes that a DCM must operate as a

    trading facility and in conjunction with that trading facility is also

    permitted to utilize additional execution methods; however, those

    additional execution methods are limited by the requirements set forth

    in DCM Core Principle 9, for which there is no identical core principle

    for SEFs.

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

    \115\ See discussion below under Sec. 37.9(a)(1)(ii)--Request

    for Quote System in the preamble.

    \116\ See discussion below under Sec. 37.9(b)(1) and (b)(4)--

    Execution Methods for Required Transactions in the preamble. Section

    13.2 will allow the Commission to consider if a broader model for

    executing on SEFs, consistent with the suggestion in Commissioner

    Sommers' dissent, would be appropriate on a case-by-case basis, in

    conformance with the CEA and the Commission's regulations. Core

    Principles and Other Requirements for Swap Execution Facilities, 76

    FR at 1259.

    \117\ See discussion below under Sec. 37.9(b)(1) and (b)(4)--

    Execution Methods for Required Transactions in the preamble.

    \118\ See Sec. 37.9(c)(2).

    \119\ CEA section 1a(50); 7 U.S.C. 1a(50).

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

    Finally, given the changes to the minimum trading functionality

    requirement, the Commission notes that SEFs are not required to offer

    indicative quote functionality. The Commission agrees with commenters

    that indicative quotes would not be appropriate for certain trading

    systems or platforms complying with the Order Book definition in final

    Sec. 37.3(a)(3) (e.g., central limit order books facilitating only

    anonymous trading).

    (c) Sec. 37.9(a)(1)(i)--Order Book (Final Sec. 37.3(a)(3))

    The Commission is also moving proposed Sec. 37.9(a)(1)(i) to final

    Sec. 37.3(a)(3) given the relocation of, and changes to, the minimum

    trading functionality section as discussed above. Proposed Sec.

    37.9(a)(1)(i) defined the term ``Order Book'' to mean: (A) An

    electronic trading facility, as that term is defined in section 1a(16)

    of the Act; \120\ (B) a trading facility, as that term is defined in

    section 1a(51) of the Act; \121\ (C) a trading system or platform in

    which all market participants in the trading system or platform can

    enter multiple bids and offers, observe bids and offers entered by

    other market participants, and choose to transact on such bids and

    offers; or (D) any such

    [[Page 33485]]

    other trading system or platform as may be determined by the

    Commission.

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

    \120\ The term ``electronic trading facility'' means ``a trading

    facility that--(A) operates by means of an electronic or

    telecommunications network; and (B) maintains an automated audit

    trail of bids, offers, and the matching of orders or the execution

    of transactions on the facility.'' CEA section 1a(16); 7 U.S.C.

    1a(16). The Commission notes that, under section 1a(16) of the Act,

    the term ``electronic trading facility'' incorporates the definition

    of ``trading facility'' as that term is defined under section 1a(51)

    of the Act.

    \121\ The term ``trading facility'' means ``a person or group of

    persons that constitutes, maintains, or provides a physical or

    electronic facility or system in which multiple participants have

    the ability to execute or trade agreements, contracts, or

    transactions--(i) by accepting bids or offers made by other

    participants that are open to multiple participants in the facility

    or system; or (ii) through the interaction of multiple bids or

    multiple offers within a system with a pre-determined non-

    discretionary automated trade matching and execution algorithm.''

    CEA section 1a(51)(A); 7 U.S.C. 1a(51)(A).

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

    (1) Summary of Comments

    Better Markets commented that the definition of an ``order book''

    should specify that SEF systems must operate pursuant to a best price,

    first-in-time trade matching algorithm.\122\

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

    \122\ Better Markets Comment Letter at 7 (Mar. 8, 2011).

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

    (2) Commission Determination

    The Commission is adopting the rule as proposed, subject to the

    modification described below.\123\ The Commission notes that the Dodd-

    Frank Act does not mandate that the Commission specify or require a

    particular trade-matching algorithm for modes of execution provided by

    SEFs. Therefore, a SEF has the discretion to use a matching algorithm

    such as a price-time, price-size-time, or pro-rata allocation,

    provided, however, that such matching algorithm is published in the

    SEF's rulebook and submitted to the Commission for review and approval

    as part of the registration application. The Commission is eliminating

    proposed Sec. 37.9(a)(1)(i)(D) because, as discussed in Sec. 37.9

    below, a SEF may petition the Commission under Sec. 13.2 to amend

    Sec. 37.9(a)(2) to include additional execution methods for Required

    Transactions.\124\

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

    \123\ The Commission is renumbering proposed Sec. 37.9(a)(1)(i)

    to Sec. 37.3(a)(3). The Commission is revising the definition in

    proposed Sec. 37.9(a)(1)(i)(C) by replacing the word ``can'' with

    the phrase ``have the ability to'' and deleting the words ``choose

    to.'' The Commission is also adding the words ``or receive'' after

    the word ``observe'' so that the definition is technology neutral.

    See ``Through Any Means of Interstate Commerce'' Language in the SEF

    Definition discussion below under Sec. Sec. 37.9(b)(1) and (b)(4)--

    Execution Methods for Required Transactions in the preamble for

    further details.

    \124\ See discussion below under Sec. 37.9(b)(1) and (b)(4)--

    Execution Methods for Required Transactions in the preamble.

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

    (d) Sec. 37.3(a)--Application Procedures \125\

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

    \125\ The Commission is renaming the title of this section from

    ``Application Procedures'' to ``Procedures for Full Registration''

    to provide greater clarity.

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

    Proposed Sec. 37.3(a) set forth the application and approval

    procedures for the registration of new SEFs. The proposed rule required

    a SEF applicant to apply to the Commission by electronically filing the

    proposed Form SEF.\126\ The proposed rule also provided that the

    Commission would either approve or deny the application or, if deemed

    appropriate, register the applicant as a SEF subject to conditions.

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

    \126\ Proposed Form SEF, as set forth in proposed appendix A to

    part 37, was to be used for initial or temporary registration as a

    SEF as well as for any amendments to an applicant's status otherwise

    not required to be submitted under part 40 of the Commission's

    regulations.

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

    (1) Summary of Comments

    The Commission received several comments encouraging the

    harmonization of the registration procedures for SEFs with the SEC's

    registration procedures for SB-SEFs.\127\ In this regard, MarketAxess

    recommended that the Commission allow an SEC-registered SB-SEF to

    notice register with the Commission.\128\ WMBAA recommended that the

    Commission and the SEC adopt a common application form, which would

    provide for a smoother, timelier transition to the new regulatory

    regime.\129\

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

    \127\ See Registration and Regulation of Security-Based Swap

    Execution Facilities, 76 FR 10948 (proposed Feb. 28, 2011). Tradeweb

    Comment Letter at 3-4 (Jun. 3, 2011); MarketAxess Comment Letter at

    20-21 (Mar. 8, 2011); WMBAA Comment Letter at 14 (Mar. 8, 2011); FSR

    Comment Letter at 10-11 (Mar. 8, 2011); Reuters Comment Letter at 3-

    4 (Mar. 8, 2011).

    \128\ MarketAxess Comment Letter at 20-21 (Mar. 8, 2011).

    \129\ WMBAA Comment Letter at 14 (Mar. 8, 2011).

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

    Tradeweb requested that the Commission confirm that SEF applicants

    do not need to file separate applications for each mode of execution

    that it will offer to participants, provided that the application

    clearly identifies the different features of the separate marketplaces

    and that each feature is in compliance with the rules.\130\

    Additionally, MarketAxess requested clarification that the Commission

    does not intend proposed Sec. 37.3(a)(6) to require amendments to Form

    SEF after the Commission approves an application.\131\

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

    \130\ Tradeweb Comment Letter at 13 (Mar. 8, 2011).

    \131\ MarketAxess Comment Letter at 29 (Mar. 8, 2011).

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

    (2) Commission Determination

    The Commission is adopting Sec. 37.3(a) and Form SEF as proposed,

    subject to certain modifications discussed below.\132\ The Commission

    notes that there is no CEA provision which provides for SEF notice

    registration for SB-SEFs. The Commission does note, however, that

    section 5h(g) of the Act provides that the Commission ``may exempt'' a

    SEF from registration if the facility is subject to comparable,

    comprehensive supervision and regulation by the SEC, a prudential

    regulator, or the appropriate governmental authorities in the home

    country of the facility.\133\ The Commission observes that the SEC and

    other regulators have not implemented comparable, comprehensive

    supervision and regulation to the Commission's SEF regulatory scheme at

    this time. The Commission also observes that, it must comprehensively

    review and understand a SEF's proposed trading models and operations,

    which will facilitate trading for a more diverse universe of financial

    instruments and underlying commodities than SB-SEFs. Therefore, at this

    time, the Commission is not allowing for exempt SEFs.

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

    \132\ The Commission is renumbering proposed Sec. 37.3(a) to

    Sec. 37.3(b) and making several non-substantive revisions to this

    provision and Form SEF for clarity. The Commission is also moving

    proposed Sec. 37.3(a)(7) regarding delegated authority to the

    Director of DMO to Sec. 37.3(h).

    \133\ CEA section 5h(g); 7 U.S.C. 7b-3(g).

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

    In response to Tradeweb's comment about separate applications, the

    Commission clarifies that a SEF applicant does not need to file

    separate applications for each mode of execution that it will offer to

    market participants, but its application, as noted in Exhibit Q to Form

    SEF, must describe each mode of execution offered.\134\ Additionally,

    in response to MarketAxess's comment about amendments to Form SEF after

    the Commission registers a SEF, the Commission is revising proposed

    Sec. 37.3(a)(6) \135\ and Form SEF to clarify that an amended Form SEF

    is required for a SEF applicant amending a pending application for

    registration or for a SEF requesting an amendment to its order of

    registration. Otherwise, once registered, a SEF must file any

    amendments to Form SEF as a submission under part 40 of the

    Commission's regulations or as specified by the Commission (e.g., by

    filing quarterly financial resources reports pursuant to Sec. 37.1306

    or by filing an amended Form SEF). As stated in the SEF NPRM, the

    Commission clarifies that if any information contained in Form SEF is

    or becomes inaccurate for any reason, even after a SEF is registered,

    the SEF must promptly make the appropriate corrections with the

    Commission.\136\

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

    \134\ The Commission notes that subsequent modifications to a

    SEF's modes of execution or any additional SEF modes of execution

    would constitute rules; therefore, the SEF must submit such rules to

    the Commission for review pursuant to the procedures under part 40

    of the Commission's regulations.

    \135\ The Commission is renumbering proposed Sec. 37.3(a)(6) to

    Sec. 37.3(b)(3).

    \136\ Core Principles and Other Requirements for Swap Execution

    Facilities, 76 FR at 1238.

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

    The Commission is adding final Sec. 37.3(b)(5) to the rule text

    that requires the Commission to review an application for registration

    as a SEF pursuant to the 180-day timeframe and procedures specified in

    CEA section

    [[Page 33486]]

    6(a).\137\ This section will be effective for SEF applicants who submit

    their applications for registration as a SEF on or after two years from

    the effective date of part 37. The Commission is adopting this

    provision so that SEF applicants are treated comparably to DCM

    applicants who currently are subject to the 180-day Commission review

    period under CEA section 6(a). Although Congress did not impose a 180-

    day review period for SEFs, the Commission believes that harmonization

    of the review periods for DCM and SEF applicants is appropriate given

    the fact that both are registered entities for the trading of swaps.

    The Commission also believes that this requirement will provide greater

    certainty for SEF applicants regarding the time period for the

    Commission's review of their applications.

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

    \137\ CEA section 6(a); 7 U.S.C. 8(a). The Commission notes that

    under CEA section 6(a), if the Commission notifies an applicant that

    its application is materially incomplete and specifies the

    deficiencies in the application, the running of the 180-day period

    is stayed from the time of such notification. The Commission also

    notes that if an applicant does not provide a complete Form SEF as

    provided for under Sec. 37.3(b)(1)(i), the Commission will notify

    the applicant, pursuant to Sec. 37.3(b)(4), that its application

    will not be deemed to have been submitted for purposes of the

    Commission's review. By ``complete'' Form SEF, the Commission means

    that the SEF applicant provides appropriately responsive answers to

    each of the informational and exhibit items set forth in Form SEF.

    The Commission notes that if the application is not deemed to have

    been submitted for purposes of the Commission's review, then the

    180-day review period (when effective) will not have commenced.

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

    Finally, the Commission is clarifying the standard upon which the

    Commission will grant or deny registration. Proposed Sec. 37.3(a)(1)

    stated that ``[t]he Commission shall approve or deny the application

    or, if deemed appropriate, register the applicant as a swap execution

    facility subject to conditions.'' In addition, proposed Sec.

    37.3(a)(2) stated that ``[t]he application must include information

    sufficient to demonstrate compliance with the core principles specified

    in Section 5h of the Act.'' Consistent with these provisions, the

    Commission is clarifying in final Sec. 37.3(b)(6) that: (i) The

    Commission will issue an order granting registration upon a Commission

    determination, in its own discretion, that the applicant has

    demonstrated compliance with the Act and the Commission's regulations

    applicable to swap execution facilities; (ii) if deemed appropriate,

    the Commission may issue an order granting registration subject to

    conditions; and (iii) the Commission may issue an order denying

    registration upon a Commission determination, in its own discretion,

    that the applicant has not demonstrated compliance with the Act and the

    Commission's regulations applicable to swap execution facilities.

    (e) Sec. 37.3(b)--Temporary Grandfather Relief From Registration \138\

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

    \138\ The Commission is renaming the title of this section from

    ``Temporary Grandfather Relief from Registration'' to ``Temporary

    Registration'' to provide greater clarity.

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

    Proposed Sec. 37.3(b) provided that an applicant for SEF

    registration may request that the Commission grant the applicant

    temporary grandfather relief from the registration requirement. The

    temporary relief would allow the applicant to continue operating during

    the pending application review process. Under the proposed rule, to

    receive temporary relief, the applicant was required to provide the

    following information to the Commission: (1) An application for SEF

    registration submitted in compliance with proposed Sec. 37.3(a); (2) a

    notification of its interest in operating under the temporary relief;

    (3) transaction data substantiating that swaps have been traded and

    continue to be traded on the applicant's trading system or platform at

    the time of its application submission; and (4) a certification that

    the applicant believes that it will meet the requirements of part 37 of

    the Commission's regulations when it operates under temporary relief.

    Under proposed Sec. 37.3(b)(2), an applicant's grant of temporary

    relief would expire on the earlier of: (1) The date that the Commission

    grants or denies SEF registration; or (2) the date that the Commission

    rescinds the temporary relief. Proposed Sec. 37.3(b)(3) contained a

    sunset date for the temporary relief provision of 365 days following

    the effective date of the final SEF regulations. Finally, the

    Commission proposed that the SEF rules, which include the requirements

    for temporary relief, would be effective 90 days after their

    publication in the Federal Register.

    (1) Summary of Comments

    (i) Comments on Temporary Grandfather Relief

    MarketAxess commented that the phrase ``temporary grandfather

    relief'' is ambiguous and recommended that the Commission rename

    ``temporary grandfather relief'' to ``temporary registration.'' \139\

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

    \139\ MarketAxess Comment Letter at 16 (Mar. 8, 2011).

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

    With respect to the substance of this provision, some commenters

    expressed concern that the existing trading activity requirement in

    proposed Sec. 37.3(b)(1)(ii) would prevent new entities from

    qualifying for temporary relief.\140\ In this regard, MarketAxess

    recommended that the Commission revise proposed Sec. 37.3(b)(1)(ii) to

    permit SEF applicants, as an alternative to providing transaction data,

    to provide materials substantiating that the applicant's system is

    operational and therefore could facilitate trading in listed swaps upon

    receiving temporary registration from the Commission.\141\

    Further, several commenters recommended alternative certification

    standards under proposed Sec. 37.3(b)(1)(iii).\142\ Bloomberg, for

    example, recommended that SEFs be required to certify only that they

    have implemented rules ``reasonably designed to ensure'' compliance

    with part 37.\143\ Similarly, MarketAxess recommended a more flexible

    certification requirement because compliance with certain core

    principles will need to await the build-out functionality of third-

    party regulatory service providers.\144\

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

    \140\ MarketAxess Comment Letter at 16-17 (Mar. 8, 2011); MFA

    Comment Letter at 4-5 (Mar. 8, 2011).

    \141\ MarketAxess Comment Letter at 16-17 (Mar. 8, 2011).

    \142\ MarketAxess Comment Letter at 4 (Jun. 3, 2011); Bloomberg

    Comment Letter at 5 (Jun. 3, 2011); State Street Comment Letter at

    6-7 (Mar. 8, 2011); WMBAA Comment Letter at 14-15 (Mar. 8, 2011);

    Tradeweb Comment Letter at 13 (Mar. 8, 2011); MarketAxess Comment

    Letter at 17-19 (Mar. 8, 2011).

    \143\ Bloomberg Comment Letter at 5 (Jun. 3, 2011).

    \144\ MarketAxess Comment Letter at 17-19 (Mar. 8, 2011).

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

    In addition, Phoenix commented that to avoid any market

    disruptions, the Commission should permit SEF applicants to operate

    under temporary relief while awaiting a Commission determination to

    either grant or deny the temporary relief request.\145\ MarketAxess

    also noted that the Commission should not ``tie its own hands'' by

    imposing a fixed one-year post-effective time period for reviewing SEF

    applications.\146\

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

    \145\ Phoenix Comment Letter at 2 (Mar. 7, 2011).

    \146\ MarketAxess Comment Letter at 20 (Mar. 8, 2011).

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

    (ii) Comments on DCM Eligibility

    CME commented that if a DCM has listed cleared swaps prior to the

    adoption of the final rules, then there is no reason to exclude them

    from applying for temporary relief.\147\ NYSE Liffe recommended that

    temporary relief remain available to DCMs either as long as it is

    available to SEF applicants or on an ongoing basis so that a DCM

    required under DCM Core Principle 9 to delist a futures contract at any

    point in the future would be allowed to seek

    [[Page 33487]]

    temporary relief from registration as a SEF.\148\

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

    \147\ CME Comment Letter at 11 (Mar. 8, 2011).

    \148\ NYSE Liffe Comment Letter at 3-4 (Sep. 2, 2011).

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

    (iii) Comments on 90-Day Effective Date of Regulations

    Some commenters recommended a longer time period for the effective

    date of the final regulations to provide applicants with additional

    time to implement the large number of changes required.\149\ Nodal

    commented that the short effective date will disadvantage smaller

    exchanges because its supporting external parties will likely

    prioritize compliance obligations in order to be responsive to the

    largest exchanges first.\150\ MarketAxess and NFA recommended that the

    Commission provide SEF applicants 180 days after adoption of the final

    rules to comply with the final SEF regulations in light of forthcoming

    operational challenges.\151\ However, SDMA supported the 90-day

    effective date and urged the Commission to be vigilant in preventing

    further delays that undermine the realization of the goals of the Dodd-

    Frank Act.\152\

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    \149\ AIMA Comment Letter at 3 (Jun. 10, 2011); Nodal Comment

    Letter at 3-5 (Jun. 3, 2011); WMBAA Comment Letter at 4-5 (Jun. 3,

    2011); CME Comment Letter at 6 (Jun. 3, 2011); MarketAxess Comment

    Letter at 19 (Mar. 8, 2011); NFA Comment Letter at 2-3 (Mar. 8,

    2011); WMBAA Comment Letter at 12-13 (Mar. 8, 2011); ICAP Comment

    Letter at 6 (Mar. 8, 2011); Nodal Comment Letter at 4-5 (Mar. 8,

    2011).

    \150\ Nodal Comment Letter at 4 (Jun. 3, 2011); Nodal Comment

    Letter at 4 (Mar. 8, 2011).

    \151\ MarketAxess Comment Letter at 19 (Mar. 8, 2011); NFA

    Comment Letter at 2-3 (Mar. 8, 2011).

    \152\ SDMA Comment Letter at 12 (Mar. 8, 2011).

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

    (2) Commission Determination

    (i) Temporary Grandfather Relief

    The Commission agrees with MarketAxess that ``temporary

    registration'' is more accurate than ``temporary grandfather relief''

    and is accordingly making such change. Additionally, based on the

    comments, the Commission is adopting proposed Sec. 37.3(b) as final

    Sec. 37.3(c) subject to a number of modifications.\153\

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

    \153\ The Commission is renumbering proposed Sec. 37.3(b) to

    Sec. 37.3(c) and making several non-substantive revisions for

    clarity.

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

    The Commission further agrees with MarketAxess and other commenters

    that the trading activity requirement as proposed in Sec.

    37.3(b)(1)(ii) may limit temporary registration to incumbent platforms.

    Therefore, the Commission is eliminating the trading activity

    requirement and will permit all SEF applicants to apply for temporary

    registration if they meet the requirements under final Sec.

    37.3(c)(1). The Commission views the revised temporary registration

    provision as promoting competition between SEFs by providing fair

    opportunities for new entities to establish trading operations in

    competition with incumbents.

    The Commission is deleting the certification requirement under

    proposed Sec. 37.3(b)(1)(iii) because it is unnecessary. The

    Commission notes, as stated in the SEF NPRM, that once a SEF applicant

    is granted temporary registration it must comply with all provisions of

    the Act and the Commission's regulations that are applicable to

    SEFs.\154\

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

    \154\ Core Principles and Other Requirements for Swap Execution

    Facilities, 76 FR at 1216.

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

    The Commission is revising the temporary registration provisions to

    clarify in final Sec. 37.3(c)(1) that a SEF applicant may apply for

    temporary registration if it submits a complete Form SEF and a

    temporary registration notice.\155\ The Commission is also revising the

    temporary registration provisions to require a SEF applicant that is

    already operating a swaps-trading platform, in reliance upon either an

    exemption granted by the Commission or some form of no-action relief

    granted by the Commission staff, to include in the temporary

    registration notice a certification that it is operating pursuant to

    such exemption or no-action relief. The Commission also clarifies that

    a SEF applicant may submit such temporary registration application

    after the final SEF regulations are published in the Federal Register

    until the termination of the temporary registration provision pursuant

    to final Sec. 37.3(c)(5).\156\

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    \155\ The applicant must comply with all of the requirements in

    final Sec. 37.3(b)(1)(i) and must submit a temporary registration

    notice to the Commission to qualify for temporary registration. See

    Final Sec. 37.3(c)(1) of the Commission's regulations.

    \156\ The Commission notes that certain entities may continue to

    operate under current exemptions while their SEF applications are

    pending, as long as the entities submit a complete application

    (i.e., the SEF applicant provides substantive answers to each of the

    informational and exhibit items set forth in Form SEF) and temporary

    registration notice before the effective date of the final SEF

    regulations. See CFTC No-Action Letter 12-48 (Dec. 11, 2012).

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

    Pursuant to final Sec. 37.3(c)(1), the Commission notes that it

    will grant a SEF applicant temporary registration upon a Commission

    determination that the applicant has provided a complete Form SEF as

    part of its registration application and submitted a notification

    requesting that the Commission grant temporary registration. If an

    applicant has not met these requirements, the Commission may deny its

    request for temporary registration. By ``complete'' Form SEF, the

    Commission means that the SEF applicant provides appropriately

    responsive answers to each of the informational and exhibit items set

    forth in Form SEF. The Commission notes that it will review a SEF

    applicant's Form SEF to ensure that it is complete, and will not

    conduct any substantive review of the form before granting or denying

    temporary registration. The Commission notes that this temporary

    registration process is similar to the notice registration process

    followed by the Commission in the context of other types of

    registrations.\157\ The Commission will review SEF applicants'

    submissions on a rolling basis and the Commission will issue notices

    either granting or denying temporary registration.\158\ The Commission

    believes that providing a clear and streamlined path to temporary

    registration will minimize the potential for regulatory arbitrage,

    ensure a level playing field, and promote competition among SEFs.

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

    \157\ See discussion below regarding swap dealer and major swap

    participant provisional registration rules.

    \158\ The Commission is delegating to the Director of DMO, upon

    consultation with the General Counsel, the authority to issue a

    notice granting or denying temporary registration. See Final Sec.

    37.3(h) of the Commission's regulations.

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

    The Commission stresses that a grant of temporary registration does

    not mean that the Commission has determined that a SEF applicant is

    fully compliant with the Act and Commission regulations, nor does it

    guarantee that a SEF applicant will eventually be granted full SEF

    registration. After granting a SEF applicant temporary registration,

    the Commission will review the applicant's application to assess

    whether the applicant is fully compliant with the requirements of the

    Act and the Commission's regulations applicable to SEFs. During such

    assessment, the Commission may request from the SEF applicant

    additional information in order to make a determination whether to

    issue a final order of registration.

    The Commission is also revising the temporary registration

    provisions to clarify in final Sec. 37.3(c)(2) that an applicant

    cannot operate as a SEF under temporary registration until the

    applicant receives a notice from the Commission or the Commission staff

    granting temporary registration.\159\ In response to Phoenix's comment

    about a SEF operating while its temporary registration is pending, the

    Commission does not believe that a SEF applicant should be allowed to

    operate as a SEF

    [[Page 33488]]

    under temporary registration before the Commission has had a chance to

    review the application to ensure that it is complete. The Commission's

    review is especially merited given the Commission's decision to permit

    temporary registration of entities that have not previously traded

    swaps.

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

    \159\ This provision is contained in final Sec. 37.3(c)(2) of

    the Commission's regulations. This rule also states that in no case

    may an applicant begin operating as a temporarily registered SEF

    until the effective date of the SEF regulations.

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

    The Commission believes that permitting entities to operate as

    temporarily registered SEFs, notwithstanding the lack of a substantive

    review of the SEF's application by the Commission, is not a novel

    concept and has been followed by the Commission in other contexts where

    it is important to allow entities to quickly reach the market, before

    an extensive Commission review. For instance, under the Commission's

    swap dealer and major swap participant registration rules, provisional

    registration is granted upon the filing of an application and

    documentation demonstrating compliance or the ability to comply with

    the CEA section 4s requirements in effect on such date--and not after

    review and approval of the documentation by the National Futures

    Association (``NFA''), as the Commission's delegee.\160\ On and after

    the date on which NFA confirms that the applicant has demonstrated its

    initial compliance with the applicable requirements, the provisional

    registration of the applicant ceases and the applicant becomes

    registered as an SD or an MSP, as the case may be.

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

    \160\ Registration of Swap Dealers and Major Swap Participants,

    77 FR 2613 (Jan. 19, 2012).

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

    The Commission envisions the SEF temporary registration process as

    operating in a similar fashion, with the Commission reviewing each

    application for completeness alone before granting temporary

    registration. Subsequently, and concurrent with the temporarily

    registered SEF's early operations, the Commission would conduct a

    comprehensive review of the application for compliance with all

    applicable SEF requirements.

    The Commission is revising proposed Sec. 37.3(b)(2) regarding the

    expiration of temporary registration to remove the ability of the

    Commission to rescind temporary registration. The Commission notes that

    the SEF NPRM did not provide a standard for the Commission to rescind

    temporary registration. Instead, in final Sec. 37.3(c)(3), the

    Commission may rely on its ability to deny full registration, which

    will also cause temporary registration to expire. Therefore, the

    Commission believes that the ability to rescind temporary registration

    is unnecessary.

    The Commission is extending the 365-day sunset provision for

    temporary registration to two years from the effective date of these

    regulations in final Sec. 37.3(c)(5).\161\ Given that the projected

    number of temporary SEF registrations may exceed 20 and the resource

    constraints faced by the Commission, the Commission may not be able to

    complete its registration reviews, enable SEFs to remedy any identified

    deficiencies, and ultimately grant or deny full registration for all of

    the SEF applicants within the proposed 365-day period. Extending the

    temporary registration provision will provide the Commission with

    adequate time to review the SEF registration applications while

    ensuring that SEFs can continue their operations under temporary

    registration, without interruption, until the Commission decides on

    their application for full registration.

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

    \161\ This provision is contained in final Sec. 37.3(c)(5) of

    the Commission's regulations.

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

    The Commission is also revising final Sec. 37.3(c)(5) to state

    that the temporary registration provision will not terminate for an

    applicant who applies for temporary registration before the termination

    of the temporary registration provision and has not been granted or

    denied registration under Sec. 37.3(b)(6) by the time of the

    termination of the temporary registration provision. In addition, final

    Sec. 37.3(c)(5) states that such an applicant may operate as a SEF

    under temporary registration upon receipt of a notice from the

    Commission granting temporary registration until the Commission grants

    or denies full registration pursuant to Sec. 37.3(b)(6). On the

    termination date of the temporary registration provision, the

    Commission will review such applicant's application pursuant to the

    180-day Commission review period and procedures in Sec. 37.3(b)(5).

    These revisions will ensure that a temporarily registered SEF who does

    not have a full registration in place by the time the temporary

    registration provision terminates will not have to stop operating on

    such termination date.

    (ii) DCM Eligibility

    The Commission is withdrawing proposed Sec. 37.3(b)(1)(ii)

    regarding the existing trading activity requirement so an operational

    DCM that seeks to create a new SEF would be able to qualify for

    temporary SEF registration. In consideration of NYSE Liffe's comment

    that temporary SEF registration for an existing DCM should not be

    subject to the sunset provision, the Commission is revising proposed

    Sec. 37.3(b) in final Sec. 37.3(c)(6) to allow for such an

    exemption.\162\ The Commission notes that a DCM is subject to a higher

    regulatory standard than a SEF such that a non-dormant DCM who seeks to

    create a new SEF in order to transfer one or more of its contracts

    should be able to meet many of the SEF requirements. Therefore, the

    Commission believes that, on an ongoing basis, an operational DCM that

    also seeks to register as a SEF in order to transfer one or more of its

    contracts (whether the transfer of the contract is motivated by DCM

    Core Principle 9 or another reason) may request SEF temporary

    registration.

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

    \162\ This provision is contained in final Sec. 37.3(c)(6) of

    the Commission's regulations.

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

    (iii) 90-Day Effective Date of Regulations

    The Commission is shortening the proposed 90-day effective date to

    60 days subsequent to publication in the Federal Register. In

    consideration of the comments received and the availability of the

    Commission staff resources, the Commission has determined to use its

    discretion to establish alternative dates for the commencement of its

    enforcement of regulatory provisions and is setting a general

    compliance date of 120 days subsequent to Federal Register

    publication.\163\ With this use of an effective date and compliance

    date, a prospective SEF that is already operating a swaps-trading

    platform in reliance on a Commission staff relief letter (e.g., CFTC

    No-Action Letter 12-48) could submit a SEF application and receive

    temporary registration before part 37's effective date so that it might

    begin operating as a SEF upon that effective date.\164\ Alternatively,

    if such a prospective SEF took additional time to prepare its SEF

    application, it would have the option of forestalling the submission of

    its application until after the effective date, so long as it submitted

    its SEF application by the compliance date.

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

    \163\ See Heckler v. Chaney, 470 U.S. 821 (1985).

    \164\ This scenario is not limited to a prospective SEF that is

    already operating a swaps-trading platform in reliance on a

    Commission staff relief letter. As noted above, all SEF applicants

    may apply for temporary registration if they meet the requirements

    under final Sec. 37.3(c)(1).

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

    The Commission believes that this combination of a 60-day effective

    date and a 120-day compliance date subsequent to Federal Register

    publication for prospective SEF applicants establishes a transition

    period that appropriately balances the Commission's need to provide

    regulatory certainty to potential applicants through issuance of final

    SEF regulations and the Commission's statutory directives to both

    promote fair

    [[Page 33489]]

    competition between swaps trading venues \165\ and promote the trading

    of swaps on SEFs.\166\ The new transition period ensures swaps market

    continuity, preserves competition between swaps trading venues, and

    facilitates the orderly restructuring of the swaps market in compliance

    with the Act and regulations thereunder. The Commission believes that

    the 60-day effective date and the 120-day compliance date approach will

    provide prospective SEF applicants with sufficient time to comply with

    the final regulations and, if they choose, to prepare an application

    for temporary registration.

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

    \165\ Section 3(b) of the Act lists the promotion of ``fair

    competition among boards of trade, other markets, and market

    participants'' as a purpose of the Act. 7 U.S.C. 5(b).

    \166\ Section 5h(e) of the Act lists the promotion of ``the

    trading of swaps on swap executive facilities'' as one goal of the

    Act. 7 U.S.C. 7b-3(e).

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

    (f) Sec. 37.3(c)--Reinstatement of Dormant Registration

    Proposed Sec. 37.3(c) provided procedures for a dormant SEF to

    reinstate its registration. The Commission received no comments on this

    section and is adopting Sec. 37.3(c) as proposed.\167\

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

    \167\ The Commission is renumbering proposed Sec. 37.3(c) to

    Sec. 37.3(d) and making several non-substantive revisions for

    clarity.

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

    (g) Sec. 37.3(d)--Request for Transfer of Registration

    Proposed Sec. 37.3(d) provided procedures that a SEF must follow

    when seeking to transfer its registration from its current legal entity

    to a new legal entity as a result of a corporate event. The Commission

    received no comments on this section and is adopting Sec. 37.3(d) as

    proposed.\168\

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

    \168\ The Commission is renumbering proposed Sec. 37.3(d) to

    Sec. 37.3(e) and making several non-substantive revisions for

    clarity.

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

    (h) Sec. 37.3(e)--Request for Withdrawal of Application for

    Registration

    Proposed Sec. 37.3(e) provided that a SEF applicant may withdraw

    its application for registration. The Commission received no comments

    on this section and is adopting Sec. 37.3(e) as proposed.\169\

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

    \169\ The Commission is renumbering proposed Sec. 37.3(e) to

    Sec. 37.3(f) and making several non-substantive revisions for

    clarity.

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

    (i) Sec. 37.3(f)--Request for Vacation of Registration

    Proposed Sec. 37.3(f) provided that a SEF may vacate its

    registration. The Commission received no comments on this section and

    is adopting Sec. 37.3(f) as proposed.\170\

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

    \170\ The Commission is renumbering proposed Sec. 37.3(f) to

    Sec. 37.3(g) and making several non-substantive revisions for

    clarity.

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

    4. Sec. 37.4--Procedures for Listing Products and Implementing Rules

    Proposed Sec. 37.4 detailed the approval and self-certification

    procedures under part 40 of the Commission's regulations that SEF

    applicants and SEFs must follow to submit its products and rules to the

    Commission. Proposed Sec. 37.4 also provided that a SEF may request

    that the Commission consider, under the provisions of section 15(b) of

    the Act,\171\ any of the SEF's rules or policies.

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

    \171\ CEA section 15(b) requires the Commission to take into

    consideration the public interest to be protected by the antitrust

    laws and endeavor to take the least anticompetitive means of

    achieving the objectives of the Act, as well as the policies and

    purposes of the Act. 7 U.S.C. 19(b).

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

    (a) Summary of Comments

    WMBAA commented that SEFs should not be required to seek Commission

    approval for their products and rules.\172\ WMBAA recommended that SEFs

    be allowed to submit to the Commission a simple self-certification that

    they complied with the applicable requirements.\173\ CME stated that

    the proposed procedures for listing products would increase the burdens

    associated with new product submissions and rule changes and would

    create new and costly bureaucratic inefficiencies, competitive

    disadvantages in the global marketplace, and impediments to

    innovation.\174\ MarketAxess recommended that the Commission revise

    proposed Sec. 37.4 to clarify that temporarily registered SEFs may

    list swaps through the Commission's approval or self-certification

    procedures.\175\

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

    \172\ WMBAA Comment Letter at 15-16 (Mar. 8, 2011).

    \173\ Id.

    \174\ CME Comment Letter at 10, 13 (Feb. 22, 2011). CME also

    provided its comments to the rulemaking titled Provisions Common to

    Registered Entities, 76 FR 44776 (Jul. 27, 2011). In addition,

    rather than repeat its comments that pertain to both the DCM and SEF

    NPRMs, CME incorporated its entire DCM rulemaking comment letter

    dated Feb. 22, 2011 as Exhibit A to its SEF comment letter dated

    Mar. 8, 2011. The Commission notes these comments by referencing the

    Feb. 22, 2011 date of CME's DCM comment letter. The Commission is

    also changing CME's reference to ``DCM'' to ``SEF'' for these

    comments.

    \175\ MarketAxess Comment Letter at 19 (Mar. 8, 2011). Tradeweb

    similarly commented that a SEF applicant should be able to introduce

    new products while it is operating under temporary relief. Tradeweb

    Comment Letter at 13 (Mar. 8, 2011).

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

    (b) Commission Determination

    The Commission is adopting proposed Sec. 37.4 subject to certain

    modifications. The Commission is removing many of the details from the

    proposed rule, which are already contained in part 40 of the

    Commission's regulations, and is instead referring SEFs to part

    40.\176\ The Commission is also removing the CEA section 15(b)

    consideration provision because, when reviewing any SEF rule, the

    Commission is already required to take into consideration the

    provisions under section 15(b) of the Act.

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

    \176\ 17 CFR part 40.

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

    In response to WMBAA's comments that SEFs should not be required to

    seek Commission approval of their products and rules, the Commission

    notes that a SEF is a registered entity under the Act and pursuant to

    section 5c(c) of the Act, registered entities must submit product terms

    and conditions and rules to the Commission for approval or under self-

    certification procedures.\177\ In addition, the Commission notes that

    CME's comments were addressed in the part 40 rulemaking and are outside

    the scope of this rulemaking.\178\ The Commission also clarifies that

    temporarily registered SEFs may list swaps or submit rules through the

    Commission's approval or self-certification procedures under part 40 of

    this chapter, and that the timelines under those procedures shall

    apply.

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

    \177\ CEA section 5c(c); 7 U.S.C. 7a-2(c).

    \178\ See Provisions Common to Registered Entities, 76 FR 44776

    (Jul. 27, 2011).

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

    5. Sec. 37.5--Information Relating to Swap Execution Facility

    Compliance

    Proposed Sec. 37.5(a) required a SEF to file with the Commission

    information related to its business as a SEF as specified in the

    Commission's request. Proposed Sec. 37.5(b) required a SEF to file

    with the Commission a written demonstration of compliance with the core

    principles. Proposed Sec. 37.5(d) delegated the Commission's authority

    to seek information as set forth in Sec. 37.5(b) to the Director of

    DMO or such other employee as the Director may designate.

    Proposed Sec. 37.5(c) required a SEF to file with the Commission a

    notice of the transfer of ten percent or more of its equity no later

    than the business day following the date on which the SEF enters into a

    firm obligation to transfer the equity interest.\179\ The proposed rule

    also required that the notification include any relevant agreement and

    a representation from the SEF that it meets all of the requirements of

    section 5h of the Act and Commission regulations adopted thereunder.

    Additionally, the proposed rule

    [[Page 33490]]

    required the SEF to notify the Commission of the consummation of the

    transaction on the day on which it occurs. Furthermore, the proposed

    rule required that, upon the transfer of the equity interest, the SEF

    certify, no later than two business days following the date on which

    the change in ownership occurs, that the SEF meets all of the

    requirements of section 5h of the Act and Commission regulations

    adopted thereunder.

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

    \179\ See generally Core Principles and Other Requirements for

    Swap Execution Facilities, 76 FR at 1217 (explaining the proposed

    ten percent threshold).

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

    (a) Summary of Comments

    The Commission did not receive any comments on proposed Sec.

    37.5(a), (b), or (d). The Commission did, however, receive comments on

    the equity interest transfer provisions in proposed Sec. 37.5(c).

    CME commented that the submissions required to be simultaneously

    filed with the initial notification of an equity interest transfer do

    not lend themselves to preparation within the 24-hour time frame

    proposed in the rules.\180\ CME further commented that the

    representation of compliance with the requirements of CEA section 5h

    and the Commission's regulations adopted thereunder would be more

    appropriate if required upon consummation of the equity interest

    transfer, rather than with the initial notification.\181\

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

    \180\ CME Comment Letter at 13 (Feb. 22, 2011).

    \181\ Id.

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

    MarketAxess commented that public companies should not have to file

    a notice of an equity interest transfer because the ownership structure

    of a public company does not implicate the control and influence

    concerns raised by the Commission in its proposal, and shareholders are

    already obligated under the SEC's regulations to report threshold

    acquisitions of equity interests within ten days of such an

    acquisition.\182\

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

    \182\ MarketAxess Comment Letter at 29 (Mar. 8, 2011).

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

    Lastly, Better Markets recognized the important implications of

    transferring control in a regulated marketplace and it recommended that

    the Commission lower the transfer threshold for reporting to five

    percent as similarly required by the SEC for public equity

    transfers.\183\

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

    \183\ Better Markets Comment Letter at 21-22 (Mar. 8, 2011).

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

    (b) Commission Determination

    The Commission is adopting Sec. 37.5(a), (b), and (d) as proposed

    subject to certain non-substantive clarifications.\184\ The Commission

    is adopting proposed Sec. 37.5(c) with certain revisions discussed

    below.

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

    \184\ The Commission is removing the reference to ``information

    relating to data entry and trade details'' in proposed Sec. 37.5(a)

    because it is unnecessary. The rule text is broad enough to

    encompass such information as it states that, upon the Commission's

    request, a SEF shall file with the Commission information related to

    its business as a SEF.

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

    The Commission is revising Sec. 37.5(c) to provide that a SEF must

    submit to the Commission a notification of each transaction involving

    the transfer of fifty percent or more of the equity interest in the

    SEF, and that such notification must be provided at the earliest

    possible time, but in no event later than the open of the business day

    that is ten business days following the date in which the SEF enters

    into a firm obligation \185\ to transfer the equity interest. However,

    in all cases, the Commission notes that a SEF must provide the

    Commission staff with sufficient time, prior to consummating the equity

    interest transfer, to review and consider the implications of the

    change in ownership, including whether the change in ownership will

    adversely impact the operations of the SEF or the SEF's ability to

    comply with the core principles and the Commission's regulations

    thereunder.

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

    \185\ The Commission interprets ``firm obligation'' to mean when

    a SEF enters into a letter of intent or any other document that

    demonstrates a SEF's firm intent to transfer its equity interest as

    described in Sec. 37.5(c).

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

    The Commission acknowledges CME's concern regarding the one

    business day time period for filing the supporting documents with the

    equity interest transfer notification. Thus, in addition to extending

    the time period to up to ten business days for a SEF to file

    notification with the Commission, the Commission is revising the rule

    to eliminate the requirement that specific documents be provided with

    the notification. Rather, the Commission is revising the rule text to

    clarify that upon receiving a notification of the equity interest

    transfer, the Commission may request appropriate documentation pursuant

    to its authority under Sec. 37.5 of the Commission's regulations. For

    example, such documentation may include, but is not limited to: (i)

    Relevant agreement(s), including any preliminary agreements (not

    including draft documents); (ii) associated changes to relevant

    corporate documents; (iii) a chart outlining any new ownership or

    corporate or organizational structure, if available; and (iv) a brief

    description of the purpose and any impact of the equity interest

    transfer.

    The Commission is deleting the requirement for a SEF to provide a

    representation of compliance with section 5h of the Act and the

    Commission regulations thereunder with the equity interest transfer

    notification, as requested by CME. The Commission agrees with CME that

    this requirement is more appropriate upon consummation of the equity

    interest transfer, rather than with the initial notification.

    Therefore, the Commission is maintaining the certification requirement

    upon consummation of the equity interest transfer as proposed in the

    SEF NPRM.

    With respect to the other comments, the Commission believes that

    the notice requirements should not be limited to privately-held

    companies as the Commission's objective is to ensure that equity

    transfers do not negatively impact the operations of registered

    entities. The Commission must oversee and ensure the continued

    compliance of all SEFs with the core principles and the Commission's

    regulations. In order to fulfill its oversight obligations, and to

    ensure that SEFs maintain compliance with their self-regulatory

    obligations, the Commission must receive a notice of an equity interest

    transfer. The Commission acknowledges the suggestion by Better Markets

    to lower the equity interest transfer threshold to five percent;

    however, the Commission believes that the revisions to Sec. 37.5(c)

    will still allow the Commission to fulfill its oversight obligations,

    while reducing the costs for SEFs to comply with the equity interest

    transfer requirements.

    Finally, the Commission is revising the rule to remind SEFs that if

    any aspect of an equity interest transfer requires the SEF to file a

    rule as defined in part 40 of the Commission regulations, then the SEF

    must comply with the rule submission requirements of section 5c(c) of

    the CEA and part 40 of this chapter, and all other applicable

    Commission regulations.

    6. Sec. 37.6--Enforceability

    Section 37.6 is intended to provide market participants who execute

    swap transactions on or pursuant to the rules of a SEF with legal

    certainty with respect to such transactions. In that regard, proposed

    Sec. 37.6(a) established that any transaction entered into, on, or

    pursuant to the rules of a SEF cannot be voided, rescinded, or held

    unenforceable as a result of: (1) The SEF violating any provision of

    section 5h of the CEA or part 37; (2) any Commission proceeding to

    alter or supplement a rule, term, or condition under section 8a(7) of

    the CEA or to declare an emergency under section 8a(9) of the CEA; or

    (3) any other proceeding the effect of which is to alter or supplement

    a specific term or condition or trading rule or procedure, or require a

    registered

    [[Page 33491]]

    SEF to adopt a specific term or condition, trading rule or procedure,

    or to take or refrain from taking a specific action. Proposed Sec.

    37.6(b) required that all transactions executed on or pursuant to the

    rules of a SEF include written documentation memorializing all terms of

    the swap transaction, the legal effect of which is to supersede any

    previous agreement between the counterparties. The proposed rule also

    required that the confirmation of all terms of the transaction take

    place at the same time as execution.\186\

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

    \186\ The Commission proposed Sec. 37.6(b) to facilitate the

    process contemplated by the confirmation definition. A swap

    ``confirmation'' is defined as the consummation (electronically or

    otherwise) of legally binding documentation (electronic or

    otherwise) that memorializes the agreement of the counterparties to

    all of the terms of a swap. A confirmation must be in writing

    (whether electronic or otherwise) and must legally supersede any

    previous agreement (electronically or otherwise). 17 CFR 45.1; Swap

    Data Recordkeeping and Reporting Requirements, 77 FR 2136, 2197

    (Jan. 13, 2012).

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    (a) Summary of Comments

    Three commenters addressed the practicality of a SEF confirming all

    terms of a transaction at the same time as execution. MarketAxess

    recommended that a SEF be responsible for confirming only the swap

    creation data in its possession at the time of execution, consistent

    with the Commission's approach in its proposed part 45

    regulations.\187\ MarketAxess also requested that the Commission

    clarify that SEFs are only responsible for producing a confirmation for

    swaps entered into on, and not just pursuant to the rules of, a

    SEF.\188\

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

    \187\ MarketAxess Comment Letter at 28-29 (Mar. 8, 2011).

    Proposed Sec. 45.3 required that for all transactions executed on a

    SEF, regardless of whether the swap was cleared, the SEF would be

    responsible for reporting to a swap data repository only the primary

    economic terms of the transaction in its possession at the time of

    execution, and that reporting of confirmation data consisting of all

    terms of the transaction would be the responsibility of either the

    derivatives clearing organization (if cleared) or one of the

    counterparties (if uncleared). Swap Data Recordkeeping and Reporting

    Requirements, 75 FR 76574, 76580-81 (proposed Dec. 8, 2010). As

    adopted by the Commission, however, Sec. 45.3 requires a SEF to

    report both the primary economic terms data as well as all

    confirmation data consisting of all transaction terms for each swap

    executed on or pursuant to the rules of the SEF as soon as

    technologically practicable after execution of the swap. 17 CFR

    45.3; Swap Data Recordkeeping and Reporting Requirements, 77 FR

    2136, 2199 (Jan. 13, 2012).

    \188\ MarketAxess Comment Letter at 29 (Mar. 8, 2011).

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

    MarkitSERV stated that when counterparties choose to execute a swap

    on a SEF that is not subject to the clearing mandate and not submitted

    for clearing to a clearinghouse, the parties will require a long-term

    credit relationship to be in place, often memorialized in an ISDA

    Master Agreement.\189\ MarkitSERV further stated that the confirmation

    terms provided by a SEF may not be able to accommodate the specificity

    of such a master agreement, thus making the SEF's confirmation

    inadequate for purposes of complying with the Commission's

    regulations.\190\

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

    \189\ MarkitSERV Comment Letter at 4-5 (Mar. 8, 2011).

    \190\ Id. MarkitSERV also expressed concern that the SEF NPRM is

    conflating the concepts of confirmation and affirmation with the

    audit trail requirements in proposed Sec. 37.205. For example,

    MarkitSERV sought clarification regarding the SEF NPRM's statement

    that ``[v]oice transactions must be entered into some form of

    electronic affirmation system immediately upon execution.'' Core

    Principles and Other Requirements for Swap Execution Facilities, 76

    FR at 1221. Given the audit trail requirement in proposed Sec.

    37.205(b)(1), which states that SEFs that ``permit intermediation

    must require that all orders or requests for quotes received by

    phone that are executable be immediately entered into the trading

    system or platform[,]'' MarkitSERV recommended that the Commission

    use the term ``electronic processing system'' instead of

    ``electronic affirmation system'' because audit trail records and

    affirmation are different concepts. Id. at 1244. MarkitSERV Comment

    Letter at 4, 6 (Mar. 8, 2011). ABC/CIEBA also sought clarification

    as to whether SEFs must enter Permitted Transactions into an

    affirmation system, and if so, ABC/CIEBA noted that the SEF NPRM is

    inconsistent with other rules. ABC/CIEBA Comment Letter at 7-8 (Mar.

    8, 2011). The Commission notes that the final SEF rules do not

    require the use of an ``electronic affirmation system.'' The

    Commission also clarifies that confirmation and the creation of an

    audit trail in Sec. 37.205 are two separate and distinct

    requirements. In addition, the Commission notes that Sec. 37.205(b)

    merely establishes the requirement that SEFs must capture audit

    trail data for regulatory purposes and does not address affirmation,

    confirmation, or the public reporting or dissemination of such data.

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

    Similarly, the Energy Working Group expressed concern over the

    provision's requirement that the SEF's confirmation supersede any

    previous agreement between the transacting parties, noting that this

    language appears to prevent a master agreement from operating between

    counterparties transacting on a SEF.\191\ The Energy Working Group also

    stated that confirmation cannot take place at the same time as

    execution because they are two distinct steps in the swap transaction

    process.\192\

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    \191\ Energy Working Group Comment Letter at 5 (Mar. 8, 2011).

    \192\ Id.

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

    (b) Commission Determination

    The Commission is adopting Sec. 37.6(a) as proposed.\193\ The

    Commission is also adopting Sec. 37.6(b) as proposed subject to the

    two revisions discussed below. Although the comments received regarding

    proposed Sec. 37.6(b) did not cite ambiguity in the SEF NPRM regarding

    a SEF's affirmative duty to provide confirmation documentation to

    counterparties, the Commission has determined to revise Sec. 37.6(b)

    to state explicitly that a ``swap execution facility shall provide each

    counterparty'' with written documentation of all terms of the

    transaction to serve as confirmation of such transaction. In response

    to MarketAxess's comments, the Commission notes that Sec. 37.6(b) is

    consistent with the requirement in final part 45 of the Commission's

    regulations that a SEF report confirmation data consisting of all terms

    of a transaction to a swap data repository (``SDR'') for each swap

    executed on or pursuant to the rules of the SEF.\194\

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

    \193\ The Commission is making certain non-substantive revisions

    to Sec. 37.6(a) for clarity.

    \194\ Part 45 requires a SEF to report all confirmation data and

    all primary economic terms data as defined in part 23 and Sec. 45.1

    of the Commission's regulations for each swap executed on or

    pursuant to the rules of the SEF as soon as technologically

    practicable after execution of the swap. 17 CFR 45.3; Swap Data

    Recordkeeping and Reporting Requirements, 77 FR 2136, 2199 (Jan. 13,

    2012). Part 45 defines confirmation data as ``all of the terms of a

    swap matched and agreed upon by the counterparties in confirming the

    swap.'' Id. at 2197.

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

    With regard to the specific comments received about the role of

    master agreements in the written confirmation provided by a SEF, the

    Commission has determined that counterparties choosing to execute a

    transaction not submitted for clearing on or pursuant to the rules of a

    SEF must have all terms, including possible long-term credit support

    arrangements, agreed to no later than execution, such that the SEF can

    provide a written confirmation inclusive of those terms at the time of

    execution and report complete, non-duplicative, and non-contradictory

    data to an SDR as soon as technologically practicable after

    execution.\195\ This requirement, as mentioned above, is necessary to

    provide market participants who execute swap transactions on or

    pursuant to the rules of a SEF with legal certainty with respect to

    such transactions, and to promote the Commission's policy goal of

    achieving ``straight-through processing'' of swap

    [[Page 33492]]

    transactions in order to facilitate orderly markets, whether bilateral

    or facility traded.\196\ Furthermore, the Commission believes that

    credit-support arrangements for uncleared transactions can impact the

    ultimate price of a swap, and thus should be agreed to no later than

    the time of trade execution in order to promote the statutory goal of

    pre-trade price transparency.\197\

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

    \195\ The Commission notes that swap trading relationship

    documentation is not required for swaps cleared by a derivatives

    clearing organization. See Sec. 23.504(a)(1) of the Commission's

    regulations. The Commission also notes that the commenters' concerns

    are most relevant to those transactions that are truly bespoke, not

    subject to the clearing mandate, and not voluntarily cleared. There

    is no reason why a SEF's written confirmation terms cannot

    incorporate by reference the privately negotiated terms of a

    freestanding master agreement for these types of transactions,

    provided that the master agreement is submitted to the SEF ahead of

    execution and the counterparties ensure that nothing in the

    confirmation terms contradict the standardized terms intended to be

    incorporated from the master agreement. See also Real-Time Public

    Reporting of Swap Transaction Data, 77 FR 1182, 1193 (Jan. 9, 2012)

    (discussing confirmation and incorporating documents by reference).

    \196\ The OTC Derivatives Supervisors' Group, a collaboration of

    market participant leadership headed by the Federal Reserve Bank of

    New York, recognized the potential of electronic trading to

    facilitate the objectives of straight-through processing in the wake

    of the 2008 financial crisis. See Confirmation, Portfolio

    Reconciliation, and Portfolio Compression Requirements for Swap

    Dealers and Major Swap Participants, 75 FR 81519, 81521-22 (proposed

    Dec. 28, 2010) (noting that ``[t]imely and accurate confirmation of

    transactions is critical for all downstream operational and risk

    management processes, including the correct calculation of cash

    flows and discharge of settlement obligations as well as accurate

    measurement of counterparty credit exposures.'').

    \197\ See CEA section 5h(e); 7 U.S.C. 7b-3(e) (stating that the

    goal of this section is to promote pre-trade price transparency in

    the swaps market). While straight-through processing may not be as

    relevant to credit risk associated with transactions executed on or

    pursuant to the rules of a SEF but not submitted for clearing, the

    data and real-time reporting requirements already finalized by the

    Commission mandate reporting by the SEF of all swap transaction

    terms ``as soon as technologically practicable'' in order to

    effectuate the statutory mandate of post-trade price transparency.

    See 17 CFR 43.3(b)(1) (real-time reporting); 17 CFR 45.3(a)(1) (swap

    data recordkeeping and reporting requirements). This allowance of a

    slight timing delay, however, is meant to account for ``the

    prevalence, implementation and use of technology by comparable

    market participants,'' and not post-execution confirmation of other

    terms such as credit agreements for uncleared swaps. See, e.g., 17

    CFR 43.2; Real-Time Public Reporting of Swap Transaction Data, 77 FR

    1182, 1191 (Jan. 9, 2012) (discussing the definition of ``as soon as

    technologically practicable'').

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

    Finally, in response to the Energy Working Group's comment that

    confirmation cannot take place at the same time as execution, the

    Commission is revising Sec. 37.6(b) to state that ``. . . specific

    customer identifiers for accounts included in bunched orders involving

    swaps need not be included in confirmations provided by a swap

    execution facility if the applicable requirements of Sec. 1.35(b)(5)

    of this chapter are met.'' The Commission acknowledges that for bunched

    orders the post-execution allocation of trades is required for

    confirmation. The above revisions to Sec. 37.6 are consistent with

    Commission regulation 1.35(b)(5) and provide sufficient time for the

    post-execution allocation of bunched orders, but allow SEFs to meet the

    requirement that confirmation takes place at the same time as

    execution.\198\

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

    \198\ See 17 CFR 1.35; Customer Clearing Documentation, Timing

    of Acceptance for Clearing, and Clearing Member Risk Management, 77

    FR 21278, 21286-287, 306 (Apr. 9, 2012); Confirmation, Portfolio

    Reconciliation, Portfolio Compression, and Swap Trading Relationship

    Documentation Requirements for Swap Dealers and Major Swap

    Participants, 77 FR 55904, 55923 (Sep. 11, 2012) for further

    details.

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

    7. Sec. 37.7--Prohibited Use of Data Collected for Regulatory Purposes

    Proposed Sec. 37.7 prohibited a SEF from using for commercial

    purposes proprietary data or personal information that it obtains from

    or on behalf of any person for regulatory purposes. The purpose of this

    provision was to protect customer privacy and prevent a SEF from using

    such information to advance its commercial interests.\199\

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

    \199\ Core Principles and Other Requirements for Swap Execution

    Facilities, 76 FR at 1218 n. 34.

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

    (a) Summary of Comments

    Several commenters recommended that the Commission adopt a more

    flexible approach toward the use of data collected for regulatory

    purposes.\200\ CME, for example, stated that a SEF should be allowed to

    use information that is provided for both regulatory and non-regulatory

    purposes for commercial purposes, as long as transparent rules or

    policies are in place.\201\ Some commenters believed that commercial

    use should be allowed, provided that market participants' identities

    are protected \202\ or prior consent is obtained.\203\ For example, FSR

    believed that commercial use should be allowed for aggregate data as

    long as the sources of the information are not revealed.\204\

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

    \200\ MarketAxess Comment Letter at 31 (Mar. 8, 2011); FSR

    Comment Letter at 9 (Mar. 8, 2011); ICE Comment Letter at 5-6 (Mar.

    8, 2011); CME Comment Letter at 14 (Feb. 22, 2011).

    \201\ CME Comment Letter at 14 (Feb. 22, 2011).

    \202\ MarketAxess Comment Letter at 31 (Mar. 8, 2011); FSR

    Comment Letter at 9 (Mar. 8, 2011).

    \203\ CME Comment Letter at 14 (Feb. 22, 2011); MarketAxess

    Comment Letter at 31 (Mar. 8, 2011).

    \204\ FSR Comment Letter at 9 (Mar. 8, 2011).

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

    However, SIFMA AMG stated that, given the broad authority under the

    proposed rules for SEFs to acquire information, the term ``proprietary

    data'' is too narrow to adequately protect market participants from

    improper disclosure.\205\ Freddie Mac requested that the Commission

    strengthen the proposed rule to additionally prohibit any SEF from

    asserting ownership rights over the trading information of any

    transacting party.\206\

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

    \205\ SIFMA AMG Comment Letter at 15-16 (Mar. 8, 2011).

    \206\ Freddie Mac Comment Letter at 5 (Mar. 8, 2011).

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

    Finally, WMBAA requested that the Commission clarify the meaning of

    ``proprietary data or personal information,'' and recommended limiting

    the rule to information obtained outside the ordinary course of trade

    execution and related to market surveillance activities.\207\

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

    \207\ WMBAA Comment Letter at 17 (Mar. 8, 2011).

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

    (b) Commission Determination

    The Commission is adopting Sec. 37.7 as proposed, subject to

    certain modifications. In response to the commenters, the Commission is

    modifying the proposed rule to allow SEFs to use proprietary data or

    personal information for business or marketing purposes if the person

    from whom it collects or receives such information clearly consents to

    the use of its information in such manner. The Commission is also

    revising the proposed rule to prohibit a SEF from conditioning access

    to its facility based upon such consent. The Commission believes that

    the consent requirement will protect persons by allowing them to first

    weigh the benefits and consequences of allowing a SEF to make

    commercial use of their information. In response to CME's comment about

    information provided for both regulatory and non-regulatory purposes,

    the Commission notes that a SEF may use information that it receives

    for both regulatory and non-regulatory purposes for business or

    marketing purposes if the source of the information clearly consents to

    the use in such a manner.

    In response to comments about the definition of ``proprietary data

    and personal information,'' the Commission declines to adopt a further

    definition and is maintaining a flexible approach. However, the

    Commission notes that some examples of proprietary data and personal

    information would include information that separately discloses

    business transactions, market positions, or trade secrets. The

    Commission recommends that SEFs define these terms in their rulebooks,

    which will be subject to Commission review during the SEF registration

    process.

    8. Sec. 37.8--Boards of Trade Operating Both a Designated Contract

    Market and a Swap Execution Facility

    Proposed Sec. 37.8(a) required that a board of trade that operates

    a DCM and also intends to operate a SEF must separately register the

    SEF under part 37, and on an ongoing basis, comply with the core

    principles under section 5h of the Act and the part 37 regulations

    issued thereunder. Proposed Sec. 37.8(b) implemented CEA section 5h(c)

    by requiring a board of trade that operates both a DCM and SEF and uses

    the same electronic trade execution system for executing and trading

    swaps on both registered entities to clearly identify to market

    participants for each swap

    [[Page 33493]]

    whether the execution or trading of such swaps is taking place on the

    DCM or the SEF.\208\

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

    \208\ CEA section 5h(c); 7 U.S.C. 7b-3(c).

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

    (a) Summary of Comments

    CME stated that the rules of a DCM and SEF would clearly identify,

    as necessary, the trade platform upon which a swap was being executed,

    rendering the requirements of proposed Sec. 37.8 unnecessary.\209\ CME

    requested that the Commission clarify whether proposed Sec. 37.8

    created additional substantive obligations on the part of DCMs and SEFs

    given that market participants often interface with electronic

    platforms via proprietary or third-party front end systems not under

    the control of DCMs or SEFs.\210\

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

    \209\ CME Comment Letter at 14 (Feb. 22, 2011).

    \210\ Id.

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

    (b) Commission Determination

    The Commission is adopting Sec. 37.8(a) as proposed, subject to

    one revision. Proposed Sec. 37.8(a) only addressed the SEF

    registration and compliance of a board of trade that already operates a

    DCM and intends to operate a SEF. To address all situations regarding

    DCM and SEF registration and compliance, the Commission is revising

    Sec. 37.8(a) to apply to ``[a]n entity that intends to operate both a

    [DCM] and a [SEF].'' The rule requires the entity to separately

    register the DCM and SEF pursuant to part 38 and part 37 of the

    Commission's regulations, respectively, and to comply with the

    applicable core principles and regulations.

    As to CME's comments regarding Sec. 37.8(b), the Commission

    clarifies that it would not be sufficient for a board of trade that

    operates both a DCM and a SEF to simply have rules that identify

    whether a transaction is being executed on the DCM or the SEF. The

    Commission notes that section 5h(c) of the Act clearly requires a board

    of trade that operates both a DCM and a SEF to identify to market

    participants whether each swap is being executed on the DCM or the

    SEF.\211\ Accordingly, a consolidated DCM/SEF trading screen must

    identify whether the execution is occurring on the DCM or the SEF,

    irrespective of how proprietary or third-party front end systems

    eventually present that data to market participants.\212\

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

    \211\ The Commission notes that only eligible contract

    participants may execute a swap on a SEF so a board of trade that

    operates both a DCM and a SEF must ensure that its SEF does not

    allow for non-eligible contract participant trading on the SEF. See

    CEA section 2(e); 7 U.S.C. 2(e).

    \212\ The Commission notes that it is not replacing the term

    ``board of trade'' in Sec. 37.8(b) with the term ``entity'' as in

    Sec. 37.8(a) because in Sec. 37.8(b) only a board of trade would

    be able to use the same electronic trade execution system for

    executing and trading swaps on the DCM and on the SEF (i.e., a

    trading facility). The Commission also notes that Sec. 37.8(b)

    implements CEA section 5h(c), which uses the term ``board of

    trade.''

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

    9. Sec. 37.9--Permitted Execution Methods \213\

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

    \213\ The Commission is renaming the title of this section from

    ``Permitted Execution Methods'' to ``Methods of Execution for

    Required and Permitted Transactions'' to provide greater clarity.

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

    As mentioned above, the SEF NPRM required a SEF to offer a minimum

    trading functionality (i.e., a centralized electronic trading screen

    upon which any market participant can post both firm and indicative

    bids and offers that are transparent to all other market participants

    of the SEF). The SEF NPRM provided that Required Transactions (i.e.,

    transactions subject to the trade execution mandate under section

    2(h)(8) of the CEA and not block trades) must be executed through the

    SEF's minimum trading functionality, Order Book meeting the minimum

    trading functionality, or RFQ System that operates in conjunction with

    the SEF's minimum trading functionality.\214\ The SEF NPRM made it

    clear that for Required Transactions, pre-trade transparency must be

    met.\215\ The SEF NPRM also allowed a SEF to provide additional

    execution methods for Permitted Transactions (i.e., transactions not

    subject to the clearing and trade execution mandates, illiquid or

    bespoke swaps, and block trades), including Voice-Based System.

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

    \214\ By ``in conjunction with the SEF's minimum trading

    functionality,'' the Commission means that the SEF NPRM required a

    SEF to offer the minimum trading functionality, and if that SEF also

    offered an RFQ System, it was required to communicate any bids or

    offers resting on the minimum trading functionality to the RFQ

    requester along with the responsive quotes. See the discussion below

    regarding ``Taken Into Account and Communicated'' Language in the

    RFQ System Definition under Sec. 37.9(a)(1)(ii)--Request for Quote

    System in the preamble for further details.

    \215\ Core Principles and Other Requirements for Swap Execution

    Facilities, 76 FR at 1220.

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

    The Commission is restructuring the order of the rule text in Sec.

    37.9 and this corresponding preamble discussion to provide clarity.

    Despite the order of other preamble sections, which generally follows

    the order of the SEF NPRM, the Commission's preamble discussion of

    Sec. 37.9 generally follows the order of the restructured rule text.

    Additionally, as discussed above in the registration section, the

    Commission is moving the minimum trading functionality and Order Book

    sections from proposed Sec. 37.9 to final Sec. 37.3.

    (a) Sec. 37.9(a)(1)(iv)--Required Transactions and Sec.

    37.9(a)(1)(v)--Permitted Transactions

    Proposed Sec. 37.9(a)(1)(iv) defined Required Transactions as

    transactions that are subject to the execution requirements under the

    Act and are made available for trading pursuant to Sec. 37.10, and are

    not block trades. Proposed Sec. 37.9(a)(1)(v) defined Permitted

    Transactions as transactions that meet any of the following

    requirements: (A) Are block trades; (B) are not swaps subject to the

    Act's clearing and execution requirements; or (C) are illiquid or

    bespoke swaps.

    (1) Summary of Comments

    Several commenters recommended revisions to the definition of

    Permitted Transactions.\216\ To ensure that there are no gaps between

    the definitions of Required Transactions and Permitted Transactions,

    MarketAxess recommended that the proposed definition of Permitted

    Transactions in Sec. 37.9(a)(1)(v) be revised to include all

    transactions that are not Required Transactions as defined in proposed

    Sec. 37.9(a)(1)(iv).\217\ Freddie Mac recommended that the Commission

    revise the proposed definition of Permitted Transactions to incorporate

    hedging transactions by any end-user (i.e., non-dealer)

    counterparty.\218\

    [[Page 33494]]

    Additionally, the Coalition commented that the Commission should define

    illiquid or bespoke transactions to include typical end-user

    trades.\219\

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

    \216\ Additionally, WMBAA commented that the distinction between

    Required Transactions and Permitted Transactions is not required or

    authorized by the CEA. WMBAA Comment Letter at 6-7 (Mar. 8, 2011).

    In this regard, the Commission notes that the CEA sets out specific

    trading requirements for swaps that are subject to the trade

    execution mandate. See CEA sections 2(h)(1) and 2(h)(8); 7 U.S.C.

    2(h)(1) and 2(h)(8). To meet these statutory requirements, final

    Sec. 37.9(a)(1) defines these swaps as Required Transactions and

    provides specific methods of execution for such swaps. To

    distinguish these swaps from other swaps that are not subject to the

    trade execution mandate, the Commission defines such swaps in final

    Sec. 37.9(c)(1) as Permitted Transactions and allows these swaps to

    be voluntarily traded on a SEF by using any method of execution. See

    discussion below regarding execution methods for Required and

    Permitted Transactions under Sec. 37.9(b)(1) and (b)(4)--Execution

    Methods for Required Transactions and Sec. 37.9(c)--Execution

    Methods for Permitted Transactions in the preamble.

    \217\ MarketAxess Comment Letter at 32 (Mar. 8, 2011).

    Similarly, ISDA/SIFMA and the Energy Working Group requested clarity

    regarding the definition of Permitted Transactions. ISDA/SIFMA

    Comment Letter at 7 (Mar. 8, 2011); Energy Working Group Comment

    Letter at 4 (Mar. 8, 2011).

    \218\ Freddie Mac Comment Letter at 3 (Mar. 8, 2011). Similarly,

    MFA recommended that the Commission expand the definition of

    Permitted Transactions to include other transactions, such as

    exchanges for physical, exchanges for swaps, and linked or packaged

    transactions. MFA Comment Letter at 8 (Mar. 8, 2011). The Commission

    interprets MFA's comment to be a request that the Commission create

    through rulemaking an exception to the CEA section 2(h)(8) trade

    execution requirement similar to the centralized market trading

    exception established by DCM Core Principle 9 for certain exchange

    of futures for related positions. See CEA section 5(d)(9); 7 U.S.C.

    7(d)(9); see also Regulation of Noncompetitive Transactions Executed

    on or Subject to the Rules of a Contract Market, 63 FR 3708 (Jan.

    26, 1998). The Commission notes that while DCM Core Principle 9 does

    permit certain exceptions to the centralized market trading

    requirements, such exceptions are all premised on there being some

    ``bona fide business purpose'' for the exception. MFA does not offer

    a specific bona fide business purpose for any of its three suggested

    off-exchange exceptions, nor is the Commission aware of any. In

    addition, MFA does not explain why an exchange of swaps for swaps

    transaction, where each leg of the transaction can presumably be

    executed on a SEF, needs to be executed off-exchange. The Commission

    observes that should swaps based on physical commodities become

    subject to the trade execution mandate, there might be some bona

    fide business purpose for executing exchanges of swaps for physicals

    transactions. However, the market participants who are most likely

    to engage in such transactions are also likely to be eligible for

    the end-user exception in CEA section 2(h)(7). As an initial matter,

    the Commission observes that swaps based on physical commodities may

    be subject to the trade execution requirement if the Commission

    determines that they are subject to the clearing requirement under

    CEA section 2(h)(1) and part 50 of the Commission's regulations.

    Should the circumstances arise where the Commission is determining

    whether physical commodity swaps should become subject to the

    clearing requirement and there are parties who seek to engage in

    exchanges of swaps for physicals transactions that are not eligible

    for the end-user exception, the Commission could at that time

    entertain requests to permit a trade execution requirement exception

    for swaps that are components of such exchanges of swaps for

    physicals transactions. However, for the above reason, the

    Commission believes that a broad exception for such off-exchange

    transactions in the absence of bona fide business purposes could

    undermine the trade execution requirement by allowing market

    participants to execute swaps subject to the trade execution

    requirement bilaterally rather than on a SEF or DCM.

    \219\ Coalition Comment Letter at 8 (Mar. 8, 2011).

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

    Several commenters also commented on the reference to block trades

    in the definition of Permitted Transactions.\220\ ISDA/SIFMA commented

    that the definition of block trade in part 43 of the Commission's

    regulations should apply to blocks executed on a SEF.\221\ Tradeweb

    sought confirmation that block size trades in swaps that are required

    to be cleared and made available to trade would not be subject to the

    minimum trading requirements for Required Transactions, but would be

    required to be reported to and processed through a SEF in a manner

    prescribed by the SEF.\222\ Similarly, GFI requested the Commission to

    confirm that block transactions must be effected on a SEF, but may be

    subject to special rules.\223\

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

    \220\ ISDA/SIFMA Comment Letter at 10 (Mar. 8, 2011); Tradeweb

    Comment Letter at 5 (Mar. 8, 2011); GFI Comment Letter at 4 (Mar. 8,

    2011).

    \221\ ISDA/SIFMA Comment Letter at 10 (Mar. 8, 2011).

    \222\ Tradeweb Comment Letter at 5 (Mar. 8, 2011).

    \223\ GFI Comment Letter at 4 (Mar. 8, 2011).

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

    (2) Commission Determination

    To ensure that there is consistency in the definitions, and in

    response to MarketAxess's comment, the Commission is: (1) Revising the

    definition of Required Transaction to mean any transaction involving a

    swap that is subject to the trade execution requirement in section

    2(h)(8) of the Act \224\; and (2) revising the definition of Permitted

    Transaction to mean any transaction not involving a swap that is

    subject to the trade execution requirement in section 2(h)(8) of the

    Act.\225\ The Commission is not revising the definition of Permitted

    Transaction to explicitly include ``hedging transactions involving end-

    users'' or ``typical end-user'' transactions because the Commission's

    revisions to the definition of Permitted Transaction are consistent

    with the CEA section 2(h)(8) trade execution requirement.\226\

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

    \224\ The Commission is renumbering proposed Sec.

    37.9(a)(1)(iv) to Sec. 37.9(a)(1). Several commenters requested

    clarification from the Commission whether inter-affiliate trades

    would be subject to the CEA section 2(h)(8) trade execution

    requirement. JP Morgan Comment Letter at 5 (Jun. 3, 2011); Rosen et

    al. Comment Letter at 20-21 (Apr. 5, 2011); Coalition Comment Letter

    at 5 (Mar. 8, 2011); ISDA/SIFMA Comment Letter at 11 (Mar. 8, 2011).

    See Clearing Exemption for Swaps Between Certain Affiliated

    Entities, 77 FR 50425 (proposed Aug. 21, 2012) for further details.

    \225\ The Commission is renumbering proposed Sec. 37.9(a)(1)(v)

    to Sec. 37.9(c)(1).

    \226\ See CEA section 2(h)(8) trade execution requirement

    discussion above under Sec. 37.3--Requirements for Registration;

    see also discussion below under Sec. 37.9(c)--Execution Methods for

    Permitted Transactions.

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

    With respect to the treatment of block transactions, the Commission

    notes that the definition of block trade in part 43 of the Commission's

    regulations applies to such transactions involving swaps that are

    listed on a SEF.\227\ The Commission also notes that the definition of

    block trade states, in part, that block trades occur away from the

    registered SEF's or DCM's trading system or platform and is executed

    pursuant to the registered SEF's or DCM's rules and procedures.\228\ As

    such, block trades are not subject to the execution methods for

    Required Transactions and Permitted Transactions in final Sec.

    37.9(a)(2) and Sec. 37.9(c)(2), respectively.\229\

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

    \227\ Section 43.2 of the Commission's regulations states that

    ``block trade'' means a publicly reportable swap transaction that:

    (1) Involves a swap that is listed on a registered SEF or DCM; (2)

    Occurs away from the registered SEF's or DCM's trading system or

    platform and is executed pursuant to the registered SEF's or DCM's

    rules and procedures; (3) Has a notional or principal amount at or

    above the appropriate minimum block size applicable to such swap;

    and (4) Is reported subject to the rules and procedures of the

    registered SEF or DCM and the rules described in this part,

    including the appropriate time delay requirements set forth in Sec.

    43.5 of this part. 17 CFR 43.2.

    \228\ Id.

    \229\ The Commission notes that the execution methods for

    Required Transactions in final Sec. 37.9(a)(2) excludes block

    trades.

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

    (b) Sec. 37.9(a)(1)(ii)--Request for Quote System

    Proposed Sec. 37.9(a)(1)(ii)(A) defined an RFQ System as a trading

    system or platform in which a market participant must transmit a

    request for quote to buy or sell a specific instrument to no less than

    five market participants in the trading system or platform, to which

    all such market participants may respond. Under the proposed rule, any

    bids or offers resting on the trading system or platform pertaining to

    the same instrument must be taken into account and communicated to the

    requester along with the responsive quotes.

    In addition, proposed Sec. 37.9(a)(1)(ii)(B) defined an RFQ System

    as a trading system or platform in which multiple market participants

    can both: (1) View real-time electronic streaming quotes, both firm and

    indicative, from multiple potential counterparties on a centralized

    electronic screen; and (2) have the option to complete a transaction

    by: (i) Accepting a firm streaming quote, or (ii) transmitting a

    request for quote to no less than five market participants, based upon

    an indicative streaming quote, taking into account any resting bids or

    offers that have been communicated to the requester along with any

    responsive quotes. Finally, proposed Sec. 37.9(a)(1)(ii)(C) provided

    that an RFQ System means any such other trading system or platform as

    may be determined by the Commission.

    (1) Summary of Comments

    (i) Comments on RFQ System Definition and Transmission to Five Market

    Participants

    In general, some commenters stated that the Commission's definition

    of an RFQ System imposes rigid requirements that are not supported by

    the SEF definition.\230\ Other commenters stated that the defined RFQ

    System preserves ``the single-dealer status quo,'' threatens to

    diminish the transparency and efficiency of the regulated swaps

    [[Page 33495]]

    market, and is inconsistent with the Dodd-Frank Act.\231\

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

    \230\ Rosen et al. Comment Letter at 10 (Apr. 5, 2011); Goldman

    Comment Letter at 2 (Mar. 8, 2011); ISDA/SIFMA Comment Letter at 2

    (Mar. 8, 2011); FXall Comment Letter at 7-8 (Mar 8, 2011); SIFMA AMG

    Comment Letter at 4-5 (Mar. 8, 2011).

    \231\ IECA Comment Letter at 3 (May 24, 2011); Mallers et al.

    Comment Letter at 3-5 (Mar. 21, 2011); AFR Comment Letter at 4, 5

    (Mar. 8, 2011). The Mallers et al. comment letter represents the

    view of a number of high frequency trading firms: Allston Trading,

    LLC, Atlantic Trading USA LLC, Bluefin Trading LLC, Chopper Trading

    LLC, DRW Holdings, LLC, Eagle Seven, LLC, Endeavor Trading, LLC,

    GETCO, Hard Eight Futures, LLC, HTG Capital Partners, IMC Financial

    Markets, Infinium Capital Management LLC, Kottke Associates, LLC,

    Liger Investments Limited, Marquette Partners, LP, Nico Holdings

    LLC, Optiver US LLC, Quantlab Financial, LLC, RGM Advisors, LLC,

    Traditum Group LLC, WH Trading, and XR Trading LLC.

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

    As noted above, Sec. 37.9(a)(1)(ii) of the SEF NPRM contained a

    requirement that a market participant transmit an RFQ to no less than

    five market participants. In the SEF NPRM, the Commission specifically

    asked for public comment on whether five is the appropriate minimum

    number of respondents that the Commission should require to potentially

    interact with a request for quote.\232\ The Commission also asked for

    public comment on the appropriate minimum number, if not five.\233\ The

    Commission received the following comments regarding the five market

    participant requirement and has responded to those comments below.

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

    \232\ Core Principles and Other Requirements for Swap Execution

    Facilities, 76 FR at 1221. The Commission asked, ``[i]n light of the

    `multiple participant to multiple participant' requirement, the

    Commission has proposed that requests for quotes be requested of at

    least five possible respondents. Is this the appropriate minimum

    number of respondents that the Commission should require to

    potentially interact with a request for quote? If not, what is an

    appropriate minimum number? Some pre-proposal commenters have

    suggested that market participants should transmit a request for

    quote to `more than one' market participant. The Commission is

    interested in receiving public comment on this matter.'' Id.

    \233\ Id.

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

    Several commenters objected to the requirement in proposed Sec.

    37.9(a)(1)(ii) that a market participant transmit an RFQ to no less

    than five market participants.\234\ The commenters raised various

    concerns with this requirement, including the potential for increased

    trading costs,\235\ decreased liquidity,\236\ decreased

    transparency,\237\ and breaking trades into smaller sizes.\238\ Several

    commenters specifically noted that the five market participant

    requirement may result in increased spreads for participants because

    non-executing market participants in the RFQ could ``front run'' the

    transaction in anticipation of the executing market participant's

    forthcoming and offsetting transactions.\239\ Many of these commenters

    additionally noted that these risks would be most pronounced in

    illiquid swaps or large-sized trades (i.e., transactions approaching

    the block trade threshold).\240\ As a result, many of the commenters

    noted that it will be difficult and costly to enter into hedging

    transactions.\241\

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

    \234\ Representative Garrett et al. Comment Letter at 1 (Apr. 5,

    2013); Eaton Vance Comment Letter at 2 (Feb. 17, 2012); Reuters

    Comment Letter at 6 (Dec. 12, 2011); Tradeweb Comment Letter at 5

    (Jun. 3, 2011); Traccr Limited Comment Letter at 2 (Jun. 3, 2011);

    FHLB Comment Letter at 12-13 (Jun. 3, 2011); AII Comment Letter at 5

    (Jun. 2, 2011); Rosen et al. Comment Letter at 11 (Apr. 5, 2011); JP

    Morgan Comment Letter at 2-3 (Mar. 8, 2011); Bloomberg Comment

    Letter at 2-3 (Mar. 8, 2011); FXall Comment Letter at 8-9 (Mar. 8,

    2011); Reuters Comment Letter at 3 (Mar. 8, 2011); BlackRock Comment

    Letter at 3-4 (Mar. 8, 2011); Tradeweb Comment Letter at 7 (Mar. 8,

    2011); FSR Comment Letter at 3 (Mar. 8, 2011); MFA Comment Letter at

    6 (Mar. 8, 2011); MetLife Comment Letter at 2-3 (Mar. 8, 2011);

    SIFMA AMG Comment Letter at 5-7 (Mar. 8, 2011); Deutsche Comment

    Letter at 3-4 (Mar. 8, 2011); MarketAxess Comment Letter at 31 (Mar.

    8, 2011); Barclays Comment Letter at 5-6 (Mar. 8, 2011); ISDA/SIFMA

    Comment Letter at 3 (Mar. 8, 2011); ABC/CIEBA Comment Letter at 6

    (Mar. 8, 2011); Global FX Comment Letter at 3 (Mar. 8, 2011);

    TruMarx Comment Letter at 6 (Mar. 8, 2011); Coalition Comment Letter

    at 5-7 (Mar. 8, 2011); WMBAA Comment Letter at 6 (Mar. 8, 2011); CME

    Comment Letter at 8 (Mar. 8, 2011); Morgan Stanley Comment Letter at

    2-3 (Mar. 2, 2011); CanDeal Comment Letter at 2-3 (Feb. 25, 2011).

    The Commission notes that some commenters in addressing this

    provision used the term ``liquidity providers'' to refer to the

    minimum number of ``market participants'' that must receive RFQs.

    See, e.g., Tradeweb Comment Letter at 5 (Jun. 3, 2011); AII Comment

    Letter at 5 (Jun. 2, 2011); Bloomberg Comment Letter at 2 (Mar. 8,

    2011); FXall Comment Letter at 9 (Mar. 8, 2011); FSR Comment Letter

    at 3 (Mar. 8, 2011). The Commission clarifies that the proposed five

    market participant requirement did not imply any requirement that

    the requested market participants operate in any particular manner,

    such as one that regularly provides liquidity or makes markets in

    the particular swap.

    \235\ Eaton Vance Comment Letter at 2 (Feb. 17, 2012); JP Morgan

    Comment Letter at 2-3 (Mar. 8, 2011); BlackRock Comment Letter at 4

    (Mar. 8, 2011); MetLife Comment Letter at 3 (Mar. 8, 2011); Global

    FX Comment Letter at 3 (Mar. 8, 2011); Morgan Stanley Comment Letter

    at 2 (Mar. 2, 2011); CanDeal Comment Letter at 2-3 (Feb. 25, 2011).

    \236\ Tradeweb Comment Letter at 5 (Jun. 3, 2011); Traccr

    Limited Comment Letter at 2 (Jun. 3, 2011); FHLB Comment Letter at

    12 (Jun. 3, 2011); JP Morgan Comment Letter at 2-3 (Mar. 8, 2011);

    BlackRock Comment Letter at 3 (Mar. 8, 2011); Tradeweb Comment

    Letter at 7 (Mar. 8, 2011); MetLife Comment Letter at 3 (Mar. 8,

    2011); CanDeal Comment Letter at 2-3 (Feb. 25, 2011).

    \237\ Tradeweb Comment Letter at 5 (Jun. 3, 2011); MetLife

    Comment Letter at 3 (Mar. 8, 2011).

    \238\ BlackRock Comment Letter at 4 (Mar. 8, 2011).

    \239\ FHLB Comment Letter at 12 (Jun. 3, 2011); AII Comment

    Letter at 5 (Jun. 2, 2011); Bloomberg Comment Letter at 2-3 (Mar. 8,

    2011); FXall Comment Letter at 8-9 (Mar. 8, 2011); BlackRock Comment

    Letter at 3-4 (Mar. 8, 2011); MetLife Comment Letter at 3 (Mar. 8,

    2011); SIFMA AMG Comment Letter at 5-6 (Mar. 8, 2011); Barclays

    Comment Letter at 5-6 (Mar. 8, 2011); ISDA/SIFMA Comment Letter at 3

    (Mar. 8, 2011); ABC/CIEBA Comment Letter at 6 (Mar. 8, 2011); Global

    FX Comment Letter at 3 (Mar. 8, 2011); Coalition Comment Letter at

    5-6 (Mar. 8, 2011); Morgan Stanley Comment Letter at 2 (Mar. 2,

    2011).

    \240\ FHLB Comment Letter at 12 (Jun. 3, 2011); AII Comment

    Letter at 5 (Jun. 2, 2011); Bloomberg Comment Letter at 2-3 (Mar. 8,

    2011); FXall Comment Letter at 8-9 (Mar. 8, 2011); MetLife Comment

    Letter at 3 (Mar. 8, 2011); SIFMA AMG Comment Letter at 5-6 (Mar. 8,

    2011); Barclays Comment Letter at 5-6 (Mar. 8, 2011); ISDA/SIFMA

    Comment Letter at 3 (Mar. 8, 2011); Global FX Comment Letter at 3

    (Mar. 8, 2011); Coalition Comment Letter at 5-6 (Mar. 8, 2011);

    Morgan Stanley Comment Letter at 2 (Mar. 2, 2011).

    \241\ FHLB Comment Letter at 12 (Jun. 3, 2011); AII Comment

    Letter at 5 (Jun. 2, 2011); Bloomberg Comment Letter at 2-3 (Mar. 8,

    2011); FXall Comment Letter at 8-9 (Mar. 8, 2011); BlackRock Comment

    Letter at 3-4 (Mar. 8, 2011); MetLife Comment Letter at 3 (Mar. 8,

    2011); SIFMA AMG Comment Letter at 5-6 (Mar. 8, 2011); Barclays

    Comment Letter at 5-6 (Mar. 8, 2011); ISDA/SIFMA Comment Letter at 3

    (Mar. 8, 2011); ABC/CIEBA Comment Letter at 6 (Mar. 8, 2011); Global

    FX Comment Letter at 3 (Mar. 8, 2011); Coalition Comment Letter at

    5-6 (Mar. 8, 2011); Morgan Stanley Comment Letter at 2 (Mar. 2,

    2011).

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

    In this regard, some commenters noted that the SEC's SB-SEF

    proposal \242\ permitted RFQs to be transmitted to one or more SEF

    participant(s).\243\ Morgan Stanley commented that, given the impact of

    signaling transactions to multiple market participants, as trade size

    grows, participants may receive better execution if their RFQs are

    transmitted to fewer than five participants.\244\ Similarly, MetLife

    commented that participants should have the flexibility to determine

    the appropriate number of respondents for a particular trade, which

    could vary based on the size and liquidity of the trade.\245\

    Additionally, Commissioner Sommers' dissent suggested an alternative

    approach to RFQ Systems that would permit a market participant to

    transmit an RFQ to ``more than one'' potential counterparty.\246\

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

    \242\ Registration and Regulation of Security-Based Swap

    Execution Facilities, 76 FR 10948 (proposed Feb. 28, 2011).

    \243\ Reuters Comment Letter at 6 (Dec. 12, 2011); Traccr

    Limited Comment Letter at 2 (Jun. 3, 2011); AII Comment Letter at 5

    (Jun. 2, 2011); Rosen et al. Comment Letter at 11 (Apr. 5, 2011); JP

    Morgan Comment Letter at 5 (Mar. 8, 2011); Reuters Comment Letter at

    3 (Mar. 8, 2011); Tradeweb Comment Letter at 7 (Mar. 8, 2011); FSR

    Comment Letter at 3 (Mar. 8, 2011); MetLife Comment Letter at 3

    (Mar. 8, 2011); SIFMA AMG Comment Letter at 5 (Mar. 8, 2011);

    Deutsche Comment Letter at 4 (Mar. 8, 2011); MarketAxess Comment

    Letter at 31 (Mar. 8, 2011); ISDA/SIFMA Comment Letter at 3 (Mar. 8,

    2011); Global FX Comment Letter at 3 (Mar. 8, 2011); Goldman Comment

    Letter at 2 (Mar. 8, 2011); TruMarx Comment Letter at 6 (Mar. 8,

    2011).

    \244\ Morgan Stanley Comment Letter at 2 (Mar. 2, 2011).

    \245\ MetLife Comment Letter at 3 (Mar. 8, 2011).

    \246\ Core Principles and Other Requirements for Swap Execution

    Facilities, 76 FR at 1259.

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

    Other commenters, however, stated that an RFQ should be transmitted

    to all participants on the SEF.\247\ Mallers et al. stated that

    participants would not be disadvantaged by disclosing an RFQ to the

    entire market for transactions below

    [[Page 33496]]

    the block trade threshold, which would not move the market.\248\ In

    their view, the five market participant requirement would allow a

    participant to conduct semi-private deals with a few favored

    participants to the exclusion of other market participants, which would

    ultimately decrease liquidity and create a substantial barrier to entry

    to the swaps market.\249\ On the other hand, SDMA supported the five

    market participant requirement.\250\ In its view, this requirement

    promotes price discovery and liquidity, whereas the single market

    participant model facilitates abusive trading practices, such as pre-

    arranged trading and ``painting the screen'' (i.e., posting of non-

    competitive quotes to confuse the market).\251\

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

    \247\ IECA Comment Letter at 3 (May 24, 2011); Mallers et al.

    Comment Letter at 4-5 (Mar. 21, 2011); Better Markets Comment Letter

    at 9 (Mar. 8, 2011); AFR Comment Letter at 4-5 (Mar. 8, 2011).

    \248\ Mallers et al. Comment Letter at 4 (Mar. 21, 2011).

    \249\ Id.

    \250\ SDMA Comment Letter at 3 (Mar. 8, 2011). See also Better

    Markets Comment Letter at 2 (Apr. 12, 2013) and Allston et al.

    Comment Letter at 1 (Feb. 28, 2013).

    \251\ SDMA Comment Letter at 5 (Feb. 28, 2013); SDMA Comment

    Letter at 3 (Mar. 8, 2011).

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

    (ii) Comments on ``Taken Into Account and Communicated'' Language in

    the RFQ System Definition

    Some commenters recommended that the Commission delete the

    requirement that resting orders be ``taken into account and

    communicated'' to the RFQ requester.\252\ FXall and Barclays stated

    that this requirement is not necessary because the RFQ requester

    already has the ability to view the resting orders on the SEF's minimum

    trading functionality or Order Book.\253\ Several commenters stated

    that this requirement is mandating that SEFs offer RFQ systems in

    conjunction with the SEF's minimum trading functionality, which is not

    required.\254\ Similarly, JP Morgan stated that the resting order

    functionality is not mandated by the statute.\255\

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

    \252\ Tradeweb Comment Letter at 5 (Jun. 3, 2011); JP Morgan

    Comment Letter at 5-6 (Mar. 8, 2011); FXall Comment Letter at 9-10

    (Mar. 8, 2011); SIFMA AMG Comment Letter at 9 (Mar. 8, 2011);

    Barclays Comment Letter at 7 (Mar. 8, 2011); Tradeweb Comment Letter

    at 6 (Mar. 8, 2011).

    \253\ FXall Comment Letter at 9 (Mar. 8, 2011); Barclays Comment

    Letter at 7 (Mar. 8, 2011).

    \254\ ISDA/SIFMA Comment Letter at 5-6 (Mar. 8, 2011); FXall

    Comment Letter at 4 (Mar. 8, 2011); MarketAxess Comment Letter at 33

    (Mar. 8, 2011); SIFMA AMG Comment Letter at 4 (Mar. 8, 2011).

    \255\ JP Morgan Comment Letter at 5 (Mar. 8, 2011).

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

    Several commenters requested clarification regarding the

    interaction between resting bids and offers and the RFQ system.\256\

    Some commenters thought that the ``taken into account and

    communicated'' language should mean that a SEF must only communicate to

    the RFQ requester the resting bids and offers, and that the RFQ

    requester has sole discretion to either respond to, or ignore, these

    resting bids and offers.\257\ ISDA/SIFMA and SIFMA AMG requested

    clarification that the resting bids and offers do not include

    indicative prices.\258\ Several commenters also stated that SEFs should

    not be required to inform the providers of resting bids and offers of

    the RFQs; otherwise, the RFQ system would be subject to market abuse by

    opportunistic third parties seeking market information, and the

    requirement would open up RFQs beyond the minimum number of

    participants.\259\

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

    \256\ Reuters Comment Letter at 1 (Jun. 13, 2012); Rosen et al.

    Comment Letter at 12-14 (Apr. 5, 2011); JP Morgan Comment Letter at

    5-6 (Mar. 8, 2011); FXall Comment Letter at 9-10 (Mar. 8, 2011);

    Tradeweb Comment Letter at 8 (Mar. 8, 2011); FSR Comment Letter at 5

    (Mar. 8, 2011); MetLife Comment Letter at 3 (Mar. 8, 2011); SIFMA

    AMG Comment Letter at 9 (Mar. 8, 2011); MarketAxess Comment Letter

    at 32 (Mar. 8, 2011); Barclays Comment Letter at 7 (Mar. 8, 2011);

    ABC/CIEBA Comment Letter at 6-7 (Mar. 8, 2011); ISDA/SIFMA Comment

    Letter at 3-4; Evolution Comment Letter at 5-6 (Mar. 8, 2011).

    \257\ JP Morgan Comment Letter at 5-6 (Mar. 8, 2011); FSR

    Comment Letter at 5 (Mar. 8, 2011); MetLife Comment Letter at 3

    (Mar. 8, 2011); SIFMA AMG Comment Letter at 9 (Mar. 8, 2011);

    MarketAxess Comment Letter at 32 (Mar. 8, 2011); ABC/CIEBA Comment

    Letter at 6-7 (Mar. 8, 2011); ISDA/SIFMA Comment Letter at 3-4 (Mar.

    8, 2011); Evolution Comment Letter at 5-6 (Mar. 8, 2011).

    \258\ ISDA/SIFMA Comment Letter at 3-4 (Mar. 8, 2011); SIFMA AMG

    Comment Letter at 9 (Mar. 8, 2011).

    \259\ FXall Comment Letter at 9-10 (Mar. 8, 2011); ISDA/SIFMA

    Comment Letter at 3-4 (Mar. 8, 2011); SIFMA AMG Comment Letter at 9

    (Mar. 8, 2011). FSR also commented that the provider of the resting

    bid should not be provided with information about the identity of

    the RFQ requester. FSR Comment Letter at 5 (Mar. 8, 2011).

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

    (iii) Comments on RFQ Disclosure Issues

    AFR and Better Markets stated that SEFs should be required to

    disclose RFQ responses to all market participants.\260\ For example,

    AFR commented that responses to RFQs should be made transparent to all

    market participants prior to trade execution, which would serve the

    statutory goal of pre-trade price transparency and would increase price

    competition.\261\ Several commenters objected to the recommendation by

    AFR and Better Markets.\262\ Some of these commenters noted that such a

    requirement could raise the same information leakage concerns as with

    the five market participant requirement.\263\

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

    \260\ AFR Comment Letter at 3 (Feb. 27, 2013); AFR Comment

    Letter at 5 (Mar. 8, 2011); Better Markets Comment Letter at 8 (Mar.

    8, 2011).

    \261\ AFR Comment Letter at 5 (Mar. 8, 2011).

    \262\ Rosen et al. Comment Letter at 14 (Apr. 5, 2011);

    MarketAxess Comment Letter at 32 (Mar. 8, 2011); Barclays Comment

    Letter at 10 (Mar. 8, 2011); Tradeweb Comment Letter at 7-8 (Mar. 8,

    2011); State Street Comment Letter at 4 (Mar. 8, 2011); Deutsche

    Comment Letter at 4 (Mar. 8, 2011).

    \263\ Tradeweb Comment Letter at 7 (Mar. 8, 2011); State Street

    Comment Letter at 4 (Mar. 8, 2011); Deutsche Comment Letter at 4

    (Mar. 8, 2011).

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

    FSR commented that market participants receiving the RFQ should

    have relevant information about the identity of the RFQ requester.\264\

    However, Tradeweb commented that the Commission should not impose a

    specific requirement that the identity of the RFQ requester be

    disclosed or anonymous.\265\ FSR also stated that SEFs should not be

    required to publish RFQs until after the trade has been completed, and

    then only as part of aggregated disclosures.\266\ Finally, State Street

    requested that the Commission clarify that an RFQ System is not

    required to provide functionality to make RFQs visible to the entire

    market, although it may voluntarily choose to do so.\267\

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

    \264\ FSR Comment Letter at 3 (Mar. 8, 2011).

    \265\ Tradeweb Comment Letter at 8 (Mar. 8, 2011).

    \266\ FSR Comment Letter at 3 (Mar. 8, 2011).

    \267\ State Street Comment Letter at 4 (Mar. 8, 2011).

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

    (2) Commission Determination

    Based on the comments, the Commission is adopting proposed Sec.

    37.9(a)(1)(ii) as final Sec. 37.9(a)(3), subject to a number of

    modifications discussed below.\268\

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

    \268\ The Commission is renumbering proposed Sec.

    37.9(a)(1)(ii) to Sec. 37.9(a)(3).

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

    (i) RFQ System Definition and Transmission to Five Market Participants

    The Commission is adopting the definition of RFQ System in proposed

    Sec. 37.9(a)(1)(ii)(A), subject to certain modifications described

    below. As explained in the SEF NPRM, the Commission believes that an

    RFQ System, as defined in Sec. 37.9, operating in conjunction with a

    SEF's minimum trading functionality (i.e., Order Book) is consistent

    with the SEF definition and promotes the goals provided in section 733

    of the Dodd-Frank Act, which are to: (1) Promote the trading of swaps

    on SEFs and (2) promote pre-trade price transparency in the swaps

    market.\269\ The Commission notes that the RFQ System definition

    requires SEFs to provide market participants the ability to access

    multiple market participants, but not necessarily the entire market, in

    conformance with the SEF definition.

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

    \269\ Core Principles and Other Requirements for Swap Execution

    Facilities, 76 FR at 1220-21.

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

    The Commission agrees with SDMA that the proposed five market

    [[Page 33497]]

    participant requirement would promote pre-trade price transparency, as

    the RFQ requester would be required to solicit executable orders, on a

    pre-trade basis, from a larger group of potential responders.\270\ A

    broader group of potential responders, in turn, encourages price

    competition between the potential responders to the RFQ and may provide

    a more reliable assessment of market value than SEF functionality that

    would permit a market participant to rely on a quote from a single RFQ

    requestee. The Commission nevertheless recognizes commenters' concerns

    about the proposed five market participant requirement, such as the

    potential for increased trading costs and information leakage to the

    non-executing market participants in the RFQ. To address these

    concerns, while still complying with the multiple-to-multiple

    requirement in the statutory SEF definition and promoting the goals of

    pre-trade price transparency and trading of swaps on SEFs provided in

    section 733 of the Dodd-Frank Act, the Commission is requiring that a

    market participant transmit an RFQ to no less than two market

    participants during a phase-in compliance period and, subsequent to

    that period, to no less than three market participants.\271\ The

    Commission believes, as noted above, that sending an RFQ to a greater

    number of market participants increases the potential for price

    competition among responders and provides a more reliable assessment of

    market value. The Commission also believes that the three market

    participant requirement, with the two market participant phase-in

    period, appropriately balances the benefits of pre-trade price

    transparency and the information leakage concerns raised by commenters.

    The revision from five to three minimum market participants will also

    provide market participants with greater flexibility in sending RFQs

    for Required Transactions, while still complying with the statutory SEF

    definition and promoting pre-trade price transparency.

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

    \270\ The Commission notes that a SEF market participant may

    send an RFQ to the entire market. See id. at 1220 and discussion

    below. The Commission also notes that there are generally two

    distinct differences between the requirements finalized in this

    release and the RFQ-type functionality offered by DCMs. First, RFQ

    functionality used by DCMs disseminates RFQs to all market

    participants. Second, the responses to the RFQs take the form of

    executable bids or offers that are entered into the DCM's order book

    or other centralized market, such that orders from any market

    participant, not just the one submitting the RFQ, can be matched

    against such responsive bids or offers. Although the Commission

    considered a minimum RFQ-to-all requirement similar to the current

    practice in DCMs, given that swaps tend to be less standardized than

    futures, the Commission believes that rules pertaining to the

    execution methods for SEFs should provide appropriate flexibility

    for market participants trading swaps. The Commission notes that the

    less restrictive minimum market participant requirement established

    by part 37 reflects the more flexible statutory provisions for SEFs

    as compared to DCMs.

    \271\ The Commission clarifies that the three market participant

    requirement does not imply any requirement that the requested market

    participants operate in any particular manner, such as a requirement

    that such participants be dedicated liquidity providers or market

    makers in the particular swap. The RFQ requester may send the RFQ to

    any three market participants on the RFQ system, subject to the

    affiliate prohibition discussed below. See supra footnote 234 for

    further details.

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

    The Commission has also determined to clarify that the market

    participants required for inclusion in an RFQ in all cases may not be

    affiliated with or controlled by the RFQ requester and may not be

    affiliated with or controlled by each other, and is revising final

    Sec. 37.9(a)(3) to clarify this point.\272\ For an RFQ requester to

    send an RFQ to another entity who is affiliated with or controlled by

    the RFQ requester is inconsistent with the purpose of requiring that

    RFQs be sent to more than one market participant, as explained both in

    the SEF NPRM and this release. The Commission notes that if an RFQ is

    transmitted to one non-affiliate and two affiliates of the requester or

    if an RFQ is transmitted to three requestees who are affiliates of each

    other, then the policy objective of promoting the goal of pre-trade

    price transparency and complying with the multiple-to-multiple

    requirement in the SEF definition could be undermined. The Commission

    is also concerned that such an outcome could disincentivize entities

    from responding to an RFQ, which would reduce price competition and

    liquidity.

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

    \272\ The Commission notes that ``affiliate'' means: (i) One

    party, directly or indirectly, holds a majority ownership interest

    in the other party, and the party that holds the majority interest

    in the other party reports its financial statements on a

    consolidated basis under Generally Accepted Accounting Principles or

    International Financial Reporting Standards, and such consolidated

    financial statements include the financial results of the majority-

    owned party; or (ii) a third party, directly or indirectly, holds a

    majority ownership interest in both parties, and the third party

    reports its financial statements on a consolidated basis under

    Generally Accepted Accounting Principles or International Financial

    Reporting Standards, and such consolidated financial statements

    include the financial results of both of the parties. A party or

    third party directly or indirectly holds a majority ownership

    interest if it directly or indirectly holds a majority of the equity

    securities of an entity, or the right to receive upon dissolution,

    or the contribution of, a majority of the capital of a partnership.

    See Commission regulation 50.52.

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

    The Commission believes, moreover, that the three market

    participant requirement is consistent with current market practice

    where, in certain markets, many market participants already choose to

    send an RFQ to multiple market participants. Tradeweb, for example,

    noted that in its experience in the U.S. Treasuries market, market

    participants on average send an RFQ to three market participants.\273\

    In addition, the Commission understands that many pension and other

    managed funds with fiduciary obligations routinely obtain quotes from

    at least three market participants in certain securities markets. The

    Commission believes that the three market participant requirement, with

    the two market participant transition period, supports a common

    industry practice of querying multiple market participants, while still

    complying with the statutory SEF definition and promoting the goals

    provided in section 733 of the Dodd-Frank Act.

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

    \273\ Tradeweb Comment Letter at 7 (Mar. 8, 2011).

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

    Furthermore, the Commission believes that the three minimum market

    participant requirement heightens the probability that multiple

    participants will respond to an RFQ and, thus, will facilitate the

    pricing improvements attendant to competition among RFQ responders. The

    Commission is aware of numerous legal, business, and technological

    issues that could prevent a market participant from responding to a

    specific RFQ. The Commission notes, for example, that DCM market maker

    programs often require participants to quote two-sided markets for 75

    to 85 percent of the trading day.\274\ Therefore, a participant in the

    market maker program may not provide quotes for a portion of the

    trading day. While there is no guarantee that even a minimum market

    participant requirement will ensure that multiple responses are

    available for all RFQs, it increases the probability that the goal of

    pre-trade price transparency is achieved and that a competitive market

    exists for all market participants.

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

    \274\ The Commission understands that such provisions are in

    place to accommodate various operational and other reasons that

    could cause a market participant to not comply with the quoting

    obligations.

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

    Finally, the Commission believes that setting the minimum RFQ

    requirement at a uniform number for all Required Transactions in all

    asset classes provides regulatory and market efficiencies and is

    appropriate for the SEF market structure at this particular time. SEFs

    and market participants will benefit from a clear and uniform standard

    that would not require them to be subject to different minimum RFQ

    requirements, and to monitor compliance with such requirements, for

    every swap or class of swaps subject to

    [[Page 33498]]

    the CEA section 2(h)(8) trade execution requirement.

    For the reasons discussed above, at this time, the Commission

    believes that the three market participant requirement implements the

    multiple-to-multiple requirement in the statutory SEF definition and

    will create an appropriate level of pre-trade price transparency for

    Required Transactions (i.e., transactions involving swaps that are

    subject to the trade execution mandate of section 2(h)(8) of the CEA)

    for market participants initiating RFQs. However, the Commission is

    also aware of the fact that a phased implementation of this requirement

    will assist market participants and prospective SEFs to make an

    efficient transition from the swap industry's current market structure

    to the more transparent execution framework set forth in these final

    rules. Therefore, to provide market participants, SEFs, and the swaps

    industry with time to adapt to the new SEF regime, the Commission is

    phasing-in the three market participant requirement. From the effective

    date of the final SEF regulations until one year from the compliance

    date of these final regulations, a market participant transmitting an

    RFQ for Required Transactions under Sec. 37.9(a)(2) must still comply

    with the RFQ definition in Sec. 37.9(a)(3), but may transmit the quote

    to no less than two market participants.\275\

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

    \275\ The Commission notes that the affiliate prohibition in

    Sec. 37.9(a)(3) applies during the interim RFQ-to-2 period.

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

    Some comments expressed support for the SEC's SB-SEF proposal,

    which allows for one-to-one RFQs. If the Commission eliminated the

    multiple market participant requirement and instead permitted RFQ

    requesters to send RFQs to a single market participant, then the

    multiple-participant-to-multiple-participant requirement in the SEF

    definition and the pre-trade price transparency goal would be

    undermined. In this regard, the Commission notes that while the SEC's

    SB-SEF proposal allows for one-to-one RFQs, it proposed to fulfill the

    multiple to multiple requirement by mandating full order interaction or

    best execution for RFQs.\276\ Under the SEC's SB-SEF proposal, an RFQ

    requester must execute against the best priced orders of any size

    within and across a SEF's modes of execution, a requirement that the

    Commission is not recommending at this time.\277\

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

    \276\ Registration and Regulation of Security-Based Swap

    Execution Facilities, 76 FR at 10953-54, 10971-74.

    \277\ Id.

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

    The Commission notes that some commenters expressed concerns about

    the risks with respect to information leakage for illiquid swaps or

    large-size trades, and the potential risk of a winner's curse for the

    market participant whose quote is accepted by the RFQ requester.

    According to the commenters, the other market participants in the RFQ

    will be aware of the RFQ, and some or all of those participants will

    attempt to front-run the trades by the winning responder to hedge or

    layoff the risk from the RFQ transaction.\278\

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

    \278\ To the extent such risks potentially exist for Required

    Transactions, the reduction of the minimum market participant

    requirement from the proposed five will help mitigate this risk.

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

    With respect to commenters' concerns about the potential winner's

    curse for illiquid swaps, the Commission clarifies that the minimum

    market participant requirement only applies to RFQ Systems for Required

    Transactions (i.e., transactions involving swaps that are subject to

    the trade execution mandate of section 2(h)(8) of the CEA); such swaps

    generally should be more liquid than swaps that are not subject to the

    trade execution mandate because they are subject to the clearing

    mandate of section 2(h)(1) of the CEA and are made available to

    trade.\279\ In this regard, the Commission notes that the interest rate

    swaps and credit default swaps that the Commission has determined are

    required to be cleared under CEA section 2(h)(1) (and are likely to be

    subject to the trade execution mandate of CEA section 2(h)(8)) are some

    of the most liquid swaps.\280\ The Commission also notes that 77 swap

    dealers have registered with the Commission and nearly all of them make

    markets in such swaps.\281\ Further, SEFs may offer RFQ systems without

    the three market participant requirement for Permitted Transactions

    (i.e., transactions not involving swaps that are subject to the trade

    execution mandate of section 2(h)(8) of the CEA).

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

    \279\ Clearing Requirement Determination Under Section 2(h) of

    the CEA, 77 FR 74284 (Dec. 13, 2012); Process for a Designated

    Contract Market or Swap Execution Facility To Make a Swap Available

    To Trade, 76 FR 77728 (proposed Dec. 14, 2011).

    \280\ Clearing Requirement Determination Under Section 2(h) of

    the CEA, 77 FR 74284. The Commission notes that these swaps already

    went through a Commission determination process that included a five

    factor review, including a liquidity review. Id. ISDA, in its letter

    requesting interpretive relief regarding the obligation to provide a

    pre-trade mid-market mark, recognized that many of the swaps that

    the Commission has determined are required to be cleared under CEA

    section 2(h)(1) are ``highly-liquid, exhibit narrow bid-ask spreads

    and are widely quoted by SD/MSPs in the marketplace . . . '' ISDA

    Comment Letter at 2 (Nov. 30, 2012).

    \281\ The Commission recognizes that not all swap dealers will

    be active in all Required Transactions. The Commission also notes

    that of the 77 currently registered swap dealers, 35 swap dealers

    are not affiliated with any other swap dealers.

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

    With respect to commenters' concerns about the potential winner's

    curse for large-sized trades, the Commission notes that block trades

    would not be subject to the execution methods for Required

    Transactions, including the three market participant requirement.\282\

    Therefore, excluding block trades from the execution methods for

    Required Transactions will address the potential risk of a winner's

    curse for such trades. The Commission also clarifies that SEFs are not

    required to display a requester's RFQ to market participants not

    participating in the RFQ.\283\

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

    \282\ See definition of block trade in Sec. 43.2 of the

    Commission's regulations.

    \283\ Similarly, as noted below, SEFs are not required to

    display responses to an RFQ to anyone but the RFQ requester.

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

    The Commission believes, in response to commenters' concerns about

    increased trading costs, that an increased number of participants

    receiving and responding to RFQs will tighten the bid-ask spreads, and

    result in lower transaction costs for market participants. The

    Commission notes that the relationship between spreads and the industry

    practice for the minimum number of RFQ recipients will vary across

    swaps and over time. Further, the Commission believes that as SEFs

    compete to grow their swaps trading volumes and deliver improved

    liquidity and lower transaction costs for their customers, the final

    rules in this release will provide them with the flexibility to

    experiment with different minimum numbers of recipients that is higher

    than the minimum articulated in this regulation. The final RFQ

    requirement will provide some protection to RFQ requesters that at

    least a minimum number of market participants will receive their RFQs,

    and thus increase the likelihood of receiving multiple, competitive

    quotes.

    Finally, the Commission is deleting the additional definition of

    RFQ System in proposed Sec. 37.9(a)(1)(ii)(B) because it is

    unnecessary.\284\ A SEF that chooses to offer an RFQ System to

    facilitate Required Transactions is required to offer the RFQ System in

    conjunction with the SEF's Order Book, which would encompass the

    requirements in proposed Sec. 37.9(a)(1)(ii)(B)(1) and

    [[Page 33499]]

    (2)(i).\285\ Additionally, a market participant is already required to

    send an RFQ to three market participants, which would also be the case

    if it is based upon an indicative quote as stated in proposed Sec.

    37.9(a)(1)(ii)(B)(2)(ii).\286\

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

    \284\ The Commission is also deleting the catch-all RFQ

    definition in proposed Sec. 37.9(a)(1)(ii)(C) as it is unnecessary.

    As discussed below, a SEF may petition the Commission under Sec.

    13.2 to amend Sec. 37.9(a)(2) to include additional execution

    methods for Required Transactions. See discussion below under Sec.

    37.9(b)(1) and (b)(4)--Execution Methods for Required Transactions

    in the preamble.

    \285\ See discussion below under Sec. 37.9(b)(1) and (b)(4)--

    Execution Methods for Required Transactions in the preamble. As

    noted above in the registration section, a SEF is not required to

    offer indicative quotes.

    \286\ Id.

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

    (ii) ``Taken Into Account and Communicated'' Language in the RFQ System

    Definition

    To address commenters' concern that the SEF NPRM was ambiguous with

    respect to the communication requirement, the Commission is modifying

    the definition of RFQ System in proposed Sec. 37.9(a)(1)(ii)(A) to

    state that a SEF must provide the RFQ requester: (1) With any firm

    resting bid or offer in the same instrument from any of the SEF's Order

    Books at the same time as the first responsive bid or offer is received

    by the RFQ requester and (2) with the ability to execute against such

    firm resting bids or offers along with the responsive orders.\287\ For

    example, a market participant transmits an RFQ to three market

    participants to buy a US $1 million notional 10-year fixed-to-floating

    US$ LIBOR interest rate swap. Any firm offer resting on the SEF's Order

    Book for a 10-year fixed-to-floating US$ LIBOR interest rate swap must

    be transmitted to the RFQ requester at the same time that the first

    responsive offer is received by the RFQ requester. The SEF must provide

    the RFQ requester with the ability to lift the firm offers and execute

    against any of the responsive orders. The final rule requires that SEFs

    communicate any resting bid or offer pertaining to the same instrument

    back to the RFQ requester, while the requester retains the discretion

    to decide whether to execute against the resting bids or offers or

    responsive orders.

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

    \287\ The Commission is renumbering proposed Sec.

    37.9(a)(1)(ii)(A) to Sec. 37.9(a)(3). The Commission notes that

    after the RFQ responses and resting bids or offers on the Order Book

    are communicated to the RFQ requester, the RFQ requester may make a

    counter request or order as long as it is submitted to 3 market

    participants, whether it be to the same 3 market participants as the

    original RFQ request, 3 different market participants, or some

    combination of both.

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

    Similar to the three market participant requirement, the Commission

    believes that the communication requirement promotes pre-trade price

    transparency and the trading of swaps on SEFs, as the RFQ requester

    will have the ability to access competitive quotes and quote providers

    will be able to have their quotes viewed by the RFQ requester. The

    Commission also clarifies that the resting bids and offers being

    communicated are not required to include indicative prices, to the

    extent that indicative prices are facilitated by the Order Book, and

    that SEFs are not required to inform the providers of the resting bids

    and offers on the Order Book of the RFQs.

    (iii) RFQ Disclosure Issues

    The Commission is clarifying that SEFs are not required to disclose

    responses to RFQs to all market participants. While the Commission

    understands that the RFQ functionality offered by some DCMs

    disseminates responses to RFQs to all market participants, it also

    notes that the less restrictive disclosure requirement for SEFs

    reflects the more flexible statutory provisions for SEFs as compared to

    DCMs. As noted in the SEF NPRM, a market participant may access fewer

    market participants than the entire market in certain situations.\288\

    In response to FSR's and Tradeweb's comments about the identity of the

    RFQ requester, the Commission clarifies that it is not imposing a

    specific requirement that the identity of the RFQ requester be

    disclosed or anonymous. The Commission is also not providing a specific

    requirement regarding the publishing of the ``request'' for a quote and

    notes that SEFs must comply with all reporting obligations as required

    in the Act and Commission's regulations. Finally, as noted in the SEF

    NPRM, acceptable RFQ Systems must permit RFQ requesters the option to

    make an RFQ visible to the entire market.\289\

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

    \288\ Core Principles and Other Requirements for Swap Execution

    Facilities, 76 FR at 1220 (stating that market participants may

    desire to interact with a limited number of market participants

    (i.e., fewer than the entire market) and are permitted to do so

    under the proposal).

    \289\ Id.

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

    (iv) Other RFQ Issues

    As noted in the SEF NPRM, an acceptable RFQ System may allow for a

    transaction to be consummated if the original request to five potential

    counterparties receives fewer than five responses.\290\ Although the

    Commission received no comment letters on this issue, some commenters

    in meetings asked the Commission to clarify the amount of time required

    to elapse before the RFQ requester can execute against the responsive

    quotes since fewer than five responses may be received. As such, the

    Commission is modifying the RFQ System definition in final Sec.

    37.9(a)(3) to state that a SEF must ensure that its trading protocols

    provide each of its market participants with equal priority in

    receiving requests for quotes and in transmitting and displaying for

    execution responsive orders. The SEF does not need to establish a

    minimum latency or specific period of time for the transmission of

    responsive orders, provided that the SEF's rulebook and prohibition on

    transmission and display priorities are appropriately designed to

    prevent market participants from seeking to avoid the three market

    participant requirement. A SEF's RFQ System and rulebook must account

    for this prohibition.

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

    \290\ Id.

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

    (c) Sec. 37.9(a)(1)(iii)--Voice-Based System

    Proposed Sec. 37.9(a)(1)(iii) defined Voice-Based System as a

    trading system or platform in which a market participant executes or

    trades a Permitted Transaction using a telephonic line or other voice-

    based service.

    (1) Commission Determination

    The Commission did not receive any comments on the definition of

    Voice-Based System. However, the Commission is deleting the definition

    of Voice-Based System in proposed Sec. 37.9(a)(1)(iii) given its

    decision below to allow SEFs to provide any execution method for

    Permitted Transactions.

    (d) Sec. Sec. 37.9(b)(1) and (b)(4)--Execution Methods for Required

    Transactions

    Proposed Sec. 37.9(b)(1) stated that Required Transactions may be

    executed on an Order Book or an RFQ System. As noted in the SEF NPRM, a

    SEF must offer the minimum trading functionality in proposed Sec.

    37.9(b)(2) (i.e., a centralized electronic screen with the ability to

    post both firm and indicative quotes visible to all market

    participants).\291\ Therefore, the SEF NPRM provided that Required

    Transactions must be executed through the SEF's minimum trading

    functionality, Order Book that meets the minimum trading functionality,

    or RFQ System that operates in conjunction with the minimum trading

    functionality.\292\ The SEF NPRM made it clear that for Required

    Transactions, pre-trade transparency must be met.\293\ Additionally,

    proposed Sec. 37.9(b)(4) stated that the Commission may, in its

    discretion, require a SEF to offer a different trading method for a

    particular swap.

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

    \291\ Id. at 1219-20.

    \292\ Id.

    \293\ Id. at 1220.

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

    For Required Transactions, the SEF NPRM did not provide for a

    specific

    [[Page 33500]]

    execution method incorporating voice. The proposal stated that trading

    systems or platforms facilitating the execution of Required

    Transactions via voice exclusively are not multiple participant to

    multiple participant and do not provide for pre-trade price

    transparency.\294\ However, the SEF NPRM noted that, while not

    acceptable as the sole method of execution for Required Transactions,

    voice would be appropriate under certain circumstances such as for a

    market participant to communicate an order to a SEF's employee or for a

    SEF's employee to assist a market participant in executing a

    trade.\295\ The SEF NPRM stated that the core principles and the

    Commission's regulations would fully apply to such communications,

    including, but not limited to, transparency, audit trail, impartial

    access, and standards for RFQs.\296\

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

    \294\ Id. at 1221.

    \295\ Id.

    \296\ Id.

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

    Although the SEF NPRM did not provide for a specific execution

    method incorporating voice for Required Transactions, it did

    contemplate the possibility of certain functionalities that operate in

    conjunction with the SEF's minimum trading functionality.\297\ In this

    regard, the SEF NPRM stated that, in addition to the SEF's minimum

    trading functionality, a SEF may offer other functionalities that

    provide multiple participants with the ability to access multiple

    participants, but not necessarily the entire market, if the market

    participant so chooses.\298\ The SEF NPRM noted that certain defined

    RFQ Systems or other systems that meet the SEF definition and comply

    with the core principles applicable to SEFs may qualify.\299\

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

    \297\ Id. at 1220.

    \298\ Id.

    \299\ Id.

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

    (1) Summary of Comments

    (i) Comments on Execution Methods for Required Transactions

    Some commenters supported the use of order books for Required

    Transactions.\300\ For example, Mallers et al. contended that a central

    order book market structure for all Required Transactions provides the

    most accurate valuation of the market, reduces systemic risks, and

    results in better prices.\301\ Other commenters supported the use of

    order book structures and RFQ models for Required Transactions.\302\

    SDMA, for example, stated that all cleared swaps should be executed

    through a central limit order book or an RFQ System.\303\

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

    \300\ Mallers et al. Comment Letter at 3 (Mar. 21, 2011); Better

    Markets Comment Letter at 5-6 (Mar. 8, 2011); AFR Comment Letter at

    4 (Mar. 8, 2011). Similarly, SDMA supports the sole use of order

    books for certain products. SDMA Comment Letter at 2 (Apr. 30,

    2013).

    \301\ Mallers et al. Comment Letter at 3 (Mar. 21, 2011).

    \302\ Tradeweb Comment Letter at 4 (Jun. 3, 2011); SDMA Comment

    Letter at 2 (Mar. 8, 2011); Deutsche Comment Letter at 3 (Mar. 8,

    2011); MFA Comment Letter at 5-6 (Mar. 8, 2011); MetLife Comment

    Letter at 2 (Mar. 8, 2011); Barclays Comment Letter at 4 (Mar. 8,

    2011); Bloomberg Comment Letter at 2 (Mar. 8, 2011); BlackRock

    Comment Letter at 4-5 (Mar. 8, 2011).

    \303\ SDMA Comment Letter at 2 (Mar. 8, 2011).

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

    Nodal recommended that the Commission explicitly include blind

    auctions as an acceptable method of execution for Required

    Transactions.\304\ Nodal commented \305\ that pre-trade transparency

    for Required Transactions should not apply to blind auctions.\306\

    Nodal articulated its view that the twin goals of pre-trade

    transparency and promoting on-exchange trading of swaps on SEFs should

    be balanced against each other, instead of being read in conjunction

    with one another.\307\

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

    \304\ Nodal Comment Letter at 3 (Mar. 8, 2011).

    \305\ Id. at 2-3; Nodal Comment Letter at 3 (Jun. 3, 2011).

    \306\ See discussion above under Sec. 37.3--Requirements for

    Registration in the preamble for a description of Nodal's blind

    auction.

    \307\ Nodal Comment Letter at 2 (Mar. 8, 2011).

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

    (ii) Comments on ``Through Any Means of Interstate Commerce'' Language

    in the SEF Definition

    Given the phrase ``through any means of interstate commerce'' in

    the CEA section 1a(50) SEF definition, many commenters supported the

    use of multiple methods of execution, such as voice, for Required

    Transactions on a SEF.\308\ JP Morgan, for example, stated that the SEF

    NPRM assumes that SEFs will always be electronic platforms, which it

    contended, appears to directly contradict the phrase ``through any

    means of interstate commerce'' in the SEF definition.\309\ According to

    WMBAA, the phrase ``through any means of interstate commerce'' in the

    SEF definition supports multiple methods of execution for Required

    Transactions on a SEF, including a combination of voice and electronic

    systems.\310\ In this regard, WMBAA stated that the Commission should

    allow any execution method for Required Transactions as long as it

    meets the multiple participant to multiple participant requirement in

    the SEF definition and the other statutory requirements for SEFs.\311\

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

    \308\ Representative Scott Garrett Comment Letter at 1 (Feb. 27,

    2013); WMBAA Comment Letter at 2-3 (Jul. 18, 2011); WMBAA Comment

    Letter at 6-8 (Jun. 3, 2011); Rosen et al. Comment Letter at 15

    (Apr. 5, 2011); JP Morgan Comment Letter at 6 (Mar. 8, 2011); WMBAA

    Comment Letter at 4-6 (Mar. 8, 2011); ICAP Comment Letter at 3, 4-5

    (Mar. 8, 2011); ISDA/SIFMA Comment Letter at 4-5 (Mar. 8, 2011); CME

    Comment Letter at 7-8 (Mar. 8, 2011).

    \309\ JP Morgan Comment Letter at 6 (Mar. 8, 2011).

    \310\ WMBAA Comment Letter at 2 (Jul. 18, 2011).

    \311\ WMBAA Comment Letter at 5 (Mar. 8, 2011).

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

    Furthermore, some members of the industry requested that the

    Commission clarify in the final rules whether ``work-up'' sessions

    would be considered an acceptable method of execution for Required

    Transactions.\312\ GFI explained one example of a work-up session

    where, after a trade is executed on an order book, one of the

    counterparties to the trade may wish to buy or sell additional

    quantities of the same instrument at the previously executed

    price.\313\ In this case, the parties initiate a work-up session to

    execute such additional quantity.\314\ After the initial counterparty

    exercises its right of first refusal, other market participants may

    also join in the trade at the previously executed price.\315\

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

    \312\ Meetings with ICAP dated Mar. 21, 2012, Mar. 9, 2012, Feb.

    16, 2012, Feb. 14, 2012; Meetings with GFI dated Mar. 14, 2012, Feb.

    16, 2012; Meeting with WMBAA dated Feb. 16, 2012; ICAP Comment

    Letter at 4 (Mar. 8, 2011).

    \313\ Meetings with GFI dated Mar. 14, 2012, Feb. 16, 2012.

    \314\ Id.

    \315\ Id.

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

    (iii) Comments on Liquidity-Based Execution Mandates

    Several commenters stated that the Dodd-Frank Act does not require

    certain methods of trading, such as an order book, based upon the

    amount of trading activity in a particular instrument.\316\ MarketAxess

    contended that nothing in the Dodd-Frank Act supports the requirement

    in proposed Sec. 37.9(b)(4) that methods of execution on a SEF should

    be based upon characteristics of a particular swap.\317\ MarketAxess

    stated that such a requirement would create uncertainty regarding a

    SEF's operational structure \318\ and, according to Tradeweb, would

    likely decrease the trading activity and liquidity of those swaps

    subject to the requirement.\319\ On the other hand, AFR contended that

    mandatorily cleared swaps meeting a certain level of trading activity

    should

    [[Page 33501]]

    only be traded through order book systems.\320\

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

    \316\ Rosen et al. Comment Letter at 10 (Apr. 5, 2011); Barclays

    Comment Letter at 11 (Mar. 8, 2011); ISDA/SFMA Comment Letter at 5

    (Mar. 8, 2011); Tradeweb Comment Letter at 6 (Mar. 8, 2011);

    MarketAxess Comment Letter at 33 (Mar. 8, 2011).

    \317\ MarketAxess Comment Letter at 33 (Mar. 8, 2011).

    \318\ Id.

    \319\ Tradeweb Comment Letter at 6 (Mar. 8, 2011).

    \320\ AFR Comment Letter at 5-6 (Mar. 8, 2011).

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

    (2) Commission Determination

    (i) Execution Methods for Required Transactions

    The Commission is revising proposed Sec. 37.9(b)(1) as final Sec.

    37.9(a)(2) to clarify that each Required Transaction that is not a

    block trade as defined in Sec. 43.2 of the Commission's regulations

    shall be executed on a SEF in accordance with one of the following

    methods of execution: (1) An Order Book as defined in Sec. 37.3(a)(3)

    or (2) an RFQ System, as defined in Sec. 37.9(a)(3), that operates in

    conjunction with an Order Book.\321\ As explained in this final

    rulemaking, the Commission believes that these execution methods are

    consistent with the SEF definition and promote the goals provided in

    section 733 of the Dodd-Frank Act. The Commission notes, however, that

    a SEF may petition the Commission under Sec. 13.2 of the Commission's

    regulations to amend Sec. 37.9(a)(2) to include additional execution

    methods.\322\ This ability of SEFs to petition the Commission replaces

    similar provisions in the SEF NPRM that were included in the Order Book

    and RFQ System definitions and provides SEFs with additional

    flexibility as existing execution methods evolve or new methods are

    developed.\323\

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

    \321\ The Commission is renumbering proposed Sec. 37.9(b)(1) to

    Sec. 37.9(a)(2).

    \322\ See 17 CFR 13.2 for further details. This will allow the

    Commission to consider if a broader model for executing on SEFs,

    consistent with the suggestion in Commissioner Sommers' dissent,

    would be appropriate on a case-by-case basis, in conformance with

    the CEA and the Commission's regulations. Core Principles and Other

    Requirements for Swap Execution Facilities, 76 FR at 1259.

    \323\ See proposed Sec. 37.9(a)(1)(i)(D) and Sec.

    37.9(a)(1)(ii)(C).

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

    In keeping with the statutory instruction that the Dodd-Frank Act

    goal of SEFs is to both ``promote the trading of swaps on swap

    execution facilities and to promote pre-trade price transparency in the

    swaps market'' \324\ (emphasis added), the Commission is reaffirming

    its view articulated in the SEF NPRM that these goals can be achieved

    for Required Transactions by providing for the execution of such

    transactions on trading systems or platforms that allow market

    participants to post bids and offers or accept bids and offers that are

    transparent to the entire market.\325\ Promoting trading on a SEF

    should not result in eliminating the need to provide some degree of

    pre-trade transparency. Therefore, even when recognizing the importance

    of promoting the trading of swaps on SEFs, some degree of pre-trade

    transparency must be met for Required Transactions.\326\ As a result,

    the Commission is declining to accept Nodal's recommendation to

    explicitly include blind auctions as an acceptable method of execution

    for Required Transactions under this rulemaking.\327\

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

    \324\ CEA section 5h(e); 7 U.S.C. 7b-3(e) (emphasis added).

    \325\ Core Principles and Other Requirements for Swap Execution

    Facilities, 76 FR at 1220.

    \326\ The Commission notes below that pre-trade transparency can

    help promote the trading of swaps on SEFs. See the Introduction

    section of the Cost Benefit Considerations section for further

    details.

    \327\ The Commission further notes that this determination does

    not accept Nodal's assertion that ``this type of blind auction

    trading platform is permissible on DCMs.'' See Nodal Comment Letter

    at 3 (Mar. 8, 2011).

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

    (ii) ``Through Any Means of Interstate Commerce'' Language in the SEF

    Definition

    In consideration of the comments regarding possible limitations on

    how the Commission interprets the phrase ``through any means of

    interstate commerce'' in the SEF definition, the Commission is revising

    the final rule text to clarify that in providing either one of the

    execution methods for Required Transactions in Sec. 37.9(a)(2)(i)(A)

    or (B) of this final rulemaking (i.e., Order Book or RFQ System that

    operates in conjunction with an Order Book), a SEF may for purposes of

    execution and communication use ``any means of interstate commerce,''

    including, but not limited to, the mail, internet, email, and

    telephone, provided that the chosen execution method satisfies the

    requirements provided in Sec. 37.3(a)(3) for Order Books or in Sec.

    37.9(a)(3) for Request for Quote Systems.\328\ With this use of the

    phrase ``any means of interstate commerce,'' the Commission is not

    limiting the means of execution or communication that a SEF may utilize

    in implementing the required execution methods for Required

    Transactions in Sec. 37.9(a)(2)(i)(A) or (B), provided that the chosen

    execution method satisfies the requirements provided in Sec.

    37.3(a)(3) for Order Books or in Sec. 37.9(a)(3) for Request for Quote

    Systems. In this regard, the Commission notes that as the swaps market

    evolves, SEFs may develop new means of execution or communication for

    use in implementing the required execution methods. Although the

    Commission notes that its regulations are technology neutral given the

    ``any means of interstate commerce'' language, it also emphasizes that,

    regardless of the means of interstate commerce utilized, a SEF must

    comply with the Act and the Commission's regulations, including the

    Sec. 37.9 execution method, impartial access, audit trail, and

    surveillance requirements. Furthermore, all transactions on the SEF

    must comply with the SEF's rules.

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

    \328\ The Commission interprets the phrase ``through any means

    of interstate commerce'' in CEA Sec. 1a(50) to allow a SEF to

    utilize a variety of means of execution or communication, including,

    but not limited to, telephones, internet communications, and

    electronic transmissions. Overstreet v. North Shore Corp., 318 U.S.

    125, 129-30 (1943) (in general, ``instrument'' of interstate

    commerce is to be interpreted broadly); United States v. Barlow, 568

    F.3d 215, 220 (5th Cir. 2009) (``It is beyond debate that internet

    and email are facilities or means of interstate commerce.''); United

    States v. Weathers, 169 F.3d 336, 341 (6th Cir. 2000) (``It is

    generally well established that telephones, even when used

    intrastate, constitute instrumentalities of interstate commerce.'');

    SEC v. Solucorp Indus., 274 F.Supp.2d 379, 419 (S.D.N.Y. 2003)

    (defendants ``used the means and instrumentalities of interstate

    commerce, including, among other things, the mails and wires,

    including the Internet, news wires and telephone lines'' to commit

    securities fraud). While the Commission's interpretation of ``any

    means of interstate commerce'' allows a SEF to utilize a wide

    variety of execution or communication means, all SEFs, regardless of

    the execution or communication means they employ, must comply with

    all of the substantive SEF requirements, including, but not limited

    to, requirements that pertain to execution. For example, a SEF using

    the telephone to execute Required Transactions must satisfy the

    execution requirements set forth in Sec. 37.9(a)(2)(i)(A) or (B).

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

    For example, to meet the RFQ System definition for Required

    Transactions, a SEF must satisfy all of the following functions, and in

    doing so, all or some of these functions may be performed over the

    telephone: (1) Receiving a request from a market participant to execute

    a trade, (2) submitting that request to at least 3 market participants

    in accordance with the RFQ System definition, (3) communicating the RFQ

    responses and resting bids or offers on the Order Book to the RFQ

    requester, and (4) executing the transaction. The Commission notes that

    regardless of the means of interstate commerce utilized, including the

    telephone, the SEF must submit the transaction into its system or

    platform so that the SEF is able to comply with the Act and the

    Commission's regulations, including audit trail, clearing, and

    reporting requirements. Given the different means of interstate

    commerce that a SEF may utilize for purposes of communication and

    execution in implementing the execution methods for Required

    Transactions in Sec. 37.9(a)(2)(i)(A) or (B), the Commission notes

    that it must evaluate each system or platform to determine whether it

    meets the requirements of Sec. 37.9(a)(2).

    The Commission, in order to provide further clarity regarding the

    means of

    [[Page 33502]]

    interstate commerce that a SEF may utilize in order to satisfy the

    execution methods for Required Transactions in Sec. 37.9(a)(2), is

    providing the following example, which the Commission intends to be

    instructive, though not comprehensive. The Commission emphasizes that

    the following example should not be construed as bright-line rules:

    RFQ System example--a market participant calls an employee

    of the SEF with a request for a quote to buy or sell a swap subject to

    the trade execution requirement in CEA section 2(h)(8). The SEF

    employee disseminates the request for a quote to no less than three

    market participants on the SEF (directly or through other SEF employees

    or both) by telephone, email, instant messaging, squawk box, some other

    means of communication, or some combination thereof. Based on the

    responses of these market participants, the SEF employee communicates

    the responsive bids or offers and the resting bids or offers on the

    SEF's Order Book \329\ to the RFQ requester by one of the above

    referenced means of communication. The RFQ requester communicates

    acceptance of one of the bids or offers to the SEF employee by one of

    the above referenced means of communication. The SEF employee informs

    those two market participants by one of the above referenced means of

    communication that the swap transaction is executed. The SEF employee

    enters the transaction into the SEF's system or platform so that the

    SEF is able to comply with the Act and the Commission's regulations,

    including audit trail, clearing, and reporting requirements. The

    Commission views this example as demonstrating acceptable uses of

    different means of interstate commerce while meeting the RFQ System

    method of execution in Sec. 37.9(a)(2).

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

    \329\ See final Sec. 37.9(a)(3) and the preamble for details

    regarding the communication of the resting bids or offers on the

    Order Book to the RFQ requester.

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

    In response to commenters, the Commission will generally allow

    work-up sessions if such trading protocols are utilized after a

    transaction is executed on the SEF's Order Book or RFQ System.\330\ The

    Commission, in order to provide further clarity regarding work-up

    sessions, is providing the following two examples, which the Commission

    intends to be instructive, though not comprehensive. The Commission

    notes that the following examples are two types of work-up session that

    may be acceptable:

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

    \330\ The Commission notes that a work-up transaction does not

    qualify as a block trade even if an individual market participant's

    transactions as part of the work-up transaction has a notional or

    principal amount at or above the appropriate minimum block size

    applicable to such swap. The Commission believes that the concepts

    of work-up transactions and block trades are mutually exclusive.

    Block trades are executed pursuant to a SEF's rules, but negotiated

    and executed off of the SEF's trading platform. A work-up

    transaction is conducted on a SEF's trading platform. See block

    trade definition in Sec. 43.2 of the Commission's regulations; see

    also Rules Prohibiting the Aggregation of Orders To Satisfy Minimum

    Block Sizes or Cap Size Requirements, and Establishing Eligibility

    Requirements for Parties to Block Trades, 77 FR 38229 (proposed Jun.

    27, 2012). Accordingly, each individual transaction that is part of

    the work-up transaction must be reported as it occurs pursuant to

    the SEF's reporting obligations.

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

    After two counterparties execute a transaction on a SEF's

    Order Book, the SEF may establish a short time period for a work-up

    session. The SEF must open up the work-up session to all market

    participants so that they may trade an additional quantity of the same

    instrument at the same price previously executed by the initial

    counterparties. In addition, any resting bids or offers on the SEF's

    Order Book equal to or better than the work-up session price must be

    included in the work-up session.\331\ The SEF may provide the initial

    counterparties execution priority in the work-up session.

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

    \331\ These resting bids or offers would be included at the

    work-up session price. The Commission notes that ``equal to or

    better than the work-up session price'' means any resting bids that

    are equal to or greater than the work-up price or any resting offers

    that are equal to or less than the work-up price.

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

    After two counterparties execute a transaction on a SEF's

    RFQ System, the SEF may establish a short time period for a work-up

    session. The SEF must open up the work-up session to all market

    participants so that they may trade an additional quantity of the same

    instrument at the same price previously executed by the initial

    counterparties. In addition, any resting bids or offers on the SEF's

    Order Book equal to or better than the work-up session price must be

    included in the work-up session.\332\ The SEF may provide the initial

    counterparties execution priority in the work-up session.

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

    \332\ Id.

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

    The SEF must have rules governing the operation of any work-up

    mechanism, including the length of the session, any priorities accorded

    the counterparties to the transaction that triggered the work-up

    session, and the handling of any orders submitted during the session

    that are not executed. A SEF must also have systems or procedures in

    place to ensure that a work-up session is accessible by, and work-up

    session information (e.g., the work-up session's trade price and

    ongoing volume) is available to, all market participants. The

    Commission believes that, if properly conducted, work-up sessions may

    enhance price discovery and foster liquidity.

    The Commission believes that a work-up session would be a trading

    protocol and, thus, constitute a rule under Sec. 40.1 of the

    Commission's regulations. Any such rule or amendment thereto must be

    codified and included in a SEF's rulebook in accordance with the rule

    review or approval procedures of part 40 of the Commission's

    regulations or during the SEF application process. Additionally, all

    transactions executed through a work-up session must comply with the

    SEF's rules. The Commission staff will provide informal guidance to SEF

    applicants on whether such work-up sessions are in compliance with the

    Act and the Commission's regulations.

    (iii) Liquidity-Based Execution Mandates

    The Commission is deleting proposed Sec. 37.9(b)(4). Given the

    incipience of the regulated swaps market, at this time, the Commission

    is not imposing a requirement for specific methods of execution for

    Required Transactions based upon the amount of trading activity in such

    transactions.

    (e) Sec. 37.9(b)(3)--Time Delay Requirement

    Proposed Sec. 37.9(b)(3) stated that SEFs must require that

    traders who have the ability to execute against a customer's order or

    to execute two customers against each other be subject to a 15-second

    timing delay between the entry of the two orders, such that one side of

    the potential transaction is disclosed and made available to other

    market participants before the second side of the potential transaction

    (whether for the trader's own account or for a second customer) is

    submitted for execution. The SEF NPRM stated that this requirement will

    provide other market participants the opportunity to join in the

    trade.\333\

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

    \333\ Core Principles and Other Requirements for Swap Execution

    Facilities, 76 FR at 1220.

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

    (1) Summary of Comments

    SDMA and Mallers et al. supported the proposed 15-second delay

    requirement as necessary to increase price transparency and market

    integrity.\334\ Mallers et al. stated that the 15-second rule provides

    a meaningful opportunity for other SEF participants to execute against

    the individual sides of the cross transaction, and that such crossing

    delays have been successfully

    [[Page 33503]]

    implemented in the futures markets.\335\ However, several commenters

    objected to the 15-second delay requirement.\336\ Some commenters

    stated that there is no statutory authority for the timing delay

    requirement.\337\ Commenters also stated that the timing delay will

    increase prices and expose traders to market risk.\338\ Freddie Mac,

    for example, stated that liquidity providers may increase prices to

    account for anticipated market movements.\339\ Some commenters also

    noted that the timing delay requirement may lead to unwillingness on

    the part of dealers to provide liquidity because they will not know

    whether they will ultimately serve as their customers' principal

    counterparty or merely as their executing agent.\340\

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

    \334\ Mallers et al. Comment Letter at 5 (Mar. 21, 2011); SDMA

    Comment Letter at 4 (Mar. 8, 2011).

    \335\ Mallers et al. Comment Letter at 5 (Mar. 21, 2011).

    \336\ WMBAA Comment Letter at 3 (Jul. 18, 2011); FHLB Comment

    Letter at 13 (Jun. 3, 2011); WMBAA Comment Letter at 9 (Jun. 3,

    2011); Rosen et al. Comment Letter at 15-16 (Apr. 5, 2011);

    BlackRock Comment Letter at 6 (Mar. 8, 2011); Global FX Comment

    Letter at 3-4 (Mar. 8, 2011); JP Morgan Comment Letter at 7 (Mar. 8,

    2011); Evolution Comment Letter at 6 (Mar. 8, 2011); WMBAA Comment

    Letter at 7 (Mar. 8, 2011); SIFMA AMG Comment Letter at 7 (Mar. 8,

    2011); TruMarx Comment Letter at 7 (Mar. 8, 2011); Deutsche Comment

    Letter at 5 (Mar. 8, 2011); FCC Comment Letter at 2 (Mar. 8, 2011);

    Phoenix Comment Letter at 2-3 (Mar. 7, 2011).

    \337\ WMBAA Comment Letter at 3 (Jul. 18, 2011); WMBAA Comment

    Letter at 9 (Jun. 3, 2011); WMBAA Comment Letter at 7 (Mar. 8,

    2011); SIFMA AMG Comment Letter at 8 (Mar. 8, 2011); Deutsche

    Comment Letter at 5 (Mar. 8, 2011); MFA Comment Letter at 8 (Mar. 8,

    2011).

    \338\ FHLB Comment Letter at 13 (Jun. 3, 2011); BlackRock

    Comment Letter at 6 (Mar. 8, 2011); WMBAA Comment Letter at 7-8

    (Mar. 8, 2011); SIFMA AMG Comment Letter at 7 (Mar. 8, 2011); FCC

    Comment Letter at 2 (Mar. 8, 2011).

    \339\ Freddie Mac Comment Letter at 3 (Mar. 8, 2011).

    \340\ WMBAA Comment Letter at 9 (Jun. 3, 2011); BlackRock

    Comment Letter at 6 (Mar. 8, 2011); MFA Comment Letter at 9 (Mar. 8,

    2011); Phoenix Comment Letter at 3 (Mar. 7, 2011).

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

    ABC/CIEBA commented that the proposed rule is unclear as to what

    limitations, if any, apply to pre-execution communications.\341\ ABC/

    CIEBA recommended that the Commission revise the proposed rule to

    permit pre-execution communications between counterparties as long as

    parties comply with the requirement to execute the trade on the

    SEF.\342\

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

    \341\ ABC/CIEBA Comment Letter at 9 (Mar. 8, 2011).

    \342\ Id. at 10.

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

    Several commenters recommended that the Commission provide

    flexibility with respect to the time period of the timing delay.\343\

    Goldman recommended that the Commission, in consultation with market

    participants and SEFs, set the delay at 1-3 seconds depending on the

    complexity of the product.\344\ FXall stated that each SEF should be

    able to decide upon the appropriate delay, taking into account the

    particular characteristics of that market.\345\

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

    \343\ Reuters Comment Letter at 5 (Dec. 12, 2011); Goldman

    Comment Letter at 3 (Mar. 8, 2011); ISDA/SIFMA Comment Letter at 6

    (Mar. 8, 2011); FXall Comment Letter at 10 (Mar. 8, 2011); MFA

    Comment Letter at 8-9 (Mar. 8, 2011).

    \344\ Goldman Comment Letter at 3 (Mar. 8, 2011).

    \345\ FXall Comment Letter at 10 (Mar. 8, 2011).

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

    Several commenters requested clarification that the 15-second delay

    requirement only applies to SEFs that operate an Order Book and not an

    RFQ System.\346\ In this regard, SIFMA AMG commented that the timing

    delay should not apply to an RFQ System because firm quotes transmitted

    in response to an RFQ would already be exposed to the market.\347\

    However, Better Markets contended that the requirement should apply to

    responsive orders in RFQ systems.\348\

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

    \346\ Reuters Comment Letter at 5 (Dec. 12, 2011); Rosen et al.

    Comment Letter at 15-16 (Apr. 5, 2011); Goldman Comment Letter at 3

    (Mar. 8, 2011); Global FX Comment Letter at 3-4 (Mar. 8, 2011);

    ISDA/SIFMA Comment Letter at 6 (Mar. 8, 2011); Barclays Comment

    Letter at 9 (Mar. 8, 2011); FSR Comment Letter at 7 (Mar. 8, 2011).

    \347\ SIFMA AMG Comment Letter at 7 (Mar. 8, 2011).

    \348\ Better Markets Comment Letter at 9 (Mar. 8, 2011).

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

    Finally, some commenters requested that the Commission clarify the

    term ``trader'' in the proposed rule.\349\ WMBAA stated that it is not

    clear whether the term ``trader'' refers to a counterparty, broker, or

    another entity.\350\ SIFMA AMG noted that the timing delay should not

    apply to asset managers executing trades on behalf of their

    clients.\351\

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

    \349\ WMBAA Comment Letter at 7 (Mar. 8, 2011); SIFMA AMG

    Comment Letter at 8 (Mar. 8, 2011); FSR Comment Letter at 6-7 (Mar.

    8, 2011).

    \350\ WMBAA Comment Letter at 7 (Mar. 8, 2011).

    \351\ SIFMA AMG Comment Letter at 8 (Mar. 8, 2011).

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

    (2) Commission Determination

    The Commission is adopting the time delay requirement for Required

    Transactions in proposed Sec. 37.9(b)(3) as final Sec. 37.9(b)(1),

    subject to the modifications described below.\352\ The Commission

    clarifies that the purpose of the time delay requirement is to ensure a

    minimum level of pre-trade price transparency for Required Transactions

    on a SEF's Order Book by allowing other market participants the

    opportunity to join or participate in a trade where a broker or dealer

    engages in some form of pre-arrangement or pre-negotiation of a

    transaction and then attempts, through the SEF's Order Book, to either

    internalize the order by executing opposite a customer or cross two

    customer orders.\353\ In addition to ensuring a minimum level of pre-

    trade price transparency, the Commission believes that the time delay

    requirement will incentivize competition between market

    participants.\354\ The Commission is revising proposed Sec. 37.9(b)(3)

    to clarify the purpose of the time delay requirement as described

    above.

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

    \352\ The Commission is renumbering proposed Sec. 37.9(b)(3) to

    Sec. 37.9(b)(1).

    \353\ The Commission clarifies that the exposure of ``orders''

    subject to the 15 second time delay into the Order Book in final

    Sec. 37.9(b)(1) means exposure of the price, size, and other terms

    of the orders.

    \354\ The Commission also notes that the time delay requirement

    is similar to certain timing delays for cross trades applicable to

    futures transactions executed on DCMs where one side of a potential

    transaction (i.e., price, size, and other terms) is exposed to the

    market for a certain period of time before the second side of the

    potential transaction is submitted for execution. See, e.g., NYMEX

    rule 533, which provides for a 5-second delay for futures and a 15-

    second delay for options, available at http://www.cmegroup.com/rulebook/NYMEX/1/5.pdf.

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

    In response to ABC/CEIBA's comment about any limitations on pre-

    execution communications, the Commission notes that a SEF that allows

    pre-execution communications must adopt rules regarding such

    communications that have been certified to or approved by the

    Commission.\355\ The Commission also notes that orders that result from

    pre-execution communications would be subject to the time delay

    requirement in the final rule text. The Commission notes that pre-

    execution communications are communications between market participants

    for the purpose of discerning interest in the execution of a

    transaction prior to the exposure of the market participants' orders

    (i.e., price, size, and other terms) to the market. Any communication

    that involves discussion of the size, side of market, or price of an

    order, or a potentially forthcoming order, constitutes a pre-execution

    communication.

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

    \355\ See, e.g., CME Rule 539.C Pre-Execution Communications

    Regarding Globex Trades, available at http://www.cmegroup.com/rulebook/CME/I/5/39.html (setting forth rules regarding pre-

    execution communications in the DCM context).

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

    The Commission acknowledges commenters' concerns that the time

    delay requirement should take into account a product's characteristics.

    Therefore, the Commission believes that the 15-second time delay

    requirement should serve as a default time delay. The Commission is

    revising the rule to allow SEFs to adjust the time period of the delay,

    based upon liquidity or other product-specific considerations as stated

    in final Sec. 37.9(b)(2). The Commission notes that such adjustments

    and accompanying justifications, as well as any establishment of a 15-

    second time delay requirement at a SEF, must be submitted

    [[Page 33504]]

    for the Commission's review pursuant to the procedures described in

    part 40 of the Commission's regulations.

    The Commission is clarifying that the 15-second time delay

    requirement is not applicable to trades that are executed through an

    RFQ System. As noted above, the purpose of the time delay requirement

    is to ensure a minimum level of pre-trade price transparency for

    Required Transactions on a SEF's Order Book. The Commission notes that

    an RFQ System already provides pre-trade price transparency to the RFQ

    requester and that a dealer attempting to cross or internalize trades

    through an RFQ System would be subject to such pre-trade price

    transparency. As such, the Commission is revising the rule text to

    clarify that the 15-second time delay requirement only applies to a

    SEF's Order Book.

    Finally, the Commission is replacing the term ``traders'' in

    proposed Sec. 37.9(b)(3) with the phrase ``brokers or dealers.'' The

    Commission intended the provision to apply only to brokers or dealers

    attempting to internalize or cross trades through a SEF's Order Book

    and acknowledges that the proposal was unclear with respect to the

    meaning of the term ``traders.'' \356\ In response to SIFMA AMG's

    concern, the Commission does not have sufficient information at this

    time to make a determination whether asset managers executing trades on

    behalf of their clients would be subject to the time delay requirement.

    The Commission staff will work with SEFs to determine if the time delay

    requirement applies to asset managers or other market participants.

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

    \356\ For example, a futures commission merchant or other market

    participant acting in the role of a broker who has the ability to

    execute against its customer's order or to execute two of its

    customers' orders against each other would be subject to the time

    delay requirement.

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

    (f) Sec. 37.9(c)--Execution Methods for Permitted Transactions

    Proposed Sec. 37.9(c)(1) provided that Permitted Transactions may

    be executed by an Order Book, RFQ System, a Voice-Based System, or any

    such other system for trading as may be permitted by the Commission. In

    addition, proposed Sec. 37.9(c)(2) stated that a registered SEF may

    submit a request to the Commission to offer trading services to

    facilitate Permitted Transactions, and that when doing so, the SEF must

    certify its compliance with Sec. 37.11 (Identification of non-cleared

    swaps or swaps not made available to trade). As noted in the SEF NPRM,

    market participants would not be required to utilize the minimum

    trading functionality in Sec. 37.9(b) to execute Permitted

    Transactions.\357\

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

    \357\ The SEF NPRM stated that pre-trade price transparency is

    not required for Permitted Transactions. Core Principles and Other

    Requirements for Swap Execution Facilities, 76 FR at 1220.

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

    (1) Summary of Comments

    SIFMA AMG stated that the Commission should not limit the execution

    modalities available to market participants who execute Permitted

    Transactions on a SEF.\358\ SIFMA AMG also stated that no statutory

    basis exists for regulatory execution requirements for Permitted

    Transactions.\359\ Additionally, several commenters stated that the

    Commission should not prescribe execution methods for swaps executed

    off a SEF.\360\

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

    \358\ SIFMA AMG Comment Letter at 10 (Mar. 8, 2011).

    \359\ Id.

    \360\ Rosen et al. Comment Letter at 19-20 (Apr. 5, 2011);

    Deutsche Comment Letter at 6 (Mar. 8, 2011); FSR Comment Letter at 8

    (Mar. 8, 2011); Global FX Comment Letter at 3 (Mar. 8, 2011);

    Barclays Comment Letter at 10 (Mar. 8, 2011); ABC/CIEBA Comment

    Letter at 7 (Mar. 8, 2011).

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

    (2) Commission Determination

    The Commission is revising proposed Sec. 37.9(c)(1) to state that

    a SEF may offer any method of execution for each Permitted

    Transaction.\361\ The Commission agrees that it should not limit the

    execution methods that are available to market participants or require

    market participants to utilize certain execution methods for Permitted

    Transactions, which are not required to be executed on a SEF. The

    Commission clarifies, however, that, in accordance with the minimum

    trading functionality requirement in final Sec. 37.3(a)(2), a SEF must

    offer an Order Book for Permitted Transactions. The Commission further

    clarifies that a market participant has the option to utilize the Order

    Book or any other method of execution that a SEF provides for Permitted

    Transactions. Additionally, the Commission clarifies that this section

    only applies to Permitted Transactions listed or traded on a SEF, and

    that this section does not apply to transactions not listed or traded

    on a SEF.\362\ Finally, the Commission is deleting proposed Sec.

    37.9(c)(2) given the deletion to proposed Sec. 37.11 as described

    below.

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

    \361\ The Commission is renumbering proposed Sec. 37.9(c)(1) to

    Sec. 37.9(c)(2).

    \362\ This section does not apply to those entities that do not

    have to register as a SEF. As noted above in the registration

    section, swap transactions that are not subject to the CEA section

    2(h)(8) trade execution requirement would not have to be executed on

    a registered SEF.

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

    (g) Future Review

    Consistent with the Commission's practice of reviewing and

    monitoring its regulatory programs, the Commission directs the

    Commission staff to conduct a general review of SEFs' experience with

    the execution methods prescribed in Commission regulations 37.3(a)(2)

    (minimum trading functionality), 37.3(a)(3) (Order Book), and 37.9

    (execution methods for Required and Permitted Transactions and time

    delay requirement for Required Transactions). If appropriate, the

    review should include any Commission staff recommendations regarding

    possible modifications to Commission regulations 37.3(a)(2),

    37.3(a)(3), or 37.9 that are consistent with the Act (e.g., a

    recommendation to modify the minimum number of RFQ requestees required

    by the RFQ definition, including whether a trading protocol in which

    the minimum number of RFQ requestees differed by swap class or another

    category would be appropriate). The Commission staff's review should be

    completed within four years of the effective date of these final SEF

    regulations, within which time the Commission believes that staff will

    have gained sufficient experience and will have three years' worth of

    data with respect to the execution methods.

    10. Sec. 37.10--Swaps Made Available for Trading

    The Dodd-Frank Act added section 2(h)(8) of the CEA to require that

    transactions involving swaps subject to the clearing requirement must

    be executed either on a DCM or SEF, unless no DCM or SEF makes the swap

    ``available to trade'' or the related transaction is subject to the

    clearing exception under section 2(h)(7) (i.e., the end-user

    exception).\363\ In the SEF NPRM, the Commission proposed to require

    SEFs to conduct annual assessments and to submit reports to the

    Commission regarding whether it has made a swap available to

    trade.\364\ In the DCM notice of proposed rulemaking (``NPRM''),\365\

    the Commission did not establish any obligation for DCMs under section

    2(h)(8) of the Act. After reviewing the SEF NPRM comments regarding the

    proposed available to trade process, and in light of the fact that the

    DCM NPRM did not establish any obligation for DCMs under section

    [[Page 33505]]

    2(h)(8) of the CEA, the Commission determined to separately issue a

    further notice of proposed rulemaking to establish a process for a DCM

    or SEF to make a swap available to trade under section 2(h)(8) of the

    Act.\366\ The Commission may implement the available to trade provision

    in a separate rulemaking.

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

    \363\ CEA sections 2(h)(7) and 2(h)(8); 7 U.S.C. 2(h)(7) and

    2(h)(8).

    \364\ Core Principles and Other Requirements for Swap Execution

    Facilities, 76 FR at 1241.

    \365\ Core Principles and Other Requirements for Designated

    Contract Markets, 75 FR 80572 (proposed Dec. 22, 2010).

    \366\ Process for a Designated Contract Market or Swap Execution

    Facility To Make a Swap Available To Trade, 76 FR 77728 (proposed

    Dec. 14, 2011).

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

    11. Sec. 37.11--Identification of Non-Cleared Swaps or Swaps Not Made

    Available to Trade

    Proposed Sec. 37.11 required a SEF that chooses to offer swaps:

    (1) Not subject to the clearing mandate under section 2(h) of the Act,

    (2) that are subject to the end-user exception from the clearing

    mandate under section 2(h)(7) of the Act, or (3) that have not been

    made available to trade pursuant to Sec. 37.10 of the Commission's

    regulations to clearly identify to market participants that the

    particular swap is to be executed bilaterally between the parties

    pursuant to one of the applicable exemptions from execution and

    clearing.

    (a) Summary of Comments

    MarketAxess expressed concern that proposed Sec. 37.11 could be

    read to require that all transactions described in the provision must

    only be executed bilaterally, and not on a SEF.\367\ To address this

    concern, MarketAxess requested the Commission clarify that Sec. 37.11

    requires a SEF choosing to facilitate Permitted Transactions to

    identify to market participants why the particular swap is a Permitted

    Transaction (i.e., falls under one of the three categories described in

    the provision).\368\

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

    \367\ MarketAxess Comment Letter at 33-34 (Mar. 8, 2011).

    \368\ Id. at 34.

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

    (b) Commission Determination

    The Commission believes that proposed Sec. 37.11 is unnecessary

    and therefore is deleting it in its entirety. Market participants

    should have sufficient notice of the swaps subject to the clearing and

    trade execution requirements. Therefore, in conjunction with the

    definitions contained in part 37 as adopted, market participants will

    know which swaps are Required Transactions and which swaps are

    Permitted Transactions, and thus the execution methods deemed

    acceptable for each.

    C. Regulations, Guidance, and Acceptable Practices for Compliance With

    the Core Principles

    As noted above, this final part 37 rulemaking establishes the

    relevant regulations, guidance, and acceptable practices applicable to

    the 15 core principles that SEFs are required to comply with initially

    and on a continuing basis as part of the conditions of registration.

    The regulations applicable to the 15 core principles are set out in

    separate subparts B through P to part 37, which includes a codification

    within each subpart of the statutory language of the respective core

    principle. The guidance and acceptable practices are set out in

    appendix B to part 37.

    1. Subpart B--Core Principle 1 (Compliance With Core Principles)

    Core Principle 1 requires a SEF to comply with the core principles

    set forth in CEA section 5h(f) and any requirement that the Commission

    may impose by rule or regulation pursuant to CEA section 8a(5) as a

    condition of obtaining and maintaining registration as a SEF.\369\

    Additionally, Core Principle 1 provides a SEF with reasonable

    discretion in establishing the manner in which it complies with the

    core principles unless the Commission determines otherwise by rule or

    regulation.\370\ In the SEF NPRM, the Commission proposed to codify the

    statutory text of Core Principle 1 in proposed Sec. 37.100, and adopts

    that rule as proposed.

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

    \369\ CEA section 5h(f)(1)(A); 7 U.S.C. 7b-3(f)(1)(A).

    \370\ CEA section 5h(f)(1)(B); 7 U.S.C. 7b-3(f)(1)(B).

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

    2. Subpart C--Core Principle 2 (Compliance With Rules)

    (a) Sec. 37.200--Core Principle 2--Compliance With Rules

    Core Principle 2 requires a SEF to establish and enforce compliance

    with its rules, including the terms and conditions of the swaps traded

    or processed on or through the SEF and any limitations on access to the

    SEF.\371\ It also requires a SEF to establish and enforce trading,

    trade processing, and participation rules that will deter abuses and

    have the capacity to detect, investigate, and enforce those rules.\372\

    A SEF must also establish rules governing the operation of the

    facility, including rules specifying trading procedures to be used in

    entering and executing orders traded or posted on the facility,

    including block trades.\373\ Finally, Core Principle 2 requires a SEF

    to provide by its rules that when a swap dealer or major swap

    participant enters into or facilitates a swap that is subject to the

    mandatory clearing requirement of section 2(h) of the Act, the swap

    dealer or major swap participant is responsible for complying with the

    mandatory trading requirement under section 2(h)(8) of the Act.\374\ In

    the SEF NPRM, the Commission proposed to codify the statutory text of

    Core Principle 2 in proposed Sec. 37.200, and adopts that rule as

    proposed.

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

    \371\ CEA section 5h(f)(2)(A); 7 U.S.C. 7b-3(f)(2)(A).

    \372\ CEA section 5h(f)(2)(B); 7 U.S.C. 7b-3(f)(2)(B). This

    section also requires a SEF to provide market participants with

    impartial access to the market and to capture information that may

    be used in establishing whether rule violations have occurred.

    \373\ CEA section 5h(f)(2)(C); 7 U.S.C. 7b-3(f)(2)(C).

    \374\ CEA section 5h(f)(2)(D); 7 U.S.C. 7b-3(f)(2)(D).

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

    (1) Summary of Comments

    Some commenters expressed general concerns regarding the proposed

    rules under Core Principle 2.\375\ FXall and State Street believed that

    the proposed rules under Core Principle 2 would require a SEF to act as

    a de facto self-regulatory organization (``SRO'') and impose burdens

    that would impede the growth of the swaps market.\376\ These commenters

    also noted that the proposed requirements were too similar to the

    regulations applicable to DCMs, which would place SEFs at a

    disadvantage compared to DCMs given that SEFs will operate in a

    competitive environment while DCMs operate in a monopolistic

    environment.\377\ ICE urged the Commission to limit its prescriptive

    rulemaking to issues that it believes require specific, binding

    rules.\378\ In this regard, several commenters recommended that the

    Commission adopt greater flexibility in implementing Core Principle

    2.\379\

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

    \375\ FXall Comment Letter at 3-4, 11 (Mar. 8, 2011); State

    Street Comment Letter at 5-6 (Mar. 8, 2011); ICE Comment Letter at 2

    (Mar. 8, 2011); WMBAA Comment Letter at 18 (Mar. 8, 2011).

    \376\ FXall Comment Letter at 3-4, 11 (Mar. 8, 2011); State

    Street Comment Letter at 5-6 (Mar. 8, 2011).

    \377\ Id.

    \378\ ICE Comment Letter at 2 (Mar. 8, 2011).

    \379\ Reuters Comment Letter at 4 (Mar. 8, 2011); FXall Comment

    Letter at 3-4, 11 (Mar. 8, 2011); ICE Comment Letter at 2 (Mar. 8,

    2011); State Street Comment Letter at 5-6 (Mar. 8, 2011).

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

    Some commenters recommended limiting the scope of the proposed

    rules under Core Principle 2.\380\ Specifically, WMBAA argued that SEFs

    may not be able to satisfy all of the requirements of the proposed

    rules given that SEFs cannot be held responsible for what

    [[Page 33506]]

    happens on a competitor's platform.\381\ Similarly, FXall believed that

    SEFs would not have the requisite market data to conduct meaningful

    compliance oversight.\382\ SIFMA AMG believed that the Commission's

    vague use of the terms ``members,'' ``market participants,'' and

    ``participants'' could potentially subject dealers' customers, and thus

    asset managers and their clients, to ``onerous'' requirements of

    multiple SEFs.\383\ Therefore, SIFMA AMG requested clarification that a

    SEF's rules would only regulate entities that actually execute

    transactions on the SEF.\384\

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

    \380\ WMBAA Comment Letter at 18 (Mar. 8, 2011); FXall Comment

    Letter at 11 (Mar. 8, 2011); MarketAxess Comment Letter at 34 (Mar.

    8, 2011); SIFMA AMG Comment Letter at 14-15 (Mar. 8, 2011).

    \381\ WMBAA Comment Letter at 18 (Mar. 8, 2011).

    \382\ FXall Comment Letter at 11 (Mar. 8, 2011).

    \383\ SIFMA AMG Comment Letter at 14-15 (Mar. 8, 2011).

    \384\ Id.

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

    (2) Commission Determination

    In response to comments by FXall and State Street about treating

    SEFs as SROs, the Commission notes that like DCMs, it views SEFs as

    SROs and amended the Commission's regulations to include them as

    SROs.\385\ Treating a SEF as an SRO is consistent with a SEF's self-

    regulatory obligations pursuant to CEA section 5h(f). Therefore, where

    appropriate, the Commission is adopting surveillance, audit trail,

    investigation, enforcement, and other requirements for SEFs.

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

    \385\ See Adaptation of Regulations to Incorporate Swaps, 77 FR

    66288 (Nov. 2, 2012). Section 1.3(ee) states that a self-regulatory

    organization ``means a contract market (as defined in Sec. 1.3(h)),

    a swap execution facility (as defined in Sec. 1.3(rrrr)), or a

    registered futures association under section 17 of the Act.'' Id. at

    66318.

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

    In response to commenters' concerns that the proposed requirements

    were similar to the regulations applicable to DCMs, the Commission

    believes that adopting similar requirements for both types of entities

    is warranted given the similar statutory self-regulatory obligations

    for both types of entities. Given that both DCMs and SEFs, regardless

    of whether they are new or existing entities, are required to fulfill

    similar self-regulatory functions, the Commission does not believe that

    this approach will adversely affect competition between DCMs and SEFs.

    In response to commenters' requests for less prescriptive rules and

    greater flexibility in applying the rules, the Commission is moving

    various provisions of the proposed rules to guidance and eliminating

    other provisions, as discussed below. The provisions that are adopted

    as final rules reflect the Commission's opinion of what is required, at

    a minimum, for any SEF to comply with the core principles. SEFs may

    take any additional steps necessary, beyond the requirements of the

    rules, to satisfy statutory obligations.

    In response to WMBAA's and FXall's comments regarding certain

    limitations faced by SEFs in terms of oversight, the Commission

    recognizes the limitations faced by SEFs with respect to position

    monitoring, cross-market surveillance, and rule enforcement and

    addresses them in the context of comments received below. In response

    to SIFMA AMG's comment about the ambiguous use of terms, the Commission

    clarifies that ``market participant'' when used with respect to a SEF

    means a person that directly or indirectly effects transactions on the

    SEF. This includes persons with trading privileges on the SEF and

    persons whose trades are intermediated. The Commission also clarifies

    that ``member'' has the meaning set forth in CEA section 1a(34).\386\

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

    \386\ CEA section 1a(34) defines ``member'' as ``an individual,

    association, partnership, corporation, or trust--(A) owning or

    holding membership in, or admitted to membership representation on,

    the registered entity . . . or (B) having trading privileges on the

    registered entity. . . .'' 7 U.S.C. 1a(34).

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

    (b) Sec. 37.201--Operation of Swap Execution Facility and Compliance

    With Rules

    Proposed Sec. 37.201(a) required a SEF to establish rules

    governing the operation of the SEF, including rules specifying trading

    procedures for entering and executing orders traded or posted on the

    SEF, including block trades.\387\ Proposed Sec. 37.201(b) further

    required a SEF to establish and impartially enforce compliance with its

    rules, including, but not limited to: (1) The terms and conditions of

    any swaps traded or processed on or through the SEF; (2) access to the

    SEF; (3) trade practice rules; (4) audit trail requirements; (5)

    disciplinary rules; and (6) mandatory clearing requirements.\388\

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

    \387\ The Commission notes that Sec. 37.201(a) codifies CEA

    section 5h(f)(2)(C). 7 U.S.C. 7b-3(f)(2)(C).

    \388\ The Commission notes that Sec. 37.201(b) codifies certain

    sections of CEA section 5h(f)(2). 7 U.S.C. 7b-3(f)(2).

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

    (1) Summary of Comments

    MarketAxess recommended that the Commission withdraw proposed Sec.

    37.201(b)(6), which required a SEF to adopt and enforce mandatory

    clearing requirements, on the basis that clearing of a swap occurs

    outside of a SEF's main responsibility to facilitate the

    transaction.\389\

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

    \389\ MarketAxess Comment Letter at 34 (Mar. 8, 2011).

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

    (2) Commission Determination

    The Commission is adopting Sec. 37.201 as proposed, subject to two

    modifications. To address the comment by MarketAxess, the Commission

    notes that proposed Sec. 37.201(b)(6) contained a drafting error, and

    therefore is replacing the term ``mandatory clearing'' with ``mandatory

    trading.'' The Commission also notes that the citation to ``part 45''

    in proposed Sec. 37.201(a) should instead cite to ``part 43.''

    Therefore, the Commission is modifying the final rule to include these

    technical changes.

    Additionally, the Commission notes that a SEF must establish and

    enforce rules for its employees. These rules must be reasonably

    designed to prevent violations of the Act and the rules of the

    Commission.\390\ Towards that end, the Commission also notes that a SEF

    must have systems in place reasonably designed to ensure that its

    employees are operating in accordance with the SEF's rules.\391\ For

    example, a SEF that is utilizing an RFQ System in conjunction with an

    Order Book for Required Transactions must establish rules specifying

    order handling procedures for its employees who receive and execute

    orders over the telephone, email, instant messaging, squawk box, some

    other method of communication, or some combination thereof so that the

    employees may comply with the RFQ System requirements as specified in

    final Sec. 37.9(a)(3).\392\

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

    \390\ The Commission notes that under Sec. 37.1501(d), a duty

    of the Chief Compliance Officer is to establish and administer

    written policies and procedures reasonably designed to prevent

    violations of the Act and the rules of the Commission.

    \391\ The Commission notes that under Sec. 37.1501(d), a duty

    of the Chief Compliance Officer is to take reasonable steps to

    ensure compliance with the Act and the rules of the Commission, and

    to establish and administer a compliance manual designed to promote

    compliance with applicable laws, rules, and regulations.

    \392\ See WMBAA Comment Letter at 2 (Feb. 15, 2013) (explaining

    that employees of a SEF provide services such as disseminating bids

    and offers, helping to understand market conditions, and executing

    transactions between counterparties).

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

    Furthermore, the Commission notes that a SEF's employees have

    certain obligations under the Commission's existing regulations. For

    example, under Sec. 1.59, a SEF's employees are prohibited from

    disclosing for any purpose inconsistent with the performance of its

    official duties any material, non-public information obtained through

    special access related to the performance of its duties.\393\

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

    \393\ Commission regulation 1.59(d).

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

    Finally, the Commission notes that under Sec. 1.2 of the

    Commission's regulations, a SEF is liable for the acts, omissions, or

    failures of its employees

    [[Page 33507]]

    acting within the scope of their employment.\394\

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

    \394\ Commission regulation 1.2.

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

    (c) Sec. 37.202--Access Requirements

    Proposed Sec. 37.202 addressed Core Principle 2's requirements

    that SEFs provide market participants with impartial access to the

    market and that SEFs adopt and enforce rules with respect to any

    limitations placed on access to the SEF.\395\

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

    \395\ CEA section 5h(f)(2)(A)(ii) and (2)(B)(i); 7 U.S.C. 7b-

    3(f)(2)(A)(ii) and (2)(B)(i).

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

    (1) Sec. 37.202(a)--Impartial Access by Members and Market

    Participants \396\

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

    \396\ The Commission is renaming the title of this section from

    ``Impartial Access by Members and Market Participants'' to

    ``Impartial Access to Markets and Market Services'' to provide

    greater clarity.

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

    Proposed Sec. 37.202(a) required that a SEF provide any eligible

    contract participant (``ECP'') and any independent software vendor

    (``ISV'') with impartial access to its market(s) and market services

    (including any indicative quote screens or any similar pricing data

    displays), providing: (1) Access criteria that are impartial,

    transparent, and applied in a fair and nondiscriminatory manner; (2) a

    process for confirming ECP status prior to being granted access to the

    SEF; and (3) comparable fees for participants receiving comparable

    access to, or services from, the SEF.

    (i) Summary of Comments

    Several commenters sought clarification that SEFs would be

    permitted to use their own reasonable discretion to determine

    individual access criteria, provided that the criteria are impartial,

    transparent, and applied in a fair and non-discriminatory manner.\397\

    In this regard, ISDA/SIFMA commented that a SEF should be able to limit

    access to its trading systems or platforms to certain types of market

    participants in order to maintain the financial integrity and

    operational safety of the trading platform.\398\ JP Morgan also stated

    that a SEF should be able to limit access to certain types of market

    participants such as swap dealers.\399\ JP Morgan commented, however,

    that the SEF NPRM's preamble language about financial and operational

    soundness is problematic because it would not allow SEFs to limit

    access to certain types of market participants.\400\ This could disrupt

    business models such as that of inter-dealer brokers whose model is

    intimately tied to the idea of serving as an intermediary to wholesale

    liquidity providers.\401\ Similarly, Rosen et al. recommended that SEFs

    should be able to use selective access criteria such as objective

    minimum capital or credit requirements or limits on participation to

    objective classes of sophisticated market participants.\402\

    MarketAxess commented that the meaning of the term ``impartial'' is

    unclear and recommended that the Commission revise proposed Sec.

    37.202(a)(1) as follows: ``Criteria that are transparent and objective

    and are applied in a fair and nondiscriminatory manner[.]'' \403\

    Tradeweb noted that, because it offers multiple marketplaces, its

    access criteria may reasonably differ for each mode of execution and

    within one mode of execution given that each market will offer

    different services and may have different types of participants.\404\

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

    \397\ Reuters Comment Letter at 5 (Mar. 8, 2011); Goldman

    Comment Letter at 4 (Mar. 8, 2011); Tradeweb Comment Letter at 10

    (Mar. 8, 2011).

    \398\ ISDA/SIFMA Comment Letter at 11 (Mar. 8, 2011).

    \399\ JP Morgan Comment Letter at 11 (Mar. 8, 2011).

    \400\ Id.

    \401\ Id.

    \402\ Rosen et al. Comment Letter at 17 (Apr. 5, 2011).

    \403\ MarketAxess Comment Letter at 23-24 (Mar. 8, 2011).

    \404\ Tradeweb Comment Letter at 10 (Mar. 8, 2011).

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

    Mallers et al. supported the impartial access requirement and its

    purpose of preventing a SEF's owners or operators from using

    discriminatory access requirements as a competitive tool against

    certain participants.\405\ Mallers et al. stated that impartial access

    is a prerequisite to having an open market in which ECPs can compete on

    a level playing field, and that the participation of additional

    liquidity providers will improve the pricing and efficiency of the

    market and reduce systemic risk.\406\ SDMA also supported the impartial

    access requirement and stated that the ability to obtain intellectual

    property licenses and the amount of royalties for intellectual property

    licenses should be fair and not used to create anticompetitive

    advantages for a particular SEF or group of market participants.\407\

    UBS requested that the Commission clarify in the final rulemaking that

    SEFs may not exclude or discriminate against participants providing

    agency services solely as a result of engaging in these

    activities.\408\

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

    \405\ Mallers et al. Comment Letter at 2-3 (Mar. 21, 2011).

    \406\ Id. at 3.

    \407\ SDMA Comment Letter at 4-5 (Mar. 8, 2011).

    \408\ UBS Comment Letter II at 1 (May 18, 2012). UBS submitted

    two comment letters on May 18, 2012. The Commission is referencing

    UBS's comment letter regarding impartial access as ``UBS Comment

    Letter II.''

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

    MarketAxess and WMBAA stated that a SEF should be able to restrict

    access to ISVs because the Dodd-Frank Act does not require SEFs to

    provide ISVs with impartial access.\409\ MarketAxess further commented

    that the Commission must permit a SEF to restrict access to an ISV who

    would use such direct access to provide a competitive advantage to

    another SEF or DCM.\410\ Similarly, WMBAA stated that SEFs could

    qualify as ISVs in order to seek access to competitors' trading systems

    or platforms, which would defeat the existing structure of competitive

    sources of liquidity.\411\ Bloomberg commented that the SEF NPRM's

    characterization of ISV is too broad; \412\ therefore, an ISV may be

    able to replicate the services of a SEF without having to register as a

    SEF.\413\ Bloomberg also requested that the Commission clarify that a

    user of an ISV service must be a participant of a SEF in order to

    access the SEF's data and/or to execute swap transactions on that

    SEF.\414\

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

    \409\ MarketAxess Comment Letter at 24 (Mar. 8, 2011); WMBAA

    Comment Letter at 19 (Mar. 8, 2011).

    \410\ MarketAxess Comment Letter at 25 (Mar. 8, 2011).

    \411\ WMBAA Comment Letter at 19 (Mar. 8, 2011).

    \412\ See Core Principles and Other Requirements for Swap

    Execution Facilities, 76 FR at 1222 n. 53 (providing examples of

    ISVs).

    \413\ Meeting with Bloomberg dated Jan. 18, 2012.

    \414\ Id.

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

    Under proposed Sec. 37.202(a)(2), MarketAxess recommended that

    SEFs be permitted to rely on a written or electronically signed

    representation by a participant seeking access to the SEF regarding its

    status as an ECP.\415\ MarketAxess stated that SEFs may then adopt

    rules to require that the participant notify the SEF immediately of any

    change to its status after the participant makes the

    representation.\416\

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

    \415\ MarketAxess Comment Letter at 25 (Mar. 8, 2011).

    \416\ Id.

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

    Better Markets commented that proposed Sec. 37.202(a)(3) should

    make clear that any form of preferential access to a SEF through fee

    arrangements should not be allowed because it would defeat the goal of

    impartial access.\417\ However, MarketAxess stated that SEFs should be

    able to provide their market participants with volume discounts and

    other pricing arrangements as long as such discounts and arrangements

    are based upon objective criteria that are applied uniformly.\418\

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

    \417\ Better Markets Comment Letter at 11-12 (Mar. 8, 2011).

    \418\ MarketAxess Comment Letter at 25 (Mar. 8, 2011).

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

    (ii) Commission Determination

    The Commission is adopting Sec. 37.202(a) as proposed, subject to

    the

    [[Page 33508]]

    modifications discussed below.\419\ The Commission does not believe

    that the statute allows a SEF to adopt rules that limit access as

    requested by ISDA/SIFMA, JP Morgan, and Rosen et al. The statutory

    language of Core Principle 2 requires that SEFs establish and enforce

    participation rules, including means to provide market participants

    with impartial access to the market, and that SEFs adopt and enforce

    rules with respect to any limitations they place on access (emphasis

    added).\420\ As stated in the SEF NPRM, the Commission reiterates that

    the purpose of the impartial access requirements is to prevent a SEF's

    owners or operators from using discriminatory access requirements as a

    competitive tool against certain ECPs or ISVs. The Commission also

    agrees with Mallers et al. who stated that the impartial access

    requirement allows ECPs to compete on a level playing field, and that

    the participation of additional liquidity providers will improve the

    pricing and efficiency of the market and reduce systemic risk. As such,

    the Commission believes that access to a SEF should be determined, for

    example, based on a SEF's impartial evaluation of an applicant's

    disciplinary history and financial and operational soundness against

    objective, pre-established criteria. As one example of such criteria,

    any ECP should be able to demonstrate financial soundness either by

    showing that it is a clearing member of a derivatives clearing

    organization (``DCO'') that clears products traded on that SEF or by

    showing that it has clearing arrangements in place with such a clearing

    member.

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

    \419\ The Commission is also making certain non-substantive

    clarifications to the rule.

    \420\ CEA sections 5h(f)(2)(A)(ii) and (2)(B)(i); 7 U.S.C. 7b-

    3(f)(2)(A)(ii) and (2)(B)(i).

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

    In this regard, the Commission believes that the impartial access

    requirement of Core Principle 2 does not allow a SEF to limit access to

    its trading systems or platforms to certain types of ECPs or ISVs as

    requested by some commenters.\421\ The Commission notes that the rule

    states ``impartial'' criteria and not ``selective'' criteria as

    recommended by some commenters. The Commission is using the term

    ``impartial'' as intended in the statute. ``Impartial'' should be

    interpreted in the ordinary sense of the word: fair, unbiased, and

    unprejudiced. Subject to these requirements, a SEF may use its own

    reasonable discretion to determine its access criteria, provided that

    the criteria are impartial, transparent and applied in a fair and non-

    discriminatory manner, and are not anti-competitive.

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

    \421\ In this regard, the Commission is clarifying in response

    to UBS's comment that a SEF may not exclude or discriminate against

    a market participant providing agency services subject to any

    limitation on such services contained in this final rulemaking.

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

    In response to Tradeweb's comment about different access criteria

    for different markets, the Commission notes that a SEF may establish

    different access criteria for each of its markets. Core Principle 2

    does not specify whether impartial access criteria must be the same for

    all of a SEF's markets or may differ for each market. Therefore, the

    Commission believes that it is within its discretion to allow a SEF to

    establish different access criteria for each of its markets. However,

    the Commission reiterates that the access criteria must be impartial

    and must not be used as a competitive tool against certain ECPs or

    ISVs. The Commission also reiterates that each similarly situated group

    of ECPs and ISVs must be treated similarly.

    In response to MarketAxess's and WMBAA's comments regarding ISVs,

    the Commission notes that Congress required SEFs to establish

    participation rules, including means to provide market participants

    with impartial access to the market.\422\ The Commission believes that

    ISVs \423\ provide market participants with additional opportunities to

    access SEFs and that, similar to ECPs, SEFs should apply impartial

    criteria in a fair and non-discriminatory manner when deciding whether

    or not to grant an ISV access. In response to MarketAxess's and WMBAA's

    comments regarding ISVs providing a competitive advantage to other

    SEFs, the Commission notes that SEFs may set rules for ISVs so they do

    not misuse data, for example, by providing the data to another SEF for

    purely competitive reasons to the exclusion of market participants. The

    Commission also notes that SEFs may charge fees to ISVs based on the

    access or services they receive from the SEF.

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

    \422\ CEA section 5h(f)(2)(B)(i); 7 U.S.C. 7b-3(f)(2)(B)(i).

    WMBAA also commented that ISVs should comply with a SEF's rules, the

    SEF core principles, and the oversight or supervision by the SEF in

    the same manner as a market participant. WMBAA Comment Letter at 19

    (Mar. 8, 2011). The Commission disagrees with WMBAA's comment

    because ISVs provide market participants with greater options to

    access SEFs and ISVs are not executing swaps on a SEF as are market

    participants. Therefore, the Commission believes that ISVs should

    not be subject to the same requirements as market participants.

    \423\ The Commission notes that examples of independent software

    vendors include: smart order routers, trading software companies

    that develop front-end trading applications, and aggregator

    platforms. Smart order routing generally involves scanning of the

    market for the best-displayed price and then routing orders to that

    market for execution. Software that serves as a front-end trading

    application is typically used by traders to input orders, monitor

    quotations, and view a record of the transactions completed during a

    trading session. As noted above in the registration section,

    aggregator platforms generally provide a portal to market

    participants so that they can access multiple SEFs, but do not

    provide for execution as execution remains on SEFs. Aggregator

    platforms may also provide access to news and analytics. The

    Commission believes that transparency and trading efficiency would

    be enhanced as a result of innovations in this field for market

    services. For instance, certain providers of market services with

    access to multiple trading systems or platforms could provide

    consolidated transaction data from such trading systems or platforms

    to market participants.

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

    In response to Bloomberg's comments, the Commission agrees that

    ISVs should not be able to replicate the services of a SEF without

    having to register as a SEF. The Commission notes that an ISV that

    merely provides a service to SEFs will not, merely because it provides

    such a service, be deemed to be a SEF as defined in CEA section 1a(50).

    However, pursuant to the registration requirements in final Sec.

    37.3(a), if an ISV offers a trading system or platform in which more

    than one market participant has the ability to execute or trade swaps

    with more than one other market participant on that system or platform,

    then the ISV has to register as a SEF.\424\ The Commission also notes

    that the user of an ISV must have been granted access by a SEF in order

    to access that SEF's data and/or to execute a swap transaction on that

    SEF through the ISV.\425\

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

    \424\ See Aggregation Services or Portals discussion above under

    Sec. 37.3--Requirements for Registration in the preamble. The

    Commission notes that footnote 423 above classifies aggregator

    platforms as a type of ISV so the discussion in this section

    regarding ISVs also applies to aggregator platforms.

    \425\ The Commission notes, however, that the user of an ISV may

    not need to have been granted access to the SEF if the ISV is only

    providing a composite quote or top level quote for multiple SEFs.

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

    The Commission notes that under Sec. 37.202(a)(2), a SEF that is

    determining whether to grant an ECP access to its facilities may rely

    on a signed representation of its ECP status.\426\ By not prescribing a

    process, the Commission is providing SEFs with flexibility and

    discretion on how to meet this requirement. The Commission also notes

    that for SEFs that permit intermediation, customers of ECPs must also

    be ECPs.\427\ In this regard, a SEF must obtain a signed representation

    [[Page 33509]]

    from an intermediary that its customers are ECPs.

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

    \426\ The Commission is replacing the term ``participant'' in

    proposed Sec. 37.202(a)(2) with the term ``eligible contract

    participant'' in final Sec. 37.202(a)(2) because the term

    ``participant'' was not defined in the SEF NPRM and the revised term

    more clearly communicates the persons to whom this rule applies. In

    this regard, the Commission notes that, prior to granting a person

    access to its facility, a SEF must obtain confirmation from the

    person of its ECP status.

    \427\ For example, the Commission notes that a customer of a

    futures commission merchant must be an ECP and a customer of a

    broker must be an ECP.

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

    To address comments submitted in connection with proposed Sec.

    37.202(a)(3) regarding fees, the Commission clarifies that Sec.

    37.202(a)(3) neither sets nor limits the fees that SEFs may charge. A

    SEF may establish different categories of ECPs or ISVs seeking access

    to, or services from, the SEF, but may not discriminate with respect to

    fees within a particular category.\428\ The Commission notes that Sec.

    37.202(a)(3) is not designed to be a rigid requirement that fails to

    take into account legitimate business justifications for offering

    different fees to different categories of entities seeking access to

    the SEF. For example, a SEF may consider the services it receives from

    members such as market making services when it determines its fee

    structure.

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

    \428\ The Commission is replacing the term ``participant'' in

    proposed Sec. 37.202(a)(3) with the terms ``eligible contract

    participants'' and ``independent software vendors'' in final Sec.

    37.202(a)(3) because the term ``participant'' was not defined in the

    SEF NPRM and the revised terms more clearly communicates the persons

    to whom this rule applies.

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

    (2) Sec. 37.202(b)--Jurisdiction

    Proposed Sec. 37.202(b) required that prior to granting any ECP

    access to its facilities, a SEF must require that the ECP consents to

    its jurisdiction.

    (i) Summary of Comments

    CME recommended that the Commission withdraw the proposed

    rule.\429\ CME contended that requiring clearing firms to obtain every

    customer's consent to the regulatory jurisdiction of each SEF would be

    costly.\430\ Moreover, CME commented that even if such consent were

    obtained, the proposed rule would be entirely ineffective in achieving

    the Commission's desired outcome.\431\ CME explained that if a non-

    member, who had consented to the SEF's jurisdiction under the proposed

    rule, committed a rule violation and subsequently elected not to

    cooperate in the investigation or disciplinary process, the SEF's only

    recourse would be to deny the non-member access and, if appropriate,

    refer the matter to the Commission.\432\ CME further explained that a

    SEF's enforcement options, and the regulatory outcomes, do not change

    based on whether or not there is a record of the non-member consenting

    to jurisdiction, but rather depend on whether the non-member chooses to

    participate in the SEF's investigative and disciplinary processes.\433\

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

    \429\ CME Comment Letter at 17 (Feb. 22, 2011).

    \430\ Id. at 16.

    \431\ Id.

    \432\ Id.

    \433\ Id.

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

    Similarly, Bloomberg requested that the Commission clarify that

    proposed Sec. 37.202(b) would only apply to a SEF's members and not

    customers of members whose orders are executed on a SEF.\434\ Bloomberg

    stated that, rather than subject all market participants to a SEF's

    jurisdiction, it would be sufficient and more practical for each SEF

    member to provide to the SEF specific information about its

    customers.\435\ WMBAA noted that a SEF may only exercise jurisdiction

    over a market participant with respect to its own rules and that the

    SEF's ultimate sanction would be to ban a market participant from its

    trading system or platform.\436\ WMBAA also stated that prohibiting a

    market participant from trading on one particular SEF has little

    utility because a market participant could continue to execute swaps on

    other SEFs.\437\

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

    \434\ Bloomberg Comment Letter at 6 (Mar. 8, 2011).

    \435\ Id.

    \436\ WMBAA Comment Letter at 19 (Mar. 8, 2011).

    \437\ Id.

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

    (ii) Commission Determination

    The Commission is adopting Sec. 37.202(b) as proposed. While

    acknowledging the comments described above, the Commission believes

    that Sec. 37.202(b) codifies jurisdictional requirements necessary to

    effectuate the statutory mandate of Core Principle 2 that a SEF shall

    have the capacity to detect, investigate, and enforce rules of the

    SEF.\438\ In the Commission's view, jurisdiction must be established by

    a SEF prior to granting eligible contract participants access to its

    markets in order to effectively investigate and sanction persons that

    violate SEF rules. In particular, a SEF should not be in the position

    of asking market participants to voluntarily submit to its jurisdiction

    and cooperate in investigatory proceedings after a potential rule

    violation has been found. Similarly, market participants should have

    advanced notice that their trading practices are subject to the rules

    of a SEF, including rules that require cooperating in investigatory and

    disciplinary processes.

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

    \438\ CEA section 5h(f)(2)(B); 7 U.S.C. 7b-3(f)(2)(B).

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

    For the avoidance of doubt, the Commission clarifies that the scope

    of Sec. 37.202(b) is not limited to members. To the contrary, all

    members and market participants of a SEF, as defined above under Sec.

    37.200, are within the scope of Sec. 37.202(b).

    In response to CME's and WMBAA's comments, the Commission notes

    that a SEF's ultimate recourse against a market participant is to deny

    such market participant access to the SEF and, if appropriate, refer

    the market participant to the Commission. The Commission has the

    authority to issue broader sanctions for market participants who commit

    SEF rule violations that also violate the CEA and Commission

    regulations. Therefore, the Commission expects that a SEF would not

    only sanction market participants as appropriate, but also refer

    matters to the Commission for additional action when necessary. The

    Commission does not agree that this action absolves SEFs from their

    responsibility to establish jurisdiction over members and market

    participants.

    (3) Sec. 37.202(c)--Limitations on Access

    Proposed Sec. 37.202(c) required a SEF to establish and

    impartially enforce rules governing any decision to allow, deny,

    suspend, or permanently bar participants' access to the SEF, including

    when such decisions are made as part of a disciplinary or emergency

    action taken by the SEF.

    (i) Commission Determination

    Although no comments were received on Sec. 37.202(c), the

    Commission is adopting the proposed rule subject to one

    modification.\439\ The Commission is replacing the term ``participant''

    with ``eligible contract participant'' because the term ``participant''

    was not defined in the SEF NPRM and the revised term more clearly

    communicates the persons to whom this rule applies.\440\ The Commission

    notes that Sec. 37.202(c) implements Core Principle 2's requirement

    regarding limitations on access to the SEF.\441\

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

    \439\ The Commission is making certain non-substantive

    clarifications to the rule.

    \440\ For the avoidance of doubt, the Commission notes that this

    rule applies to the SEF's members and market participants.

    \441\ CEA section 5h(f)(2)(A)(ii); 7 U.S.C. 7b-3(f)(2)(A)(ii).

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

    (d) Sec. 37.203--Rule Enforcement Program

    Proposed Sec. 37.203 required a SEF to establish and enforce

    trading, trade processing, and participation rules that will deter

    abuses and have the capacity to detect, investigate, and enforce those

    rules.\442\

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

    \442\ The Commission notes that Sec. 37.203 codifies CEA

    section 5h(f)(2)(B). 7 U.S.C. 7b-3(f)(2)(B).

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

    (1) Sec. 37.203(a)--Abusive Trading Practices Prohibited

    Proposed Sec. 37.203(a) required a SEF to prohibit certain abusive

    trading practices, including front-running, wash trading, pre-arranged

    trading, fraudulent

    [[Page 33510]]

    trading, money passes, and any other trading practices that the SEF

    deems to be abusive. The proposed rule further obligated a SEF to

    ``prohibit any other manipulative or disruptive trading practices

    prohibited by the Act or by the Commission pursuant to Commission

    regulations.'' SEFs permitting intermediation were required to prohibit

    additional trading practices, such as trading ahead of customer orders,

    trading against customer orders, accommodation trading, and improper

    cross trading. As explained in the SEF NPRM, prohibited trading

    practices include those proscribed by section 747 of the Dodd-Frank

    Act.\443\

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

    \443\ Core Principles and Other Requirements for Swap Execution

    Facilities, 76 FR at 1223 n.61. Section 747 of the Dodd-Frank Act

    amended CEA section 4c(a) to make it unlawful for any person to

    engage in any trading, practice, or conduct on or subject to the

    rules of a registered entity that--(A) violates bids or offers; (B)

    demonstrates intentional or reckless disregard for the orderly

    execution of transactions during the closing period; or (C) is, is

    of the character of, or is commonly known to the trade as, spoofing

    (bidding or offering with the intent to cancel the bid or offer

    before execution). See Antidisruptive Practices Authority, 76 FR

    14943 (proposed Mar. 18, 2011) for proposed interpretive guidance on

    these three new statutory provisions of CEA section 4c(a)(5).

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

    (i) Summary of Comments

    CME and ABC/CIEBA commented that the proposed rule is problematic

    because it enumerated prohibited trade practices without specifically

    defining them.\444\ CME stated that SEFs should have reasonable

    discretion to establish rules appropriate to their markets that are

    consistent with the CEA and that satisfy the core principles.\445\ CME

    questioned, in particular, how to interpret the proposed prohibition on

    pre-arranged trading with respect to rules that allow for block

    trading, exchange for related position transactions, and pre-execution

    communications subject to specified conditions.\446\

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

    \444\ ABC/CIEBA Comment Letter at 9 (Mar. 8, 2011); CME Comment

    Letter at 17-18 (Feb. 22, 2011).

    \445\ CME Comment Letter at 17 (Feb. 22, 2011).

    \446\ Id. at 17-18.

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

    WMBAA contended that the enumerated abusive trading practices

    appear more commonly in markets with retail participants, and therefore

    are more likely to occur on a DCM rather than a SEF.\447\ Accordingly,

    WMBAA recommended that the Commission include in the final rule abusive

    trading practices that are more likely to occur on a SEF.\448\ Finally,

    Better Markets recommended that the Commission expand its list of

    prohibited trade practices to ban certain high-frequency trading

    practices, including exploiting a large quantity or block trade, price

    spraying (which it views as a form of front-running), rebate

    harvesting, and layering the market (which it analogizes to

    spoofing).\449\

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

    \447\ WMBAA Comment Letter at 20 (Mar. 8, 2011).

    \448\ Id.

    \449\ Better Markets Comment Letter at 13-17 (Mar. 8, 2011).

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

    (ii) Commission Determination

    The Commission is adopting proposed Sec. 37.203(a), subject to one

    modification described below. In response to CME's and ABC/CIEBA's

    comments regarding the perceived vagueness of the enumerated trading

    practices, the Commission notes that the enumerated abusive trading

    practices reflect the trading practices that are typically accepted as

    prohibited conduct by regulators and derivatives exchanges in the

    industry. In the SEF NPRM, the Commission stated that the proposed

    prohibited trading practices are a compilation of abusive trading

    practices that DCMs already prohibit.\450\ The Commission also noted in

    the final DCM rulemaking that the prohibited trading practices are

    typically already prohibited in DCM rulebooks.\451\ Although the

    Commission believes, as noted by CME, that a SEF should have reasonable

    discretion to establish rules for its markets, the Commission believes,

    at a minimum, that a SEF must prohibit the abusive trading practices

    identified in the rule.

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

    \450\ Core Principles and Other Requirements for Swap Execution

    Facilities, 76 FR at 1223.

    \451\ Core Principles and Other Requirements for Designated

    Contract Markets, 77 FR 36612, 36626 (Jun. 19, 2012).

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

    In response to CME's comment about how to interpret the prohibition

    on pre-arranged trading with respect to rules that allow for block

    trading and other types of trading, the Commission is amending proposed

    Sec. 37.203(a) to clarify that a SEF must prohibit pre-arranged

    trading, except for block trades permitted under part 43 of the

    Commission's regulations or other types of transactions certified to or

    approved by the Commission pursuant to the procedures under part 40 of

    the Commission's regulations. This change clarifies that these types of

    transactions will not be subject to the prohibition on pre-arranged

    trading. The Commission also clarifies, as discussed above under the

    time delay requirement, that the prohibition on pre-arranged trading

    does not limit pre-execution communications between market

    participants, subject to the rules of the SEF. Accordingly, SEFs that

    permit pre-execution communications must establish and enforce rules

    relating to such communications.

    In response to WMBAA's comment that the enumerated abusive trading

    practices are more suited to DCMs rather than SEFs, the Commission

    believes that similar prohibitions are necessary to promote consistent

    protection for all market participants across the swaps market.

    Therefore, the Commission believes that the enumerated abusive trading

    practices should be prohibited by DCMs and SEFs. The Commission notes

    that requiring SEFs to proscribe trading practices which are prohibited

    by the Act and Commission regulations does not create any additional

    obligations beyond the existing statutory and regulatory requirements

    applicable to all SEFs.

    The Commission agrees with WMBAA and Better Markets that other

    abusive trading practices may exist. In this regard, Sec. 37.203(a)

    provides a non-exhaustive, non-exclusive list. The regulations adopted

    in this final release provide a SEF with reasonable discretion to

    establish rules that prohibit additional abusive trading practices.

    Additionally, not only must a SEF prohibit any other trading practices

    that a SEF deems abusive,\452\ it must also establish and enforce rules

    that will deter abuses under statutory Core Principle 2.\453\

    Therefore, if a SEF identifies additional abusive trading practices

    that are likely to occur on its trading systems and platforms, then the

    SEF is required, by statute and Commission regulation, to prohibit such

    abusive trading practices. The Commission anticipates that as SEFs gain

    experience with exchange-listed swaps, it may periodically revisit the

    list of prohibited abusive trading practices under Sec. 37.203(a).

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

    \452\ See Final Sec. 37.203(a) in the Commission's regulations.

    \453\ CEA section 5h(f)(2); 7 U.S.C. 7b-3(f)(2).

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

    (2) Sec. 37.203(b)--Capacity to Detect and Investigate Rule Violations

    Proposed Sec. 37.203(b) required a SEF to have arrangements and

    resources for effective rule enforcement, which included a SEF's

    authority to collect information and examine books and records of SEF

    members and market participants. As discussed in the preamble to the

    SEF NPRM, the Commission believes that a SEF can best administer its

    compliance and rule enforcement obligations by having the ability to

    reach the books and records of all market participants.\454\ Proposed

    Sec. 37.203(b) also required a SEF's arrangements and resources to

    facilitate

    [[Page 33511]]

    the direct supervision of the market and the analysis of data collected

    to determine whether a rule violation has occurred.

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

    \454\ Core Principles and Other Requirements for Swap Execution

    Facilities, 76 FR at 1223.

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

    (i) Summary of Comments

    FXall and CME requested that the Commission clarify the provision

    in proposed Sec. 37.203(b) that requires a SEF to have the authority

    to examine the books and records of its members and market

    participants.\455\ Specifically, CME expressed concern that the

    proposed rule would subject non-registered market participants to

    recordkeeping requirements that currently apply only to member,

    registrants, and direct access clients of its platform, which it does

    not believe would be effective.\456\ CME also commented that the

    proposed rule does not detail which books, records, and information a

    SEF must be able to obtain from its non-member market

    participants.\457\ FXall expressed concern that the requirement for a

    SEF to have the authority to examine the books and records of its

    members and market participants could be interpreted to require a SEF

    to conduct a full regulatory examination program.\458\ FXall,

    therefore, recommended that the Commission clarify that this

    requirement only applies as may be necessary for a SEF to investigate a

    specific potential rule violation that the SEF has detected in the

    ordinary course of its trade practice surveillance routine or has

    otherwise been brought to its attention.\459\

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

    \455\ FXall Comment Letter at 11-12 (Mar. 8, 2011); CME Comment

    Letter at 18 (Feb. 22, 2011).

    \456\ CME Comment Letter at 18 (Feb. 22, 2011).

    \457\ Id.

    \458\ FXall Comment Letter at 11-12 (Mar. 8, 2011).

    \459\ Id.

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

    (ii) Commission Determination

    The Commission is adopting Sec. 37.203(b) as proposed, subject to

    the following modification. To address CME's concerns about the scope

    of proposed Sec. 37.203(b), the Commission is replacing the term

    ``market participant'' with ``persons under investigation.'' The

    Commission recognizes that using the term ``market participant'' could

    significantly increase the regulatory responsibilities for SEFs. Thus,

    the Commission clarifies that Sec. 37.203(b) places upon a SEF an

    affirmative obligation to have the authority to examine books and

    records from its members and from any persons under investigation for

    effective enforcement of its rules. The Commission also notes that the

    books and records collected by the SEF should encompass all information

    and documents that are necessary to detect and prosecute rule

    violations. In response to FXall's comment, the Commission clarifies

    that the requirement for a SEF to have the authority to examine books

    and records does not require a SEF to conduct a full regulatory

    examination program. However, the Commission notes that in addition to

    the SEF's obligations pursuant to Sec. 37.203(b), the audit trail

    requirements in Sec. 37.205(c)(2) require a SEF to establish a program

    for effective enforcement of its audit trail and recordkeeping

    requirements, which would require the examination of books and records.

    (3) Sec. 37.203(c)--Compliance Staff and Resources

    Proposed Sec. 37.203(c)(1) provided that a SEF must establish and

    maintain sufficient compliance staff and resources to conduct a number

    of enumerated tasks, such as audit trail reviews, trade practice

    surveillance, market surveillance, and real-time monitoring. Proposed

    Sec. 37.203(c)(2) required a SEF to continually monitor the size and

    workload of its compliance staff and, on at least an annual basis,

    formally evaluate the need to increase its compliance staff and

    resources. The proposed rule also set forth certain factors that a SEF

    should consider in determining the appropriate level of compliance

    staff and resources.

    (i) Summary of Comments

    Two commenters sought clarification regarding a SEF's compliance

    resources.\460\ WMBAA requested that the Commission clarify whether the

    resources and staff of a compliance department may be shared with

    affiliates or between multiple SEFs, and if so, how these shared

    resources would be considered in meeting the requirements for

    sufficient compliance staff and resources.\461\ WMBAA also requested

    clarification as to whether a SEF could consider its third party

    service provider's resources and staff for purposes of evaluating the

    adequacy of its compliance staff and resources.\462\ MarketAxess

    believed that the process by which a SEF must conduct a formal

    evaluation of its compliance resources was unclear.\463\ MarketAxess

    also noted that while the findings of such an evaluation could result

    in the need to increase a SEF's compliance staff and resources, it

    could also result in a decrease.\464\ Accordingly, MarketAxess

    suggested that the Commission remove the term ``formally'' and clarify

    that the evaluation of compliance resources could result in either an

    increase or decrease in compliance staff and resources.\465\

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

    \460\ WMBAA Comment Letter at 21 (Mar. 8, 2011); MarketAxess

    Comment Letter at 35 (Mar. 8, 2011).

    \461\ WMBAA Comment Letter at 21 (Mar. 8, 2011).

    \462\ Id.

    \463\ MarketAxess Comment Letter at 35 (Mar. 8, 2011).

    \464\ Id.

    \465\ Id.

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

    (ii) Commission Determination

    The Commission is adopting Sec. 37.203(c) as proposed, subject to

    one modification discussed below.\466\ The Commission agrees in part

    with WMBAA's recommendation that some SEF compliance staff can be

    shared among affiliated entities under the appropriate circumstances.

    However, such arrangements would require prior review by the Commission

    staff and appropriate legal documentation between the affiliated

    entities with respect to any shared staff (e.g., secondment or

    regulatory services agreements that define responsibilities; establish

    decision-trees for matters of regulatory consequence; and provide for

    exclusive authority and responsibility by each SEF with respect to

    matters on its markets). The Commission also emphasizes that any

    sharing of compliance staff does not diminish each SEF's obligation to

    maintain sufficient staff to meet its own regulatory needs. The

    Commission believes that compliance resources may not be shared between

    non-affiliated SEFs given potential conflict issues. However, the

    Commission recognizes that a SEF may provide regulatory services to a

    non-affiliated SEF pursuant to a regulatory services agreement.

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

    \466\ The Commission is making certain non-substantive

    clarifications to proposed Sec. 37.203(c)(1). The Commission is

    also renumbering proposed Sec. 37.203(c)(1) to Sec. 37.203(c).

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

    The Commission believes that a SEF may take into consideration the

    staff and resources of its regulatory service provider when evaluating

    the sufficiency of its own compliance staff. Regardless of whether a

    SEF utilizes a regulatory service provider or shares its compliance

    staff with an affiliate, the Commission emphasizes that the SEF must

    maintain sufficient internal compliance staff to oversee the quality

    and effectiveness of the regulatory services provided and to make

    certain regulatory decisions, as required by Sec. 37.204.

    Finally, the Commission is deleting proposed Sec. 37.203(c)(2),

    which required that a SEF monitor the size and workload of its

    compliance staff on a continuous basis and, on at least an annual

    basis, formally evaluate the need to increase its compliance resources

    and

    [[Page 33512]]

    staff. The Commission believes that the obligation that a SEF monitor

    the adequacy of its compliance staff and resources are implicit in

    proposed Sec. 37.203(c)(1). The final rule provides greater

    flexibility to SEFs in determining their approach to monitoring their

    compliance resources.

    (4) Sec. 37.203(d)--Automated Trade Surveillance System

    Proposed Sec. 37.203(d) required a SEF to maintain an automated

    trade surveillance system capable of detecting and investigating

    potential trade practice violations. The proposed rule also required

    that an acceptable automated trade surveillance system must have the

    capability to generate alerts on a trade date plus one day (T+1) basis

    to assist staff in detecting potential violations. The automated trade

    surveillance system, among other requirements, must maintain all trade

    and order data, including order modifications and cancellations, and

    must have the capability to compute, retain, and compare trading

    statistics; compute trade gains and losses; and reconstruct the

    sequence of trading activity.

    (i) Summary of Comments

    CME and WMBAA expressed concern about the capabilities required of

    an automated trade surveillance system under the proposed rule.\467\

    Specifically, CME stated that it has been unable to design an automated

    surveillance system that automates the actual investigation of

    potential trade practice violations.\468\ CME also challenged the use

    of what it deemed as ``broad and ambiguous'' terms to describe the

    required capabilities of such a system, and recommended that the

    Commission consider applying a more flexible, core principles-based

    approach to implementing the requirement.\469\ WMBAA argued that it

    would be impossible to create an automated trade surveillance system

    with the capabilities described in the proposed rule without knowledge

    of a participant's complete trading activity, including trading

    activity that takes place on other SEFs.\470\

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

    \467\ CME Comment Letter at 19-20 (Feb. 22, 2011); WMBAA Comment

    Letter at 21 (Mar. 8, 2011).

    \468\ CME Comment Letter at 19-20 (Feb. 22, 2011).

    \469\ Id. at 20.

    \470\ WMBAA Comment Letter at 21 (Mar. 8, 2011).

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

    Better Markets recommended that data recorded by an automated trade

    surveillance system be time-stamped at intervals consistent with the

    capabilities of high-frequency traders that will transact on SEFs.\471\

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

    \471\ Better Markets Comment Letter at 18 (Mar. 8, 2011).

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

    (ii) Commission Determination

    The Commission is adopting proposed Sec. 37.203(d), subject to two

    modifications discussed below. First, the Commission is moving the

    requirement that an automated trade surveillance system maintain all

    data reflecting the details of each order entered into the trading

    system to final Sec. 37.205(b). The Commission believes that Sec.

    37.205(b) is a more logical place in the Commission's rules to address

    this aspect of a SEF's automated surveillance system because it also

    specifies the requirements for a SEF's audit trail program, including a

    history of all orders and trades.

    Second, the Commission is deleting the word ``investigating'' from

    proposed Sec. 37.203(d) to remove any confusion, as noted by CME. The

    Commission notes, in response to CME's comment, that the final rules do

    not require a SEF's automated trade surveillance system to conduct the

    actual investigations. The Commission believes that the actual

    investigation would be carried out by a SEF's compliance staff with the

    assistance of automated surveillance tools.

    In response to CME's comment pertaining to the breadth of the rule,

    the Commission believes that effective surveillance of trading markets

    requires that a SEF maintain an automated trade surveillance system

    capable of detecting trade practice violations to assist compliance

    staff in analyzing large data sets and investigating patterns of

    conduct that may go otherwise unnoticed. The Commission also believes

    that the analytical tools enumerated in the rule are a necessary

    component of an effective trade surveillance system. This rule, as

    modified, therefore fulfills the statutory requirement of Core

    Principle 2 by assisting the SEF in detecting, investigating, and

    enforcing trading rules that will deter abuses.\472\

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

    \472\ CEA section 5h(f)(2)(B); 7 U.S.C. 7b-3(f)(2)(B).

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

    The Commission acknowledges the inter-SEF surveillance limitations

    expressed by WMBAA. The Commission notes that the purpose of Sec.

    37.203(d) is to ensure that a SEF's compliance staff has the necessary

    tools to detect, analyze, and investigate potential trade practice

    violations on the SEF's trading systems or platforms; it does not

    obligate a SEF to establish a cross-market trade practice surveillance

    program.

    Although the Commission acknowledges the merits of the

    recommendation by Better Markets to include time stamps at intervals

    consistent with the capabilities of high-frequency traders, the

    Commission does not believe that it is necessary to modify Sec.

    37.203(d) to address this concern. As discussed in Sec. 37.401 below,

    there are efforts underway both within and outside of the Commission to

    define and develop approaches for better monitoring of high-frequency

    and algorithmic trading.\473\ However, while the rule does not specify

    the granularity of time-stamped data, a SEF's automated trade

    surveillance system should have the ability to readily determine the

    sequence in which orders are entered. This reflects the Commission's

    belief that an automated trade surveillance system should time-stamp

    data with the granularity necessary to conduct effective surveillance

    of all trade-related activity, including high-frequency trading, while

    leaving the details of the system to the SEF.

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

    \473\ See discussion below regarding high-frequency trading

    under Sec. 37.401--General Requirements in the preamble.

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

    The Commission notes that the accurate time-stamping of data is

    particularly important for SEFs that use an RFQ System, including an

    RFQ System with a voice component. For such SEFs, the accurate time-

    stamping of both their Order Book and RFQ System activity is critical

    for ensuring both that the SEF itself has a robust surveillance system

    and that the Commission is able to monitor the SEF's adherence to part

    37's Order Book-RFQ System integration requirements.

    (5) Sec. 37.203(e)--Real-Time Market Monitoring

    Proposed Sec. 37.203(e) required a SEF to conduct real-time market

    monitoring of all trading activity on its electronic trading platform

    to ensure orderly trading and to identify market or system anomalies.

    The proposed rule further required a SEF to have the authority to

    adjust prices and cancel trades when needed to mitigate ``market

    disrupting events'' caused by platform malfunctions or errors in orders

    submitted by market participants. In addition, proposed Sec. 37.203(e)

    required that any trade price adjustments or trade cancellations be

    transparent to the market and subject to standards that are clear,

    fair, and publicly available.

    (i) Summary of Comments

    CME stated that the proposed standards would be difficult for any

    SEF to reasonably meet because they require

    [[Page 33513]]

    monitoring of all trading activity on a platform to ensure orderly

    trading.\474\ CME also reiterated its belief that the proposed rules

    are overly prescriptive and recommended that the Commission provide

    application guidance instead of a rule.\475\ WMBAA requested

    clarification that a SEF's obligation to conduct real-time market

    monitoring does not include the requirement to conduct automated trade

    surveillance under Sec. 37.203(d).\476\

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

    \474\ CME Comment Letter at 21 (Feb. 22, 2011).

    \475\ Id. at 20-21.

    \476\ WMBAA Comment Letter at 21 (Mar. 8, 2011).

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

    Two commenters opined on the requirement for a SEF to modify or

    cancel a swap transaction.\477\ SIFMA AMG argued that a SEF should not

    be able to modify or cancel a swap transaction under any circumstances

    without the express consent of the counterparties.\478\ SIFMA AMG also

    stated that if counterparties consent to an adjustment, then clearing

    entities, executing brokers, DCMs, and middleware platforms should also

    make the appropriate adjustment.\479\ ISDA/SIFMA recommended that the

    Commission adopt a uniform standard for ``market disrupting events.''

    \480\

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

    \477\ SIFMA AMG Comment Letter at 14 (Mar. 8, 2011); ISDA/SIFMA

    Comment Letter at 13 (Mar. 8, 2011).

    \478\ SIFMA AMG Comment Letter at 14 (Mar. 8, 2011).

    \479\ Id.

    \480\ ISDA/SIFMA Comment Letter at 13 (Mar. 8, 2011).

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

    Better Markets stated that a SEF's obligation to conduct real-time

    market monitoring should include monitoring orders and cancellations

    that are time-stamped at intervals consistent with the capabilities of

    high-frequency traders to identify abusive high frequency trading

    strategies.\481\

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

    \481\ Better Markets Comment Letter at 18 (Mar. 8, 2011).

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

    (ii) Commission Determination

    The Commission is adopting proposed Sec. 37.203(e), subject to one

    modification. The Commission agrees with CME that real-time market

    monitoring cannot ``ensure'' orderly trading at all times, but the

    Commission believes that such monitoring must identify disorderly

    trading when it occurs. Accordingly, the Commission is modifying

    proposed Sec. 37.203(e) to require a SEF to conduct real-time market

    monitoring ``to identify disorderly trading,'' instead of ``to ensure

    orderly trading.''

    In response to CME's comment that the rule is overly prescriptive,

    the Commission believes that Sec. 37.203(e) grants a SEF the

    flexibility to determine the best way to conduct real-time market

    monitoring so that it can effectively monitor its markets. The

    Commission also believes that the rule correctly mandates that a SEF

    conduct real-time market monitoring of all trading activity that occurs

    on its system or platform in order to detect disorderly trading and

    market or system anomalies, and take appropriate regulatory action. The

    Commission believes that this rule fulfills the statutory requirement

    of Core Principle 2, which requires a SEF to have the capacity to

    detect, investigate, and enforce trading rules that will deter

    abuses.\482\

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

    \482\ CEA section 5h(f)(2)(B); 7 U.S.C. 7b-3(f)(2)(B).

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

    In response to WMBAA's comment, the Commission clarifies that a

    SEF's obligation to conduct real-time market monitoring does not

    encompass the automated trade surveillance requirement in Sec.

    37.203(d). The Commission notes that while real-time market monitoring

    and trade practice surveillance are both self-regulatory functions

    assigned to all SEFs, these functions are generally independent and

    serve different purposes. As discussed in the SEF NPRM, market

    monitoring is conducted on a real-time basis so that a SEF can take

    mitigating action against any market or system anomalies on its trading

    system or platform.\483\ Trade practice surveillance, on the other

    hand, involves reconstructing and analyzing order, trade, and other

    data post-execution to identify potential violations and anomalies

    found in trade data.\484\ Further, as noted in the SEF NPRM, the

    automated trade surveillance system typically differs from the system

    used to conduct real-time market monitoring.\485\

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

    \483\ Core Principles and Other Requirements for Swap Execution

    Facilities, 76 FR at 1224.

    \484\ Id. at 1223-24.

    \485\ Id. at 1224.

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

    The Commission disagrees with SIFMA AMG's comment that a SEF should

    not be able to modify or cancel a swap transaction under any

    circumstances without the express consent of the counterparties. The

    Commission believes that a SEF should have the authority to modify or

    cancel a swap transaction without the consent of the counterparties

    under certain limited circumstances. For example, a SEF should be able

    to cancel a trade when such trade was executed due to a technological

    error on the part of the SEF. Further, the Commission believes that the

    rule's requirement that any modifications or cancellations by the SEF

    be transparent to the market and subject to standards that are clear,

    fair, and publicly available will provide protection to counterparties.

    The Commission also acknowledges the validity of SIFMA AMG's concern

    that any adjustment to a swap transaction should also be reflected by

    entities involved in the clearing and processing of the swap. However,

    since imposing such a requirement on entities involved in the clearing

    and processing of swaps is outside the scope of this SEF rulemaking,

    the Commission declines to address this issue in these final rules.

    The Commission also rejects ISDA/SIFMA's recommendation to define

    the term ``market disrupting events,'' as it does not believe that a

    rule definition could reasonably capture the universe of potentially

    market disrupting events. The Commission notes that industry

    definitions for terms such as ``market disrupting events'' generally

    only establish a process or framework for counterparties and other

    third parties to determine whether such an event has occurred and can

    be subject to challenge, resulting in delayed determinations with

    limited utility for effective trade monitoring. Although the Commission

    believes that coordination among SEFs regarding market disrupting

    events may be appropriate, and encourages SEFs to do so, the Commission

    is not defining ``market disrupting events'' at this time. The

    Commission may provide examples at a later time once it gains further

    knowledge regarding the types of market disrupting events that are

    likely to occur on a SEF.

    In response to the comment by Better Markets about high-frequency

    trading, the Commission declines to modify proposed Sec. 37.203(e) to

    include concepts related specifically to high-frequency trading at this

    time.\486\ The Commission believes that a SEF's real-time market

    monitoring system should be structured to conduct effective market

    monitoring for all order and trade types, including, but not limited

    to, high frequency trading.

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

    \486\ See discussion below regarding high-frequency trading

    under Sec. 37.401--General Requirements in the preamble.

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

    (6) Sec. 37.203(f)--Investigations and Investigation Reports

    Proposed Sec. 37.203(f) required a SEF to establish procedures for

    conducting investigations, provided timelines for completing such

    investigations, detailed the requirements of an investigation report,

    and provided for warning letters.

    (i) Sec. 37.203(f)(1)--Procedures

    Proposed Sec. 37.203(f)(1) required a SEF to have procedures that

    require its compliance staff to conduct investigations of possible rule

    [[Page 33514]]

    violations. The proposed rule required that an investigation be

    commenced upon the Commission staff's request or upon discovery of

    information by the SEF indicating a possible basis for finding that a

    violation has occurred or will occur.

    (A) Summary of Comments

    CME argued that the proposed rule diminishes a SEF's discretion to

    determine the matters that warrant a formal investigation because at

    the time of discovery or upon receipt of information, and before any

    review has occurred, there will always be ``a possible basis'' that a

    violation has occurred or will occur.\487\ CME agreed that formal

    written referrals from the Commission, law enforcement authorities,

    other regulatory agencies, or other SROs should result in a formal

    investigation in every instance.\488\ However, CME contended that a SEF

    should have reasonable discretion to determine how it responds to

    complaints, leads, and other types of referrals, including the

    discretion to follow-up with a less formal inquiry in certain

    situations.\489\

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

    \487\ CME Comment Letter at 21 (Feb. 22, 2011).

    \488\ Id.

    \489\ Id.

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

    MarketAxess expressed concern that the proposed rule is not clear

    as to whether a SEF can contract its investigations to its regulatory

    service provider.\490\ MarketAxess recommended that the Commission

    modify the proposed rule by replacing ``compliance staff'' with ``swap

    execution facility'' to clarify that a regulatory service provider that

    is responsible for a SEF's rule enforcement program can conduct

    investigations on behalf of the SEF.\491\

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

    \490\ MarketAxess Comment Letter at 35 (Mar. 8, 2011).

    \491\ Id. at 35-36.

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

    (B) Commission Determination

    The Commission is adopting Sec. 37.203(f)(1) as proposed, subject

    to certain modifications described below. The Commission confirms that

    in certain circumstances a SEF should have reasonable discretion

    regarding whether or not to open an investigation, as noted by CME.

    Accordingly, the Commission is amending proposed Sec. 37.203(f)(1) to

    provide that an investigation must be commenced by the SEF upon the

    receipt of a request from Commission staff or upon the discovery or

    receipt of information that indicates a ``reasonable basis'' for

    finding that a violation may have occurred or will occur.

    In response to MarketAxess's comment that the proposed rule is

    unclear, the Commission confirms that a SEF may contract with a

    regulatory service provider, as provided for under Sec. 37.204, whose

    staff may perform the functions assigned to a SEF's compliance staff

    under this rule. In this regard, the Commission also notes that the SEF

    must maintain sufficient internal compliance staff to oversee the

    quality and effectiveness of the regulatory services provided on its

    behalf, and to make certain regulatory decisions, as required by Sec.

    37.204.

    (ii) Sec. 37.203(f)(2)--Timeliness

    Under proposed Sec. 37.203(f)(2), the Commission required that

    investigations be completed in a timely manner, defined as 12 months

    after an investigation is opened, absent enumerated mitigating

    circumstances.

    (A) Summary of Comments

    CME generally supported the proposed rule, but recommended that the

    list of possible mitigating circumstances also include the domicile of

    the subjects and cooperative enforcement matters since the SEF may not

    have independent control over the pace of the investigation.\492\ CME

    also requested that the Commission clarify that the twelve month period

    for completing an investigation referenced in proposed Sec.

    37.203(f)(2) is separate from the time period necessary to prosecute an

    investigation.\493\

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

    \492\ CME Comment Letter at 21 (Feb. 22, 2011).

    \493\ Id. at 21-22.

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

    (B) Commission Determination

    The Commission is adopting Sec. 37.203(f)(2) as proposed. The

    Commission believes that a 12-month period to complete an investigation

    is appropriate and timely. Although the Commission agrees with CME that

    additional mitigating factors could justifiably contribute to a delay

    in completing an investigation within a 12-month period, the Commission

    notes that the factors included in the proposed rule were not intended

    to be an exhaustive list of mitigating circumstances. In the

    Commission's view, the factors listed in the proposed rule represent

    some of the more common examples that could delay completion of an

    investigation within the 12-month period. The Commission also confirms

    that Sec. 37.203(f)(2) only applies to the investigation phase of a

    matter, and is separate from the time period necessary to prosecute an

    investigation.

    (iii) Sec. 37.203(f)(3)--Investigation Reports When a Reasonable Basis

    Exists for Finding a Violation

    Proposed Sec. 37.203(f)(3) required a SEF's compliance staff to

    submit an investigation report for disciplinary action any time staff

    determined that a reasonable basis existed for finding a rule

    violation. The proposed rule also enumerated the items that must be

    included in the investigation report, including the market

    participant's disciplinary history.

    (A) Summary of Comments

    CME and ICE commented on the requirement that a respondent's

    disciplinary history be included in the investigation report that is

    submitted to a Review Panel.\494\ CME asserted that a respondent's

    disciplinary history would only be relevant if a prior offense is an

    element of proof for the potential rule violation under review.\495\

    ICE commented that only substantive violations in the respondent's

    history would be relevant to the Review Panel's deliberations.\496\

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

    \494\ ICE Comment Letter at 7 (Mar. 8, 2011); CME Comment Letter

    at 22, 35 (Feb. 22, 2011).

    \495\ CME Comment Letter at 35 (Feb. 22, 2011).

    \496\ ICE Comment Letter at 7 (Mar. 8, 2011).

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

    CME commented that rule violations can range from very minor to

    egregious and not every rule violation merits formal disciplinary

    action.\497\ CME argued that warning letters are sufficient to address

    minor rule violations, rather than the issuance of a formal

    investigatory report.\498\

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

    \497\ CME Comment Letter at 22 (Feb. 22, 2011).

    \498\ Id.

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

    MarketAxess stated that the proposed rule does not specify to whom

    the investigation reports must be submitted, and recommended that the

    reports be submitted to the SEF's Chief Compliance Officer, consistent

    with Core Principle 15.\499\

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

    \499\ MarketAxess Comment Letter at 36 (Mar. 8, 2011).

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

    (B) Commission Determination

    The Commission is adopting Sec. 37.203(f)(3) as proposed, subject

    to one modification. The Commission agrees with CME and ICE that a

    respondent's disciplinary history is not always relevant to the

    determination of whether the respondent has committed a further

    violation of a SEF's rules. Accordingly, the Commission is removing

    this requirement from the final rule. The Commission notes, however,

    that all disciplinary sanctions, including sanctions imposed pursuant

    to an accepted settlement offer, must take into account the

    respondent's disciplinary history.

    [[Page 33515]]

    The Commission confirms, as recommended by CME, that ``minor

    transgressions'' can be addressed by a SEF's compliance staff with the

    issuance of warning letters as discussed below in Sec. 37.203(f)(5).

    However, as further discussed below in Sec. 37.203(f)(5), no more than

    one warning letter may be issued to the same person or entity found to

    have committed the same rule violation more than once within a rolling

    12-month period.\500\

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

    \500\ The Commission notes that a SEF's issuance of a warning

    letter for the violation of a SEF rule neither precludes the

    Commission from taking an enforcement action against the recipient

    of the warning letter based upon the same underlying conduct, nor

    does it provide a defense against any such Commission enforcement

    action.

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

    Finally, the Commission clarifies that a SEF's compliance staff

    should submit all completed investigation reports to the member or

    members of the SEF's compliance department responsible for reviewing

    such reports and determining the next steps in the process, such as

    whether to refer the matter to the SEF's disciplinary panel or

    authorized compliance staff under Sec. 37.206(c).

    (iv) Sec. 37.203(f)(4)--Investigation Reports When No Reasonable Basis

    Exists for Finding a Violation

    Proposed Sec. 37.203(f)(4) required compliance staff to prepare an

    investigation report upon concluding an investigation and determining

    that no reasonable basis exists for finding a rule violation. If the

    investigation report recommended that a disciplinary panel should issue

    a warning letter, then the investigation report must also include a

    copy of the warning letter and the market participant's disciplinary

    history, including copies of warning letters.

    (A) Summary of Comments

    CME noted that its Market Regulation Department currently has the

    authority to administratively close a case and issue a warning letter

    without disciplinary committee approval.\501\ Accordingly, CME

    recommended that the Commission amend the proposed rule to reflect that

    a SEF will also have such authority.\502\

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

    \501\ CME Comment Letter at 21 (Feb. 22, 2011).

    \502\ Id.

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

    (B) Commission Determination

    The Commission is adopting Sec. 37.203(f)(4) as proposed, subject

    to one modification.\503\ The Commission is eliminating the provision

    that discussed the concept of warning letters because the Commission

    does not believe that a SEF would need to limit the number of warning

    letters that can be issued when a rule violation has not been found.

    The Commission notes, however, that this modification does not impact

    the limitation on the number of warning letters that may be issued by a

    disciplinary panel or by compliance staff to the same person or entity

    for the same violation committed more than once in a rolling 12-month

    period when a rule violation has been found. The Commission clarifies,

    in response to CME's comment, that a SEF may authorize its compliance

    staff to close a case administratively and issue a warning letter

    without disciplinary panel approval when a reasonable basis does not

    exist for finding a rule violation.

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

    \503\ Similar to Sec. 37.203(f)(3), the Commission notes that a

    SEF's compliance staff should submit all completed investigation

    reports to the member or members of the SEF's compliance department

    responsible for reviewing such reports and determining the next

    steps to take.

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

    (v) Sec. 37.203(f)(5)--Warning Letters

    Proposed Sec. 37.203(f)(5) provided that a SEF may authorize its

    compliance staff to issue a warning letter or to recommend that a

    disciplinary committee issue a warning letter. The proposed rule also

    prohibited a SEF from issuing more than one warning letter to the same

    person or entity for the same potential violation during a rolling 12-

    month period.

    (A) Summary of Comments

    Some commenters opposed the proposed limitation on the number of

    warning letters issued during a rolling 12-month period.\504\ CME

    contended that the rule does not consider important factors that are

    relevant to a SEF when evaluating potential sanctions in a disciplinary

    matter.\505\ CME believed that the SEF should have discretion to

    determine the appropriate actions in all cases based on the ``totality

    of the circumstances.'' \506\ ICE stated that this limitation would

    discourage self-reporting of violations because of the lack of

    discretion in a resulting penalty assessment.\507\ MarketAxess

    requested that the Commission adopt a more uniform approach with

    respect to warning letters, permitting them to be issued as a sanction

    or an indication of a finding of a violation in all SEF contexts.\508\

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

    \504\ ICE Comment Letter at 7 (Mar. 8, 2011); CME Comment Letter

    at 22 (Feb. 22, 2011).

    \505\ CME Comment Letter at 22 (Feb. 22, 2011).

    \506\ Id.

    \507\ ICE Comment Letter at 7 (Mar. 8, 2011).

    \508\ MarketAxess Comment Letter at 36 (Mar. 8, 2011).

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

    (B) Commission Determination

    The Commission is adopting proposed Sec. 37.203(f)(5), subject to

    certain modifications, including converting a portion of the rule to

    guidance in appendix B to part 37.

    The Commission is maintaining in the final rule the limitation on

    the number of warning letters issued. The Commission acknowledges the

    comments from CME and ICE concerning the issuance of warning letters,

    but believes that to ensure that warning letters serve as effective

    deterrents and to preserve the value of disciplinary sanctions, no more

    than one warning letter may be issued to the same person or entity

    found to have committed the same rule violation more than once within a

    rolling 12-month period.\509\ As discussed in the SEF NPRM, while a

    warning letter may be appropriate for a first-time violation, the

    Commission does not believe that more than one warning letter in a

    rolling 12-month period for the same violation is ever

    appropriate.\510\ Further, a policy of issuing repeated warning

    letters, rather than issuing meaningful sanctions, to market

    participants who repeatedly violate the same rules reduces the

    effectiveness of a SEF's rule enforcement program.\511\

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

    \509\ For purposes of this rule, the Commission does not

    consider a ``reminder letter'' or such other similar letter to be

    any different than a warning letter.

    \510\ Core Principles and Other Requirements for Swap Execution

    Facilities, 76 FR at 1224.

    \511\ Id.

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

    However, in response to commenters' concerns, the Commission is

    narrowing the application of this rule to warning letters that contain

    an affirmative finding that a rule violation has occurred. Therefore,

    the Commission is removing the provision in the proposed rule that a

    warning letter issued in accordance with this section is not a penalty

    or an indication that a finding of a violation has been made. To remain

    consistent with the modifications to proposed Sec. 37.203(f)(3) and

    (f)(4), the Commission is also deleting the proposed requirement that

    investigation reports required by paragraphs (f)(3) and (f)(4) of this

    section must include a copy of the warning letter issued by compliance

    staff.

    As noted above, the Commission agrees with CME's comment that minor

    transgressions can be addressed by a SEF's compliance staff issuing a

    warning letter. Accordingly, in order to provide a SEF with flexibility

    in this regard, the Commission is moving this provision of the rule to

    the guidance in appendix B to part 37. The text of the guidance

    provides that the rules of a SEF may authorize its compliance staff to

    issue a warning letter to a person or entity under investigation or to

    [[Page 33516]]

    recommend that a disciplinary panel take such action.

    (7) Sec. 37.203(g)--Additional Rules Required

    Proposed Sec. 37.203(g) required a SEF to adopt and enforce any

    additional rules that it believes are necessary to comply with the

    requirements of Sec. 37.203.

    (i) Commission Determination

    The Commission did not receive any comments on proposed Sec.

    37.203(g); however, the Commission is moving this rule to the guidance

    in appendix B to part 37. The Commission believes that this requirement

    is already implicit in Core Principle 2 and need not be addressed

    separately as a final rule. Additionally, moving proposed Sec.

    37.203(g) to guidance provides SEFs with added flexibility in adopting

    additional rules that it believes are necessary to comply with the

    rules related to Core Principle 2. Consistent with this determination,

    the Commission is replacing proposed Sec. 37.203(g) with final Sec.

    37.203(g) (titled ``Additional sources for compliance'') that simply

    permits SEFs to rely upon the guidance in appendix B to part 37 to

    demonstrate to the Commission compliance with Sec. 37.203.

    (e) Sec. 37.204--Regulatory Services Provided by a Third Party

    (1) Sec. 37.204(a)--Use of Third-Party Provider Permitted \512\

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

    \512\ The Commission is renaming the title of this section from

    ``Use of Third-Party Provider Permitted'' to ``Use of Regulatory

    Service Provider Permitted'' to provide greater clarity.

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

    Proposed Sec. 37.204(a) allowed a SEF to contract with a

    registered futures association or another registered entity to assist

    in complying with the SEF core principles, as approved by the

    Commission. The proposed rule also stated that a SEF that elects to use

    the services of a regulatory service provider must ensure that such

    provider has the capacity and resources to provide timely and effective

    regulatory services. The proposed rule further stated that a SEF will

    at all times remain responsible for the performance of any regulatory

    services received, for compliance with the SEF's obligations under the

    Act and Commission regulations, and for the regulatory service

    provider's performance on its behalf.

    (i) Summary of Comments

    Commenters generally supported the Commission's proposal to allow

    third parties to provide regulatory services.\513\ However, MarketAxess

    argued that the Commission should permit an entity that is not a

    registered futures association or another registered entity with the

    Commission to perform regulatory services on behalf of a SEF, such as

    the Financial Industry Regulatory Authority (``FINRA'').\514\ In the

    alternative, MarketAxess recommended that the Commission should permit

    SEFs, if desired, to form a joint venture to create a special

    regulatory service provider for SEFs that would not be a registered

    entity.\515\ Similarly, several commenters supported a centralized,

    common regulatory organization (``CRO'') that would facilitate

    compliance with SEF core principles.\516\ In this regard, WMBAA stated

    that a CRO would establish a uniform SEF standard of conduct,

    streamline the Commission's evaluation of each SEF registration

    application, and conduct effective surveillance of fungible swap

    products trading on multiple SEFs.\517\

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

    \513\ MarketAxess Comment Letter at 14-15 (Mar. 8, 2011);

    Reuters Comment Letter at 5 (Mar. 8, 2011); Bloomberg Comment Letter

    at 4-5 (Mar. 8, 2011); NFA Comment Letter at 1 (Mar. 8, 2011).

    \514\ MarketAxess Comment Letter at 15 (Mar. 8, 2011).

    \515\ Id.

    \516\ Parity Energy Comment Letter at 5 (Mar. 25, 2011); WMBAA

    Comment Letter at 22 (Mar. 8, 2011); FXall Comment Letter at 12

    (Mar. 8, 2011).

    \517\ WMBAA Comment Letter at 22 (Mar. 8, 2011).

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

    MarketAxess and Tradeweb requested clarification on how the

    Commission will assess and approve regulatory service providers.\518\

    In this regard, Tradeweb commented that SEFs should have flexibility in

    contracting with third party service providers, so long as the SEF uses

    reasonable diligence and acts in a manner consistent with market

    practice.\519\

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

    \518\ MarketAxess Comment Letter at 15 (Mar. 8, 2011); Tradeweb

    Comment Letter at 10 (Mar. 8, 2011).

    \519\ Tradeweb Comment Letter at 10 (Mar. 8, 2011).

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

    (ii) Commission Determination

    The Commission is adopting Sec. 37.204(a) as proposed, subject to

    two modifications. In response to MarketAxess's comment about non-

    registered entities performing regulatory services, the Commission is

    revising the proposed rule to allow FINRA to assist SEFs in complying

    with the core principles. The Commission notes that FINRA has provided

    similar regulatory services for the securities industry for many years

    and may serve as a self-regulatory organization for SB-SEFs. Therefore,

    the Commission believes that allowing FINRA to serve as a regulatory

    service provider for SEFs is appropriate because FINRA is likely to

    have the qualifications, capacity, and resources to provide timely and

    effective regulatory services for SEFs.

    The Commission recognizes the concerns that WMBAA and others have

    with respect to SEFs conducting market-wide surveillance activities. As

    discussed elsewhere in this final rulemaking,\520\ an individual SEF

    may have limited ability to monitor trading activities across markets

    since individual swaps may be listed on multiple SEFs (as well as any

    DCMs listing swaps). The Commission clarifies that a SEF (or a

    regulatory service provider on a SEF's behalf), under Core Principle 2

    and the Commission's regulations thereunder, is only responsible for

    surveillance and rule enforcement of the SEF's systems and platforms,

    and Core Principle 2 does not impose a cross-market surveillance

    requirement on a SEF.\521\ Therefore, the final rules do not require

    the use of a single industry-wide CRO to assist SEFs with cross-market

    surveillance. While not requiring it, the final rules also do not

    prohibit the use of a single industry-wide CRO.

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

    \520\ See, e.g., discussion under Sec. 37.203(d)--Automated

    Trade Surveillance System and Core Principle 6--Position Limits or

    Accountability in the preamble.

    \521\ The Commission notes that other core principles, such as

    Core Principle 4, and the Commission's regulations thereunder may

    require SEFs to conduct certain cross-market monitoring.

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

    In response to MarketAxess's and Tradeweb's comments regarding the

    Commission's assessment and approval of regulatory service providers,

    the Commission notes that it will assess and approve the use of such

    service providers during the full registration process. The Commission

    also notes that Exhibit N to Form SEF requests executed or executable

    copies of any agreements with regulatory service providers.

    Finally, the Commission is modifying Sec. 37.204(a) to make clear

    that a SEF may use the services of a regulatory service provider for

    the provision of services to assist the SEF in complying with ``the Act

    and Commission regulations thereunder'' rather than simply the SEF core

    principles as stated in proposed Sec. 37.204(a). The modification

    aligns the rule text with what the Commission has always intended to be

    the range of a SEF's self-regulatory obligations.

    (2) Sec. 37.204(b)--Duty To Supervise Third Party \522\

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

    \522\ The Commission is renaming the title of this section from

    ``Duty to Supervise Third Party'' to ``Duty to Supervise Regulatory

    Service Provider'' to provide greater clarity.

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

    Proposed Sec. 37.204(b) required that a SEF maintain sufficient

    compliance staff to supervise any services performed by

    [[Page 33517]]

    a regulatory service provider. The proposed rule also required that the

    SEF hold regular meetings with its regulatory service provider to

    discuss current work and other matters of regulatory concern, as well

    as conduct periodic reviews of the adequacy and effectiveness of

    services provided on its behalf. In addition, proposed Sec. 37.204(b)

    required a SEF to carefully document the reviews and make them

    available to the Commission upon request.

    (i) Summary of Comments

    Two commenters recommended that the Commission adopt a more

    flexible rule with respect to a SEF's duty to supervise its regulatory

    service provider.\523\ In this regard, NFA recommended that the

    Commission provide flexibility to a SEF and its regulatory service

    provider to mutually determine the necessary process for a SEF to

    supervise its regulatory service provider.\524\ CME recommended that

    the Commission move the rule to guidance or acceptable practices.\525\

    In particular, CME pointed to the requirements that a SEF conduct

    periodic reviews of the services provided and hold regular meetings

    with the regulatory service provider to discuss ongoing investigations,

    trading patterns, market participants, and any other matters of

    regulatory concern.\526\ CME stated that ``[w]hile it may well be that

    it is constructive for the [SEF] to hold regular meetings with its

    service provider and `discuss market participants,' the core principle

    should stand on its own and the [SEF] should have the flexibility to

    determine how best to demonstrate compliance with the core principle.''

    \527\

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

    \523\ NFA Comment Letter at 2 (Mar. 8, 2011); CME Comment Letter

    at 18-19 (Feb. 22, 2011).

    \524\ NFA Comment Letter at 2 (Mar. 8, 2011).

    \525\ CME Comment Letter at 19 (Feb. 22, 2011).

    \526\ Id. at 18-19.

    \527\ Id. at 19.

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

    (ii) Commission Determination

    The Commission is adopting Sec. 37.204(b) as proposed.\528\ The

    Commission acknowledges the commenters' desire for a flexible approach,

    but notes that a SEF that elects to use a regulatory service provider

    remains responsible for the regulatory services received and for

    compliance with the Act and Commission regulations. The SEF therefore

    must properly supervise the quality and effectiveness of the regulatory

    services provided on its behalf. The Commission believes that proper

    supervision will require that a SEF have complete and timely knowledge

    of relevant work performed by the SEF's regulatory service provider on

    its behalf. The Commission also believes that this knowledge can only

    be acquired through periodic reviews and regular meetings required

    under Sec. 37.204(b).

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

    \528\ The Commission is making certain non-substantive

    clarifications to Sec. 37.204(b).

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

    (3) Sec. 37.204(c)--Regulatory Decisions Required From the SEF

    Proposed Sec. 37.204(c) required a SEF that utilizes a regulatory

    service provider to retain exclusive authority over all substantive

    decisions made by its regulatory service provider, including the

    cancellation of trades, issuance of disciplinary charges, denials of

    access to the trading platform for disciplinary reasons, and any

    decision to open an investigation into a possible rule violation.

    Further, the proposed rule required a SEF to document any instance

    where its actions differed from those recommended by its regulatory

    service provider.

    (i) Summary of Comments

    CME objected to the idea that all decisions concerning the

    cancellation of trades remain in the exclusive authority of the

    SEF.\529\ CME contended that a SEF may be better served by granting

    such authority to a regulatory service provider because such decisions

    require prompt decision-making.\530\

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

    \529\ CME Comment Letter at 19 (Feb. 22, 2011).

    \530\ Id.

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

    (ii) Commission Determination

    The Commission is adopting Sec. 37.204(c) as proposed, subject to

    two modifications. First, the Commission is removing the requirement

    that a decision to open an investigation reside exclusively with the

    SEF. The final rule grants a SEF the latitude to determine whether

    investigations will be opened by the SEF, by its regulatory service

    provider, or some combination of the two. The Commission believes that

    opening investigations is an administrative task and does not

    necessarily imply the threat of formal disciplinary action or sanctions

    against a market participant. Second, the Commission is amending the

    rule to clarify that when a SEF documents instances when its actions

    differ from those recommended by its regulatory service provider, the

    SEF must include the reasons for the course of action recommended by

    the regulatory service provider and the reasons why the SEF chose a

    different course of action.

    The Commission disagrees with CME's comment concerning the

    ``cancellation of trades'' and believes that a SEF must retain

    exclusive authority in this regard. Cancelling trades is an important

    exercise of a SEF's authority over its markets and market participants.

    Cancelled trades may have meaningful economic consequences to the swap

    counterparties involved in the transaction, and may be the subject of

    contention between the counterparties if they do not both agree to the

    cancellation. The Commission emphasizes that permanent, consequential

    decisions must remain with the SEF.

    (f) Sec. 37.205--Audit Trail

    Proposed Sec. 37.205 implements Core Principle 2's requirement

    that SEFs capture information that may be used in establishing whether

    rule violations have occurred.\531\ Accordingly, proposed Sec. 37.205

    required a SEF to establish procedures to capture and retain

    information that may be used in establishing whether rule violations

    have occurred. The proposed rule, along with its subparts, established

    the requirements of an acceptable audit trail program and the

    enforcement of such program.

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

    \531\ CEA section 5h(f)(2)(B)(ii); 7 U.S.C. 7b-3(f)(2)(B)(ii).

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

    (1) Sec. 37.205(a)--Audit Trail Required

    Proposed Sec. 37.205(a) required a SEF to capture and retain all

    audit trail data so that the SEF has the ability to detect,

    investigate, and prevent customer and market abuses. The proposed rule

    also provided that the audit trail data must be sufficient to

    reconstruct all transactions within a reasonable period of time and to

    provide evidence of any rule violations that may have occurred.

    Proposed Sec. 37.205(a) further provided that the audit trail must

    permit the SEF to track a customer order from the time of receipt

    through fill, allocation, or other disposition, and must include both

    order and trade data.

    (i) Summary of Comments

    WMBAA requested that the Commission establish a common format for

    audit trail data to ensure consistency among all SEFs and to make the

    information easier for the Commission to use and review when

    investigating customer and market abuses.\532\

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

    \532\ WMBAA Comment Letter at 22-23 (Mar. 8, 2011).

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

    (ii) Commission Determination

    The Commission is adopting Sec. 37.205(a) as proposed, subject to

    the

    [[Page 33518]]

    modifications described below.\533\ The Commission believes that the

    requirement that SEFs capture and retain all audit trial data is

    essential to ensuring that SEFs can capture information to establish

    whether rule violations have occurred, as required by Core Principle

    2.\534\ Additionally, the creation and retention of a comprehensive

    audit trail will enable SEFs to properly reconstruct any and all market

    and trading events and to conduct a thorough forensic review of all

    market information. The Commission believes that the ability to

    reconstruct markets in such a manner is a fundamental element of a

    SEF's surveillance and rule enforcement programs. Consistent with these

    principles, the Commission is modifying Sec. 37.205(a) to clarify that

    the audit trail data must be sufficient to reconstruct trades and

    sufficient to reconstruct indications of interest, requests for quotes,

    and orders within a reasonable period of time.

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

    \533\ The Commission is making certain non-substantive

    clarifications to Sec. 37.205(a).

    \534\ CEA section 5h(f)(2)(B)(ii); 7 U.S.C. 7b-3(f)(2)(B)(ii).

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

    Both the proposed and final rules in Sec. 37.205(a) require that a

    SEF ``capture and retain all audit trail data necessary to detect,

    investigate, and prevent customer and market abuses'' (emphasis added).

    The Commission notes that information required to detect abuses may in

    some cases include all communications between market participants and a

    SEF's trading system or platform. The Commission also notes that a

    SEF's obligation to capture in its audit trail all data necessary to

    detect, investigate, and prevent customer and market abuses is not

    altered by the nature of the trading system or platform that a SEF may

    choose to utilize, including a system or platform that, for example,

    utilizes the telephone. For example, an acceptable audit trail for a

    SEF with a telephone component should include communications between

    the SEF's employees and their customers, as well as any communications

    between employees as they work customer indications of interest,

    requests for quotes, orders, and trades. An acceptable audit trail must

    capture the totality of communications (including, but not limited to,

    telephone, instant messaging, email, written records, and electronic

    communications within a trading system or platform) that could be

    necessary to detect, investigate, and prevent customer and market

    abuses, as required by both proposed and final Sec. 37.205(a).

    The Commission believes that WMBAA's suggestion to establish a

    common format for audit trail data may provide some value for SEFs that

    wish to coordinate and establish such a standard. However, the intent

    of the final rules is to require that a SEF establish and maintain an

    effective audit trail program, not to dictate the method or form for

    maintaining such information. Importantly, the rule, by not being

    prescriptive, provides SEFs with flexibility to determine the manner

    and the technology necessary and appropriate to meet the requirements.

    The Commission notes, nevertheless, that staff from the Commission's

    Office of Data and Technology will coordinate with SEFs to establish

    standards for the submission of audit trail data to the Commission.

    (2) Sec. 37.205(b)--Elements of an Acceptable Audit Trail Program

    Proposed Sec. 37.205(b)(1) required a SEF's audit trail to include

    original source documents, on which trade execution information was

    originally recorded, as well as records for customer orders, whether or

    not they were filled. The proposed rule also required that a SEF that

    permits intermediation must require all executable orders or RFQs

    received over the telephone to be immediately entered into the trading

    system or platform. Proposed Sec. 37.205(b)(2) required that a SEF's

    audit trail program include a transaction history database and

    specified the trade information required to be included in the

    database. Proposed Sec. 37.205(b)(3) required the audit trail program

    to also have electronic analysis capability for the transaction history

    database. Proposed Sec. 37.205(b)(4) required the audit trail program

    to include the ability to safely store all audit trail data and to

    retain it in accordance with the recordkeeping requirements of SEF Core

    Principle 10 and its associated regulations.

    (i) Summary of Comments

    WMBAA commented that the requirement for records to be retained for

    customer orders should not apply to indications of interest because it

    would extend beyond the Commission's statutory authority and the audit

    trail requirements currently in place in other financial markets, and

    would be unnecessarily costly and burdensome.\535\ WMBAA also commented

    that the audit trail requirements must permit the retention of relevant

    information through various modes because SEFs may operate trade

    execution platforms ``through any means of interstate commerce.'' \536\

    Better Markets commented that audit trail records, such as records of

    customers' orders and their disposition, must be time-stamped at

    intervals that are consistent with the capabilities of high-frequency

    traders that use SEFs.\537\

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

    \535\ WMBAA Comment Letter at 23 (Mar. 8, 2011).

    \536\ Id.

    \537\ Better Markets Comment Letter at 18 (Mar. 8, 2011).

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

    (ii) Commission Determination

    The Commission is adopting proposed Sec. 37.205(b), subject to the

    modifications discussed below. The Commission is clarifying that ``time

    of trade execution'' must be included in the data points of an

    acceptable audit trail, and is noting this clarification in final Sec.

    37.205(b)(1). The Commission is also revising proposed Sec.

    37.205(b)(2) to specify that a transaction history database must

    include a history of ``all indications of interest, requests for

    quotes, orders, and trades entered into a [SEF's] trading system or

    platform, including all order modifications and cancellations.''

    Further, the Commission is revising proposed Sec. 37.205(b)(3) to

    specifically state that a SEF's electronic analysis capability must

    provide it with the ``ability to reconstruct indications of interest,

    requests for quotes, orders, and trades, and identify possible trading

    violations.'' The revisions to Sec. 37.205(b)(2) and (b)(3), subject

    to the additions of the indications of interest and requests for quotes

    language, reflect regulatory requirements previously proposed as part

    of Sec. 37.203(d), but, as noted above, the Commission is moving these

    requirements to final Sec. 37.205(b). Additionally, the Commission is

    revising proposed Sec. 37.205(b)(2) by replacing the customer type

    indicators listed in the proposed rule with the term ``customer type

    indicator code.''

    In response to WMBAA's comment regarding indications of interest,

    the Commission believes that retaining information about indications of

    interest provides another important detail of an audit trail, just as

    information of filled, unfilled, or cancelled orders provides important

    information for the SEF. This information enables a SEF to fulfill its

    statutory duty under Core Principle 2, which requires a SEF to capture

    information that may be used in establishing whether rule violations

    have occurred.\538\ Absent this information, SEFs would be limited in

    their ability to monitor their markets and to detect, investigate, and

    prevent customer and market abuses and trading

    [[Page 33519]]

    rule violations. However, as discussed above, the Commission has

    removed the requirement for SEFs to offer indicative quote

    functionality, which should reduce the costs of complying with the

    audit trail requirements.\539\

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

    \538\ CEA section 5h(f)(2)(B)(ii); 7 U.S.C. 7b-3(f)(2)(B)(ii).

    \539\ See discussion above regarding Minimum Trading

    Functionality under Sec. 37.3--Requirements for Registration in the

    preamble.

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

    In response to WMBAA's comment about the flexibility of audit trail

    requirements to accommodate various methods of execution, the

    Commission notes that proposed Sec. 37.205(b) did not discriminate

    based on the method of execution. Given the Commission's clarification

    that a SEF may utilize any means of interstate commerce in providing

    the execution methods in Sec. 37.9(a)(2)(i)(A) or (B), the Commission

    emphasizes that no matter how an indication of interest, request for

    quote, or order is communicated or a trade is executed, an audit trail

    that satisfies the requirements set forth in Sec. 37.205 must be

    created.

    The Commission is also making certain conforming changes to Sec.

    37.205(b)(1) to harmonize its provisions with the Commission's

    determination that a SEF may utilize any means of interstate commerce

    in providing the execution methods in Sec. 37.9(a)(2)(i)(A) or (B).

    First, the Commission is adding ``indications of interest'' to the

    items that must be immediately captured in the audit trail pursuant to

    Sec. 37.205(b)(1). Second, while proposed Sec. 37.205(b)(1) required

    that all executable orders or requests for quotes ``be immediately

    entered into the trading system or platform,'' Sec. 37.205(b)(1) as

    adopted requires that such information be immediately ``captured in the

    audit trail.'' This approach more accurately reflects the intent of

    Sec. 37.205, whose purpose is to ensure an adequate audit trail,

    rather than to address the operation of a SEF's trading system or

    platform.

    Accordingly, the final rules in Sec. 37.205(b)(1) include

    conforming changes that remove the reference in proposed Sec.

    37.205(b)(1) to orders or requests for quotes ``that are executable,''

    and also remove the qualification that a SEF's obligation to capture

    information in the audit trail is dependent on whether the SEF permits

    intermediation. Finally, the final rules remove the additional audit

    trail requirement in proposed Sec. 37.205(b)(1) for orders and

    requests for quotes that cannot be immediately entered into the trading

    system or platform. These clarifications are consistent with the

    Commission's intention in Sec. 37.205(a) that a SEF's audit trail

    ``capture and retain all audit trail data necessary to detect,

    investigate, and prevent customer and market abuses.'' It is the

    Commission's intent throughout Sec. 37.205 to ensure that all SEFs'

    audit trails are equally comprehensive and effective regardless of the

    means of interstate commerce that a SEF may provide to meet the

    execution methods in Sec. 37.9(a)(2)(i)(A) or (B).

    Although Sec. 37.205 sets forth a unified set of audit trail

    requirements for all methods of execution, the Commission notes that a

    SEF, for example, that utilizes the telephone as a means of interstate

    commerce in providing the execution methods in Sec. 37.9(a)(2)(i)(A)

    or (B) may comply with the audit trail requirements by utilizing

    different technologies than a SEF that does not utilize the telephone.

    For example, the Commission believes that a SEF that utilizes the

    telephone may comply with the audit trail requirements in Sec.

    37.205(a) for oral communications by recording all such communications

    that relate to swap transactions, and all communications that may

    subsequently result in swap transactions. Such recordings must allow

    for reconstruction of communications between the SEF and its customers;

    reconstruction of internal and external communications involving SEF

    employees who are ascertaining or providing indications of interest,

    requests for quotes, or orders; reconstruction of executed

    transactions; provide evidence of any rule violations; track a

    customer's order; and capture order and trade data as required under

    Sec. 37.205(a).

    The Commission also believes that a SEF that utilizes the telephone

    may comply with the original source document requirement in Sec.

    37.205(b)(1) for oral communications by retaining each recording's

    original media. By storing the recordings in a digital database and

    supplementing it with additional data as necessary, the Commission

    believes that a SEF that utilizes the telephone may comply with the

    transaction history database requirement in Sec. 37.205(b)(2) for oral

    communications. Additionally, the Commission believes that a SEF that

    utilizes the telephone may comply with the electronic analysis

    capability in Sec. 37.205(b)(3) for oral communications by ensuring

    that its digital database of recordings is capable of being searched

    and analyzed. The Commission notes, however, that Sec. 37.205(b) does

    not establish an affirmative requirement to create recordings of oral

    communications if the audit trail requirements are met through other

    methods. The discussion above regarding the applicability of audit

    trail requirements to SEFs that utilize the telephone in providing the

    execution methods in Sec. 37.9(a)(2) applies equally to SEFs that use

    non-telephonic means of communication (e.g., instant messaging or

    email). In all cases, the operative requirement is to capture in the

    audit trail and the transaction history database the totality of

    communications that could be necessary to detect, investigate, and

    prevent customer and market abuses.

    The Commission acknowledges the comment by Better Markets regarding

    time-stamping audit trail records at intervals that are consistent with

    the capabilities of high-frequency traders. While the audit trail rules

    do not specify the granularity of time-stamped data, the Commission

    believes that the audit trail rules adopted herein, particularly the

    requirements that a SEF retain and maintain all data necessary to

    permit it to reconstruct trading, will help to ensure that audit trail

    records are time-stamped with the granularity necessary to reconstruct

    trades and investigate possible trading violations, including for high-

    frequency trading.\540\

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

    \540\ The Commission notes, as stated above under Sec.

    37.203(d)--Automated Trade Surveillance System in the preamble, that

    the accurate time stamping of data is particularly important for

    SEFs that use an RFQ System, including an RFQ System with a voice

    component. For such SEFs, the accurate time stamping of both their

    Order Book and RFQ System activity is critical for ensuring both

    that the SEF itself has a robust audit trail system and that the

    Commission is able to monitor the SEF's adherence to part 37's Order

    Book-RFQ System integration requirements.

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

    (3) Sec. 37.205(c)--Enforcement of Audit Trail Requirements

    Proposed Sec. 37.205(c)(1) required that a SEF conduct reviews, at

    least annually, of its members and market participants to verify their

    compliance with the SEF's audit trail and recordkeeping requirements.

    Proposed Sec. 37.205(c)(1) also set forth minimum review criteria.

    Proposed Sec. 37.205(c)(2) required that a SEF develop a program for

    effective enforcement of its audit trail and recordkeeping

    requirements, including a requirement that a SEF levy meaningful

    sanctions when deficiencies are found. Proposed Sec. 37.205(c)(2) also

    stated that sanctions may not include more than one warning letter for

    the same violation within a rolling twelve-month period.

    (i) Summary of Comments

    Some commenters stated that annual audits are unnecessary and

    unduly

    [[Page 33520]]

    burdensome.\541\ CME commented that annual audits of all SEF market

    participants would be costly and unproductive, and should instead apply

    at the clearing firm level.\542\ MarketAxess recommended that the

    Commission require a single entity or self-regulatory organization,

    such as FINRA or NFA, to conduct the audit of each SEF market

    participant.\543\ Tradeweb commented that the proposed annual audit

    review requirement is not required of DCMs and, as such, should not be

    required of SEFs.\544\

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

    \541\ Tradeweb Comment Letter at 6 (Jun. 3, 2011); MarketAxess

    Comment Letter at 22 (Mar. 8, 2011); CME Comment Letter at 33 (Feb.

    22, 2011).

    \542\ CME Comment Letter at 33 (Feb. 22, 2011).

    \543\ MarketAxess Comment Letter at 22 (Mar. 8, 2011).

    \544\ Tradeweb Comment Letter at 6 (Jun. 3, 2011).

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

    (ii) Commission Determination

    The Commission is adopting Sec. 37.205(c) as proposed, subject to

    certain modifications as discussed below. The Commission disagrees with

    commenters who assert that the annual audit review requirement is

    unnecessary, unduly burdensome, costly, and unproductive. Through its

    experience with DCMs and DCOs, the Commission has learned that

    sampling-based reviews of audit trail and recordkeeping requirements

    are inadequate to ensure compliance with audit trail rules. The

    Commission believes that the requirements under Sec. 37.205(c) are

    necessary to ensure that SEFs have accurate and consistent access to

    all data needed to reconstruct all transactions in their markets and to

    provide evidence of customer and market abuses. Absent reliable audit

    trail data, a SEF's ability to detect or investigate customer or market

    abuses may be severely diminished.

    However, in response to commenters' concerns that the rule is

    burdensome, the Commission is narrowing the scope of the proposed rule

    by removing the reference to ``market participants'' and instead

    stating that the annual audit review requirement only applies to

    members and those persons and firms that are subject to the SEF's

    recordkeeping rules. As a result of this revision, the Commission

    declines to adopt CME's recommendation to require annual audit trail

    reviews only at the clearing firm level.

    The Commission is maintaining proposed Sec. 37.205(c)(2) as a rule

    to ensure that SEFs impose meaningful sanctions for violations of audit

    trail and recordkeeping rules. However, the Commission is revising the

    rule to clarify that the limit on warning letters only applies where a

    SEF's compliance staff finds an actual rule violation, rather than just

    the suspicion of a violation. This change is consistent with the

    revisions in other sections discussing warning letters.\545\

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

    \545\ See, e.g., discussion above under Sec. 37.203(f)(5)--

    Warning Letters in the preamble.

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

    In response to MarketAxess's recommendation that a single entity

    conduct the audit of each SEF market participant, the Commission

    believes that a SEF can monitor market participants on its own platform

    without relying upon a single cross-market self-regulatory

    organization. However, a SEF may use a regulatory service provider

    pursuant to Sec. 37.204 to assist it in complying with the

    requirements under Sec. 37.205(c).

    In response to Tradeweb's comment that the annual audit review

    requirement is not required of DCMs, the Commission notes that it

    adopted a similar requirement for DCMs under Sec. 38.553 of the

    Commission's regulations, to apply to all members and persons and firms

    subject to the DCM's recordkeeping rules.\546\ The Commission believes

    that similar requirements are appropriate because, as noted above,

    SEFs, like DCMs, must have accurate and consistent access to all data

    needed to reconstruct all transactions in their markets, including

    indications of interest, requests for quotes, orders, and trades, and

    to detect, investigate, and prevent customer and market abuses.

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

    \546\ Core Principles and Other Requirements for Designated

    Contract Markets, 77 FR at 36704.

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

    (g) Sec. 37.206--Disciplinary Procedures and Sanctions

    (1) Sec. 37.206--Disciplinary Procedures and Sanctions

    Proposed Sec. 37.206 addressed SEF Core Principle 2's requirement

    that SEFs establish and enforce trading, trade processing, and

    participation rules to deter abuse, and have the capacity to

    investigate and enforce such abuses.\547\ Proposed Sec. 37.206

    provided that SEFs must establish trading, trade processing, and

    participation rules that will deter abuses and have the capacity to

    enforce such rules through prompt and effective disciplinary action.

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

    \547\ CEA section 5h(f)(2)(B); 7 U.S.C. 7b-3(f)(2)(B).

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

    (i) Summary of Comments

    Some commenters generally stated that the proposed disciplinary

    procedures go beyond the statute and intent of Congress.\548\ In this

    regard, FXall stated that, unlike DCMs, retail customers will not be

    participants on SEFs; therefore, the same level of protection afforded

    to DCM participants is not required for SEFs.\549\ Some commenters

    recommended that the proposed disciplinary procedures should be

    streamlined through the use of a staff summary fine program.\550\ Some

    commenters also requested that SEFs be granted greater flexibility to

    establish their own disciplinary procedures.\551\ Tradeweb stated that

    the proposed disciplinary procedures would impose significant costs on

    SEFs and should be contracted to a central, third-party self-regulatory

    organization.\552\

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

    \548\ MarketAxess Comment Letter at 23 (Mar. 8, 2011); ABC/CIEBA

    Comment Letter at 11 (Mar. 8, 2011); FXall Comment Letter at 12

    (Mar. 8, 2011); ICAP Comment Letter at 5-6 (Mar. 8, 2011); State

    Street Comment Letter at 5 (Mar. 8, 2011).

    \549\ FXall Comment Letter at 12 (Mar. 8, 2011).

    \550\ MarketAxess Comment Letter at 23 (Mar. 8, 2011), WMBAA

    Comment Letter at 24 (Mar. 8, 2011); FXall Comment Letter at 12

    (Mar. 8, 2011).

    \551\ FXall Comment Letter at 12 (Mar. 8, 2011); ICAP Comment

    Letter at 6 (Mar. 8, 2011); Reuters Comment Letter at 4 (Mar. 8,

    2011); WMBAA Comment Letter at 23 (Mar. 8, 2011); State Street

    Comment Letter at 5 (Mar. 8, 2011).

    \552\ Tradeweb Comment Letter at 10 (Mar. 8, 2011). Parity

    Energy also commented that the proposed disciplinary rules will

    impose unnecessary costs and create unnecessary duplication and the

    possibility of conflicting rules. Parity Energy Comment Letter at 4

    (Mar. 25, 2011).

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

    (ii) Commission Determination

    The Commission's evaluation of public comments with respect to

    proposed Sec. 37.206 is based on its understanding that a SEF's

    obligation to establish adequate disciplinary rules is implicit in the

    statutory language of Core Principle 2, which requires, in part, that a

    SEF establish and enforce trading, trade processing, and participation

    rules to deter abuse and have the capacity to investigate and enforce

    such rules.\553\ The Commission also takes note of public comments

    requesting greater flexibility in the application of SEF disciplinary

    rules. Accordingly, consistent with both its statutory mandate and its

    evaluation of the public comments received, the Commission is adopting

    elements of Sec. 37.206 as proposed, while also moving to guidance or

    eliminating other parts of the proposed rules.\554\

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

    \553\ CEA section 5h(f)(2)(B); 7 U.S.C. 7b-3(f)(2)(B).

    \554\ The Commission is also revising Sec. 37.206 to include

    the term ``member'' in addition to the term ``market participant''

    in order to provide greater detail and clarity. The Commission

    notes, as described above in Sec. 37.200, that the term ``market

    participant'' encompasses SEF ``members.''

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

    The Commission believes that the specific disciplinary rules

    retained in the final rules are those that are essential to the

    promotion of market integrity by ensuring that SEF markets are free of

    fraud or abuse, and also helping to provide basic procedural fairness

    for SEF disciplinary

    [[Page 33521]]

    respondents. While the SEF NPRM noted that the SEF disciplinary

    procedures parallel those for DCMs,\555\ the Commission has determined

    that the level of protection offered by the proposed rules was more

    appropriate for markets that include retail participants, in contrast

    to SEFs, whose participants are limited to ECPs.\556\ Consequently, the

    Commission is moving to guidance numerous procedural protections set

    forth in the proposed rules that are more tailored to retail

    participants, including the requirements relating to the issuance of a

    notice of charges, and a respondent's right to representation, right to

    answer charges, and right to request a hearing.

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

    \555\ Core Principles and Other Requirements for Swap Execution

    Facilities, 76 FR at 1225 n. 73.

    \556\ The Commission also believes that guidance is more

    appropriate for the SEF disciplinary procedures because the SEF core

    principles do not have a parallel to DCM Core Principle 13, which

    specifically discusses disciplinary procedures.

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

    The remaining final rules provide an essential framework that the

    Commission believes adequately ensures the effectiveness of a SEF's

    disciplinary program. Accordingly, the Commission is maintaining the

    proposed disciplinary rules that represent the most critical components

    of a disciplinary program, including the requirements that a SEF: (1)

    Establish disciplinary panels that meet certain composition

    requirements; (2) levy meaningful disciplinary sanctions to deter

    recidivism; and (3) issue no more than one warning letter per rolling

    12-month period for the same violation by the same respondent. The

    Commission believes that with these modifications, Sec. 37.206 strikes

    the appropriate balance between providing the flexibility requested by

    the commenters and ensuring that SEFs comply with their statutory

    obligation under Core Principle 2.

    Some commenters recommended that the proposed disciplinary

    procedures should be streamlined through the use of a summary fine

    program. The Commission believes that, while summary fines may be

    appropriate for some disciplinary matters, such as recordkeeping

    violations, many disciplinary matters are dynamic and require the

    balancing of multiple unique facts and circumstances, which cannot be

    addressed through a summary fine program. Therefore, the Commission

    declines to adopt a summary fine program in lieu of disciplinary

    procedures.

    In response to Tradeweb's comment about contracting out certain

    aspects of a SEF's disciplinary functions to a central third-party, the

    Commission notes that it views SEFs as SROs,\557\ with all the

    attendant self-regulatory responsibilities to establish and enforce

    rules necessary to promote market integrity and the protection of

    market participants. Such responsibilities include the adherence to,

    and maintenance of, disciplinary procedures. The Commission notes that

    a SEF may utilize the services of a third-party regulatory service

    provider for assistance in performing its self-regulatory functions, as

    provided for in Sec. 37.204.

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

    \557\ See Adaptation of Regulations to Incorporate Swaps, 77 FR

    66288 (Nov. 2, 2012). Section 1.3(ee) states that a self-regulatory

    organization ``means a contract market (as defined in Sec. 1.3(h)),

    a swap execution facility (as defined in Sec. 1.3(rrrr)), or a

    registered futures association under section 17 of the Act.'' Id. at

    66318.

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

    (2) Sec. 37.206(a)--Enforcement Staff

    Proposed Sec. 37.206(a) required that a SEF establish and maintain

    sufficient enforcement staff and resources to effectively and promptly

    prosecute possible rule violations within the SEF's jurisdiction.

    Proposed Sec. 37.206(a) also required a SEF to monitor the size and

    workload of its enforcement staff annually. In addition, proposed Sec.

    37.206(a) included provisions to ensure the independence of the

    enforcement staff and to help promote disciplinary procedures that are

    free of potential conflicts of interest.

    (i) Commission Determination

    In response to the general comments requesting greater flexibility

    regarding disciplinary procedures, the Commission is moving all of the

    requirements of proposed Sec. 37.206(a) to guidance, except for the

    critical requirement that a SEF maintain sufficient enforcement staff

    and resources. The Commission believes that sufficient enforcement

    staff and resources are essential to the effective performance of a

    SEF's disciplinary program and are necessary to comply with Core

    Principle 2. Without a sufficient enforcement staff and resources, a

    SEF would be unable to promptly investigate and adjudicate potential

    rule violations and deter future violations. To maintain consistency

    with the revisions to proposed Sec. 37.203(c)(2), the Commission is

    deleting from the rule the reference that a SEF monitor the size and

    workload of its enforcement staff annually to provide greater

    flexibility to SEFs in determining their approach to monitoring their

    enforcement resources. Nonetheless, the Commission believes that a

    SEF's obligation to monitor its enforcement staff and resources is

    implicit in the requirement to maintain adequate enforcement staff and

    resources.

    (3) Sec. 37.206(b)--Disciplinary Panels

    Proposed Sec. 37.206(b)(1) required a SEF to establish one or more

    Review Panels and one or more Hearing Panels. The composition of both

    panels was required to meet the composition requirements of proposed

    Sec. 40.9(c)(3)(ii) \558\ and could not include any members of the

    SEF's compliance staff or any person involved in adjudicating any other

    stage of the same proceeding. Proposed Sec. 37.206(b)(2) provided that

    a Review Panel must be responsible for determining whether a reasonable

    basis exists for finding a violation of SEF rules and for authorizing

    the issuance of a notice of charges. If a notice of charges is issued,

    proposed Sec. 37.206(b)(3) provided that a Hearing Panel must be

    responsible for adjudicating the matter and issuing sanctions.

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

    \558\ Section 40.9(c)(3)(ii), as proposed, in the separate

    release titled Requirements for Derivatives Clearing Organizations,

    Designated Contract Markets, and Swap Execution Facilities Regarding

    the Mitigation of Conflicts of Interest, provided that ``Each

    Disciplinary Panel shall include at least one person who would not

    be disqualified from serving as a Public Director by Sec.

    1.3(ccc)(1)(i)-(vi) and (2) of this chapter (a ``Public

    Participant''). Such Public Participant shall chair each

    Disciplinary Panel. In addition, any registered entity specified in

    paragraph (c)(3)(i) of this section shall adopt rules that would, at

    a minimum: (A) Further preclude any group or class of participants

    from dominating or exercising disproportionate influence on a

    Disciplinary Panel and (B) Prohibit any member of a Disciplinary

    Panel from participating in deliberations or voting on any matter in

    which the member has a financial interest.'' 75 FR 63732, 63752

    (proposed Oct. 18, 2010).

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

    (i) Summary of Comments

    MetLife supported the proposed rule and agreed that SEFs should

    maintain a clear separation between disciplinary bodies that recommend

    the issuance of charges and those responsible for adjudicating

    matters.\559\ CME stated that the Commission should not require a

    prescriptive approach to disciplinary panels, as SEFs may develop

    structures that clearly satisfy the objective of the core principle,

    but that may not precisely comply with the rule text.\560\ CME

    illustrated two practices it believed may be precluded by the text of

    proposed Sec. 37.206(b): (1) CME's Market Regulation staff determines

    whether certain non-egregious rule violations merit referral to a

    Review Panel and they issue warning letters on an administrative basis;

    and (2) CME's hearing panel adjudicates a disciplinary case prior to

    the issuance of charges

    [[Page 33522]]

    pursuant to a supported settlement agreement.\561\

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

    \559\ MetLife Comment Letter at 6 (Mar. 8, 2011).

    \560\ CME Comment Letter at 35 (Feb. 22, 2011).

    \561\ Id.

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

    (ii) Commission Determination

    The Commission is adopting Sec. 37.206(b) as proposed, subject to

    certain modifications described below. The Commission considered

    commenters' views and believes that the proposed rule can be modified

    to provide additional flexibility without diminishing its purpose.

    Accordingly, final Sec. 37.206(b) will require SEFs to have one or

    more disciplinary panels, without imposing a specific requirement for

    SEFs to maintain a Review Panel and a Hearing Panel.\562\ However, even

    under this single-panel approach, individuals who determine to issue

    charges in a particular disciplinary matter may not also adjudicate the

    matter. Therefore, final Sec. 37.206(b) permits flexibility in the

    structure of SEFs' disciplinary bodies, but not in the basic

    prohibition, supported by MetLife, against vesting the same individuals

    with the authority to both issue and adjudicate charges in the same

    matter.

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

    \562\ The Commission notes that it is replacing specific panel

    names (i.e., Review Panel and Hearing Panel) with a generic

    reference to the ``disciplinary panel'' throughout part 37.

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

    The modifications reflected in final Sec. 37.206(b), together with

    the revisions made to the text of proposed Sec. 37.206(d) that will

    now be included as guidance, as discussed below, provide additional

    flexibility by permitting SEFs to rely on their authorized compliance

    staff, rather than on a disciplinary panel, to issue disciplinary

    charges. However, the Commission notes that the adjudication of charges

    must still be performed by a disciplinary panel.

    Finally, the Commission is adopting the composition and conflicts

    requirements for disciplinary panels with one modification, by

    replacing the reference to Sec. 40.9(c)(3)(ii) with a reference to the

    more general ``part 40 of this chapter'' to accommodate any re-

    enumeration that may occur with respect to proposed Sec.

    40.9(c)(3)(ii).

    (4) Sec. 37.206(c)--Review of Investigation Report

    Proposed Sec. 37.206(c) required a Review Panel to promptly review

    an investigation report received pursuant to proposed Sec.

    37.203(f)(3), and to take one of the following actions within 30 days

    of receipt: (1) Promptly direct compliance staff to conduct further

    investigation if the Review Panel determined that additional

    investigation or evidence was needed, (2) direct that no further action

    be taken if the Review Panel determined that no reasonable basis

    existed for finding a violation or that prosecution was unwarranted, or

    (3) direct that the person or entity alleged to have committed a

    violation be served with a notice of charges if the Review Panel

    determined that a reasonable basis existed for finding a violation and

    adjudication was warranted.

    (i) Summary of Comments

    CME agreed that an investigation report should include the

    subject's disciplinary history; however, CME disagreed with the

    requirement in proposed Sec. 37.203(f) that the disciplinary history

    be included in the version of the investigation report sent to the

    Review Panel.\563\ CME believed that the disciplinary history should

    not be considered by the Review Panel at all when determining whether

    to issue formal charges, arguing that a participant's disciplinary

    history is not relevant to the consideration of whether it committed a

    further violation of SEF rules.\564\

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

    \563\ CME Comment Letter at 35 (Feb. 22, 2011).

    \564\ Id. While the Commission largely agrees with CME's

    comment, the Commission directs interested parties to Sec.

    37.203(f) for a further discussion of the required components of

    investigation reports.

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

    (ii) Commission Determination

    In response to the general comments requesting greater flexibility,

    the Commission is eliminating all of proposed Sec. 37.206(c) except

    for paragraph (3) of the proposed rule. In addition, the Commission is

    adding language to paragraph (3) to provide SEFs with the flexibility

    to allow authorized compliance staff to review an investigation report

    and determine whether a notice of charges should be issued in a

    particular matter. The Commission is also revising the text of

    paragraph (3) to follow the single-panel approach provided for in Sec.

    37.206(b). Proposed Sec. 37.206(c)(3), with the revisions described

    above, is being incorporated into proposed Sec. 37.206(d). As

    described below, all of proposed Sec. 37.206(d) is being moved to the

    guidance in appendix B to part 37.

    (5) Sec. 37.206(d)--Notice of Charges

    Proposed Sec. 37.206(d) described the minimally acceptable

    contents of a notice of charges issued by a Review Panel. Specifically,

    proposed Sec. 37.206(d) provided that a notice of charges must

    adequately state the acts, conduct, or practices in which the

    respondent is alleged to have engaged; state the rule(s) alleged to

    have been violated; advise the respondent that he is entitled, upon

    request, to a hearing on the charges; and prescribe the period within

    which a hearing may be requested. Paragraphs (1) and (2) of the

    proposed rule permitted a SEF to adopt rules providing that: (1) The

    failure to request a hearing within the time prescribed in the notice,

    except for good cause, may be deemed a waiver of the right to a

    hearing; and (2) the failure to answer or expressly deny a charge may

    be deemed to be an admission of such charge.

    (i) Commission Determination

    Although no comments were received on proposed Sec. 37.206(d), the

    Commission believes that it can provide SEFs with additional

    flexibility by moving the entire rule to the guidance in appendix B to

    part 37.\565\ Moreover, since paragraphs (1) and (2) of proposed Sec.

    37.206(d) allowed, but did not require, a SEF to issue rules regarding

    failures to request a hearing and expressly answer or deny a charge,

    the Commission believes that the language in these paragraphs is better

    suited as guidance rather than a rule.

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

    \565\ As mentioned above, the Commission is moving paragraph (3)

    of proposed Sec. 37.206(c) to the text of proposed Sec. 37.206(d)

    that will now be included as guidance.

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

    (6) Sec. 37.206(e)--Right to Representation

    Proposed Sec. 37.206(e) provided for a respondent's right, upon

    receiving a notice of charges, to be represented by legal counsel or

    any other representative of its choosing in all succeeding stages of

    the disciplinary process.

    (i) Summary of Comments

    CME commented that this rule should be limited to avoid conflicts

    of interest in representation and, accordingly, requested that the rule

    be revised to clarify that a respondent may not be represented by: (1)

    A member of the SEF's disciplinary committees; (2) a member of the

    SEF's Board of Directors; (3) an employee of the SEF; or (4) a person

    substantially related to the underlying investigation, such as a

    material witness or other respondent.\566\

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

    \566\ CME Comment Letter at 35 (Feb. 22, 2011).

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

    (ii) Commission Determination

    The Commission is moving proposed Sec. 37.206(e) in its entirety

    to the guidance in appendix B to part 37, subject to the following

    modification. The Commission is amending the language to incorporate

    CME's recommendation. The guidance states that upon being served with a

    notice of charges, a respondent should have the right to be represented

    by legal counsel or any other representative of its choosing in all

    succeeding stages of the disciplinary process, except by any

    [[Page 33523]]

    member of the SEF's board of directors or disciplinary panel, any

    employee of the SEF, or any person substantially related to the

    underlying investigations, such as a material witness or respondent.

    The Commission believes that this revision appropriately addresses the

    conflicts of interest noted by CME.

    (7) Sec. 37.206(f)--Answer to Charges

    Proposed Sec. 37.206(f) required that a respondent be given a

    reasonable period of time to file an answer to a notice of charges. The

    proposed rule also provided that the rules of a SEF may prescribe

    certain aspects of the answer, which were enumerated in paragraphs (1)

    through (3).\567\

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

    \567\ These aspects were that: (1) The answer must be in writing

    and include a statement that the respondent admits, denies, or does

    not have and is unable to obtain sufficient information to admit or

    deny each allegation; (2) failure to file an answer on a timely

    basis shall be deemed an admission of all allegations in the notice

    of charges; and (3) failure in an answer to deny expressly a charge

    shall be deemed to be an admission of such charge.

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

    (i) Commission Determination

    Although no comments were received on proposed Sec. 37.206(f), the

    Commission is moving the entire rule to the guidance in appendix B to

    part 37, with certain modifications, in order to provide SEFs with

    greater flexibility to adopt their own disciplinary procedures. The

    Commission is also condensing the guidance by replacing paragraphs (1)

    through (3) with language making clear that any rules adopted by a SEF

    governing the requirements and timeliness of a respondent's answer to a

    notice of charges should be ``fair, equitable, and publicly

    available.''

    (8) Sec. 37.206(g)--Admission or Failure To Deny Charges

    Proposed Sec. 37.206(g) provided that a SEF may adopt rules

    whereby a respondent who admits or fails to deny any of the charges

    alleged in the notice of charges may be found by the Hearing Panel to

    have committed the violations charged. If a SEF adopted such rules,

    paragraphs (1) through (3) of the proposed rule provided that: (1) The

    Hearing Panel must impose a sanction for each violation found to have

    been committed; (2) the Hearing Panel must promptly notify the

    respondent in writing of any sanction to be imposed and advise the

    respondent that it may request a hearing on such sanction within a

    specified period of time; and (3) the rules of the SEF may provide that

    if the respondent fails to request a hearing within the period of time

    specified in the notice, then the respondent will be deemed to have

    accepted the sanction.

    (i) Commission Determination

    Although the Commission did not receive comments on proposed Sec.

    37.206(g), the Commission is moving the entire rule, with certain

    modifications, to the guidance in appendix B to part 37.\568\ Given

    that proposed Sec. 37.206(g) allowed, but did not require, a SEF to

    issue rules regarding a respondent's admission or failure to deny

    charges, the Commission believes that the proposed rule is better

    suited as guidance rather than a rule. The Commission also believes

    that adopting the proposed rule as guidance, rather than a rule, will

    provide SEFs greater flexibility in administering their obligations,

    consistent with the general comments seeking the same. Furthermore, the

    Commission is modifying the text of proposed Sec. 37.206(g)(2) that

    will now be included as guidance to clarify that a respondent may

    request a hearing ``within the period of time, which should be stated

    in the notice.''

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

    \568\ The Commission notes that the text that will now be

    included as guidance is being modified to reflect the single-panel

    approach adopted in Sec. 37.206(b), replacing specific panel names

    with a generic reference to the ``disciplinary panel.''

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

    (9) Sec. 37.206(h)--Denial of Charges and Right to Hearing

    Proposed Sec. 37.206(h) required that in every instance where a

    respondent has requested a hearing on a charge that is denied, or on a

    sanction set by the Hearing Panel pursuant to proposed Sec. 37.206(g),

    the respondent must be given the opportunity for a hearing in

    accordance with the requirements of proposed Sec. 37.206(j). Proposed

    Sec. 37.206(h) also gave SEFs the option to adopt rules that provided,

    except for good cause, the hearing must be concerned only with those

    charges denied and/or sanctions set by the Hearing Panel under proposed

    Sec. 37.206(g) for which a hearing has been requested.

    (i) Commission Determination

    The Commission received no comments on proposed Sec. 37.206(h),

    but is moving the entire rule, with certain modifications, to the

    guidance in appendix B to part 37.\569\ In order to provide SEFs with

    further flexibility, even within the guidance, the Commission is also

    removing the proposed rule's reference to a SEF's ability to limit

    hearings to only those charges denied and/or sanctions set by the

    Hearing Panel under proposed Sec. 37.206(g) for which a hearing has

    been requested.

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

    \569\ The Commission is revising the proposed rule to reflect

    the single-panel approach adopted in Sec. 37.206(b), replacing

    specific panel names with a generic reference to the ``disciplinary

    panel.'' The Commission is also removing the references to proposed

    Sec. Sec. 37.206(g) and (j) given that the Commission is moving

    proposed Sec. 37.206(g) to guidance, and either eliminating or

    moving certain provisions of proposed Sec. 37.206(j) to guidance.

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

    (10) Sec. 37.206(i)--Settlement Offers

    Proposed Sec. 37.206(i) provided the procedures that a SEF must

    follow if it permits the use of settlements to resolve disciplinary

    cases. Paragraph (1) of the proposed rule stated that the rules of a

    SEF may permit a respondent to submit a written offer of settlement any

    time after the investigation report is completed. The proposed rule

    also permitted the disciplinary panel presiding over the matter to

    accept the offer of settlement, but prohibited the panel from altering

    the terms of the offer unless the respondent agreed. In addition,

    paragraph (2) of the proposed rule provided that the rules of the SEF

    may allow a disciplinary panel to permit the respondent to accept a

    sanction without admitting or denying the rule violations upon which

    the sanction is based.

    Paragraph (3) of the proposed rule stated that a disciplinary panel

    accepting a settlement offer must issue a written decision specifying

    the rule violations it has reason to believe were committed, and any

    sanction imposed, including any order of restitution where customer

    harm has been demonstrated. Paragraph (3) also provided that if an

    offer of settlement is accepted without the agreement of a SEF's

    enforcement staff, then the decision must adequately support the

    Hearing Panel's acceptance of the settlement. Finally, paragraph (4) of

    the proposed rule allowed a respondent to withdraw his or her offer of

    settlement at any time before final acceptance by a disciplinary panel.

    If an offer is withdrawn after submission, or is rejected by a

    disciplinary panel, the respondent must not be deemed to have made any

    admissions by reason of the offer of settlement and must not be

    otherwise prejudiced by having submitted the offer of settlement.

    (i) Commission Determination

    Although the Commission received no comments on proposed Sec.

    37.206(i), the Commission is moving the entire rule, with certain

    modifications, to the guidance in appendix B to part 37.\570\

    [[Page 33524]]

    The Commission believes that adopting the proposed rule as guidance,

    rather than a rule, will provide SEFs greater flexibility in

    administering their obligations, consistent with the general comments

    seeking the same. Furthermore, the Commission is revising the guidance

    text to make it consistent with its modifications to the customer

    restitution provisions adopted below with respect to proposed Sec.

    37.206(n).

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

    \570\ The Commission notes that the text that will now be

    included as guidance is being modified to reflect the single-panel

    approach adopted in Sec. 37.206(b), replacing specific panel names

    with a generic reference to the ``disciplinary panel.''

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

    (11) Sec. 37.206(j)--Hearings

    Proposed Sec. 37.206(j) required a SEF to adopt rules that provide

    certain minimum procedural safeguards for any hearing conducted

    pursuant to a notice of charges. In general, proposed Sec. Sec.

    37.206(j)(1)(i) through (j)(1)(vii) required the following: (i) A fair

    hearing; (ii) authority for a respondent to examine evidence relied on

    by enforcement staff in presenting the charges; (iii) the SEF's

    enforcement and compliance staffs to be parties to the hearing and the

    enforcement staff to present its case on the charges and sanctions;

    (iv) the respondent to be entitled to appear personally at the hearing,

    to cross-examine and call witnesses, and to present evidence; (v) the

    SEF to require persons within its jurisdiction who are called as

    witnesses to participate in the hearing and produce evidence; (vi) a

    copy of the hearing be made and be a part of the record of the

    proceeding if the respondent requested the hearing; and (vii) the rules

    of the SEF may provide that the cost of transcribing the record be

    borne by the respondent in certain circumstances. Additionally,

    proposed Sec. 37.206(j)(2) specified that the rules of the SEF may

    provide that a sanction be summarily imposed upon any person within its

    jurisdiction whose actions impede the progress of a hearing.

    (i) Summary of Comments

    CME recommended that proposed Sec. 37.206(j)(1)(ii) be revised so

    that a respondent may not access protected attorney work product,

    attorney-client communications, and investigative work product (e.g.,

    investigation and exception reports).\571\

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

    \571\ CME Comment Letter at 36 (Feb. 22, 2011).

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

    (ii) Commission Determination

    The Commission is partially adopting proposed Sec. 37.206(j), and

    is either eliminating or moving to guidance the remaining portion of

    the rule. The Commission is maintaining as a rule the provisions

    requiring the following: (1) Hearings must be fair; and (2) if a

    respondent requested a hearing, a copy of the hearing be made and be a

    part of the record of the proceeding.\572\ The Commission is

    eliminating proposed Sec. 37.206(j)(1)(vii), a discretionary rule that

    in certain cases allowed for the cost of transcribing the record of the

    hearing to be borne by the respondent. The Commission is moving the

    remainder of proposed Sec. 37.206(j) to the guidance in appendix B to

    part 37. The Commission believes that these revisions are appropriate

    given commenters' requests for greater flexibility to establish their

    own disciplinary procedures.

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

    \572\ The Commission is renumbering proposed Sec. 37.206(j) to

    Sec. 37.206(c). The Commission is also revising the proposed rule

    to reflect the single-panel approach adopted in Sec. 37.206(b),

    replacing specific panel names with a generic reference to the

    ``disciplinary panel.'' The Commission is also revising the

    reference to Sec. 37.206(l) in proposed Sec. 37.206(j)(1)(vi)

    given that it is moving proposed Sec. 37.206(l) to guidance.

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

    The Commission agrees with CME's comment that a SEF should be

    permitted to withhold certain documents from a respondent in certain

    circumstances. Therefore, the Commission is revising the text of

    proposed Sec. 37.206(j)(1)(ii), which will now be included in

    guidance, to provide that a SEF may withhold documents that: (i) Are

    privileged or constitute attorney work product; (ii) were prepared by

    an employee of the SEF but will not be offered in evidence in the

    disciplinary proceedings; (iii) may disclose a technique or guideline

    used in examinations, investigations, or enforcement proceedings; or

    (iv) disclose the identity of a confidential source.

    (12) Sec. 37.206(k)--Decisions

    Proposed Sec. 37.206(k) required a Hearing Panel, promptly

    following a hearing conducted in accordance with proposed Sec.

    37.206(j), to render a written decision based upon the weight of the

    evidence and to provide a copy to the respondent. Paragraphs (1)

    through (6) detailed the items to be included in the decision.

    (i) Commission Determination

    The Commission received no comments on proposed Sec. 37.206(k) and

    is adopting the rule as proposed with certain non-substantive

    clarifications.\573\

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

    \573\ The Commission is renumbering proposed Sec. 37.206(k) to

    Sec. 37.206(d). The Commission is also revising the reference to

    Sec. 37.206(j) in proposed Sec. 37.206(k) given that the

    Commission has either eliminated or moved to guidance many of the

    provisions of proposed Sec. 37.206(j). The Commission is also

    revising the proposed rule to reflect the single-panel approach

    adopted in Sec. 37.206(b), replacing specific panel names with a

    generic reference to the ``disciplinary panel.''

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

    (13) Sec. 37.206(l)--Right to Appeal

    Proposed Sec. 37.206(l) provided the procedures that a SEF must

    follow in the event that the SEF's rules permit an appeal. For SEFs

    that permit appeals, the language in paragraphs (1) through (4) of

    proposed Sec. 37.206(l) generally required the SEF to: (1) Establish

    an appellate panel; (2) ensure that the appellate panel composition is

    consistent with Sec. 40.9(c)(iv) and not include any members of the

    SEF's compliance staff or any person involved in adjudicating any other

    stage of the same proceeding; (3) conduct the appeal solely on the

    record before the Hearing Panel, except for good cause shown; and (4)

    issue a written decision of the board of appeals and provide a copy to

    the respondent.

    (i) Commission Determination

    Although the Commission received no comments on proposed Sec.

    37.206(l), the Commission is moving the entire rule to the guidance in

    appendix B to part 37.\574\ Given that proposed Sec. 37.206(l)

    allowed, but did not require, a SEF to issue rules regarding a

    respondent's right to appeal, the Commission believes that the proposed

    rule is better suited as guidance rather than a rule. The Commission

    also believes that adopting the proposed rule as guidance, rather than

    a rule, will provide SEFs greater flexibility in administering their

    obligations, consistent with the general comments seeking the same.

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

    \574\ The Commission notes that the reference to Sec.

    40.9(c)(iv) in the proposed rule was a technical error. Instead,

    proposed Sec. 37.206(l) should have referenced the composition

    requirements of an appellate panel outlined in proposed Sec.

    40.9(c)(3)(iii). However, to accommodate any re-enumeration that may

    occur with respect to proposed Sec. 40.9(c)(3)(iii), the Commission

    is replacing the mistaken reference to Sec. 40.9(c)(iv) with a more

    general reference to part 40 in the guidance text. See Requirements

    for Derivatives Clearing Organizations, Designated Contract Markets,

    and Swap Execution Facilities Regarding the Mitigation of Conflicts

    of Interest, 75 FR 63732, 63752 (proposed Oct. 18, 2010). The

    Commission is also revising the reference to Sec. 37.206(k) in

    proposed Sec. 37.206(l)(4) to Sec. 37.206(d) given the renumbering

    in Sec. 37.206. Finally, the Commission is revising the proposed

    rule to reflect the single-panel approach adopted in Sec.

    37.206(b), replacing specific panel names with a generic reference

    to the ``disciplinary panel.''

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

    (14) Sec. 37.206(m)--Final Decisions

    Proposed Sec. 37.206(m) required that each SEF establish rules

    setting forth when a decision rendered under Sec. 37.206 will become

    the final decision of the SEF.

    (i) Commission Determination

    Although the Commission received no comments on proposed Sec.

    37.206(m), the Commission is moving the entire rule to

    [[Page 33525]]

    the guidance in appendix B to part 37. The Commission believes that

    adopting the proposed rule as guidance rather than a rule provides a

    SEF with additional flexibility to establish disciplinary procedures to

    meet its obligations pursuant to Core Principle 2.

    (15) Sec. 37.206(n)--Disciplinary Sanctions

    Proposed Sec. 37.206(n) required that disciplinary sanctions

    imposed by a SEF must be commensurate with the violations committed and

    must be clearly sufficient to deter recidivism or similar violations by

    other market participants. In addition, the proposed rule required that

    a SEF take into account a respondent's disciplinary history when

    evaluating appropriate sanctions. The proposed rule further required

    that in the event of demonstrated customer harm, any disciplinary

    sanction must include full customer restitution.

    (i) Summary of Comments

    WMBAA recommended that any limitation of a market participant's

    access to a SEF imposed in response to a rule violation should be

    recognized and enforced consistently among all SEFs.\575\ WMBAA also

    recommended that any disciplinary sanction imposed by a SEF should be

    published and made available to market participants.\576\ Such

    requirements, WMBAA argued, are necessary in order to prevent market

    participants from gaming the system and maintaining access to markets

    after violations.\577\

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

    \575\ WMBAA Comment Letter at 23 (Mar. 8, 2011).

    \576\ Id.

    \577\ Id. at 24.

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

    (ii) Commission Determination

    The Commission is adopting proposed Sec. 37.206(n), subject to

    certain modifications.\578\ The Commission is revising proposed Sec.

    37.206(n) to clarify that a respondent's disciplinary history should be

    taken into account in all sanction determinations, including sanctions

    imposed pursuant to an accepted settlement offer. Furthermore, the

    Commission is revising proposed Sec. 37.206(n) so that it does not

    require customer restitution if the amount of restitution or the

    recipient cannot be reasonably determined.\579\

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

    \578\ The Commission is renumbering proposed Sec. 37.206(n) to

    Sec. 37.206(e).

    \579\ The Commission notes that commenters to the DCM rulemaking

    requested this change and, after considering the comments, the

    Commission believes that this revision should also be applicable to

    SEFs. Core Principles and Other Requirements for Designated Contract

    Markets, 77 FR at 36654-55.

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

    The Commission acknowledges WMBAA's comment that disciplinary

    sanctions may not be recognized and enforced consistently across SEFs.

    However, each SEF is a distinct entity with its own rulebook and set of

    disciplinary procedures. Therefore, each SEF must determine the

    sanctions that are appropriate for its own market and thus the same

    conduct may result in different sanctions at different SEFs. The

    Commission does not believe that such sanction variation supports the

    mandatory recognition of sanctions across SEFs. However, if a SEF

    believes that it is important to recognize and enforce sanctions

    against market participants imposed by other SEFs or DCMs, then the SEF

    may implement appropriate rules.

    The Commission agrees with WMBAA that any disciplinary sanction

    imposed by a SEF should be published and made available to market

    participants. Commission Regulation 9.11(a) requires that ``[w]henever

    an exchange decision pursuant to which a disciplinary action or access

    denial action is to be imposed has become final, the exchange must,

    within thirty days thereafter, provide written notice of such action to

    . . . the Commission . . . .'' \580\ The Commission has issued guidance

    that an exchange may comply with Sec. 9.11(a) by transmitting or

    delivering the notice to NFA to be included in NFA's Background

    Affiliation Status Information Center database, which is available to

    the public online.\581\ The Commission also notes that a SEF may adopt

    rules regarding the publishing of disciplinary sanctions imposed by the

    SEF.

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

    \580\ Section 37.2 states that a SEF shall comply with part 9 of

    the Commission's regulations.

    \581\ NFA's Background Affiliation Status Information Center

    database is available at http://www.nfa.futures.org/basicnet/.

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

    (16) Sec. 37.206(o)--Summary Fines for Violations of Rules Regarding

    Timely Submission of Records

    Proposed Sec. 37.206(o) permitted a SEF to adopt a summary fine

    schedule for violations of rules relating to the timely submission of

    accurate records required for clearing or verifying each day's

    transactions. Under the proposed rule, a SEF may permit its compliance

    staff to summarily impose minor sanctions against persons within the

    SEF's jurisdiction for violating such rules. The proposed rule made

    clear that a SEF's summary fine schedule must not permit more than one

    warning letter in a rolling 12-month period for the same violation

    before sanctions are imposed and must provide for progressively larger

    fines for recurring violations.

    (i) Summary of Comments

    CME objected to the restriction of one warning letter per rolling

    12-month period.\582\ MarketAxess also requested that the Commission

    adopt a uniform approach with respect to warning letters, either

    permitting warning letters as a sanction or an indication of a finding

    of a violation in all SEF contexts.\583\

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

    \582\ CME Comment Letter at 36 (Feb. 22, 2011).

    \583\ MarketAxess Comment Letter at 36 (Mar. 8, 2011).

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

    (ii) Commission Determination

    The Commission is partially adopting proposed Sec. 37.206(o) and

    is converting the remaining portion of the rule to guidance in appendix

    B to part 37.\584\ The Commission is maintaining as a rule the

    provision in the proposed rule that prohibits a SEF from issuing more

    than one warning letter per rolling 12-month period for the same

    violation. As discussed above, the Commission believes that in order to

    ensure that warning letters serve as effective deterrents, and to

    preserve the value of disciplinary sanctions, no more than one warning

    letter may be issued to the same person or entity found to have

    committed the same rule violation within a rolling 12-month

    period.\585\ While a warning letter may be appropriate for a first-time

    violation, the Commission does not believe that more than one warning

    letter in a rolling 12-month period for the same violation is ever

    appropriate.\586\

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

    \584\ The Commission is renumbering proposed Sec. 37.206(o) to

    Sec. 37.206(f). The Commission is also retitling this section as

    ``Warning letters.''

    \585\ For purposes of this rule, the Commission does not

    consider a ``reminder letter'' or such other similar letter to be

    any different than a warning letter.

    \586\ See Core Principles and Other Requirements for Swap

    Execution Facilities, 76 FR at 1224.

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

    However, in response to MarketAxess's comment, the Commission is

    narrowing the application of this rule to warning letters that contain

    an affirmative finding that a rule violation has occurred.

    Additionally, in order to provide flexibility, the compliance date of

    this rule will be one year from the effective date of the final SEF

    rules so that persons and entities may adapt to the new SEF regime. The

    Commission is converting the remainder of proposed Sec. 37.206(o) to

    guidance in appendix B to part 37 because the proposed rule allowed,

    but did not require, a SEF to adopt a summary fine schedule.

    (17) Sec. 37.206(p)--Emergency Disciplinary Actions

    Proposed Sec. 37.206(p) provided that a SEF may impose a sanction,

    including

    [[Page 33526]]

    a suspension, or take other summary action against a person or entity

    subject to its jurisdiction upon a reasonable belief that such

    immediate action is necessary to protect the best interest of the

    marketplace. The proposed rule also provided that any emergency action

    taken by the SEF must be in accordance with certain procedural

    safeguards as enumerated in the proposed rule.\587\

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

    \587\ The Commission notes that, pursuant to Sec. 9.11 and

    Sec. 37.2, SEFs must provide the Commission with notice of any

    disciplinary actions that they take, including emergency

    disciplinary actions.

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

    (i) Commission Determination

    Although the Commission received no comments on proposed Sec.

    37.206(p), the Commission is moving the entire rule to the guidance in

    appendix B to part 37 because it is a discretionary rule.\588\ The

    Commission also believes that adopting the proposed rule as guidance,

    rather than a rule, will provide SEFs greater flexibility in

    administering their obligations, consistent with the general comments

    seeking the same.

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

    \588\ The Commission is also revising the reference to Sec.

    37.206(j) in proposed Sec. 37.206(p)(ii) given that the Commission

    has either eliminated or moved to guidance many of the provisions of

    proposed Sec. 37.206(j).

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

    The Commission is also codifying new Sec. 37.206(g) \589\ (titled

    ``Additional sources for compliance'') that permits SEFs to refer to

    the guidance and/or acceptable practices in appendix B to part 37 to

    demonstrate to the Commission compliance with the requirements of Sec.

    37.206.

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

    \589\ The Commission notes that this paragraph's numbering is

    due to the renumbering of Sec. 37.206.

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

    (h) Sec. 37.207--Swaps Subject to Mandatory Clearing

    Proposed Sec. 37.207 required that a SEF provide rules that when a

    swap dealer or major swap participant enters into or facilitates a swap

    transaction subject to the mandatory clearing requirement under section

    2(h) of the Act, the swap dealer or major swap participant shall be

    responsible for complying with the mandatory trading requirement under

    section 2(h)(8) of the Act.

    (1) Summary of Comments

    FXall stated that proposed Sec. 37.207 could be read to require a

    SEF to be responsible for policing the conduct of swap dealers and

    major swap participants generally, and not only with respect to their

    trading on such SEF.\590\ In this regard, MarketAxess stated that a

    SEF's obligation to require swap dealers and major swap participants to

    comply with the mandatory trading requirement should only extend to

    swaps that are executed pursuant to its own rules.\591\ MarketAxess

    also noted that proposed Sec. 37.207 is identical to proposed Sec.

    37.200(d) and therefore is unnecessary.\592\ WMBAA commented that there

    is no statutory basis to impose the requirement in proposed Sec.

    37.207.\593\

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

    \590\ FXall Comment Letter at 11 (Mar. 8, 2011).

    \591\ MarketAxess Comment Letter at 34 (Mar. 8, 2011).

    \592\ Id.

    \593\ WMBAA Comment Letter at 24 (Mar. 8, 2011).

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

    (2) Commission Determination

    The Commission agrees with MarketAxess that proposed Sec. 37.207

    is identical to Sec. 37.200(d) and is therefore eliminating proposed

    Sec. 37.207. In response to WMBAA's comment, the Commission notes that

    Sec. 37.200(d) recites the statutory text of Core Principle 2 and thus

    provides the statutory basis for codification of the statutory text as

    a regulation.\594\ To address FXall's and MarketAxess's concerns, the

    Commission clarifies that a SEF's rules pursuant to Sec. 37.200(d)

    need only apply to swaps executed on or pursuant to the rules of that

    SEF.

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

    \594\ CEA section 5h(f)(2)(D); 7 U.S.C. 7b-3(f)(2)(D).

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

    3. Subpart D--Core Principle 3 (Swaps Not Readily Susceptible to

    Manipulation)

    Core Principle 3 requires that a SEF permit trading only in swaps

    that are not readily susceptible to manipulation.\595\ In the SEF NPRM,

    the Commission proposed to codify the statutory text of Core Principle

    3 in proposed Sec. 37.300, and adopts that rule as proposed.

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

    \595\ CEA section 5h(f)(3); 7 U.S.C. 7b-3(f)(3).

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

    To demonstrate to the Commission compliance with Core Principle 3,

    proposed Sec. 37.301 required a SEF to submit new swap contracts in

    advance to the Commission pursuant to part 40 of the Commission's

    regulations, and provide to the Commission the information required

    under appendix C to part 38. The Commission also proposed guidance for

    compliance with Core Principle 3 under appendix B to part 37, which

    noted the importance of the reference price for a swap contract. The

    guidance also stated that Core Principle 3 requires that the reference

    price used by a swap not be readily susceptible to manipulation.

    (a) Summary of Comments \596\

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

    \596\ The Commission notes that in Argus's joint DCM and SEF

    rulemaking comment letter dated Feb. 22, 2011, it commented on Core

    Principle 3 and specifically, the Commission's guidance in appendix

    C to part 38--Demonstration of Compliance That a Contract is Not

    Readily Susceptible to Manipulation. The Commission has addressed

    Argus's comments in the DCM final rulemaking, Core Principles and

    Other Requirements for Designated Contract Markets, 77 FR at 36633-

    34. The Commission also notes that in CME's SEF rulemaking comment

    letter dated Mar. 8, 2011 and DCM rulemaking comment letter dated

    Feb. 22, 2011, it commented on the Commission's guidance in appendix

    C to part 38. The Commission has also addressed CME's comments in

    the DCM final rulemaking, Core Principles and Other Requirements for

    Designated Contract Markets, 77 FR at 36632-34.

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

    Reuters generally supported Core Principle 3, and the requirement

    that SEFs should have in place appropriate systems and controls to

    identify and manage situations where the market or individual swap

    contract may be susceptible to manipulation or fraud.\597\ GFI

    commented that once the Commission has declared a swap subject to

    mandatory clearing, a SEF should not be required to ensure that the

    contract is not readily susceptible to manipulation since such activity

    would be redundant.\598\ According to GFI, the Commission would not

    make a swap subject to mandatory clearing unless it believed that the

    swap is not subject to manipulation.\599\

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

    \597\ Reuters Comment Letter at 5 (Mar. 8, 2011).

    \598\ GFI Comment Letter at 4-5 (Mar. 8, 2011).

    \599\ Id. at 5.

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

    (b) Commission Determination

    The Commission is adopting Sec. 37.301 as proposed, subject to

    certain modifications for clarity. The Commission is deleting from the

    rule the references to prior approval or self-certification for new

    product submissions under part 40 of the Commission's regulations

    because those details are covered under Sec. 37.4 and part 40. The

    Commission is also adding to the rule a reference to the guidance and/

    or acceptable practices in appendix B to part 37. This reference was

    inadvertently omitted from the SEF NPRM.

    In response to GFI's comments, the Commission notes that section 5h

    of the Act requires that a SEF permit trading only in swaps that are

    not readily susceptible to manipulation.\600\ The Commission notes that

    this is a separate and distinct requirement for a SEF to comply with,

    as opposed to the Commission determination as to whether a swap is

    subject to mandatory clearing. The Commission does not have the

    authority under CEA section 4(c)(1) to exempt SEFs from complying with

    the core principles.

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

    \600\ CEA section 5h(f)(3); 7 U.S.C. 7b-3(f)(3).

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

    The Commission notes that the requirement that a SEF permit trading

    in swaps that are not readily susceptible to manipulation requires a

    SEF to be responsible for the terms and conditions of the swap

    contracts which trade on its facility. To meet this requirement, the

    [[Page 33527]]

    guidance includes items that a SEF should consider in developing swap

    contract terms and conditions for both physical delivery and cash-

    settled contracts. The Commission recognizes that a SEF may permit

    trading in a wide range of swaps, some standardized and others

    customized and complex. The Commission staff is available to consult

    with SEFs should questions arise regarding the information that SEFs

    should submit to the Commission to satisfy the requirements of Core

    Principle 3, especially for the SEF's more customized and complex swap

    contracts. The Commission will take into account these considerations

    when determining whether a SEF satisfies the requirements of Core

    Principle 3.

    4. Subpart E--Core Principle 4 (Monitoring of Trading and Trade

    Processing)

    Under Core Principle 4, a SEF must establish and enforce rules or

    terms and conditions defining, or specifications detailing trading

    procedures to be used in entering and executing orders traded on or

    through the facilities of the SEF and procedures for trade processing

    of swaps on or through the facilities of the SEF.\601\ Core Principle 4

    also requires a SEF to monitor trading in swaps to prevent

    manipulation, price distortion, and disruptions of the delivery or cash

    settlement process through surveillance, compliance, and disciplinary

    practices and procedures, including methods for conducting real-time

    monitoring of trading and comprehensive and accurate trade

    reconstructions.\602\ In the SEF NPRM, the Commission proposed to

    codify the statutory text of Core Principle 4 in proposed Sec. 37.400,

    and adopts that rule as proposed.

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

    \601\ CEA section 5h(f)(4); 7 U.S.C. 7b-3(f)(4).

    \602\ Id.

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

    As discussed above under Core Principle 3, the Commission

    recognizes that a SEF may permit trading in a wide range of swaps, some

    standardized and others customized and complex. The Commission staff is

    available to consult with SEFs should questions arise regarding how to

    satisfy the requirements of Core Principle 4, especially for the SEF's

    more customized and complex swap contracts. The Commission will take

    into account these considerations when determining whether a SEF

    satisfies the requirements of Core Principle 4.

    (a) Sec. 37.401--General Requirements

    Proposed Sec. 37.401(a) required a SEF to collect and evaluate

    data on individual traders' market activity on an ongoing basis in

    order to detect and prevent manipulation, price distortions and, where

    possible, disruptions of the delivery or cash-settlement process.

    Proposed Sec. 37.401(b) required a SEF to monitor and evaluate general

    market data in order to detect and prevent manipulative activity that

    would result in the failure of the market price to reflect the normal

    forces of supply and demand. Proposed Sec. 37.401(c) required a SEF to

    have the capacity to conduct real-time monitoring of trading and

    comprehensive and accurate trade reconstruction. Further, the proposed

    rule required that intraday trade monitoring must include the capacity

    to detect abnormal price movements, unusual trading volumes,

    impairments to market liquidity, and position-limit violations.

    Finally, proposed Sec. 37.401(d) required a SEF to have either manual

    processes or automated alerts that are effective in detecting and

    preventing trading abuses. The Commission noted in the SEF NPRM

    preamble that it would be difficult, if not impossible, for a SEF to

    monitor for market disruptions in markets with high transaction volume

    and a large number of trades unless the SEF installed automated trading

    alerts.\603\

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

    \603\ Core Principles and Other Requirements for Swap Execution

    Facilities, 76 FR at 1227.

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

    (1) Summary of Comments

    Several commenters sought clarification that proposed Sec. 37.401

    limits a SEF's oversight of market participant activity to its own

    SEF.\604\ Tradeweb, for example, commented that a SEF cannot ensure

    that a marketplace other than its own has not been manipulated to

    affect the SEF's swaps because the SEF will not have enough information

    about the other marketplaces.\605\

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

    \604\ Bloomberg Comment Letter 3-4 (Jun. 3, 2011); Parity Energy

    Comment Letter at 4 (Mar. 25, 2011); Tradeweb Comment Letter at 11

    (Mar. 8, 2011); MarketAxess Comment Letter at 22 (Mar. 8, 2011);

    WMBAA Comment Letter at 25 (Mar. 8, 2011).

    \605\ Tradeweb Comment Letter at 11 (Mar. 8, 2011).

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

    WMBAA requested that the Commission clarify what it means by

    ``individual traders'' and ``market activity'' in proposed Sec.

    37.401(a).\606\ WMBAA also sought clarification regarding what

    constitutes ``general market data'' in proposed Sec. 37.401(b).\607\

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

    \606\ WMBAA Comment Letter at 25 (Mar. 8, 2011).

    \607\ Id.

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

    CME commented that the Commission's requirements for real-time

    monitoring in proposed Sec. 37.401(c) are overly broad, and stated

    that requiring real-time monitoring capabilities across every

    instrument for vague terms such as ``abnormal price movements,''

    ``unusual trading volumes,'' and ``impairments to market liquidity''

    does not provide a SEF with sufficient clarity with respect to what

    specific capabilities satisfy the standard.\608\ Similarly, ICE

    requested that the Commission delete the phrase ``impairments to market

    liquidity'' from the rule, arguing that the wording is vague and has no

    foundation in the core principle.\609\

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

    \608\ CME Comment Letter at 24 (Feb. 22, 2011).

    \609\ ICE Comment Letter at 4 (Mar. 8, 2011).

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

    ICE and CME also expressed concern regarding the real-time

    monitoring of position limits.\610\ ICE stated that real-time

    monitoring of position limits may be flawed given that option deltas

    change throughout the day, the destination of allocated and give-up

    transactions are not immediately known, and off-exchange transactions

    may not be reported in real-time.\611\ CME stated that effective real-

    time monitoring of position limits is challenging given that the

    identical contract will frequently trade in multiple competitive

    venues.\612\

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

    \610\ ICE Comment Letter at 4 (Mar. 8, 2011); CME Comment Letter

    at 24 (Feb. 22, 2011).

    \611\ ICE Comment Letter at 4 (Mar. 8, 2011).

    \612\ CME Comment Letter at 24 (Feb. 22, 2011).

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

    In response to the Commission's questions in the SEF NPRM regarding

    high frequency trading, CME raised concerns over the absence of a

    definition for high frequency trading, which CME claimed can include

    many different trading strategies.\613\ CME questioned whether the

    Commission had unique concerns about high frequency traders, and

    further remarked that the Commission has not articulated what purpose

    would be served by singling out high frequency trading for special

    monitoring.\614\ CME stated, however, that it has the capability to

    monitor the messaging frequency of participants in their markets and

    can quickly and easily identify which participants generate high

    messaging traffic.\615\ With respect to the ability of automated

    trading systems to detect and flag high frequency trading anomalies,

    CME commented that it is unclear what specific types of anomalies would

    be uniquely of concern in the context of a high frequency trader as

    opposed to any other type of trader.\616\ CME noted that its systems

    were designed to identify anomalies or transaction patterns that

    violate their rules or might otherwise be

    [[Page 33528]]

    indicative of some other risk to the orderly functioning of the

    markets.\617\

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

    \613\ Id. at 25.

    \614\ Id.

    \615\ Id.

    \616\ Id.

    \617\ Id.

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

    (2) Commission Determination

    The Commission is adopting Sec. 37.401 as proposed, subject to

    certain modifications, including converting portions of the rule to

    guidance in appendix B to part 37.\618\

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

    \618\ The Commission is moving proposed Sec. 37.401(d) to the

    guidance in appendix B to part 37 and moving the ``trade

    reconstruction'' language in proposed Sec. 37.401(c) to final Sec.

    37.401(d).

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

    To address commenters' concerns whether Sec. 37.401 requires a SEF

    to monitor market activity beyond its own market, the Commission notes

    that the Act requires a SEF to monitor trading in swaps to prevent

    manipulation, price distortion, and disruptions of the delivery or cash

    settlement process.\619\ Given this statutory requirement, there are

    certain instances where a SEF must monitor market activity beyond its

    own market.\620\ As noted below, a SEF must assess whether trading in a

    third-party index or instrument used as a reference price or the

    underlying commodity for its listed swaps is being used to affect

    prices on its market.\621\ The Commission, however, provides

    flexibility to SEFs by not prescribing in the regulations the specific

    methods for monitoring. To provide additional flexibility, in instances

    where a SEF can demonstrate to the Commission that trading activity off

    the SEF's facility is not relevant to threats of manipulation,

    distortion, or disruption for trading conducted on its own facility,

    then the SEF may limit monitoring to trading activity on its own

    facility.

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

    \619\ CEA section 5h(f)(4)(B); 7 U.S.C. 7b-3(f)(4)(B).

    \620\ Refer to the guidance under Core Principle 4 in appendix B

    to part 37 for examples of methods for monitoring market activity

    beyond a SEF's own market.

    \621\ See discussion below under Sec. 37.403--Additional

    Requirements for Cash-Settled Swaps and Sec. 37.404--Ability To

    Obtain Information in the preamble.

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

    In response to WMBAA's concerns regarding the clarification of

    certain terms in Sec. 37.401(a), the Commission is revising the rule

    text to change the term ``individual traders'' to ``market

    participants'' as ``individual traders'' was meant to apply to a SEF's

    market participants. The Commission also clarifies that ``market

    activity'' means its market participants' ``trading'' activity. In

    Sec. 37.401(b), ``general market data'' means that a SEF shall monitor

    and evaluate general market conditions related to its swaps. For

    example, a SEF must monitor the pricing of the underlying commodity or

    a third-party index or instrument used as a reference price for its

    swaps as compared to the prices on its markets.

    The Commission is also revising the rule to clarify that: (a) Real-

    time monitoring is to detect and, when necessary, resolve

    abnormalities; and (b) reconstructing trading activity is to detect

    instances or threats of manipulation, price distortion, and

    disruptions.

    In the guidance, the Commission is clarifying that monitoring of

    trading activity in listed swaps should be designed to prevent

    manipulation, price distortion, and disruptions. The Commission

    believes that SEFs should have rules in place that allow it to

    intervene to prevent or reduce market disruptions given such

    requirement in Core Principle 4. The Commission also notes that once a

    threatened or actual disruption is detected, the SEF should take steps

    to prevent the disruption or reduce its severity.

    In the guidance, the Commission is also clarifying what activities

    should be included in real-time monitoring as compared to what

    activities may be done on a T+1 basis. The Commission believes that

    monitoring of price movements and trading volumes in order to detect,

    and when necessary, resolve abnormalities should be accomplished in

    real time in order to achieve, as much as possible, the statute's

    emphasis on preventive actions. It is acceptable, however, to have a

    program that detects instances or threats of manipulation, price

    distortion, and disruptions on at least a T+1 basis, incorporating any

    additional data that is available on such T+1 basis, including trade

    reconstruction data. The Commission notes that it dropped the

    requirements for a SEF to monitor for ``impairments to market

    liquidity'' and ``position limit violations'' given commenters'

    concerns about the difficulty of such monitoring.

    The Commission is moving to guidance the requirement to have

    automated alerts in proposed Sec. 37.401(d). The Commission believes

    that automated trading alerts, preferably in real time, are the most

    effective means of detecting market anomalies. However, a SEF may

    demonstrate that its manual processes are effective.

    As for the Commission's inquiry in the SEF NPRM about requiring

    additional monitoring of high frequency trading, the Commission

    believes that a SEF should be capable of monitoring all types of

    trading that may occur on its facility, including trading that may be

    characterized as ``high frequency.'' The Commission has decided not to

    implement, at this time, further rules pertaining to the monitoring of

    high frequency trading. The Commission is encouraged that there are

    efforts underway both within and outside of the Commission, to define

    and develop approaches for better monitoring of high-frequency and

    algorithmic trading. This is particularly evident from recent work done

    at the request of the Commission's Technology Advisory Committee

    (``TAC'').\622\ Further, the United Kingdom government's Foresight

    Project also commissioned a recently released report on the future of

    computer trading in financial markets, which aims to assess the risks

    and benefits of automated buying and selling.\623\ These efforts may

    assist the Commission's further development of a regulatory framework

    for high frequency trading activities.

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

    \622\ See, e.g., ``Recommendations on Pre-Trade Practices for

    Trading Firms, Clearing Firms and Exchanges involved in Direct

    Market Access,'' Pre-Trade Functionality Subcommittee of the CFTC's

    Technology Advisory Committee (Mar. 1, 2011) (``TAC Subcommittee

    Recommendations''), available at http://www.cftc.gov/ucm/groups/public/@swaps/documents/dfsubmission/tacpresentation030111_ptfs2.pdf. The Commission notes that the subcommittee report was

    submitted to the TAC and made available for public comment, but no

    final action has been taken by the full committee.

    \623\ See UK Government Office for Science, Foresight Project,

    The Future of Computer Trading in Financial Markets (working paper),

    available at http://www.bis.gov.uk/foresight/our-work/projects/current-projects/computer-trading/working-paper.

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

    (b) Sec. 37.402--Additional Requirements for Physical-Delivery Swaps

    Proposed Sec. 37.402 required, for physical-delivery swaps, that a

    SEF monitor each swap's terms and conditions, monitor the adequacy of

    deliverable supplies, assess whether supplies are available to those

    making physical delivery and saleable by those taking delivery, and

    monitor the ownership of deliverable supplies. Proposed Sec. 37.402

    also required that a SEF address any conditions that are causing price

    distortions or market disruptions.

    (1) Summary of Comments

    CME commented that proposed Sec. 37.402 should be an acceptable

    practice instead of a prescriptive rule.\624\ Parity Energy commented

    that in a market where numerous SEFs permit trading in identical swaps,

    requiring each SEF to monitor the adequacy, size, and ownership of

    deliverable supply as well as the delivery locations and commodity

    characteristics is duplicative, unmanageable, and creates the risk of

    conflicting conclusions.\625\

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

    \624\ CME Comment Letter at 25 (Feb. 22, 2011).

    \625\ Parity Energy Comment Letter at 4 (Mar. 25, 2011).

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

    [[Page 33529]]

    (2) Commission Determination

    The Commission is adopting Sec. 37.402 as proposed, subject to

    certain modifications, including converting portions of the rule to

    guidance in appendix B to part 37.\626\ In response to comments and to

    provide SEFs with greater flexibility, the Commission is revising the

    requirement in proposed Sec. 37.402(a)(2) \627\ so that SEFs only have

    to monitor the ``availability'' of the commodity supply instead of

    monitoring whether the supply is ``adequate.'' The Commission is also

    removing from proposed Sec. 37.402 the requirements that SEFs monitor

    specific details of the supply, marketing, and ownership of the

    commodity to be physically delivered. Instead, appendix B to part 37

    lists guidance for monitoring conditions that may cause a physical-

    delivery swap to become susceptible to price manipulation or

    distortion, including monitoring the general availability of the

    commodity specified by the swap, the commodity's general

    characteristics, the delivery locations, and, if available, information

    on the size and ownership of deliverable supplies. Moving these

    specific details to guidance will provide SEFs with additional

    flexibility in meeting their monitoring obligations associated with

    physical-delivery swaps.

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

    \626\ The Commission is renumbering proposed Sec. 37.402(a)(1)

    and (a)(2) to Sec. 37.402(a) and (b), respectively. The Commission

    is deleting or moving to guidance proposed Sec. 37.402(a)(3),

    (a)(4), and (b).

    \627\ Proposed Sec. 37.402(a)(2) is now final Sec. 37.402(b).

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

    (c) Sec. 37.403--Additional Requirements for Cash-Settled Swaps

    Proposed Sec. 37.403(a) required, for cash-settled swaps, that a

    SEF monitor: (a) The availability and pricing of the commodity making

    up the index to which the swap is settled and; (b) the continued

    appropriateness of the methodology for deriving the index for SEFs that

    compute their own indices. Where a swap is settled by reference to the

    price of an instrument traded in another venue, proposed Sec.

    37.403(b) required that the SEF either have an information sharing

    agreement with the other venue or be able to independently determine

    that positions or trading in the reference instrument are not being

    manipulated to affect positions or trading in its swap.

    (1) Summary of Comments

    Argus expressed concern regarding the requirement in proposed Sec.

    37.403(a)(1) for a SEF to monitor the availability and pricing of the

    commodity making up the index to which the swap will be settled,

    particularly where an index price is published based upon transactions

    that are executed off the SEF.\628\ Argus noted that if a SEF is

    required to perform this monitoring function, a SEF may choose not to

    list the swap and market participants would not have a hedging

    instrument.\629\ Argus also commented that the cost to monitor

    transactions that are executed off of the SEF could be

    prohibitive.\630\

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

    \628\ Argus Comment Letter at 6 (Feb. 22, 2011).

    \629\ Id.

    \630\ Id. at 7.

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

    Several commenters expressed concern about the requirement in

    proposed Sec. 37.403(b) that a SEF have an information sharing

    agreement with, or monitor positions or trading in, another venue when

    a swap listed on the SEF is settled by reference to the price of an

    instrument traded on another venue.\631\ ICE stated that the proposal

    places an undue burden on SEFs to monitor positions held at other

    trading venues, and that this requirement would be more efficiently

    facilitated by a central regulatory body such as the Commission.\632\

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

    \631\ Parity Energy Comment Letter at 5 (Mar. 25, 2011); ICE

    Comment Letter at 4-5 (Mar. 8, 2011); Nodal Comment Letter at 5

    (Mar. 8, 2011); CME Comment Letter at 11 (Mar. 8, 2011).

    \632\ ICE Comment Letter at 4-5 (Mar. 8, 2011).

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

    Similarly, CME stated that the Commission is uniquely situated to

    add regulatory value to the industry by reviewing for potential cross-

    venue rule violations because the Commission is the central repository

    for position information delivered to it on a daily basis in a common

    format across all venues.\633\ CME asserted that the SEF NPRM's

    proposed alternative of requiring SEFs and their customers to report

    information that the Commission already receives or will be receiving

    is an onerous burden.\634\ CME further asserted that the SEF NPRM's

    other proposed alternative, that the SEF enter into an information-

    sharing agreement with the other venue, will result in additional costs

    to both entities and that it may not be practical or prudent for a SEF

    to enter into such an agreement with the other venue.\635\

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

    \633\ CME Comment Letter at 11 (Mar. 8, 2011).

    \634\ Id.

    \635\ Id.

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

    Finally, Nodal stated that a SEF that is a party to an industry

    agreement such as the International Information Sharing Memorandum of

    Understanding and Agreement should satisfy the information sharing

    requirement in the proposed rule by virtue of such agreement.\636\

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

    \636\ Nodal Comment Letter at 5 (Mar. 8, 2011).

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

    (2) Commission Determination

    The Commission is adopting Sec. 37.403 as proposed, subject to

    certain modifications, including converting portions of the rule to

    guidance in appendix B to part 37.\637\ The Act requires SEFs to

    monitor trading in swaps to prevent disruptions of the cash settlement

    process.\638\ However, in response to Argus's comment about the costs

    of proposed Sec. 37.403(a)(1), the Commission has removed from the

    rule the requirement that a SEF monitor the availability and pricing of

    the commodity making up the index to which the swap will be settled.

    Section 37.403(a) \639\ now requires that a SEF monitor the pricing of

    the reference price used to determine cash flows or settlement. The

    Commission believes that SEFs must monitor the pricing of the reference

    price in order to comply with Core Principle 4's requirement to prevent

    manipulation, price distortion, and disruptions of the cash settlement

    process. As noted in the SEF NPRM, market participants may have

    incentives to disrupt or manipulate reference prices for cash-settled

    swaps.\640\

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

    \637\ The Commission is renumbering proposed Sec. 37.403(a)(1)

    and (a)(2) to Sec. 37.403(a), (b), and (c). The Commission is

    moving proposed Sec. 37.403(b) to Sec. 37.404(a).

    \638\ CEA section 5h(f)(4)(B); 7 U.S.C. 7b-3(f)(4)(B).

    \639\ Final Sec. 37.403(a) was proposed Sec. 37.403(a)(1).

    \640\ Core Principles and Other Requirements for Swap Execution

    Facilities, 76 FR at 1228.

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

    Although no comments were received on proposed Sec.

    37.403(a)(2),\641\ the Commission is revising the rule so that the

    requirement for monitoring the continued appropriateness of the

    methodology for deriving the reference price only applies when the

    reference price is formulated and computed by the SEF. In order to

    reduce the burden on SEFs, the Commission is clarifying in new Sec.

    37.403(c) that when the reference price relies on a third-party index

    or instrument, including an index or instrument traded on another

    venue, the SEF must only monitor the ``continued appropriateness'' of

    the index or instrument as opposed to specifically monitoring the

    ``continued appropriateness of the methodology'' for deriving the

    index. To provide SEFs with greater flexibility, the Commission is

    moving the other requirements for monitoring in proposed Sec.

    37.403(a)(2) to the guidance in appendix B to part 37. Specifically,

    the guidance notes that if a SEF computes its own reference price, it

    should promptly amend any methodologies or impose new methodologies as

    necessary to resolve threats of disruption or distortions. For

    [[Page 33530]]

    reference prices that rely upon a third-party index or instrument, the

    Commission notes in the guidance that the SEF should conduct due

    diligence to ensure that the reference price is not susceptible to

    manipulation.

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

    \641\ The Commission is renumbering proposed Sec. 37.403(a)(2)

    to Sec. 37.403(b).

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

    With respect to commenters' concerns about the requirement in

    proposed Sec. 37.403(b) for a SEF to have an information-sharing

    agreement with, or monitor positions or trading in, another venue when

    a swap listed on the SEF is settled by reference to the price of an

    instrument traded on another venue, the Commission notes that the Act

    requires SEFs to monitor trading in swaps to prevent disruptions of the

    cash settlement process.\642\ Given this statutory requirement, the

    Commission believes that a SEF must have access to sufficient

    information to determine whether trading in the instrument or index

    used as a reference price for its listed swaps is being used to affect

    prices on its market. The Commission is adopting this general

    requirement, but is moving it to Sec. 37.404 where it more logically

    belongs.

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

    \642\ CEA section 5h(f)(4)(B); 7 U.S.C. 7b-3(f)(4)(B).

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

    Although, as CME noted, the Commission does obtain certain position

    information in the large-trader reporting systems for swaps, the

    Commission may not routinely obtain such position information,

    including where a SEF's swap settles to the price of a non-U.S. index

    or instrument. However, in response to ICE's and CME's concerns and to

    reduce the burden on SEFs, the Commission is removing from the rule

    text the requirement for SEFs to assess ``positions'' and is moving it

    to the guidance in appendix B to part 37. The Commission is also moving

    to the guidance the specific methods for a SEF to obtain information to

    assess whether trading in the reference market is being used to affect

    prices on its market. The guidance also allows SEFs to limit such

    information gathering to market participants that conduct substantial

    trading on its facility.

    (d) Sec. 37.404--Ability To Obtain Information

    Proposed Sec. 37.404(a) provided that a SEF must have rules that

    require traders in its swaps to keep and make available records of

    their activity in underlying commodities and related derivatives

    markets and swaps. Proposed Sec. 37.404(b) required that a SEF with

    customers trading through intermediaries have a large-trader reporting

    system or other means to obtain position information.

    (1) Summary of Comments

    CME commented that the Commission should specify in acceptable

    practices the types of records that traders are required to keep under

    proposed Sec. 37.404(a).\643\ WMBAA commented that the requirement for

    a SEF to force traders to maintain trading and financial records is not

    required under the CEA.\644\

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

    \643\ CME Comment Letter at 26 (Feb. 22, 2011).

    \644\ WMBAA Comment Letter at 26 (Mar. 8, 2011).

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

    (2) Commission Determination

    The Commission is adopting Sec. 37.404 as proposed, subject to

    certain modifications, including providing guidance in appendix B to

    part 37.\645\ As noted above in the discussion of Sec. 37.403, the

    Commission is moving to Sec. 37.404 the requirement for a SEF to

    assess whether trading in swaps listed on its market, in the index or

    instrument used as a reference price, or in the underlying commodity

    for its swaps is being used to affect prices in its market.\646\

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

    \645\ The Commission is changing the phrase ``traders in its

    swaps'' to ``its market participants'' to provide clarity.

    \646\ The Commission notes that this requirement is now in Sec.

    37.404(a).

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

    With respect to CME's and WMBAA's comments on proposed Sec.

    37.404(a),\647\ the Commission disagrees that this rule is unnecessary

    or that the requirements should instead be codified as acceptable

    practices. Core Principle 4 requires a SEF to monitor trading in swaps

    to prevent manipulation, price distortion, and disruptions.\648\ In its

    experience regulating the futures market, the Commission has found

    market participants' records to be an invaluable tool in its

    surveillance efforts, and believes that a SEF should have direct access

    to such information in order to discharge its obligations under the SEF

    core principles, including Core Principle 4. However, the Commission

    notes that in the guidance for this rule, a SEF may limit the

    application of this requirement to those market participants who

    conduct substantial trading activity on its facility, which is

    consistent with the Commission's similar requirements that large

    traders keep records for futures trading under Sec. 18.05 and for

    swaps trading under Sec. 20.6 of the Commission's regulations. The

    Commission also notes that the requirement for market participants to

    keep such records is sound commercial practice, and that market

    participants are likely already maintaining such trading records. In

    response to CME's comment, the Commission notes that the nature of

    records covered varies with the type of market and a market

    participant's involvement, but would generally include purchases,

    sales, ownership, production, processing, and use of swaps, the

    underlying commodity, and other derivatives that have some relationship

    to, or effect on, the market participant's trading in the listed swap.

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

    \647\ The Commission notes that this requirement is now in Sec.

    37.404(b).

    \648\ CEA section 5h(f)(4)(B); 7 U.S.C. 7b-3(f)(4)(B).

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

    The Commission is also deleting the requirements under proposed

    Sec. 37.404(b) and replacing it, in the guidance, with a more general

    requirement for a SEF to demonstrate that it can obtain position and

    trading information directly from market participants or, if not

    available from them, through information-sharing agreements. Moreover,

    the guidance for this rule allows a SEF to limit the acquisition of

    such information to those market participants who conduct substantial

    trading on its facility. The Commission is making this change in

    response to commenters' concerns, as noted in other sections, about

    obtaining position information because a SEF will not have the

    capability to monitor trading activities conducted on other trading

    venues.\649\

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

    \649\ See, e.g., comments below under Core Principle 6--Position

    Limits or Accountability in the preamble.

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

    (e) Sec. 37.405--Risk Controls for Trading

    Proposed Sec. 37.405 required that a SEF have risk controls to

    reduce the potential risk of market disruptions, including, but not

    limited to, market restrictions that pause or halt trading in market

    conditions prescribed by the SEF. Additionally, the rule provided that

    where a SEF's swap is linked to, or a substitute for, other swaps on

    the SEF or on other trading venues, including where a swap is based on

    the level of an equity index, such risk controls must be coordinated

    with those on the similar markets or trading venues, to the extent

    possible.

    The preamble of the SEF NPRM recognized that pauses and halts are

    only one category of risk controls, and that additional controls may be

    necessary to further reduce the potential for market disruptions.\650\

    The SEF NPRM preamble specifically listed several risk controls that

    the Commission believed may be appropriate, including price collars or

    bands, maximum order size limits, stop loss order protections, kill

    buttons, and any others that may be suggested by commenters.\651\

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

    \650\ Core Principles and Other Requirements for Swap Execution

    Facilities, 76 FR at 1228.

    \651\ Id.

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

    [[Page 33531]]

    (1) Summary of Comments

    Several commenters asserted that a SEF should have some discretion

    to determine the specific risk controls that are implemented within its

    markets.\652\ CME commented that the marketplace would benefit from

    some standardization of the types of pre-trade risk controls employed

    by SEFs and other trading venues, and expressed support for an

    acceptable practices framework that includes pre-trade quantity limits,

    price banding, and messaging throttles, but argued that the specific

    parameters of such controls should be determined by each SEF.\653\ ICE

    recommended that the Commission take a flexible approach to risk

    controls so as not to hinder innovation in developing new mechanisms to

    prevent market disruptions.\654\ ICE did, however, recommend that the

    Commission expressly require a SEF to have pre-trade risk controls or

    checks, which are especially important in thinly traded markets where

    RFQs are more common.\655\

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

    \652\ ICE Comment Letter at 5 (Mar. 8, 2011); Tradeweb Comment

    Letter at 11 (Mar. 8, 2011); CME Comment Letter at 27 (Feb. 22,

    2011).

    \653\ CME Comment Letter at 27 (Feb. 22, 2011).

    \654\ ICE Comment Letter at 5 (Mar. 8, 2011).

    \655\ Id.

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

    SDMA supported the requirement in proposed Sec. 37.405, but noted

    that the rule should include pre-trade and post-trade risk control

    requirements that are uniform across the market.\656\ SDMA noted that a

    uniform approach would create a much needed single regulatory approach

    to risk management across the derivatives market, enhance market

    integrity, and decrease systemic risk.\657\ SDMA agreed with the best

    practices for pre-trade and post-trade risk controls as noted in the

    Pre-Trade Functionality Subcommittee of the CFTC TAC's Recommendations

    on Pre-Trade Practices for Trading Firms, Clearing Firms and Exchanges

    involved in Direct Market Access.\658\

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

    \656\ SDMA Comment Letter at 5 (Mar. 8, 2011).

    \657\ Id. at 6.

    \658\ Id. See TAC Subcommittee Recommendations (Mar. 1, 2011).

    The report recommended several pre-trade risk controls for

    implementation at the exchange level, which were largely consistent

    with the pre-trade controls listed in the preamble to the SEF NPRM.

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

    Finally, CME objected to the requirement to coordinate risk

    controls.\659\ CME stated that a SEF should retain the flexibility to

    determine and implement risk controls that it believes are necessary to

    protect the integrity of its markets.\660\ CME recommended that the

    Commission work constructively with registered entities to facilitate

    coordination.\661\

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

    \659\ CME Comment Letter at 26 (Feb. 22, 2011).

    \660\ Id.

    \661\ Id.

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

    (2) Commission Determination

    The Commission is adopting proposed Sec. 37.405, subject to

    certain modifications, including converting a portion of the rule to

    the guidance in appendix B to part 37. As stated in the SEF NPRM, the

    Commission believes that pauses and halts are effective risk management

    tools that must be implemented by a SEF to facilitate orderly

    markets.\662\ Automated risk control mechanisms, including pauses and

    halts, have proven to be effective and necessary in preventing market

    disruptions in the futures market and, therefore, will remain as part

    of the rule.

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

    \662\ Core Principles and Other Requirements for Swap Execution

    Facilities, 76 FR at 1228.

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

    As noted by SDMA, the Pre-Trade Functionality Subcommittee of the

    TAC issued a report that recommended the implementation of several

    trade risk controls at the exchange level.\663\ The controls

    recommended in the Subcommittee report were consistent, in large part,

    with the trade controls referenced in the preamble to the SEF NPRM, and

    which are being adopted in the guidance in appendix B to part 37.\664\

    The TAC accepted the Subcommittee report, which specifically

    recommended that exchanges implement pre-trade limits on order size,

    price collars around the current price, intraday position limits (of a

    type that represent financial risk to the clearing member), message

    throttles, and clear error-trade and order-cancellation policies.\665\

    The Subcommittee report also noted that ``[s]ome measure of

    standardization of pre-trade risk controls at the exchange level is the

    cheapest, most effective and most robust path to addressing the

    Commission's concern [for preserving market integrity].'' \666\

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

    \663\ TAC Subcommittee Recommendations (Mar. 1, 2011).

    \664\ The preamble to the SEF NPRM specifically mentioned daily

    price limits, order size limits, trading pauses, stop logic

    functionality, among others. Core Principles and Other Requirements

    for Swap Execution Facilities, 76 FR at 1228.

    \665\ TAC Subcommittee Recommendations at 4-5 (Mar. 1, 2011).

    The TAC discussed this report's findings at its meeting on March 1,

    2011. See Transcript of Third Meeting of Technology Advisory

    Committee (Mar. 1, 2011) available at http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/tac_030111_transcript.pdf.

    \666\ TAC Subcommittee Recommendations at 4 (Mar. 1, 2011).

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

    The Commission believes that the implementation of specific types

    of other risk controls is generally desirable, but also recognizes that

    such risk controls should be adapted to the unique characteristics of

    the markets to which they apply. A SEF implementing any such additional

    risk controls should consider the balance between avoiding a market

    disruption while not impeding a market's price discovery function.

    Controls that unduly restrict a market's ability to respond to

    legitimate market events will interfere with price discovery.

    Accordingly, consistent with many of the comments on this subject, the

    Commission is enumerating specific types of risk controls, in addition

    to pauses and halts, that a SEF may implement in the guidance rather

    than in the rule, in order to provide a SEF with greater discretion to

    select among the enumerated risk controls, or to create new risk

    controls that meet the unique characteristics of its markets. A SEF

    will also have discretion in determining the parameters for the

    selected controls.

    Additionally, in response to CME's concern about the requirement to

    coordinate risk controls, the Commission is moving this language from

    proposed Sec. 37.405 to the guidance. Specifically, a SEF with a swap

    that is fungible with, linked to, or a substitute for other swaps on

    the SEF or on other trading venues, should, to the extent practicable,

    coordinate its risk controls with any similar controls placed on those

    other swaps. The guidance also states that if a SEF's swap is based on

    the level of an equity index, such risk controls should, to the extent

    practicable, be coordinated with any similar controls placed on

    national security exchanges.

    (f) Sec. 37.406--Trade Reconstruction

    Under Core Principle 4, Congress required that a SEF have the

    ability to comprehensively and accurately reconstruct all trading on

    its facility.\667\ Proposed Sec. 37.406 set forth this requirement,

    including the requirement that audit-trail data and reconstructions be

    made available to the Commission in a form, manner, and time as

    determined by the Commission.

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

    \667\ CEA section 5h(f)(4)(B); 7 U.S.C. 7b-3(f)(4)(B).

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

    (1) Summary of Comments

    CME commented that audit trail data is extremely detailed and

    voluminous and that SEFs should be given adequate time to prepare the

    trading data before it is supplied to the Commission.\668\ In this

    regard, CME recommended that the wording ``in a form, manner, and time

    as determined by the Commission'' be

    [[Page 33532]]

    replaced with ``such reasonable time as determined by the Commission.''

    \669\

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

    \668\ CME Comment Letter at 27 (Feb. 22, 2011).

    \669\ Id.

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

    (2) Commission Determination

    The Commission is revising the rule so that a SEF shall be required

    to make audit trail data and reconstructions available to the

    Commission ``in a form, manner, and time that is acceptable to the

    Commission.'' The Commission notes that it will work with SEFs to

    provide them with adequate time to supply such information to the

    Commission.

    (g) Sec. 37.407--Additional Rules Required

    Proposed Sec. 37.407 required a SEF to adopt and enforce any

    additional rules that it believes are necessary to comply with the

    requirements of subpart E of part 37.

    (1) Commission Determination

    Although the Commission did not receive any comments on the

    proposed rule, the Commission is revising the rule to state that

    applicants and SEFs may refer to the guidance and/or acceptable

    practices in appendix B to part 37 to demonstrate to the Commission

    compliance with the requirements of section 37.400. The Commission is

    also moving proposed Sec. 37.407 to new Sec. 37.408, titled

    ``Additional sources for compliance.''

    In new Sec. 37.407, titled ``Regulatory service provider,'' the

    Commission is clarifying that a SEF can comply with the regulations in

    subpart E through a dedicated regulatory department or by contracting

    with a regulatory service provider pursuant to Sec. 37.204.

    5. Subpart F--Core Principle 5 (Ability To Obtain Information)

    Core Principle 5 requires a SEF to: (a) Establish and enforce rules

    that will allow the facility to obtain any necessary information to

    perform any of the functions described in section 5h of the Act, (b)

    provide the information to the Commission on request, and (c) have the

    capacity to carry out international information-sharing agreements as

    the Commission may require.\670\ In the SEF NPRM, the Commission

    proposed to codify the statutory text of Core Principle 5 in proposed

    Sec. 37.500, and adopts that rule as proposed.

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

    \670\ CEA section 5h(f)(5); 7 U.S.C. 7b-3(f)(5).

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

    (a) Sec. 37.501--Establish and Enforce Rules

    Proposed Sec. 37.501 required a SEF to establish and enforce rules

    that will allow the SEF to have the ability and authority to obtain

    sufficient information to allow it to fully perform its operational,

    risk management, governance, and regulatory functions and any

    requirements under part 37, including the capacity to carry out

    international information-sharing agreements as the Commission may

    require.

    (1) Commission Determination

    The Commission received no comments on proposed Sec. 37.501 and is

    adopting the rule as proposed. The Commission believes that Sec.

    37.501 appropriately implements the requirement in Core Principle 5 for

    a SEF to establish and enforce rules that will allow the SEF to obtain

    any necessary information to perform any of its functions described in

    section 5h of the Act.\671\

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

    \671\ CEA section 5h(f)(5)(A); 7 U.S.C. 7b-3(f)(5)(A).

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

    (b) Sec. 37.502--Collection of Information

    Proposed Sec. 37.502 required a SEF to have rules that allow it to

    collect information on a routine basis, allow for the collection of

    non-routine data from its participants, and allow for its examination

    of books and records kept by the traders on its facility.

    (1) Summary of Comments

    WMBAA commented that aside from participants who contractually

    agree to provide information, a SEF does not possess the legal

    authority to obtain such information.\672\ Additionally, WMBAA stated

    that the burden to collect information should be placed upon

    counterparties.\673\ In the alternative, WMBAA stated that the

    Commission should require a SEF and its participants to enter into

    third party service provider agreements for the collection of the

    required information.\674\ MarketAxess commented that it is not clear

    what is meant by ``non-routine data'' in proposed Sec. 37.502 and that

    the rule should make clear that a SEF is only required to collect and

    maintain participant information that is directly related to such

    participants' activity conducted pursuant to the SEF's rules.\675\

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

    \672\ WMBAA Comment Letter at 26 (Mar. 8, 2011).

    \673\ Id.

    \674\ Id.

    \675\ MarketAxess Comment Letter at 37 (Mar. 8, 2011).

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

    (2) Commission Determination

    The Commission is adopting Sec. 37.502 as proposed.\676\ In

    response to WMBAA's and MarketAxess's comments, the Commission notes

    that Core Principle 5 requires a SEF to establish and enforce rules

    that will allow it to obtain any necessary information to perform any

    of its functions described in section 5h of the Act. The Act and the

    Commission's regulations provide a SEF with the legal authority to

    collect such information. As mentioned in Sec. 37.204 above, a SEF may

    contract with a regulatory service provider to perform regulatory

    services on behalf of a SEF. Thus, a SEF may enter into a third party

    regulatory service provider agreement for the collection of information

    under Sec. 37.502. Additionally, as mentioned in Sec. 37.404 above,

    the Act requires SEFs to monitor trading in swaps to prevent

    manipulation, price distortion, and disruptions through surveillance,

    compliance, and disciplinary practices and procedures.\677\ The

    Commission believes that market participant records are a valuable tool

    in conducting an effective surveillance program; thus, a SEF should

    have direct access to such information in order to discharge its

    obligations under the core principles. The Commission notes that market

    participants are likely maintaining trading records as part of sound

    business practices so requiring SEFs to have rules that allow them to

    access such information should not present a burden. To address

    MarketAxess's comment about ``non-routine data,'' the Commission

    clarifies that ``non-routine data'' means the collection of data on an

    ad-hoc basis, such as data that may be collected during an

    investigation.

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

    \676\ The Commission is changing the terms ``participants'' and

    ``traders'' to ``market participants'' to provide clarity.

    \677\ CEA section 5h(f)(4)(B); 7 U.S.C. 7b-3(f)(4)(B).

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

    (c) Sec. 37.503--Provide Information to the Commission

    Proposed Sec. 37.503 required a SEF to provide information in its

    possession to the Commission upon request, in a form and manner that

    the Commission approves.

    (1) Commission Determination

    The Commission received no comments on proposed Sec. 37.503 and is

    adopting the rule as proposed. The Commission believes that Sec.

    37.503 appropriately implements the requirement in Core Principle 5 for

    a SEF to provide information to the Commission on request.\678\

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

    \678\ CEA section 5h(f)(5)(B); 7 U.S.C. 7b-3(f)(5)(B).

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

    (d) Sec. 37.504--Information-Sharing Agreements

    Proposed Sec. 37.504 required a SEF to share information with

    other regulatory organizations, data repositories, and reporting

    services as required by the

    [[Page 33533]]

    Commission or as otherwise necessary and appropriate to fulfill its

    self-regulatory and reporting responsibilities. The proposed rule also

    stated that appropriate information-sharing agreements can be

    established with such entities or the Commission can act in conjunction

    with the SEF to carry out such information sharing.

    (1) Summary of Comments

    WMBAA commented that the proposed rule could be interpreted to

    require a SEF to share information with its competitors, unless the

    information is disseminated by a neutral third party pursuant to a

    services agreement.\679\ WMBAA also requested clarification regarding

    the circumstances in which the Commission would determine to carry out

    information sharing itself, as opposed to a SEF entering into

    information-sharing agreements with the relevant entity.\680\

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

    \679\ WMBAA Comment Letter at 27 (Mar. 8, 2011).

    \680\ Id.

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

    (2) Commission Determination

    The Commission is adopting Sec. 37.504 as proposed, subject to one

    modification. The Commission is revising the rule to change the term

    ``reporting services'' to ``third party data reporting services.'' The

    Commission clarifies that the term ``reporting services'' was meant to

    refer to independent third parties that would provide trading data on a

    public basis and was not meant to include competitor SEFs. To address

    WMBAA's comment about information sharing, the Commission clarifies

    that a SEF may work with the Commission to fulfill its information

    sharing requirements in the absence of agreements with SDRs, regulatory

    bodies, or third party data reporting services. Given that each SEF is

    unique, a particular SEF would need to contact the Commission to

    discuss how the information sharing requirements could be fulfilled.

    6. Subpart G--Core Principle 6 (Position Limits or Accountability)

    Core Principle 6 requires that a SEF adopt for each swap, as is

    necessary and appropriate, position limits or position accountability

    to reduce the potential threat of market manipulation or

    congestion.\681\ In addition, Core Principle 6 requires that for any

    contract that is subject to a federal position limit under CEA section

    4a(a), the SEF set its position limits at a level no higher than the

    position limitation established by the Commission and monitor positions

    established on or through the SEF for compliance with the limit set by

    the Commission and the limit, if any, set by the SEF.\682\ In the SEF

    NPRM, the Commission proposed to codify the statutory text of Core

    Principle 6 in proposed Sec. 37.600, and adopts that rule as proposed.

    Proposed Sec. 37.601 repeated the requirements in Sec. 37.600 and

    required that SEFs establish position limits in accordance with the

    requirements set forth in part 151 of the Commission's regulations.

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

    \681\ CEA section 5h(f)(6); 7 U.S.C. 7b-3(f)(6).

    \682\ Id.

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

    (a) Summary of Comments

    Several commenters stated that SEFs will have difficulty enforcing

    position limitations.\683\ Many of these commenters noted that SEFs

    will lack knowledge of a market participant's activity on other venues,

    and that will prevent a SEF from being able to calculate the true

    position of a market participant.\684\ In this regard, Phoenix stated

    that market participants will be allowed to trade on multiple SEFs so

    any one SEF's information concerning a market participant's position

    will be virtually meaningless, as the market participant may sell a

    large position on one SEF and simultaneously buy the same amount of the

    instrument on another SEF.\685\ WMBAA recommended that a common

    regulatory organization or third party regulatory service provider

    monitor position limits because they will have the capability to ensure

    coordinated oversight of the trading activity on multiple SEFs and the

    ability to implement disciplinary action if needed.\686\ Reuters and

    Phoenix recommended that the Commission or its designee monitor

    position limits.\687\ Alice recommended that, for cleared swaps, DCOs

    maintain position limits, and when a swap is cleared by multiple DCOs,

    one DCO would be the primary for a given participant and the other DCOs

    would report positions to that DCO.\688\

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

    \683\ Bloomberg Comment Letter at 3-4 (Jun. 3, 2011); Alice

    Comment Letter at 5 (May 31, 2011); Rosen et al. Comment Letter at

    22 (Apr. 5, 2011); WMBAA Comment Letter at 27 (Mar. 8, 2011);

    Tradeweb Comment Letter at 11 (Mar. 8, 2011); Reuters Comment Letter

    at 6 (Mar. 8, 2011); Phoenix Comment Letter at 3 (Mar. 7, 2011).

    \684\ WMBAA Comment Letter at 2 (Apr. 11, 2013); Bloomberg

    Comment Letter at 3-4 (Jun. 3, 2011); Rosen et al. Comment Letter at

    22 (Apr. 5, 2011); WMBAA Comment Letter at 27 (Mar. 8, 2011);

    Tradeweb Comment Letter at 11 (Mar. 8, 2011); Phoenix Comment Letter

    at 3 (Mar. 7, 2011).

    \685\ Phoenix Comment Letter at 3-4 (Mar. 7, 2011).

    \686\ WMBAA Comment Letter at 27 (Mar. 8, 2011).

    \687\ Reuters Comment Letter at 6 (Mar. 8, 2011); Phoenix

    Comment Letter at 4 (Mar. 7, 2011).

    \688\ Alice Comment Letter at 5 (May 31, 2011).

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

    Despite the concerns raised by other commenters, Phoenix noted

    that, if required, a SEF can monitor position limits of market

    participants based upon the trading activity that takes place only on

    the SEF's platform.\689\ Tradeweb also requested confirmation from the

    Commission that a SEF must only monitor its market participants'

    position limits or positions in particular instruments with respect to

    positions entered into on its own platforms.\690\

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

    \689\ Phoenix Comment Letter at 4 (Mar. 7, 2011).

    \690\ Tradeweb Comment Letter at 11 (Mar. 8, 2011).

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

    (b) Commission Determination

    In response to commenters concerns about monitoring position

    limits, the Commission is removing the requirements in Sec. 37.601.

    Instead, final Sec. 37.601 states that until such time that compliance

    is required under part 151 of this chapter,\691\ a SEF may refer to the

    guidance and/or acceptable practices in appendix B to part 37 to

    demonstrate to the Commission compliance with the requirements of Sec.

    37.600.

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

    \691\ See Position Limits for Derivatives, 76 FR 4752 (proposed

    Jan. 26, 2011).

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

    The guidance provides a SEF with reasonable discretion to comply

    with Sec. 37.600, including considering part 150 of the Commission's

    regulations.\692\ The guidance also states that for Required

    Transactions as defined in Sec. 37.9, a SEF may demonstrate compliance

    with Sec. 37.600 by setting and enforcing position limitations or

    position accountability levels only with respect to trading on the

    SEF's own market. For example, a SEF could satisfy the position

    accountability requirement by setting up a compliance program that

    continuously monitors the trading activity of its market participants

    and has procedures in place for remedying any violations of position

    levels. For Permitted Transactions as defined in Sec. 37.9, a SEF may

    demonstrate compliance with Sec. 37.600 by setting and enforcing

    position accountability levels or sending the Commission a list of

    Permitted Transactions traded on the SEF. Therefore, a SEF is not

    required to monitor its market participants' activity on other venues

    with respect to monitoring position limits.

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

    \692\ Part 150 of the Commission's regulations contains the

    current position limits regime.

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

    In response to comments that a common regulatory organization or

    the Commission should monitor position limits, the Commission notes

    that Core Principle 6 places the responsibility on a SEF to adopt and

    monitor position limits. The Dodd-Frank Act does not mandate that a

    common regulatory organization or the Commission monitor position

    limits. The Dodd-Frank Act also does not provide the Commission with

    the authority to exempt a SEF from

    [[Page 33534]]

    certain core principles. Therefore, the Commission is providing a SEF

    with flexibility to adopt and monitor position limits as described

    above.

    7. Subpart H--Core Principle 7 (Financial Integrity of Transactions)

    Core Principle 7 requires a SEF to establish and enforce rules and

    procedures for ensuring the financial integrity of swaps entered on or

    through the facilities of the SEF, including the clearance and

    settlement of the swaps pursuant to section 2(h)(1) of the Act.\693\ In

    the SEF NPRM, the Commission proposed to codify the statutory text of

    Core Principle 7 in proposed Sec. 37.700, and adopts that rule as

    proposed.

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

    \693\ CEA section 5h(f)(7); 7 U.S.C. 7b-3(f)(7).

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

    (a) Sec. 37.701--Mandatory Clearing \694\

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

    \694\ The Commission is renaming the title of this section from

    ``Mandatory Clearing'' to ``Required Clearing'' to be consistent

    with terminology used in the CEA and the Commission's regulations.

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

    Proposed Sec. 37.701 required transactions executed on or through

    a SEF to be cleared through a Commission registered DCO unless the

    transaction is excepted from clearing under section 2(h)(7) of the Act

    or the swap is not subject to the clearing requirement under section

    2(h)(1) of the Act.

    (1) Summary of Comments

    ISDA/SIFMA commented that section 2(h)(1) of the CEA provides that

    swaps subject to the clearing requirement must be submitted for

    clearing to a registered DCO or a DCO that is exempt from registration;

    however, proposed Sec. 37.701 requires that transactions executed

    through a SEF be cleared only through a Commission-registered DCO.\695\

    ISDA/SIFMA recommended that the rule be amended to permit the use of

    exempt DCOs.\696\ MarketAxess recommended that proposed Sec. 37.701 be

    revised to permit a SEF to rely on a representation from an end-user

    that it qualifies for the section 2(h)(7) exemption.\697\

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

    \695\ ISDA/SIFMA Comment Letter at 13 (Mar. 8, 2011).

    \696\ Id.

    \697\ MarketAxess Comment Letter at 38 (Mar. 8, 2011).

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

    (2) Commission Determination

    The Commission is adopting Sec. 37.701 as proposed, subject to

    certain revisions. The Commission is modifying Sec. 37.701 to state

    that ``[t]ransactions executed on or through the swap execution

    facility that are required to be cleared under section 2(h)(1)(A) of

    the Act or are voluntarily cleared by the counterparties shall be

    cleared through a Commission-registered derivatives clearing

    organization, or a derivatives clearing organization that the

    Commission has determined is exempt from registration.'' The Commission

    is deleting proposed Sec. 37.701(a), which referred to the end-user

    exception under CEA section 2(h)(7) because, as modified, the final

    rule text clarifies that any swaps that are required to be cleared or

    that are voluntarily cleared must be cleared through a registered DCO,

    or a DCO that the Commission has determined is exempt from

    registration. The Commission notes that swaps that are subject to the

    clearing requirement must be submitted for clearing, except where the

    swap may be eligible for an exception or exemption from the clearing

    requirement pursuant to either the exception provided under section

    2(h)(7) of the Act and Sec. 50.50 of the Commission's regulations, or

    an exemption provided under part 50 of the Commission's regulations.

    The rule also provides that counterparties that elect to clear a swap

    that is not required to be cleared may do so voluntarily through a

    Commission-registered DCO, or a DCO that the Commission has determined

    is exempt from registration.

    In response to ISDA/SIFMA's recommendation that the rule be amended

    to permit the use of exempt DCOs, the Commission is mindful that CEA

    section 2(h)(1) provides that swaps subject to the clearing requirement

    must be submitted for clearing to a registered DCO or a DCO that is

    exempt from registration under the Act. The Commission further notes

    that under CEA section 5b(h), the Commission has discretionary

    authority to exempt DCOs, conditionally or unconditionally, from the

    applicable DCO registration requirements.\698\ Specifically, section

    5b(h) of the Act provides that ``[t]he Commission may exempt,

    conditionally or unconditionally, a derivatives clearing organization

    from registration under this section for the clearing of swaps if the

    Commission determines that the [DCO] is subject to comparable,

    comprehensive supervision and regulation by the Securities and Exchange

    Commission or the appropriate government authorities in the home

    country of the organization.'' \699\ Thus, the Commission has

    discretion to exempt from registration DCOs that, at a minimum, are

    subject to comparable and comprehensive supervision by another

    regulator.

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

    \698\ CEA section 5b(h); 7 U.S.C. 7a-1(h).

    \699\ Id.

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

    The Commission notes that it has not yet exercised its

    discretionary authority to exempt DCOs from registration.

    Notwithstanding that there are no exempt DCOs at this time, the

    Commission has determined to revise the rule text as suggested by ISDA/

    SIFMA. If the Commission determines to exercise its authority to exempt

    DCOs from applicable registration requirements, the Commission would

    likely address, among other things, the conditions and limitations

    applicable to clearing swaps for customers subject to section 4d(f) of

    the Act.\700\

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

    \700\ The Commission will address any necessary revisions to

    part 37 at such time as it determines to exercise its discretionary

    authority to exempt DCOs from certain DCO registration requirements.

    For example, if exempt DCOs are limited to clearing for only certain

    types of market participants, then the Commission will take action

    to ensure that SEF market participants have impartial access to swap

    clearing through registered DCOs.

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

    Until such time as the Commission determines to exercise its

    authority to exempt DCOs from the applicable registration requirement,

    SEFs must route all swaps through registered DCOs, which are the

    appropriate entities to perform the clearing functions under CEA

    section 2(h)(1) at this time. Registered DCOs are subject to the CEA,

    the Commission's regulations, and its regulatory programs. Among other

    things, registered DCOs are supervised for compliance with the

    Commission's regulations, and subjected to ongoing risk surveillance

    and regular examinations.

    In consideration of MarketAxess's comment that a SEF should be able

    to rely on a representation from an end-user that it qualifies for the

    CEA section 2(h)(7) exception, the Commission clarifies that a SEF is

    not obligated to make any determinations with respect to applicability

    of the exceptions to the clearing requirement.

    (b) Sec. 37.702--General Financial Integrity

    Proposed Sec. 37.702(a) required a SEF to provide for the

    financial integrity of its transactions by establishing minimum

    financial standards for its members. At a minimum, a SEF would have to

    ensure that its members meet the definition of ``eligible contract

    participant'' under CEA section 1(a)(18). Proposed Sec. 37.702(b)

    required a SEF, for transactions cleared by a DCO, to have the capacity

    to route transactions to the DCO in a manner acceptable to the DCO for

    purposes of ongoing risk management. In proposed Sec. 37.702(c), for

    transactions that are not cleared by a DCO, a SEF must require members

    to demonstrate that they: (1) Have entered into credit arrangement

    documentation for the transaction, (2) have the ability to exchange

    collateral, and (3) meet any credit filters that the SEF may adopt.

    Proposed Sec. 37.702(d) required a SEF to implement any additional

    safeguards

    [[Page 33535]]

    that may be required by Commission regulations.

    (1) Summary of Comments

    Bloomberg commented, with respect to proposed Sec. 37.702(a), that

    a SEF should be able to determine a market participant's ability to

    meet any minimum financial standards by virtue of confirming that the

    participant has access to a DCO either as a member or through an

    intermediary.\701\ According to Bloomberg, it is not necessary to set

    separate, duplicative financial requirements at the SEF level that are

    redundant to the exhaustive financial requirements that will be

    associated with access to a DCO.\702\

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

    \701\ Bloomberg Comment Letter at 5 (Mar. 8, 2011).

    \702\ Id.

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

    With respect to proposed Sec. 37.702(b), Reuters agreed that SEFs

    should assure the secure and prompt routing to a DCO for swap

    transactions subject to the clearing requirement.\703\ MarketAxess

    commented that SEFs should be able to send a trade to the DCO via an

    affirmation hub.\704\ Use of affirmation hubs, according to

    MarketAxess, would allow SEFs to enjoy lower costs and is preferred by

    its clients.\705\

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

    \703\ Reuters Comment Letter at 6 (Mar. 8, 2011).

    \704\ MarketAxess Comment Letter at 35 (Mar. 8, 2011).

    \705\ Id.

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

    The Commission received several comments with regard to proposed

    Sec. 37.702(c). The Energy Working Group noted that proposed Sec.

    37.702(c) should be narrower in scope and that a SEF should be able to

    fulfill its obligation by ensuring that the counterparties have entered

    into bilateral credit support arrangements.\706\ MarketAxess wrote that

    a SEF is not in a position to determine whether members' credit filters

    or exchanges of collateral are sufficient.\707\ Reuters noted that the

    existence of credit and/or collateral arrangements should be primarily

    a matter between the counterparties.\708\ ISDA/SIFMA commented that the

    Commission should not create new collateral requirements for end-users

    transacting through a SEF.\709\ ABC/CIEBA commented that proposed Sec.

    37.702(c) would impose costly burdens on SEFs.\710\

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

    \706\ Energy Working Group Comment Letter at 5 (Mar. 8, 2011).

    \707\ MarketAxess Comment Letter at 37 (Mar. 8, 2011).

    \708\ Reuters Comment Letter at 6 (Mar. 8, 2011).

    \709\ ISDA/SIFMA Comment Letter at 13 (Mar. 8, 2011).

    \710\ ABC/CEIBA Comment Letter at 11 (Mar. 8, 2011).

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

    Goldman noted that there are circumstances where a swap that is

    subject to the clearing requirement may not be accepted for clearing

    for credit or other reasons.\711\ In such cases and depending on the

    SEF's rules under Core Principle 7, parties that execute through the

    SEF either would face one another in an uncleared, bilateral

    transaction or would potentially owe amounts arising from the trade not

    being accepted for clearing.\712\ Therefore, Goldman recommended that

    parties should be able to learn the identities of their counterparty

    when transacting in cleared and uncleared swaps.\713\

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

    \711\ Goldman Comment Letter at 5 (Mar. 8, 2011).

    \712\ Id.

    \713\ Id.

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

    (2) Commission Determination

    The Commission has considered the comments received and is adopting

    Sec. 37.702(a) as proposed. In response to Bloomberg's comment about

    setting financial requirements at the SEF level, the Commission

    disagrees that a SEF should be able to determine a member's ability to

    meet any minimum financial standards by virtue of confirming that the

    member has access to a DCO. The Commission notes that a DCO only

    screens clearing members, and not customers, according to financial

    standards. Therefore, unless a SEF member is also a clearing member,

    the SEF will not be able to determine the member's ability to meet any

    minimum financial standards by virtue of confirming that the member has

    access to a DCO. The Commission also notes that there is no affirmative

    obligation for a DCO to ensure that its members, customers, or

    counterparties are ECPs. Therefore, a SEF must ensure that its members

    qualify as ECPs and may rely on representations from its members to

    fulfill this requirement.\714\

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

    \714\ The Commission notes that under Sec. 37.202(a)(2), a SEF

    that permits intermediation must also obtain signed representations

    from intermediaries that their customers are ECPs.

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

    Last year, the Commission adopted rules regarding the processing of

    cleared trades.\715\ In that rulemaking, the Commission proposed a new

    Sec. 37.702(b) \716\ and adopted a revised Sec. 37.702(b) \717\

    regarding cleared swaps traded through a SEF. That final rule required

    a SEF to provide for the financial integrity of its transactions that

    are cleared by a DCO: (a) By ensuring that it has the capacity to route

    transactions to the DCO in a manner acceptable to the DCO for purposes

    of clearing; and (b) by coordinating with each DCO to which it submits

    transactions for clearing, in the development of rules and procedures

    to facilitate prompt and efficient transaction processing in accordance

    with the requirements of Sec. 39.12(b)(7) of the Commission's

    regulations.\718\

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

    \715\ Customer Clearing Documentation, Timing of Acceptance for

    Clearing, and Clearing Member Risk Management, 77 FR 21278 (Apr. 9,

    2012).

    \716\ Requirements for Processing, Clearing, and Transfer of

    Customer Positions, 76 FR 13101, 13109-10 (proposed Mar. 10, 2011).

    \717\ Customer Clearing Documentation, Timing of Acceptance for

    Clearing, and Clearing Member Risk Management, 77 FR at 21309.

    \718\ Id.

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

    In response to MarketAxess's comment about affirmation hubs, the

    Commission notes that Sec. 37.702(b), as adopted in April 2012,

    requires a SEF to route a swap to a DCO in a manner acceptable to the

    DCO.\719\ If the DCO views the use of an affirmation hub as an

    acceptable means for routing the swap, the routing otherwise complies

    with Sec. 37.702(b), and the trade is processed in accordance with the

    standards set forth in Sec. Sec. 1.74, 39.12, 23.506, and 23.610 of

    the Commission's regulations, then the use of an affirmation hub for

    routing a swap to a DCO for clearing would be permissible.

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

    \719\ Id.

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

    In consideration of the comments with respect to uncleared swaps,

    the Commission is eliminating proposed Sec. 37.702(c). The Commission

    agrees with commenters that requiring SEFs to monitor the credit and

    collateral arrangements of parties transacting uncleared swaps goes

    beyond the scope of what should be expected of a SEF. To address

    Goldman's comments requesting that the Commission mandate that a SEF's

    rules require identification of the counterparties prior to a swap

    transaction, the Commission believes that a SEF should retain

    discretion in this regard. Finally, the Commission is deleting proposed

    Sec. 37.702(d) as it is unnecessary because a SEF must already

    implement safeguards as required by Commission regulations.

    (c) Sec. 37.703--Monitoring for Financial Soundness

    Proposed Sec. 37.703 required a SEF to monitor its members'

    compliance with the SEF's minimum financial standards and routinely

    receive and promptly review financial and related information from its

    members.

    (1) Summary of Comments

    ABC/CIEBA commented that this requirement would create significant

    barriers to entry, stifle competition, and lead to higher transaction

    costs.\720\ FXall commented that like DCMs, SEFs should be permitted to

    delegate their financial surveillance functions to the

    [[Page 33536]]

    Joint Audit Committee to the extent that its members are registered

    with NFA.\721\ For non-NFA members, FXall recommended that SEFs be

    permitted to delegate financial surveillance obligations to the

    members' primary financial regulator or otherwise outsource such duties

    to a third party service provider.\722\

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

    \720\ ABC/CEIBA Comment Letter at 11 (Mar. 8, 2011).

    \721\ FXall Comment Letter at 13 (Mar. 8, 2011).

    \722\ Id.

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

    (2) Commission Determination

    The Commission agrees with the commenters that burdensome financial

    surveillance obligations may lead to higher transaction costs.

    Therefore, in consideration of the comments, the Commission is revising

    Sec. 37.703 to state that a SEF must monitor its members to ensure

    that they continue to qualify as ECPs. With regard to the comment

    requesting delegation of the proposed Sec. 37.703 responsibilities to

    the Joint Audit Committee, the Commission notes that final Sec.

    37.703, as revised, obviates the need for any such delegation. Under

    final Sec. 37.703, a SEF need only ensure that its members remain ECPs

    and may rely on representations from its members.

    8. Subpart I--Core Principle 8 (Emergency Authority)

    Core Principle 8 requires a SEF to adopt rules to provide for the

    exercise of emergency authority, in consultation or cooperation with

    the Commission, as is necessary and appropriate, including the

    authority to liquidate or transfer open positions in any swap or to

    suspend or curtail trading in a swap.\723\ In the SEF NPRM, the

    Commission proposed to codify the statutory text of Core Principle 8 in

    proposed Sec. 37.800, and adopts that rule as proposed.\724\

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

    \723\ CEA section 5h(f)(8); 7 U.S.C. 7b-3(f)(8).

    \724\ The Commission notes that Commission regulation

    40.6(a)(6)(i) provides that any SEF rule that establishes general

    standards or guidelines for taking emergency actions must be

    submitted to the Commission pursuant to regulation 40.6(a).

    Relatedly, Commission regulation 40.6(a)(6)(ii) provides particular

    emergency actions shall be filed with the Commission ``prior to

    [its] implementation, or, if not practicable, . . . at the earlier

    possible time after implementation, but in no event more than

    twenty-four hours after implementation.''

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

    (a) Sec. 37.801--Additional Sources for Compliance

    Proposed Sec. 37.801 referred applicants and SEFs to the guidance

    and/or acceptable practices in appendix B to part 37 to demonstrate

    compliance with Core Principle 8. The guidance reflected the

    Commission's belief that the need for emergency action may also arise

    from related markets traded on other platforms and that there should be

    an increased emphasis on cross-market coordination of emergency

    actions. In that regard, the proposed guidance provided that, in

    consultation and cooperation with the Commission, a SEF should have the

    authority to intervene as necessary to maintain markets with fair and

    orderly trading and to prevent or address manipulation or disruptive

    trading practices, whether the need for intervention arises exclusively

    from the SEF's market or as part of a coordinated, cross-market

    intervention. The proposed guidance also provided that in situations

    where a swap is traded on more than one platform, emergency action to

    liquidate or transfer open interest must be as directed, or agreed to,

    by the Commission or the Commission's staff. The proposed guidance also

    clarified that the SEF should have rules that allow it to take market

    actions as may be directed by the Commission.

    In addition to providing for rules, procedures, and guidelines for

    emergency intervention, the guidance noted that SEFs should provide

    prompt notification and explanation to the Commission of the exercise

    of emergency authority, and that information on all regulatory actions

    carried out pursuant to a SEF's emergency authority should be included

    in a timely submission of a certified rule.

    (1) Summary of Comments

    Several commenters expressed concern about a SEFs ability to

    liquidate or transfer open positions.\725\ Bloomberg stated that,

    because a SEF will not hold a participant's swap positions, the

    Commission should only require that a SEF adopt rules requiring it to

    coordinate with a DCO to facilitate the liquidation or transfer of

    positions during an emergency.\726\ Similarly, WMBAA noted that a SEF

    will not maintain counterparty positions and thus it may not possess

    the ability to liquidate or transfer those positions.\727\ Reuters

    stated that liquidating open positions does not fall within a trading

    platform's traditional role in the market.\728\

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

    \725\ Bloomberg Comment Letter at 4 (Jun. 3, 2011); Bloomberg

    Comment Letter at 5-6 (Mar. 8, 2011); WMBAA Comment Letter at 28

    (Mar. 8, 2011); Reuters Comment Letter at 7 (Mar.8, 2011).

    \726\ Bloomberg Comment Letter at 4 (Jun. 3, 2011); Bloomberg

    Comment Letter at 5-6 (Mar. 8, 2011).

    \727\ WMBAA Comment Letter at 28 (Mar. 8, 2011).

    \728\ Reuters Comment Letter at 7 (Mar. 8, 2011).

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

    CME stated that SEFs must have the flexibility and independence

    necessary to address market emergencies.\729\ Alternatively, ISDA/SIFMA

    commented that the Core Principle 8 rules should adopt uniform

    standards and that those standards must consider the interaction

    between SEFs, DCMs, clearing organizations, swap data repositories, and

    other market-wide institutions.\730\

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

    \729\ CME Comment Letter at 28 (Feb. 22, 2011).

    \730\ ISDA/SIFMA Comment Letter at 13 (Mar. 8, 2011).

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

    (2) Commission Determination

    The Commission is adopting Sec. 37.801 as proposed, with certain

    modifications to the guidance in appendix B to part 37. The Commission

    acknowledges commenters concerns regarding a SEF's ability to liquidate

    or transfer open positions; however, the statute requires a SEF to have

    the authority to liquidate or transfer open positions.\731\ The

    Commission expects that SEFs would establish such authority over open

    positions through their rules and/or participant agreements and that

    the exercise of any such authority would, consistent with the statute,

    be done in coordination with the Commission and relevant DCOs.

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

    \731\ CEA section 5h(f)(8); 7 U.S.C. 7b-3(f)(8).

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

    The Commission is making slight revisions to the guidance to

    clarify that SEFs retain the authority to independently respond to

    emergencies in an effective and timely manner consistent with the

    nature of the emergency, as long as all such actions taken by the SEF

    are made in good faith to protect the integrity of the markets. The

    Commission believes that market emergencies can vary with the type of

    market and any number of unusual circumstances so SEFs need flexibility

    to carry out emergency actions. The Commission believes that the

    guidance strikes a reasonable balance between the need for flexibility

    and the need for standards in the case of coordinated cross-market

    intervention.

    9. Subpart J--Core Principle 9 (Timely Publication of Trading

    Information)

    Core Principle 9 requires a SEF to make public timely information

    on price, trading volume, and other trading data on swaps to the extent

    prescribed by the Commission.\732\ It also requires a SEF to have the

    capacity to electronically capture and transmit trade information for

    those transactions that occur on its facility.\733\ In the SEF NPRM,

    the Commission proposed to codify the statutory text of Core Principle

    9 in proposed Sec. 37.900. Proposed Sec. 37.901 required that, for

    swaps traded on or through a SEF, the SEF report specified swap data as

    [[Page 33537]]

    provided under part 43 \734\ and part 45 \735\ of the Commission's

    regulations and meet the requirements of part 16 of the Commission's

    regulations. Proposed Sec. 37.902 required a SEF to have the capacity

    to electronically capture trade information with respect to

    transactions executed on the facility.

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

    \732\ CEA section 5h(f)(9); 7 U.S.C. 7b-3(f)(9).

    \733\ Id.

    \734\ 17 CFR part 43; Real-Time Reporting of Swap Transaction

    Data, 77 FR 1182 (Jan. 9, 2012).

    \735\ 17 CFR part 45; Swap Data Recordkeeping and Reporting

    Requirements, 77 FR 2136 (Jan. 13, 2012).

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

    (a) Summary of Comments

    In response to the Commission's questions in the SEF NPRM about

    end-of-day price reporting for interest rate swaps and the Commission's

    proposed revisions to Sec. 16.01,\736\ Eris stated the following: (1)

    It is reasonable to require a market to report publicly each trade

    (including instrument, price, and volume) intra-day, as soon as the

    trade occurs; (2) daily open interest should be published publicly in a

    summary fashion and should be grouped in maturity buckets based on the

    remaining tenor of each instrument; (3) as to end-of-day pricing, a

    clearing house will settle contracts based upon a market-driven curve,

    and the methodology, as well as the inputs and components, of the curve

    should be made transparent to the full trading community; and (4) the

    clearing house should publish the specific settlement value applied to

    each cleared swap in the daily mark-to-market process.\737\ Eris also

    stated that SEFs and DCMs should be held to the same reporting standard

    in this respect.\738\

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

    \736\ The Commission proposed certain revisions to Sec. 16.01

    in the DCM NPRM. See Core Principles and Other Requirements for

    Designated Contract Markets, 75 FR 80572 (proposed Dec. 22, 2010)

    for further details.

    \737\ Eris Comment Letter at 5 (Mar. 8, 2011).

    \738\ Id.

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

    MarketAxess commented that proposed Sec. 37.900(b) and Sec.

    37.902 are duplicative and that proposed Sec. 37.902 should be

    withdrawn.\739\

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

    \739\ MarketAxess Comment Letter at 39 (Mar. 8, 2011).

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

    (b) Commission Determination

    The Commission is adopting Sec. 37.900 and Sec. 37.901 as

    proposed. The Commission acknowledges MarketAxess's comment that Sec.

    37.902 is duplicative to Sec. 37.900(b) and thus is withdrawing Sec.

    37.902. In response to Eris's comment about the same reporting

    standards for SEFs and DCMs that list swaps, the Commission notes that

    a SEF, similar to a DCM, must meet the same requirements under part 16

    of the Commission's regulations for swaps reporting.\740\ The

    Commission also notes that it codified Sec. 16.01 in the final DCM

    rulemaking, and in that rulemaking, the Commission states that it

    considered the proposed reporting standard put forth by Eris, but the

    Commission believes that the more detailed reporting obligations under

    Sec. 16.01 are warranted at this time in light of the novelty of swaps

    trading on regulated exchanges.\741\

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

    \740\ The Commission notes that Sec. 16.00 is applicable to a

    SEF only to the extent that such SEF has clearing members and lists

    options on physicals for trading. Section 16.01 is applicable to a

    SEF for all swaps and options traded thereon. Section 16.02 is

    applicable to a SEF only to the extent that such SEF lists options

    for trading.

    \741\ Core Principles and Other Requirements for Designated

    Contract Markets, 77 FR 36612, 36642 (Jun. 19, 2012).

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

    10. Subpart K--Core Principle 10 (Recordkeeping and Reporting)

    Core Principle 10 establishes recordkeeping and reporting

    requirements for SEFs.\742\ In the SEF NPRM, the Commission proposed to

    codify the statutory text of Core Principle 10 in proposed Sec.

    37.1000, and adopts that rule as proposed.

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

    \742\ CEA section 5h(f)(10); 7 U.S.C. 7b-3(f)(10).

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

    Proposed Sec. 37.1001 required a SEF to maintain records of all

    business activities, including a complete audit trail, investigatory

    files, and disciplinary files, in a form and manner acceptable to the

    Commission for at least five years in accordance with the requirements

    of section 1.31 and part 45 of this chapter. Proposed Sec. 37.1002

    required a SEF to report to the Commission such information that the

    Commission determines to be necessary or appropriate for it to perform

    its duties. Proposed Sec. 37.1003 required a SEF to keep records

    relating to swaps defined in section 1a(47)(A)(v) of the CEA open to

    inspection and examination by the SEC.

    (a) Summary of Comments

    MarketAxess stated that a SEF should be permitted to use a

    regulatory service provider with respect to its recordkeeping and

    reporting requirements.\743\ CME commented that proposed Sec. 37.1003

    does not provide any guidance as to what records will need to be

    retained and for how long they must be retained.\744\

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

    \743\ MarketAxess Comment Letter at 39 (Mar. 8, 2011).

    \744\ CME Comment Letter at 38 (Feb. 22, 2011).

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

    (b) Commission Determination

    The Commission is adopting Sec. 37.1001 as proposed. The

    Commission is also withdrawing proposed Sec. 37.1002 and Sec. 37.1003

    because they are repetitive of paragraphs (a)(2) and (a)(3) of Sec.

    37.1000. In response to MarketAxess's comment, the Commission notes

    that a SEF may utilize the services of a regulatory service provider

    pursuant to Sec. 37.204 to assist the SEF in complying with its

    responsibilities under Core Principle 10. In response to CME's comment,

    the Commission notes that in accordance with Core Principle 10 and

    Sec. 1.31 of the Commission's regulations, a SEF should retain ``any''

    records relevant to swaps defined in section 1a(47)(A)(v) of the Act

    and that the SEF should leave such records open to inspection and

    examination for a period of five years. The Commission staff also

    consulted with representatives from the SEC, who confirmed that the

    SEC's relevant recordkeeping requirements typically extend for a period

    of five years.\745\

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

    \745\ See Registration and Regulation of Security-Based Swap

    Execution Facilities, 76 FR at 10982, 11063 (Proposed Rule 818(b)

    requires SB-SEFs to keep books and records ``for a period of not

    less than five years, the first two years in an easily accessible

    place). Rule 17a-1(b) (240.17a-1(b) requires national securities

    exchanges, among others, to keep books and records for a period of

    not less than five years, the first two years in an easily

    accessible place, subject to a destruction and disposition

    provisions, which allows exchanges to destroy physical documents

    pursuant to an effective and approved plan regarding such

    destruction and transferring/indexing of such documents onto some

    recording medium.). 17 CFR 240.17a-1(b).

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

    11. Subpart L--Core Principle 11 (Antitrust Considerations)

    Core Principle 11 governs the antitrust obligations of SEFs.\746\

    In the SEF NPRM, the Commission proposed to codify the statutory text

    of Core Principle 11 in proposed Sec. 37.1100, and adopts that rule as

    proposed. Additionally, proposed Sec. 37.1101 referred applicants and

    SEFs to the guidance in appendix B to part 37 for purposes of

    demonstrating compliance with proposed Sec. 37.1100.

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

    \746\ CEA section 5h(f)(11); 7 U.S.C. 7b-3(f)(11).

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

    (a) Summary of Comments

    NGSA commented that if SEFs are allowed to select the SDR to which

    SEF-executed swaps are reported, there is a threat of anticompetitive

    tying of swap data reporting services from a particular SDR to the

    SEF's services, which may harm competition among SDRs.\747\

    Accordingly, NGSA recommended that the Commission amend the proposed

    rules to explicitly prohibit a SEF from tying the swap data reporting

    services of a particular SDR to the swap execution services provided by

    such SEF and from entering into an exclusive agreement

    [[Page 33538]]

    with any SDR to report all swaps to such SDR.\748\

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

    \747\ NGSA Comment Letter at 2 (Jun. 8, 2012). DTCC also raised

    this concern in its comment letter. DTCC Comment Letter at 3 (Jun.

    10, 2011).

    \748\ NGSA Comment Letter at 5 (Jun. 8, 2012).

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

    (b) Commission Determination

    The Commission is adopting Sec. 37.1101 and the corresponding

    guidance in appendix B to part 37 as proposed and declines to revise

    the proposed rules as NGSA recommends. The Commission notes that under

    Core Principle 11, SEFs may not adopt any rule or take any action that

    results in any unreasonable restraint of trade or impose any material

    anticompetitive burden on trading or clearing. The Commission believes

    that Core Principle 11 adequately addresses NGSA's concern. The

    Commission also notes that it has not limited a SEF's choice of DCOs.

    The Commission believes that SDRs and DCOs should be able to compete

    for a SEF's business subject to the anticompetitive considerations

    under Core Principle 11. Additionally, the Commission notes that

    multiple SEFs are likely to trade the same swap contracts so market

    participants will be able to choose the appropriate SEF to trade swaps

    based on SDR and other considerations.

    12. Subpart M--Core Principle 12 (Conflicts of Interest)

    Core Principle 12 governs conflicts of interest.\749\ In the SEF

    NPRM, the Commission proposed to codify the statutory text of Core

    Principle 12 in proposed Sec. 37.1200, and adopts that rule as

    proposed. As noted in the SEF NPRM, the substantive regulations

    implementing Core Principle 12 were proposed in a separate release

    titled ``Requirements for Derivatives Clearing Organizations,

    Designated Contract Markets, and Swap Execution Facilities Regarding

    the Mitigation of Conflicts of Interest.'' \750\ Until such time as the

    Commission may adopt the substantive rules implementing Core Principle

    12, SEFs have reasonable discretion to comply with this core principle

    as stated in Sec. 37.100.

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

    \749\ CEA section 5h(f)(12); 7 U.S.C. 7b-3(f)(12).

    \750\ Requirements for Derivatives Clearing Organizations,

    Designated Contract Markets, and Swap Execution Facilities Regarding

    the Mitigation of Conflicts of Interest, 75 FR 63732 (proposed Oct.

    18, 2010).

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

    13. Subpart N--Core Principle 13 (Financial Resources)

    Core Principle 13 requires a SEF to have adequate financial,

    operational, and managerial resources to discharge each of its

    responsibilities.\751\ In particular, Core Principle 13 states that a

    SEF's financial resources are considered to be adequate if the value of

    such resources exceeds the total amount that would enable the SEF to

    cover its operating costs for a period of at least one year, calculated

    on a rolling basis.\752\ In the SEF NPRM, the Commission proposed to

    codify the statutory text of Core Principle 13 in proposed Sec.

    37.1300, and adopts that rule as proposed.

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

    \751\ CEA section 5h(f)(13); 7 U.S.C. 7b-3(f)(13).

    \752\ Id.

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

    (a) Sec. 37.1301--General Requirements

    Proposed Sec. 37.1301 set forth the financial resources

    requirements for SEFs in order to implement Core Principle 13. Proposed

    Sec. 37.1301(a) required a SEF to maintain financial resources

    sufficient to enable it to perform its functions in compliance with the

    SEF core principles. Proposed Sec. 37.1301(b) required an entity

    operating as both a SEF and a DCO to comply with both the SEF financial

    resources requirements and the DCO financial resources requirements in

    Sec. 39.11.\753\ Proposed Sec. 37.1301(c) stated that financial

    resources would be considered sufficient if their value is at least

    equal to a total amount that would enable the SEF, or applicant for

    designation as such, to cover its operating costs for a period of at

    least one year, calculated on a rolling basis.

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

    \753\ See Derivatives Clearing Organization General Provisions

    and Core Principles, 76 FR 69334 (Nov. 8, 2011). Commission

    regulation Sec. 39.11 establishes requirements that a DCO will have

    to meet in order to comply with DCO Core Principle B (Financial

    Resources), as amended by the Dodd-Frank Act. Amended Core Principle

    B requires a DCO to possess financial resources that, at a minimum,

    exceed the total amount that would enable the DCO to meet its

    financial obligations to its clearing members notwithstanding a

    default by the clearing member creating the largest financial

    exposure for the DCO in extreme but plausible conditions; and enable

    the DCO to cover its operating costs for a period of one year, as

    calculated on a rolling basis.

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

    (1) Summary of Comments

    Several commenters raised concerns about the financial resources

    requirement to cover one year of operating costs. Parity Energy

    recommended that the Commission interpret ``operating costs of a swap

    execution facility for a 1-year period'' to be the cost to the SEF of

    an orderly wind-down of operations, where the SEF is one of many

    execution avenues for standardized, cleared swaps and its failure would

    have minimal impact on market risk or stability.\754\ Phoenix

    recommended that because a SEF does not take or hold positions in any

    of the products traded on it, an orderly wind-down of a SEF should take

    six months so SEFs should be required to maintain financial resources

    to cover six months of its operating costs.\755\ Similarly, TruMarx

    contended that SEFs should not have such stringent financial resources

    standards because a SEF is a trading platform and, therefore, will not

    carry on its books the risks of positions and trades executed on

    it.\756\ Rather, TruMarx stated that risk will be borne by the

    principals entering into the transactions, their clearing brokers, and

    clearing houses.\757\

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

    \754\ Parity Energy Comment Letter at 6 (Mar. 25, 2011).

    \755\ Phoenix Comment Letter at 4 (Mar. 7, 2011).

    \756\ TruMarx Comment Letter at 7 (Mar. 8, 2011).

    \757\ Id.

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

    Alternatively, SDMA noted that it would be disruptive to the market

    if a SEF went into bankruptcy.\758\ Therefore, it contended that 12

    months of working capital is the absolute minimum amount of financial

    resources that SEFs should have, and recommend that the Commission

    require that SEFs have 18 months of working capital.\759\

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

    \758\ SDMA Comment Letter at 12 (Mar. 8, 2011).

    \759\ Id.

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

    (2) Commission Determination

    The Commission is adopting Sec. 37.1301 as proposed.\760\ To

    address the concerns about the financial resources requirement, the

    Commission notes that Core Principle 13 requires each SEF to maintain

    adequate financial resources to discharge its responsibilities.\761\ In

    order to fulfill this responsibility, the core principle states that

    the financial resources of a SEF shall be considered to be adequate if

    the value of the financial resources exceeds the total amount that

    would enable the SEF to cover its operating costs for a period of one

    year, calculated on a rolling basis.\762\

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

    \760\ The Commission is making a technical change due to the

    fact that the cross reference in Sec. 37.1301(b) should include

    ``of this chapter'' at the end of the reference in order to comply

    with federal regulatory guidelines. Accordingly, the Commission is

    revising Sec. 37.1301(b) to read: ``An entity that operates as both

    a swap execution facility and a derivatives clearing organization

    shall also comply with the financial resources requirements of

    section 39.11 of this chapter.'' The Commission is also removing the

    phrase ``or applicant for designation as such'' from Sec.

    37.1301(c) because it is unnecessary. Section 37.3 and Form SEF read

    together make clear that an applicant must comply with the financial

    resources requirement.

    \761\ CEA section 5h(f)(13)(A); 7 U.S.C. 7b-3(f)(13)(A).

    \762\ CEA section 5h(f)(13)(B); 7 U.S.C. 7b-3(f)(13)(B).

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

    In response to comments that Core Principle 13 should be

    interpreted to mean the cost to wind-down a SEF's operations, the

    Commission notes that such an interpretation would require SEFs to have

    significantly less financial resources. The Commission believes that a

    SEF's financial strength is vital to ensure that the SEF can discharge

    its

    [[Page 33539]]

    core principle responsibilities in accordance with the CEA and that

    those costs are greater than the cost to wind-down operations. Based on

    its experience regulating DCMs and DCOs, the Commission has learned

    that financial strength is vital to market continuity and the ability

    of an entity to withstand unpredictable market events, and believes

    that one year of operating expenses on a rolling basis is appropriate.

    For these reasons, the Commission also disagrees with TruMarx's

    argument that SEFs should not have such stringent financial resources

    standards because they will not hold the risks of positions and trades.

    (b) Sec. 37.1302--Types of Financial Resources

    Proposed Sec. 37.1302 set forth the type of financial resources

    available to satisfy the requirements of proposed Sec. 37.1301. The

    proposed rule stated that financial resources may include: (a) The

    SEF's own capital; and (b) Any other financial resource deemed

    acceptable by the Commission. The Commission invited comment regarding

    particular financial resources to be included in the final

    regulation.\763\

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

    \763\ Core Principles and Other Requirements for Swap Execution

    Facilities, 76 FR at 1230.

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

    (1) Summary of Comments

    Several commenters recommended that the Commission include specific

    examples of financial resources that might satisfy the requirement.

    Phoenix recommended that the Commission include in final Sec. 37.1302

    the following financial resources: assets of a parent company that

    wholly owns the SEF, and, subject to Sec. 37.1304 (Valuation of

    financial resources), the SEF's accounts receivable from SEF

    members.\764\ Phoenix contended that as long as the parent company has

    committed to guarantee the financial resource obligations of the SEF,

    those assets should be available to the SEF, and that amounts owed to a

    SEF by its customers are easily obtainable by a SEF.\765\ CME believed

    that Congress intended the term ``financial resources'' to be construed

    broadly and include anything of value at the SEF's disposal, including

    operating revenues.\766\ Reuters recommended that assets of affiliated

    entities within a corporate group should be acceptable types of

    financial resources.\767\

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

    \764\ Phoenix Comment Letter at 5 (Mar. 7, 2011).

    \765\ Id.

    \766\ CME Comment Letter at 37 (Feb. 22, 2011).

    \767\ Reuters Comment Letter at 8 (Mar. 8, 2011).

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

    (2) Commission Determination

    The Commission is revising proposed Sec. 37.1302(a) to state that

    a SEF's own capital means its assets minus its liabilities calculated

    in accordance with U.S. Generally Accepted Accounting Principles

    (``GAAP''). The Commission believes that if a particular financial

    resource is an asset under GAAP, then it is appropriate for inclusion

    in the calculation for this rule. If a particular financial resource is

    not an asset under GAAP, but based upon the facts and circumstances a

    SEF believes that the particular financial resource should be

    acceptable, the Commission staff will work with the SEF to determine

    whether such resource is acceptable. In this regard, the Commission is

    clarifying that the language in final Sec. 37.1302(b) is intended to

    provide flexibility to both SEFs and the Commission in determining

    other acceptable types of financial resources on a case-by-case basis.

    Finally, the Commission notes that it may not have jurisdiction

    over a SEF's parent company or its affiliates; therefore, the

    Commission cannot consider the parent company's or affiliates'

    financial resources in determining whether the SEF possesses adequate

    financial resources.

    (c) Sec. 37.1303--Computation of Financial Resource Requirement \768\

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

    \768\ The Commission is renaming the title of this section from

    ``Computation of Financial Resource Requirement'' to ``Computation

    of Projected Operating Costs to Meet Financial Resource

    Requirement'' to provide greater clarity.

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

    Proposed Sec. 37.1303 required a SEF, each fiscal quarter, to make

    a reasonable calculation of its projected operating costs over a

    twelve-month period to determine the amount needed to meet the

    requirements of proposed Sec. 37.1301. Proposed Sec. 37.1303 provided

    SEFs with reasonable discretion to determine the methodology used to

    compute such projected operating costs. The proposed rule authorized

    the Commission to review the methodology and require changes as

    appropriate.

    (1) Summary of Comments

    MarketAxess noted that the proposed regulations do not prescribe

    specific methodologies for computing projected operating costs and

    recommended that the Commission provide a safe harbor for specific

    methodologies.\769\

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

    \769\ MarketAxess Comment Letter at 39 (Mar. 8, 2011).

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

    (2) Commission Determination

    The Commission is adopting Sec. 37.1303 as proposed because it

    provides flexibility to both SEFs and the Commission regarding the

    calculation of projected operating costs.\770\ This flexibility would

    be limited if the Commission prescribed specific methodologies for

    computing projected operating costs in the rule text. In response to

    MarketAxess's comment, the Commission notes that SEFs may work with the

    Commission staff to create an appropriate methodology for computing

    such operating costs.

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

    \770\ The Commission is revising the language of Sec. 37.1303

    for clarity.

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

    (d) Sec. 37.1304--Valuation of Financial Resources

    Proposed Sec. 37.1304 required a SEF, not less than quarterly, to

    compute the current market value of each financial resource used to

    meet its obligations under proposed Sec. 37.1301. The proposed rule

    required SEFs to perform the valuation at other times as appropriate.

    As stated in the SEF NPRM, the rule is designed to address the need to

    update valuations in circumstances where there may have been material

    fluctuations in market value that could impact a SEF's ability to meet

    its obligations under proposed Sec. 37.1301.\771\ The proposed rule

    required that, when valuing a financial resource, the SEF reduce the

    value, as appropriate, to reflect any market or credit risk specific to

    that particular resource (i.e., apply a haircut).\772\ The SEF NPRM

    stated that the Commission would permit SEFs to exercise discretion to

    determine applicable haircuts, which would be subject to Commission

    review and acceptance.\773\

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

    \771\ Core Principles and Other Requirements for Swap Execution

    Facilities, 76 FR at 1231.

    \772\ A ``haircut'' is a deduction taken from the value of an

    asset to reserve for potential future adverse price movements in

    such asset.

    \773\ Core Principles and Other Requirements for Swap Execution

    Facilities, 76 FR at 1231 n. 102.

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

    (1) Summary of Comments

    MarketAxess commented that proposed Sec. 37.1304 did not prescribe

    specific methodologies for valuing financial resources and recommended

    that the Commission provide a safe harbor for specific

    methodologies.\774\

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

    \774\ MarketAxess Comment Letter at 39 (Mar. 8, 2011).

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

    (2) Commission Determination

    The Commission is adopting Sec. 37.1304 as proposed.\775\ As with

    [[Page 33540]]

    Sec. 37.1303, Sec. 37.1304 provides flexibility to both SEFs and the

    Commission regarding the valuation of financial resources. This

    flexibility would be limited if the Commission prescribed specific

    methodologies for valuing financial resources in the rule text. In

    response to MarketAxess's comment, the Commission notes that SEFs may

    work with the Commission staff to create an appropriate methodology for

    valuing such financial resources.

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

    \775\ MarketAxess noted that Sec. 37.1304 contains a

    typographical error as it mistakenly cross-references proposed Sec.

    37.701, which relates to the mandatory clearing requirement, instead

    of proposed Sec. 37.1301. The Commission has made this technical

    change in the final rule. Additionally, the Commission is revising

    the language of Sec. 37.1304 for clarity.

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

    (e) Sec. 37.1305--Liquidity of Financial Resources

    Proposed Sec. 37.1305 required a SEF's financial resources to

    include unencumbered, liquid financial assets (i.e., cash and/or highly

    liquid securities) equal to at least six months' operating costs. As

    noted in the SEF NPRM, the Commission believes that the requirement to

    have six months' worth of unencumbered, liquid financial assets would

    provide a SEF time to liquidate the remaining financial assets it would

    need to continue operating for the last six months of the required one-

    year period.\776\ The proposed rule stated that if any portion of such

    financial resources is not sufficiently liquid, the SEF may take into

    account a committed line of credit or similar facility to satisfy this

    requirement. As stated in the SEF NPRM, a SEF may only use a committed

    line of credit or similar facility to meet the liquidity requirements

    set forth in Sec. 37.1305.\777\ Accordingly, the SEF NPRM stated that

    a committed line of credit or similar facility is not available to a

    SEF to satisfy the financial resources requirements of Sec.

    37.1301.\778\

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

    \776\ Core Principles and Other Requirements for Swap Execution

    Facilities, 76 FR at 1231.

    \777\ Id.

    \778\ Id.

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

    (1) Summary of Comments

    Several commenters recommended alternate liquidity requirements to

    the six months of operating costs. CME commented that the liquidity

    measurement is only relevant in the context of winding-down operations,

    and claimed that a three-month period, rather than a six-month period,

    is a more accurate assessment of how long it would take for a SEF to

    wind down.\779\ Similarly, Phoenix recommended that a SEF be required

    to maintain liquid assets equal to three months of operating

    expenses.\780\ Parity Energy commented that the Commission should

    tailor financial requirements to a SEF's size and market impact and

    recommended limiting the six month liquid asset requirement to only

    those SEFs whose failure could impact market stability.\781\ SDMA,

    however, recommended that the Commission require SEFs to have at least

    12 months of unencumbered capital.\782\

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

    \779\ CME Comment Letter at 37 (Feb. 22, 2011).

    \780\ Phoenix Comment Letter at 4 (Mar. 7, 2011).

    \781\ Parity Energy Comment Letter at 6 (Mar. 25, 2011).

    \782\ SDMA Comment Letter at 12 (Mar. 8, 2011).

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

    (2) Commission Determination

    The Commission is adopting Sec. 37.1305 as proposed. The

    Commission views a six month period as appropriate for a wind down

    period and notes that commenters did not provide any support for

    alternative time frames. In response to Parity Energy's comment, the

    Commission notes that the purpose of the liquidity requirement is so

    that all SEFs have liquid financial assets to allow them to continue to

    operate and to wind down in an orderly fashion. Therefore, the

    Commission is not limiting the liquidity requirement to only those SEFs

    whose failure could impact market stability. In this regard, the

    Commission notes that the statutory financial resources requirements

    apply to all SEFs and are necessary to ensure core principle

    compliance. The statute does not distinguish SEFs' financial resources

    based on their market impact.

    The Commission also notes that it is using the term

    ``unencumbered'' in Sec. 37.1305 in the normal commercial sense to

    refer to assets that are not subject to a security interest or other

    adverse claims. By ``committed line of credit or similar facility,''

    the Commission means a committed, irrevocable contractual obligation to

    provide funds on demand with preconditions limited to the execution of

    appropriate agreements. For example, a facility with a material adverse

    financial condition restriction would not be acceptable. The purpose of

    this requirement is for a SEF to have no impediments to accessing its

    line of credit at the time it needs liquidity. Further, SEFs are

    encouraged to periodically check their line of credit arrangements to

    confirm that no operational difficulties are present.

    (f) Sec. 37.1306--Reporting Requirements \783\

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

    \783\ The Commission is renaming the title of this section from

    ``Reporting Requirements'' to ``Reporting to the Commission'' to

    provide greater clarity.

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

    Proposed Sec. 37.1306(a)(1) required that, at the end of each

    fiscal quarter, or at any time upon Commission request, a SEF report to

    the Commission: (i) The amount of financial resources necessary to meet

    the requirements of Sec. 37.1301; and (ii) the value of each financial

    resource available to meet those requirements. Proposed Sec.

    37.1306(a)(2) required a SEF to provide the Commission with a financial

    statement, including balance sheet, income statement, and statement of

    cash flows of the SEF or of its parent company. Proposed Sec.

    37.1306(b) required calculations to be made on the last business day of

    the SEF's fiscal quarter.

    Proposed Sec. 37.1306(c) required a SEF to provide the Commission

    with sufficient documentation explaining the methodology it used to

    calculate its financial requirements and the basis for its valuation

    and liquidity determinations. The proposed rule also required the SEF

    to provide copies of any agreements establishing or amending a credit

    facility, insurance coverage, or any similar arrangement that evidences

    or otherwise supports its conclusions.

    Finally, proposed Sec. 37.1306(d) required SEFs to file the report

    no later than 17 business days \784\ from the end of its fiscal quarter

    but allowed SEFs to request an extension of time from the Commission.

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

    \784\ This filing deadline is consistent with the deadline

    imposed on FCMs for the filing of monthly financial reports. See 17

    CFR 1.10(b) for further details.

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

    (1) Summary of Comments

    CME wrote that it would not be feasible for SEFs to comply with the

    proposed filing deadline of 17 business days from the end of a SEF's

    fiscal quarter.\785\ CME recommended a reporting deadline of 40

    calendar days after the end of each fiscal quarter and 60 calendar days

    after the end of the fiscal year, which it noted is consistent with the

    SEC's reporting requirements.\786\ CME also sought clarification that

    consolidated financial statements covering multiple registered entities

    satisfy the reporting requirements.\787\

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

    \785\ CME Comment Letter at 38 (Feb. 22, 2011).

    \786\ Id.

    \787\ Id.

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

    MarketAxess stated that the proposed reporting requirements are

    unnecessary and burdensome, and recommended that the Commission allow a

    senior officer of the SEF to represent to the Commission that the SEF

    satisfies the financial resources requirements.\788\

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

    \788\ MarketAxess Comment Letter at 40 (Mar. 8, 2011).

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

    Two commenters discussed disclosure of the reports. CME recommended

    that the Commission clarify that filings made in compliance with the

    proposed financial resources regulations are confidential.\789\

    [[Page 33541]]

    However, SIFMA AMG commented that SEFs should submit to the Commission

    and make available for public comment evidence demonstrating sufficient

    resources.\790\

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

    \789\ CME Comment Letter at 38 (Feb. 22, 2011).

    \790\ SIMFA AMG Comment Letter at 13 (Mar. 8, 2011).

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

    (2) Commission Determination

    The Commission is adopting Sec. 37.1306 as proposed, subject to

    certain amendments to the filing deadlines.\791\ The Commission agrees

    with CME that the proposed 17 business day filing deadline may be

    burdensome. In the final rule, the Commission is extending the 17

    business day proposed filing deadline to 40 calendar days for the

    fiscal quarter reports and to 60 calendar days for the fiscal year-end

    report, which will also harmonize the filing deadlines with the SEC's

    requirements for its Form 10-Q and Form 10-K. The Commission also

    clarifies that consolidated financial statements must disclose all

    relevant and appropriate figures such that a determination of the

    sufficiency of financial resources of a SEF can be made without

    additional requests for information from the entity. In such case,

    consolidated financial statements would comply with the reporting

    requirements.

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

    \791\ The Commission is also making certain non-substantive

    clarifications to Sec. 37.1306.

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

    In response to MarketAxess's comment that the reporting

    requirements are unnecessary and burdensome, the Commission believes

    that prudent financial management requires SEFs to prepare and review

    financial reports on a regular basis and expects that SEFs would

    regularly review their finances. In this regard, the Commission notes

    that because of the importance of this requirement, a mere

    representation by a senior officer is insufficient for verification

    that the SEF meets its financial obligations. The quarterly reporting

    required by Sec. 37.1306 will adequately provide the Commission with

    assurance that a SEF satisfies its financial resources requirements.

    The Commission notes that DCMs and DCOs have similar financial

    resources reporting obligations and does not believe that SEFs should

    be treated differently. The Commission also believes that much of the

    information required by the reports should be readily available to a

    sophisticated organization, which the Commission expects would

    regularly account for its financial resources. As such, the Commission

    notes that the cost of submitting these reports to the Commission would

    be de minimis.

    The Commission further clarifies that it does not intend to make

    financial resources reports public. However, where such information is,

    in fact, confidential, the Commission encourages SEFs to submit a

    written request for confidential treatment of such filings under the

    Freedom of Information Act (``FOIA''), pursuant to the procedures

    established in section 145.9 of the Commission's regulations.\792\ The

    determination of whether to disclose or exempt such information in the

    context of a FOIA proceeding would be governed by the provisions of

    part 145 and any other relevant provision.

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

    \792\ 17 CFR 145.9.

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

    Finally, the Commission is adding new Sec. 37.1307 titled

    ``Delegation of Authority'' to the final SEF rules to delegate

    authority to the Director of DMO to perform certain functions that are

    reserved to the Commission under subpart N.

    14. Subpart O--Core Principle 14 (System Safeguards)

    Core Principle 14 pertains to the establishment of system

    safeguards and requires SEFs to: (1) Establish and maintain a program

    of risk analysis and oversight to identify and minimize sources of

    operational risk through the development of appropriate controls and

    procedures and the development of automated systems that are reliable,

    secure, and have adequate scalable capacity; (2) establish and maintain

    emergency procedures, backup facilities, and a plan for disaster

    recovery that allow for the timely recovery and resumption of

    operations and the fulfillment of the responsibilities and obligations

    of the SEF; and (3) periodically conduct tests to verify that backup

    resources are sufficient to ensure continued order processing and trade

    matching, price reporting, market surveillance, and maintenance of a

    comprehensive and accurate audit trail.\793\ In the SEF NPRM, the

    Commission proposed to codify the statutory text of Core Principle 14

    in proposed Sec. 37.1400, and adopts that rule as proposed.

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

    \793\ CEA section 5h(f)(14); 7 U.S.C. 7b-3(f)(14).

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

    (a) Sec. 37.1401--Requirements

    Proposed Sec. 37.1401(a) required a SEF to: Establish and maintain

    a program of risk analysis and oversight; establish and maintain

    emergency procedures, backup facilities, and a plan for disaster

    recovery; and periodically conduct tests to verify that backup

    resources are sufficient. Proposed Sec. 37.1401(b) required that a

    SEF's program of risk analysis and oversight address six categories of

    risk analysis and oversight, including: Information security; business

    continuity-disaster recovery (``BC-DR'') planning and resources;

    capacity and performance planning; systems operations; systems

    development and quality assurance; and physical security and

    environmental controls. Proposed Sec. 37.1401(c) suggested that a SEF

    follow generally accepted standards and best practices when addressing

    the categories of risk analysis and oversight.

    Proposed Sec. 37.1401(d) and (e) also required each SEF to

    maintain a BC-DR plan, BC-DR resources, emergency procedures, and

    backup facilities sufficient to enable timely recovery and resumption

    of its operations and ongoing fulfillment of its responsibilities and

    obligations as a SEF following any disruption, either through

    sufficient infrastructure and personnel resources of its own or through

    sufficient contractual arrangements with other SEFs or disaster

    recovery service providers. If the Commission determines that a SEF is

    a critical financial market, then that SEF would be subject to more

    stringent requirements, set forth in Sec. 40.9 of the Commission's

    regulations.

    The proposed rule also required each SEF to notify the Commission

    staff of various system security-related events, including prompt

    notice of all electronic trading halts and systems malfunctions

    (proposed Sec. 37.1401(f)(1)), cyber-security incidents (proposed

    Sec. 37.1401(f)(2)), and any activation of the SEF's BC-DR plan

    (proposed Sec. 37.1401(f)(3)). In addition, the proposed rule required

    each SEF to provide the Commission staff with timely advance notice of

    all planned changes to automated systems that may impact the

    reliability, security, or adequate scalable capacity of such systems

    (proposed Sec. 37.1401(g)(1)) and planned changes to programs of risk

    analysis and oversight (proposed Sec. 37.1401(g)(2)).

    The proposed rule also required each SEF to provide relevant

    documents to the Commission (proposed Sec. 37.1401(h)) and to conduct

    regular, periodic, objective testing and review of its automated

    systems (proposed Sec. 37.1401(i)). Moreover, proposed Sec.

    37.1401(j) required each SEF, to the extent practicable, to coordinate

    its BC-DR plan with those of the market participants upon whom it

    depends to provide liquidity, to initiate coordinated testing of such

    plans, and to ensure that its BC-DR plan takes into account the BC-DR

    plans of relevant telecommunications, power, water, and

    [[Page 33542]]

    other essential service providers. Finally, proposed Sec. 37.1401(k)

    stated that part 46 of the Commission's regulations governs the

    obligations of entities determined to be critical financial markets,

    with respect to maintenance and geographical dispersal of disaster

    recovery resources.

    (1) Summary of Comments

    CME objected to what it considers to be an overly broad requirement

    in proposed Sec. 37.1401(f)(1) to notify the Commission staff promptly

    of all electronic trading halts and systems malfunctions.\794\ CME

    stated that the required reporting should be limited only to material

    system failures.\795\ CME also objected to proposed Sec.

    37.1401(g)(1), stating that the requirement that SEFs provide the

    Commission with timely advance notice of all planned changes to

    automated systems that may impact the reliability, security, or

    adequate scalable capacity of such systems is overly burdensome, and

    not cost effective.\796\ Additionally, CME stated that the proposed

    Sec. 37.1401(g)(2) requirement that SEFs provide timely advance notice

    of all planned changes to their program of risk analysis and oversight

    is too broad and generally unnecessary.\797\ Finally, CME noted that it

    does not control, or generally have access to, the details of the

    disaster recovery plans of its major vendors.\798\

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

    \794\ CME Comment Letter at 36 (Feb. 22, 2011).

    \795\ Id.

    \796\ Id. at 37.

    \797\ Id.

    \798\ Id.

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

    MarketAxess and WMBAA sought clarification of the criteria used to

    determine which SEFs are ``critical financial markets,'' as referenced

    in proposed Sec. 37.1401(d).\799\

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

    \799\ MarketAxess Comment Letter at 40 (Mar. 8, 2011); WMBAA

    Comment Letter at 28 (Mar. 8, 2011).

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

    (2) Commission Determination

    As noted in the SEF NPRM, automated systems play a central and

    critical role in today's electronic financial market environment, and

    the oversight of core principle compliance by SEFs with respect to

    automated systems is an essential part of effective oversight of swaps

    market.\800\ Advanced computer systems are fundamental to a SEF's

    ability to meet its obligations and responsibilities under the core

    principles.\801\ Accordingly, the Commission is adopting Sec. 37.1401

    as proposed, subject to the modifications described below.

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

    \800\ Core Principles and Other Requirements for Swap Execution

    Facilities, 76 FR at 1231.

    \801\ Id.

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

    Although the Commission did not receive related comments, the

    Commission is eliminating proposed Sec. 37.1401(a) because this

    paragraph is repetitious of proposed rule Sec. 37.1400. The Commission

    is also moving the following portions of proposed Sec. 37.1401 to the

    guidance in appendix B to part 37 because the rules as proposed

    provided SEFs with a degree of discretion: (1) Proposed Sec.

    37.1401(c) suggesting that a SEF follow generally accepted standards

    and best practices in addressing the categories of its risk analysis

    and oversight program; (2) the portion of proposed Sec. 37.1401(i)

    suggesting that a SEF's testing of its automated systems and BC-DR

    capabilities be conducted by qualified, independent professionals; and

    (3) proposed Sec. 37.1401(j) suggesting that a SEF coordinate its BC-

    DR plan with those of others.\802\ Given that these proposed provisions

    provided SEFs with a degree of discretion, the Commission believes that

    they are better suited as guidance rather than rules, and as guidance,

    SEFs will have greater flexibility in administering their obligations.

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

    \802\ As a result of these changes, proposed section (b) is

    adopted as section (a), proposed section (d) is adopted as section

    (b), proposed section (e) is adopted as section (c), proposed

    section (f) is adopted as section (d), proposed section (g) is

    adopted as section (e), proposed section (h) is adopted as section

    (f), proposed section (i) is adopted as section (g), and proposed

    section (k) is adopted as section (h).

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

    In response to CME's comments, the Commission is revising proposed

    Sec. 37.1401(f)(1) to provide that SEFs only need to promptly notify

    the Commission staff of all material system malfunctions. With respect

    to planned changes to automated systems or programs of risk analysis

    and oversight, the Commission is revising proposed Sec. 37.1401(g) to

    require timely advance notification of all material changes to

    automated systems and to programs of risk analysis and oversight. The

    Commission believes that these revisions are appropriate because the

    scope of the proposed rules may have been too broad as CME noted. The

    Commission notes that proposed Sec. 37.1401(j) does not require SEFs

    to control or have access to the details of the disaster recovery plans

    of its major vendors. Rather, the requirement in the proposed rule,

    which is being adopted as guidance, suggests coordination to the extent

    possible.

    In response to comments from WMBAA and MarketAxess, the Commission

    is revising proposed Sec. 37.1401(d) to include a reference to

    appendix E to part 40 of the Commission's regulations, which describes

    the Commission's criteria for determining whether a SEF is a critical

    financial market.\803\ Appendix E to part 40 describes the evaluation

    and notification process for SEFs once designated as a critical

    financial market.\804\

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

    \803\ Business Continuity and Disaster Recovery, 75 FR 42633

    (proposed Jul. 22, 2010). The Commission notes that this rulemaking

    is not yet final.

    \804\ Id. at 42639.

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

    With respect to the references to Sec. 40.9 regarding critical

    financial markets in proposed Sec. 37.1401(d) and 37.1401(k), the

    Commission notes that Sec. 40.9, which was proposed in a separate

    rulemaking,\805\ is not yet final. However, SEFs deemed critical

    financial markets will be subject to the requirements set forth in

    Sec. 40.9 upon its effective date. The Commission further notes that

    the reference to part 46 in proposed Sec. 37.1401(k) was a technical

    error. Instead, the proposed rule should have referenced part 40.

    Accordingly, the Commission is replacing the mistaken reference to part

    46 with a reference to part 40.

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

    \805\ Id. at 42638-39.

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

    15. Subpart P--Core Principle 15 (Designation of Chief Compliance

    Officer)

    Core Principle 15 establishes the position and duties of chief

    compliance officer (``CCO'').\806\ Core Principle 15 also requires the

    CCO to design procedures to establish the handling, management

    response, remediation, retesting, and closing of noncompliance

    issues.\807\ The statute also requires a CCO to prepare and sign an

    annual compliance report that is filed with the Commission.\808\ In

    addition, Core Principle 15 requires the CCO to include in the report a

    certification that, under penalty of law, the report is accurate and

    complete.\809\ In the SEF NPRM, the Commission proposed to codify the

    statutory text of Core Principle 15 in proposed Sec. 37.1500, and

    adopts that rule as proposed.

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

    \806\ CEA section 5h(f)(15); 7 U.S.C. 7b-3(f)(15).

    \807\ Id.

    \808\ Id.

    \809\ Id.

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

    (a) Sec. 37.1501--Chief Compliance Officer

    Proposed Sec. 37.1501 implemented the statutory provisions of Core

    Principle 15 and granted CCOs the authority necessary to fulfill their

    responsibilities.

    (1) Sec. 37.1501(a)--Definition of Board of Directors

    Proposed Sec. 37.1501(a) defined ``board of directors'' as the

    board of directors of

    [[Page 33543]]

    a swap execution facility or for those swap execution facilities whose

    organizational structure does not include a board of directors, a body

    performing a function similar to a board of directors.

    (i) Commission Determination

    The Commission received no comments on Sec. 37.1501(a) and is

    adopting the rule as proposed.

    (2) Sec. 37.1501(b)--Designation and Qualifications of Chief

    Compliance Officer

    Proposed Sec. 37.1501(b)(1) required a SEF to establish a CCO

    position and to designate an individual to serve in that capacity.

    Proposed Sec. 37.1501(b)(1)(i) required that a SEF provide its CCO

    with the authority and resources to develop and enforce policies and

    procedures necessary to fulfill its statutory and regulatory duties. In

    addition, proposed Sec. 37.1501(b)(1)(ii) provided that CCOs must have

    supervisory authority over all staff acting in furtherance of the CCO's

    statutory, regulatory, and self-regulatory obligations.

    Proposed Sec. 37.1501(b)(2) required that a CCO have the

    appropriate background and skills to fulfill the responsibilities of

    the position. Proposed Sec. 37.1501(b)(2)(i) prohibited anyone who

    would be disqualified from registration under CEA sections 8a(2) or

    8a(3) from serving as a CCO.\810\ Proposed Sec. 37.1501(b)(2)(ii)

    prohibited a CCO from being a member of the SEF's legal department or

    its general counsel.\811\

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

    \810\ See Core Principles and Other Requirements for Swap

    Execution Facilities, 76 FR at 1232 (discussing the reasons for this

    requirement).

    \811\ Id.

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

    (i) Summary of Comments

    Some commenters stated that by mandating that the CCO have the

    authority and resources to ``enforce'' a SEF's policies and procedures,

    the proposed rules change the traditional role of a CCO and give the

    CCO authority that should be reserved for senior management.\812\ These

    commenters stated that the traditional and proper role of a CCO is to

    advise management on compliance issues and that management has the

    authority to enforce compliance policies and procedures.\813\ The

    commenters recommended that the Commission revise the proposed rules to

    give effect to the well-established and critical distinction between a

    CCO and management.\814\

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

    \812\ WMBAA Comment Letter II at 2-6 (Mar. 8, 2011); FXall

    Comment Letter at 14-15 (Mar. 8, 2011); CME Comment Letter at 5-6

    (Feb. 7, 2011). WMBAA submitted two comment letters to the SEF

    rulemaking comment file on Mar. 8, 2011. The second comment letter

    referred to herein as ``WMBAA Comment Letter II'' only pertains to

    the SEF NPRM's proposed CCO provisions. Additionally, rather than

    repeat its comments regarding the CCO provisions that pertain to

    both the DCO and SEF NPRMs, CME incorporated its entire DCO

    rulemaking comment letter regarding CCOs dated Feb. 7, 2011 as

    Exhibit B to its SEF comment letter dated Mar. 8, 2011. The

    Commission notes these comments by referencing the Feb. 7, 2011 date

    of CME's DCO comment letter regarding CCOs. The Commission is also

    changing CME's reference to ``DCO'' to ``SEF'' for these comments.

    \813\ WMBAA Comment Letter II at 2-6 (Mar. 8, 2011); FXall

    Comment Letter at 14-15 (Mar. 8, 2011); CME Comment Letter at 5-6

    (Feb. 7, 2011).

    \814\ WMBAA Comment Letter II at 6 (Mar. 8, 2011); FXall Comment

    Letter at 14-15 (Mar. 8, 2011); CME Comment Letter at 6 (Feb. 7,

    2011).

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

    Some commenters stated that the proposed rules should not prohibit

    a CCO from serving as the SEF's general counsel or as a member of the

    SEF's legal department.\815\ WMBAA noted that it is not uncommon for a

    company's CCO to be its general counsel.\816\ Similarly, CME noted that

    many CCOs have certain other job responsibilities, most typically in

    related ``control areas'' such as the Legal Department or Internal

    Audit.\817\ Additionally, MarketAxess stated that this prohibition

    could prevent a smaller SEF from structuring its internal management in

    the most efficient manner.\818\ Parity Energy recommended that this

    requirement only apply to SEFs that could have a substantial impact on

    market risk and stability if they were to fail.\819\ However, Tradeweb

    and Better Markets expressed support for a dedicated CCO position

    independent of a SEF's legal department.\820\ Better Markets also

    commented that in situations where there are a number of affiliated

    organizations, a single senior CCO should have overall responsibility

    for each affiliated and controlled entity, even if the individual

    entities have CCOs.\821\

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

    \815\ WMBAA Comment Letter II at 6-7 (Mar. 8, 2011); MarketAxess

    Comment Letter at 27 (Mar. 8, 2011); ICE Comment Letter at 6-7 (Mar.

    8, 2011); CME Comment Letter at 3 (Feb. 7, 2011).

    \816\ WMBAA Comment Letter II at 6 (Mar. 8, 2011).

    \817\ CME Comment Letter at 3 (Feb. 7, 2011).

    \818\ MarketAxess Comment Letter at 27 n. 31 (Mar. 8, 2011).

    \819\ Parity Energy Comment Letter at 6 (Mar. 25, 2011).

    \820\ Tradeweb Comment Letter at 12 (Mar. 8, 2011); Better

    Markets Comment Letter at 19 (Mar. 8, 2011).

    \821\ Better Markets Comment Letter at 19 (Mar. 8, 2011).

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

    (ii) Commission Determination

    The Commission is adopting Sec. 37.1501(b) as proposed, subject to

    two modifications described below. In general, the Commission disagrees

    with the commenters who believe that a CCO's function is solely to

    monitor and advise on compliance issues. These commenters do not

    provide any statutory support for this view and their position appears

    to conflict with the statutory responsibilities of a CCO as set forth

    in the Act. In particular, CEA section 5h(f)(15)(B) requires a CCO to

    ``resolve any conflicts of interest that may arise'' and to ``ensure

    compliance with this Act.'' \822\ These duties suggest that a CCO is

    intended to be more than just an advisor, and must have the appropriate

    authority to enforce policies and procedures related to his or her

    areas of responsibility. The Commission believes that such authority is

    particularly important for a SEF CCO, given the CCO's responsibility in

    overseeing a SEF's self-regulatory programs.

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

    \822\ CEA sections 5h(f)(15)(B)(iii) and (v); 7 U.S.C. 7b-

    3(f)(15)(B)(iii) and (v).

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

    However, to clarify the CCO's supervisory authority, the Commission

    is amending proposed Sec. 37.1501(b)(1)(ii) to state that ``[t]he

    chief compliance officer shall have supervisory authority over all

    staff acting at the direction of the chief compliance officer''

    (emphasis added). This modification provides greater clarity as to the

    SEF staff that must be under the managerial oversight of a CCO by

    emphasizing that such staff includes persons necessary for SEFs to

    fulfill their self-regulatory obligations, including compliance staff

    (e.g., trade practice and market surveillance staff and enforcement

    staff). The Commission notes that other SEF staff are not captured by

    the requirements of Sec. 37.1501(b)(1).

    The Commission is withdrawing proposed Sec. 37.1501(b)(2)(ii),

    which prohibits the CCO from serving as a SEF's general counsel or as a

    member of its legal department. In the SEF NPRM, the Commission noted

    that there is potentially a conflict of interest present if a CCO

    serves as a SEF's general counsel or as a member of its legal

    department.\823\ However, the Commission has determined that the

    potential costs of hiring additional staff to satisfy the requirement

    in proposed Sec. 37.1501(b)(2)(ii) may impose an excessive burden on

    SEFs, particularly smaller SEFs.

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

    \823\ Core Principles and Other Requirements for Swap Execution

    Facilities, 76 FR at 1232, n. 103.

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

    Although the Commission is eliminating proposed Sec.

    37.1501(b)(2)(ii) from the final SEF rules, the Commission notes that a

    conflict of interest may compromise a CCO's

    [[Page 33544]]

    ability to effectively fulfill his or her responsibilities as a CCO,

    and that such conflicts may be more likely to arise when a CCO is also

    employed as the SEF's general counsel or within its legal department.

    Therefore, the Commission expects that as soon as any conflict of

    interest becomes apparent, a SEF will immediately implement contingency

    measures. For example, a SEF may reassign the conflicted matter to an

    alternate employee who does not report to the CCO and who does not

    possess a conflict of interest. The Commission believes that a SEF's

    Regulatory Oversight Committee (``ROC'') \824\ should regularly monitor

    for potential conflicts of interest in its oversight of the CCO, and

    should be particularly involved in the oversight of any matter in which

    a CCO was recused.

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

    \824\ See Requirements for Derivatives Clearing Organizations,

    Designated Contract Markets, and Swap Execution Facilities Regarding

    the Mitigation of Conflicts of Interest, 75 FR 63732, 63747-48

    (proposed Oct. 18, 2010). Proposed Sec. 37.19(b) describes the role

    of the ROC. The Commission notes that this rule is not yet final.

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

    The Commission disagrees with the recommendation by Better Markets

    to require a single senior CCO to have responsibility over multiple

    affiliated registered entities, some of which would be required by the

    CEA and Commission regulations to have their own CCOs. Such a situation

    might cause unnecessary confusion and dilute CCO accountability at the

    individual entity level. Additionally, the Commission believes that the

    proposed rule is sufficient to manage instances where there are a

    number of affiliated organizations within a corporate family. In these

    instances, each SEF would be required to appoint its own CCO.

    (3) Sec. 37.1501(c)--Appointment, Supervision, and Removal of Chief

    Compliance Officer

    Proposed Sec. 37.1501(c)(1) required that a CCO's appointment and

    compensation be approved by a majority of the SEF's board of directors

    or its senior officer. Proposed Sec. 37.1501(c)(1) also required a CCO

    to meet with the SEF's board of directors at least annually and the ROC

    at least quarterly, and to provide any information requested regarding

    the SEF's regulatory program. In addition, proposed Sec. 37.1501(c)(1)

    required a SEF to notify the Commission of the appointment of a new CCO

    within two business days of such appointment. Proposed Sec.

    37.1501(c)(2) required a CCO to report directly to the board of

    directors or to the senior officer of the SEF, at the SEF's discretion.

    Proposed Sec. 37.1501(c)(3) required approval of a majority of a SEF's

    board of directors to remove a CCO. If a SEF does not have a board of

    directors, the proposed rule provided that the CCO may be removed by

    its senior officer. Proposed Sec. 37.1501(c)(3) also required a SEF to

    notify the Commission of, and explain the reasons for, the departure of

    the CCO within two business days. In addition, proposed Sec.

    37.1501(c)(3) required a SEF to immediately appoint an interim CCO, to

    appoint a permanent CCO as soon as reasonably practicable, and to

    notify the Commission within two business days of appointing any new

    interim or permanent CCO.

    (i) Summary of Comments

    Some commenters requested that the Commission define the term

    ``senior officer'' and provided recommendations.\825\ FXall recommended

    that the Commission define the term ``senior officer'' to include the

    SEF's president, chief executive officer, chief legal officer, or other

    officer with ultimate supervisory authority for the SEF entity.\826\

    CME recommended that the term ``senior officer'' be defined to include

    the senior officer of a division that is engaged in SEF activities

    rather than the senior officer of a larger corporation.\827\

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

    \825\ FXall Comment Letter at 14 (Mar. 8, 2011); Tradeweb

    Comment Letter at 12 n.8 (Mar. 8, 2011); CME Comment Letter at 2-3

    (Feb. 7, 2011).

    \826\ FXall Comment Letter at 14 (Mar. 8, 2011).

    \827\ CME Comment Letter at 2-3 (Feb. 7, 2011).

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

    Commenters also requested that the Commission grant a SEF greater

    flexibility in determining how a CCO is appointed, compensated,

    supervised, and removed.\828\ In this regard, WMBAA stated that a CCO

    should be permitted to satisfy the statutory requirement of reporting

    to the board of directors or a senior officer by reporting to a

    ROC.\829\ MarketAxess commented that the proposed requirements for a

    majority of the board of directors to approve the appointment,

    compensation, and removal of the CCO go beyond the statutory mandate

    and would effectively place the CCO at the same level as the SEF's

    senior officer.\830\ CME argued that each SEF should be given the

    flexibility to take additional steps beyond those required in the

    proposed rule, based on the SEF's particular corporate structure, size,

    and complexity, to ensure an appropriate level of independence for its

    CCO.\831\

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

    \828\ Tradeweb Comment Letter at 6 (Jun. 3, 2011); MarketAxess

    Comment Letter at 26 (Mar. 8, 2011); WMBAA Comment Letter II at 7

    (Mar. 8, 2011); Tradeweb Comment Letter at 12 (Mar. 8, 2011).

    \829\ WMBAA Comment Letter II at 7 (Mar. 8, 2011).

    \830\ MarketAxess Comment Letter at 26 (Mar. 8, 2011).

    \831\ CME Comment Letter at 9 (Feb. 7, 2011).

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

    AFR and Better Markets recommended, however, that the rules for

    CCO's appointment, compensation, supervision, and removal be

    strengthened.\832\ AFR recommended that CCOs be responsible only to a

    SEF's ROC.\833\ It argued that CCO independence may only be ensured by

    vesting oversight of the position exclusively in public directors.\834\

    Similarly, Better Markets recommended that decisions relating to a

    CCO's designation, compensation, and termination should be the sole

    responsibility of the independent members of the board of

    directors.\835\

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

    \832\ AFR Comment Letter at 6 (Mar. 8, 2011); Better Markets

    Comment Letter at 19-20 (Mar. 8, 2011).

    \833\ AFR Comment Letter at 6 (Mar. 8, 2011).

    \834\ Id.

    \835\ Better Markets Comment Letter at 19-20 (Mar. 8, 2011).

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

    (ii) Commission Determination

    The Commission is adopting Sec. 37.1501(c) as proposed, subject to

    several modifications described below.\836\ In response to commenters'

    requests to define the term ``senior officer,'' the Commission

    believes, based on the statutory language that requires a CCO to report

    directly to the ``board or to the senior officer,'' that ``senior

    officer'' would only include the most senior executive officer of the

    legal entity that is registered as a SEF.

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

    \836\ The Commission is making certain non-substantive revisions

    to Sec. 37.1501(c) for clarity.

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

    In response to the commenters' requests for greater flexibility,

    the Commission believes that proposed Sec. 37.1501(c) generally

    strikes the appropriate balance between flexibility and ensuring that a

    SEF's CCO is insulated from day-to-day commercial pressures. The

    proposed rules provide a degree of flexibility by allowing a SEF's

    board of directors or senior officer to appoint, set the compensation

    of, and supervise the CCO. The proposed rules also protect the CCO from

    undue influence by requiring that the board of directors or the senior

    officer (if the SEF does not have a board of directors) be responsible

    for removing the CCO and that the CCO meet with the board of directors

    at least annually and with the ROC at least quarterly. In response to

    CME's comment about additional flexibility beyond the rules, the

    Commission notes that Sec. 37.1501(c) sets forth minimum standards so

    a SEF may implement additional measures if it deems doing so necessary

    to insulate the CCO from undue influence. The Commission encourages

    SEFs to review and enact conflict mitigation procedures as appropriate

    for their specific

    [[Page 33545]]

    corporate and/or organizational structure.

    However, the Commission is revising proposed Sec. 37.1501(c) in

    six respects. First, the Commission is modifying proposed Sec.

    37.1501(c)(1) to more clearly state that the CCO is obligated to meet

    with the board of directors at least annually and with the ROC at least

    quarterly, even if the CCO was appointed by, or is supervised by, the

    senior officer of the facility. Second, to clarify a CCO's duty to

    provide information to a SEF's board of directors or ROC, the

    Commission is modifying proposed Sec. 37.1501(c)(1) to state that

    ``[t]he chief compliance officer shall provide any information

    regarding the swap execution facility's self-regulatory program that is

    requested by the board of directors or the regulatory oversight

    committee'' (emphasis added). Third, the Commission is eliminating the

    requirement in proposed Sec. 37.1501(c)(1) that a CCO's appointment

    and compensation require the approval of a majority of a SEF's board of

    directors. The Commission believes that board of director approval is a

    sufficient requirement for appointment, and that a SEF should have

    appropriate discretion to determine the voting percentage necessary to

    appoint a CCO or determine salary. Fourth, the Commission is

    eliminating the requirement in proposed Sec. 37.1501(c)(3) that a SEF

    explain the reason for the departure of a CCO within two business days.

    The Commission believes that the specific reason for the departure may

    be unnecessary in most instances. However, the Commission will have the

    opportunity to investigate the reason for the departure if it so

    desires because a SEF must notify the Commission of a CCO's departure

    within two business days. Fifth, the Commission is eliminating the

    requirement in proposed Sec. 37.1501(c)(3) that a SEF immediately

    appoint an interim CCO, and appoint a new permanent CCO as soon as

    reasonably practicable, upon the removal of a CCO. The Commission

    believes that the requirement to appoint a new CCO is implicit in Sec.

    37.1501(b)(1), which requires that a SEF designate an individual to

    serve as CCO. Finally, the Commission is eliminating the requirement in

    proposed Sec. 37.1501(c)(3) that a SEF notify the Commission within

    two business days of appointing a new CCO because this requirement is

    already included in Sec. 37.1501(c)(1).

    (4) Sec. 37.1501(d)--Duties of Chief Compliance Officer

    Proposed Sec. 37.1501(d) generally listed the following CCO

    duties: (1) Overseeing and reviewing compliance with section 5h of the

    CEA and related Commission regulations; (2) in consultation with the

    board of directors or the senior officer, resolving any conflicts of

    interest that may arise; (3) establishing and administering written

    policies and procedures reasonably designed to prevent violations of

    the CEA and Commission regulations; (4) ensuring compliance with the

    CEA and Commission regulations relating to agreements, contracts, or

    transactions, and with Commission regulations issued under section 5h

    of the CEA; (5) establishing procedures for the remediation of

    noncompliance issues identified by the CCO; (6) establishing and

    following appropriate procedures for noncompliance issues; (7)

    establishing a compliance manual and administering a code of ethics;

    (8) supervising a SEF's self-regulatory program; and (9) supervising

    the effectiveness and sufficiency of any regulatory services provided

    to the SEF.

    (i) Summary of Comments

    Better Markets and CME commented on proposed Sec. 37.1501(d)(2)

    regarding conflicts of interest.\837\ Better Markets recommended that

    the Commission revise proposed Sec. 37.1501(d)(2) to require a CCO to

    consult with both the independent members of the board of directors and

    the senior officer when resolving conflicts of interest, which are

    particularly contentious.\838\ CME requested that the Commission revise

    proposed Sec. 37.1501(d)(2) to require a CCO to establish policies and

    procedures reasonably designed to resolve any conflicts of interest

    that may arise.\839\ Although CME conceded that the language in

    proposed Sec. 37.1501(d)(2) mirrors the language in the Act, it

    believes that Congress did not intend for the CCO to resolve conflicts

    in the executive or managerial sense.\840\

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

    \837\ Better Markets Comment Letter at 20 (Mar. 8, 2011); CME

    Comment Letter at 6 (Feb. 7, 2011).

    \838\ Better Markets Comment Letter at 19, 20 (Mar. 8, 2011).

    \839\ CME Comment Letter at 6 (Feb. 7, 2011).

    \840\ Id.

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

    Several commenters argued that proposed Sec. 37.1501(d)(4),

    requiring a CCO to ``ensure'' compliance with the Act and Commission

    regulations, is an impracticable standard.\841\ Instead, many of these

    commenters recommended alternative language, which generally stated

    that the CCO put in place policies and procedures that reasonably

    ensure compliance with the Act and Commission regulations.\842\

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

    \841\ Tradeweb Comment Letter at 6-7 (Jun. 3, 2011); WMBAA

    Comment Letter II at 5-6 (Mar. 8, 2011); MarketAxess Comment Letter

    at 26 (Mar. 8, 2011); Tradeweb Comment Letter at 12 (Mar. 8, 2011);

    CME Comment Letter at 4 (Feb. 7, 2011).

    \842\ Tradeweb Comment Letter at 6-7 (Jun. 3, 2011); Tradeweb

    Comment Letter at 12 (Mar. 8, 2011); CME Comment Letter at 4 (Feb.

    7, 2011).

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

    CME also took issue with the requirement in proposed Sec.

    37.1501(d)(6), which requires a CCO to ``follow'' appropriate

    procedures for the handling, management response, remediation,

    retesting, and closing of noncompliance issues.\843\ CME requested that

    the Commission eliminate this requirement, which it believes is a

    function of senior management.\844\ Additionally, WMBAA recommended

    that the Commission delete proposed Sec. 37.1501(d)(8) and (d)(9),

    regarding the supervision of a SEF's self-regulatory program and any

    regulatory service provider, because these functions should be the

    responsibility of management.\845\

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

    \843\ CME Comment Letter at 6 (Feb. 7, 2011).

    \844\ Id.

    \845\ WMBAA Comment Letter II at 6 (Mar. 8, 2011).

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

    (ii) Commission Determination

    The Commission is adopting Sec. 37.1501(d) as proposed, subject to

    certain modifications described below. The Commission is revising

    proposed Sec. 37.1501(d)(2) to clarify that the list of enumerated

    conflicts of interest is not exhaustive.\846\ The Commission is not

    adopting the recommendation by Better Markets to require the CCO to

    consult with both the independent members of the board of directors and

    the senior officer when resolving conflicts of interest. Considering

    the statutory provisions of CEA section 5h, the Commission believes

    that it is unnecessary to require the CCO to do so. However, the

    Commission notes that Sec. 37.1501(d)(2) sets forth minimum standards

    so a SEF may institute higher standards, such as requiring its CCO to

    consult with both the independent members of the board of directors and

    the senior officer when resolving conflicts of interest. The Commission

    also declines to adopt CME's recommendation regarding conflicts of

    interest. As CME acknowledged, the Commission is following the

    statutory language in its implementation of Sec. 37.1501(d)(2).

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

    \846\ The Commission notes that the preamble to the SEF NPRM

    already clarified this point. To provide additional clarity, the

    Commission is clarifying this point in the final rule by adding the

    word ``including'' before the list of enumerated conflicts of

    interest. See Core Principles and Other Requirements for Swap

    Execution Facilities, 76 FR at 1233.

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

    In response to commenters' concerns about the requirement to

    ``ensure'' compliance in proposed Sec. 37.1501(d)(4),

    [[Page 33546]]

    the Commission is modifying the rule to state that the CCO shall take

    ``reasonable steps to ensure compliance with the Act and the rules of

    the Commission.'' The Commission understands that a single individual

    cannot guarantee compliance with the CEA and Commission regulations.

    The Commission believes that this modification is responsive to

    commenters' concerns and is consistent with the final rules for other

    registered entities.\847\ The Commission is also removing the reference

    to ``agreements, contracts, or transactions'' in proposed Sec.

    37.1501(d)(4) to more closely follow the language in the Act. In making

    this modification, the Commission does not intend to modify any

    substantive obligations of the CCO with regard to agreements,

    contracts, or transactions to the extent that these documents implicate

    the Act or Commission regulations under the Act.

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

    \847\ See, e.g., Swap Data Repositories: Registration Standards,

    Duties and Core Principles, 76 FR 54538, 54584 (Sept. 1, 2011)

    (stating that the duties of an SDR's CCO include ``[t]aking

    reasonable steps to ensure compliance with the Act and Commission

    regulations . . .''); Derivatives Clearing Organization General

    Provisions and Core Principles, 76 FR 69334, 69434 (Nov. 8, 2011)

    (stating that the duties of a DCO's CCO include ``[t]aking

    reasonable steps to ensure compliance with the Act and Commission

    regulations . . .'').

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

    In order to clarify differences between the SEF NPRM's preamble and

    rule text regarding proposed Sec. 37.1501(d)(7), the Commission is

    revising the rule to state that the CCO's duties include

    ``[e]stablishing and administering a compliance manual designed to

    promote compliance with the applicable laws, rules, and regulations . .

    .'' (emphasis added). The Commission also disagrees with CME and WMBAA

    that the requirements in proposed Sec. 37.1501(d)(6), (d)(8), and

    (d)(9) are functions of management. These provisions, as discussed

    above, require a CCO to establish and follow appropriate procedures

    regarding noncompliance issues, supervise the SEF's self-regulatory

    program, and supervise the effectiveness and sufficiency of any

    regulatory service provider. As noted above, the Commission disagrees

    with the commenters who believe that a CCO's function is solely to

    monitor and advise on compliance issues. Finally, the Commission is

    revising proposed Sec. 37.1501(d)(9) to remove the references to

    ``registered futures association'' and ``other registered entity'' and,

    instead, adding a reference to ``regulatory service provider'' given

    the inclusion of FINRA as a regulatory service provider under Sec.

    37.204.

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

    \848\ The Commission is renaming the title of this section from

    ``Annual Compliance Report Prepared by Chief Compliance Officer'' to

    ``Preparation of Annual Compliance Report.''

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

    (5) Sec. 37.1501(e)--Annual Compliance Report Prepared by Chief

    Compliance Officer \848\

    Proposed Sec. 37.1501(e) generally enumerated the following

    information that must be included in the annual compliance report: (1)

    A description of the SEF's written policies and procedures, including

    the code of ethics and conflicts of interest policies; (2) a detailed

    review of the SEF's compliance with CEA section 5h and Commission

    regulations, which, among other requirements, identifies the policies

    and procedures that ensure compliance with the core principles; (3) a

    list of any material changes to the compliance policies and procedures

    since the last annual compliance report; (4) a description of staffing

    and resources set aside for the SEF's compliance program; (5) a

    description of any material compliance matters, including instances of

    noncompliance; (6) any objections to the annual compliance report by

    those persons who have oversight responsibility for the CCO; and (7) a

    certification by the CCO that, to the best of his or her knowledge and

    reasonable belief, and under penalty of law, the annual compliance

    report is accurate and complete.

    (i) Summary of Comments

    FXall and CME asserted that the information required to be included

    in the annual compliance report is too detailed.\849\ FXall, for

    example, commented that the requirements for the annual compliance

    report go beyond those set forth in the Dodd-Frank Act and that

    producing the report will consume considerable resources.\850\ FXall

    proposed alternative requirements, which it believes would be more in-

    line with the requirements in the Dodd-Frank Act.\851\

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

    \849\ FXall Comment Letter at 16-17 (Mar. 8, 2011); CME Comment

    Letter at 7-8 (Feb. 7, 2011).

    \850\ FXall Comment Letter at 16 (Mar. 8, 2011).

    \851\ See id. for details regarding FXall's proposed

    alternatives.

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

    With respect to the requirement in proposed Sec. 37.1501(e)(2)(i)

    to identify policies and procedures that ``ensure'' compliance with the

    core principles, FXall and CME stated that policies and procedures

    cannot ``ensure'' or guaranty compliance, but can only be reasonably

    designed to result in compliance.\852\ CME also recommended that the

    requirement in proposed Sec. 37.1501(e)(5) to describe any material

    compliance matters be revised to require the report to identify ``any

    material non-compliance issues that were not properly addressed.''

    \853\ MarketAxess recommended that the Commission remove proposed Sec.

    37.1501(e)(6) because in its opinion other persons should be able to

    correct the CCO's annual report.\854\

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

    \852\ FXall Comment Letter at 17 (Mar. 8, 2011); CME Comment

    Letter at 7 (Feb. 7, 2011).

    \853\ CME Comment Letter at 7-8 (Feb. 7, 2011).

    \854\ MarketAxess Comment Letter at 26 (Mar. 8, 2011).

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

    MarketAxess and FSR expressed their concern that the CCO's

    certification of the annual compliance report in proposed Sec.

    37.1501(e)(7) may impose strict liability on a CCO where the report

    contains even a minor and insignificant error.\855\ These commenters

    recommended adding a materiality qualifier to the certification.\856\

    Additionally, both FXall and CME recommended that the SEF's senior

    officer, not the CCO, certify the accuracy of the annual compliance

    report.\857\

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

    \855\ MarketAxess Comment Letter at 26 (Mar. 8, 2011); FSR

    Comment Letter at 10 (Mar. 8, 2011).

    \856\ Id.

    \857\ FXall Comment Letter at 15 (Mar. 8, 2011); CME Comment

    Letter at 8 (Feb. 7, 2011).

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

    (ii) Commission Determination

    The Commission is adopting Sec. 37.1501(e) as proposed, subject to

    certain modifications described below. The Commission disagrees with

    the comments from FXall and CME regarding the complexity and the burden

    of the annual compliance report. The annual compliance report is meant

    to provide the Commission with a detailed account of a SEF's compliance

    with the CEA and Commission regulations, as well as a detailed account

    of a SEF's self-regulatory program. The Commission believes that the

    level of detail the proposed rules require, including the requirement

    that the annual report include a description of all noncompliance

    issues identified, is necessary to ensure that the Commission can

    determine the effectiveness of a SEF's compliance and self-regulatory

    programs.\858\

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

    \858\ In this regard, the Commission disagrees with CME's

    recommendation regarding proposed Sec. 37.1501(e)(5).

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

    However, in response to comments, the Commission is revising

    proposed Sec. 37.1501(e)(2)(i) to require that the annual compliance

    report identify ``the policies and procedures that are designed to

    ensure compliance with each subsection and core principle, including

    each duty specified in section 5h(f)(15)(B) of the Act . . .''

    (emphasis added). The Commission is also removing proposed Sec.

    37.1501(e)(6), which requires the annual compliance report to include

    any objections by

    [[Page 33547]]

    those persons who oversee the CCO.\859\ The Commission believes that

    the board of directors \860\ may append its own comments if desired,

    but the statutory text and the Commission's implementing regulations do

    not require it.

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

    \859\ As a result of this deletion, the Commission is adopting

    proposed Sec. 37.1501(e)(7) as Sec. 37.1501(e)(6).

    \860\ If a SEF does not have a board of directors, then the

    senior officer of the SEF may append his or her own comments if

    desired.

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

    The Commission disagrees with the comments from MarketAxess and FSR

    regarding the inclusion of a materiality qualifier to the certification

    requirement. The Commission believes that the current certification

    sufficiently protects the CCO from being held strictly liable for any

    minor inaccuracies because it includes a ``knowledge'' and ``reasonable

    belief'' qualifier. The Commission also disagrees with CME's and

    FXall's comments to have the SEF's CEO, instead of the CCO, certify the

    accuracy of the annual compliance report. While the CEA does not

    explicitly require that the CCO certify the report, it does require

    that the CCO ``annually prepare and sign'' the report, and that the

    report ``include a certification that, under penalty of law, the

    compliance report is accurate and complete.'' \861\ The Commission

    believes that these two requirements read together provide sufficient

    basis for the CCO to certify that the report is accurate and complete.

    However, the Commission is modifying Sec. 37.1501(e) to explicitly

    state that the CCO ``sign'' the annual compliance report in order to

    follow the statutory text more closely.

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

    \861\ CEA section 5h(f)(15)(D); 7 U.S.C. 7b-3(f)15)(D).

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

    (6) Sec. 37.1501(f)--Submission of Annual Compliance Report by Chief

    Compliance Officer to the Commission \862\

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

    \862\ The Commission is renaming the title of this section from

    ``Submission of Annual Compliance Report by Chief Compliance Officer

    to the Commission'' to ``Submission of Annual Compliance Report.''

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

    Proposed Sec. 37.1501(f)(1) required, among other items, that the

    CCO provide the annual compliance report to the board of directors or

    the senior officer for review, prior to submission to the Commission.

    The proposed rule also stated that the board of directors or the senior

    officer may not require the CCO to make any changes to the report.

    Proposed Sec. 37.1501(f)(2) required that the annual compliance report

    be electronically provided to the Commission not more than 60 days

    after the end of the SEF's fiscal year. Proposed Sec. 37.1501(f)(3)

    required the CCO to promptly file an amendment to an annual compliance

    report upon discovery of any material error or omission. Proposed Sec.

    37.1501(f)(4) allowed a SEF to request an extension of time to file its

    compliance report based on substantial, undue hardship. Finally,

    proposed Sec. 37.1501(f)(5) stated that annual compliance reports will

    be treated as exempt from mandatory public disclosure for purposes of

    FOIA \863\ and the Sunshine Act \864\ and parts 145 and 147 of the

    Commission's regulations.

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

    \863\ 5 U.S.C. 552.

    \864\ 5 U.S.C. 552b(b).

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

    (i) Summary of Comments

    Some commenters stated that proposed Sec. 37.1501(f)(1) should be

    modified to allow the board of directors or the senior officer to make

    changes to the annual compliance report.\865\ These commenters

    generally argued that the CCO should be accountable to management and,

    by not permitting the board of directors or the senior officer to

    revise the report, the proposed rule undermines the authority of the

    board of directors.\866\ Better Markets recommended that the CCO should

    be required to present his or her finalized report to the board of

    directors and executive management prior to its submission.\867\ Better

    Markets further recommended that the independent directors and/or the

    Audit Committee, as well as the entire board of directors, review and

    approve the report or detail where and why it disagrees with any

    provision before submission to the Commission.\868\

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

    \865\ FXall Comment Letter at 17-18 (Mar. 8, 2011); WMBAA

    Comment Letter II at 7 (Mar. 8, 2011); MarketAxess Comment Letter at

    26 (Mar. 8, 2011).

    \866\ Id.

    \867\ Better Markets Comment Letter at 20 (Mar. 8, 2011).

    \868\ Id.

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

    With respect to proposed Sec. 37.1501(f)(5), CME recommended that

    the Commission expressly state that annual compliance reports are

    confidential documents that are not subject to public disclosure by

    listing such reports as a specifically exempt item in Commission

    regulation 145.5.\869\

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

    \869\ CME Comment Letter at 9 (Feb. 7, 2011).

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

    (ii) Commission Determination

    The Commission is adopting Sec. 37.1501(f) as proposed, subject to

    two modifications described below. The Commission has determined not to

    adopt the commenters' recommendation to allow the board of directors or

    the senior officer to make changes to the annual compliance report. The

    Commission believes that allowing the board of directors or the senior

    officer to make changes to the report would prevent the CCO from making

    a complete and accurate assessment of a SEF's compliance program. The

    Commission has determined not to adopt the recommendation by Better

    Markets that the board of directors approve the annual compliance

    report or detail any disagreement. The Commission believes that

    requiring the board of directors to approve the report increases the

    risk that the CCO would be subject to undue influence by the board or

    by management. The Commission notes that the board of directors may

    include its own opinion of the annual compliance report if it disagrees

    with the CCO's assessment. The Commission believes that the rule

    strikes the appropriate balance between ensuring that the board of

    directors cannot adversely influence the content of the annual

    compliance report and granting the board the opportunity to express its

    opinion of the report to the Commission.

    The Commission is revising proposed Sec. 37.1501(f)(2) to clarify

    that a SEF shall submit its annual compliance report to the Commission

    concurrently with the SEF's filing of its fourth fiscal quarter

    financial report pursuant to Sec. 37.1306. The Commission is making

    this technical correction because CEA section 5h(f)(15)(D)(ii) sets

    forth such a requirement, which was inadvertently omitted from the

    proposed rules.\870\

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

    \870\ CEA section 5h(f)(15)(D)(ii); 7 U.S.C. 7b-3(f)(15)(D)(ii).

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

    Additionally, the Commission is withdrawing proposed Sec.

    37.1501(f)(5). The Commission acknowledges CME's concern regarding the

    public release of annual compliance reports and clarifies that the

    Commission does not intend to make annual compliance reports public.

    However, where such information is, in fact, confidential, the

    Commission encourages SEFs to submit a written request for confidential

    treatment of such filings under FOIA, pursuant to the procedures

    established in section 145.9 of the Commission's regulations.\871\ The

    determination of whether to disclose or exempt such information in the

    context of a FOIA proceeding would be governed by the provisions of

    part 145 and any other relevant provision.

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

    \871\ 17 CFR 145.9.

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

    (7) Sec. 37.1501(g)--Recordkeeping

    Proposed Sec. 37.1501(g)(1) generally stated that a SEF must

    maintain the following records: (i) A copy of written policies and

    procedures adopted in furtherance of compliance with the Act and

    Commission regulations; (ii) copies

    [[Page 33548]]

    of all materials created in furtherance of the CCO's duties listed in

    paragraphs (d)(6) and (d)(7) of proposed Sec. 37.1501; (iii) copies of

    all materials in connection with the review and submission of the

    annual compliance report; and (iv) any records relevant to a SEF's

    annual report. Proposed Sec. 37.1501(g)(2) required a SEF to maintain

    these records in accordance with Sec. 1.31 and part 45 of the

    Commission's regulations.

    (i) Summary of Comments

    MarketAxess commented that the final rule should provide an

    exception for legally privileged materials.\872\ MarketAxess argued

    that it is unreasonable for the Commission to take the position that a

    CCO should not be able to receive privileged advice from counsel in an

    effort to comply with these new, complex, and uncertain rules.\873\

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

    \872\ MarketAxess Comment Letter at 27 (Mar. 8, 2011).

    \873\ Id.

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

    (ii) Commission Determination

    The Commission is adopting Sec. 37.1501(g) as proposed.\874\ The

    Commission does not believe that Sec. 37.1501(g) changes existing

    Commission policies regarding the assertion of attorney-client

    privilege by registrants. As stated in the SEF NPRM, the Commission

    designed Sec. 37.1501(g) to ensure that the Commission staff would be

    able to obtain the necessary information to determine whether a SEF has

    complied with the CEA and applicable regulations.\875\ The Commission

    believes that proposed Sec. 37.1501(g) properly accomplishes this

    goal.

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

    \874\ The Commission is making certain non-substantive

    clarifications to Sec. 37.1501(g). In addition, the Commission is

    revising the citation to paragraphs ``(d)(6) and (d)(7)'' in

    proposed Sec. 37.1501(g)(1)(ii) to cite to paragraphs ``(d)(8) and

    (d)(9).'' The Commission notes that this was a drafting error.

    \875\ Core Principles and Other Requirements for Swap Execution

    Facilities, 76 FR at 1235.

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

    Finally, the Commission is adding new Sec. 37.1501(h) titled

    ``Delegation of authority'' to the final SEF rules to delegate

    authority to the Director of DMO to grant or deny a swap execution

    facility's request for an extension of time to file its annual

    compliance report under paragraph (f)(4) of Sec. 37.1501.

    III. Related Matters

    A. Regulatory Flexibility Act

    The Regulatory Flexibility Act (``RFA'') \876\ requires federal

    agencies, in promulgating regulations, to consider the impact of those

    regulations on small entities. The regulations adopted herein will

    affect SEFs. The Commission has previously established certain

    definitions of ``small entities'' to be used by the Commission in

    evaluating the impact of its regulations on small entities in

    accordance with the RFA.\877\ In addition, the Commission has

    previously determined that DCMs, derivatives transaction execution

    facilities (``DTEFs''), exempt commercial markets (``ECMs''), exempt

    boards of trade (``EBOTs''), and DCOs are not small entities for the

    purpose of the RFA.\878\

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

    \876\ 5 U.S.C. 601 et seq.

    \877\ See 47 FR 18618-21 (Apr. 30, 1982).

    \878\ See 47 FR 18618, 18619 (Apr. 30, 1982) discussing DCMs; 66

    FR 42256, 42268 (Aug. 10, 2001) discussing DTEFs, ECMs, and EBOTs;

    and 66 FR 45604, 45609 (Aug. 29, 2001) discussing DCOs.

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

    While SEFs are new entities to be regulated by the Commission

    pursuant to the Dodd-Frank Act,\879\ in the SEF NPRM the Commission

    proposed that SEFs should not be considered as small entities for the

    purpose of the RFA for essentially the same reasons that DCMs and DCOs

    have previously been determined not to be small entities.\880\ The

    Commission received no comments on the impact of the rules contained

    herein on small entities. Therefore, the Chairman, on behalf of the

    Commission, hereby certifies, pursuant to 5 U.S.C. 605(b), that the

    regulations will not have a significant economic impact on a

    substantial number of small entities.

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

    \879\ Dodd Frank Wall Street Reform and Consumer Protection Act,

    Public Law 111-203, 124 Stat. 1376 (2010).

    \880\ Core Principles and Other Requirements for Swap Execution

    Facilities, 76 FR at 1235.

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

    B. Paperwork Reduction Act

    The Paperwork Reduction Act (``PRA'') \881\ imposes certain

    requirements on federal agencies in connection with their conducting or

    sponsoring any collection of information as defined by the PRA. An

    agency may not conduct or sponsor, and a person is not required to

    respond to, a collection of information unless it displays a currently

    valid control number issued by the Office of Management and Budget

    (``OMB''). This final rulemaking contains new collection of information

    requirements within the meaning of the PRA. Accordingly, in connection

    with the SEF NPRM, the Commission submitted an information collection

    request, titled ``Core Principles and Other Requirements for Swap

    Execution Facilities,'' to OMB for its review and approval in

    accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11. Additionally,

    pursuant to 44 U.S.C. 3506(c)(2)(B), the Commission, in the SEF NPRM,

    requested comments from the public on the proposed information

    collection requirements in order to, among other items, evaluate the

    necessity of the proposed collections of information and minimize the

    burden of the information collection requirements on respondents.\882\

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

    \881\ 44 U.S.C. 3501 et seq.

    \882\ Core Principles and Other Requirements for Swap Execution

    Facilities, 76 FR at 1236.

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

    On April 28, 2011, OMB assigned control number 3038-0074 to this

    collection of information, but withheld final approval pending the

    Commission's resubmission of the information collection, which includes

    a description of the comments received on the collection and the

    Commission's responses thereto. The Commission has revised some of its

    proposed estimates of the number of mandatory responses in order to

    clarify the Commission's original intent; otherwise, the proposed

    burden hour estimates are being adopted as discussed herein. The

    Commission has submitted the revised information collection request to

    OMB for its review, which will be made available by OMB at http://www.reginfo.gov/public/do/PRAMain.

    As noted in the SEF NPRM, the Commission will protect proprietary

    information according to the Freedom of Information Act and 17 CFR part

    145, ``Commission Records and Information.'' In addition, section

    8(a)(1) of the CEA strictly prohibits the Commission, unless

    specifically authorized by the CEA, from making public ``data and

    information that would separately disclose the business transactions or

    market positions of any person and trade secrets or names of

    customers.'' \883\ The Commission is also required to protect certain

    information contained in a government system of records according to

    the Privacy Act of 1974.\884\

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

    \883\ 7 U.S.C. 12(a)(1).

    \884\ 5 U.S.C. 552a.

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

    1. Proposed Collection of Information

    In the SEF NPRM, the Commission estimated that each SEF respondent

    would have an average annual reporting burden of 308 hours.\885\ In

    deriving this estimate, the Commission compared the reporting

    requirements for other entities that fall under the Commission's

    regulatory oversight, such as an Exempt Commercial Market with a

    significant price discovery contract (``SPDC ECM''), a DTEF, and a

    DCM.\886\ Specifically, the Commission estimated that a SEF will have

    more reporting requirements than a SPDC ECM and a DTEF, but fewer

    [[Page 33549]]

    reporting requirements than a DCM (as most recently calculated).\887\

    The Commission employed an average of its most recent hourly burdens

    for DCMs, DTEFs, and SPDC ECMs.\888\ Those hourly burdens provided in

    the SEF NPRM are noted below:

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

    \885\ Core Principles and Other Requirements for Swap Execution

    Facilities, 76 FR at 1236.

    \886\ Id.

    \887\ Id. SPDC ECMs were subject to 9 core principles, DTEFs

    were subject to 9 core principles, and DCMs are subject to 23 core

    principles. SEFs will be subject to 15 core principles. Id. at 1236

    n. 124.

    \888\ Id. at 1236.

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

    Current estimate of DCM's annual burden: 440 hours per DCM 889

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

    \889\ After passage of the Commodity Futures Modernization Act

    of 2000 and a switch to the core principles framework for DCMs, the

    Commission estimated that the recordkeeping and reporting

    obligations imposed by part 38 would total 300 burden hours per DCM.

    See A New Regulatory Framework for Trading Facilities,

    Intermediaries and Clearing Organizations, 66 FR 42256, 42268 (Aug.

    10, 2001); 66 FR 14262, 14268 (proposed Mar. 9, 2001). In 2007, the

    Commission amended the acceptable practices in part 38 for

    minimizing conflicts of interest, estimating that the amendments

    would increase the information collection and reporting burden by an

    additional 70 hours per DCM. See Conflicts of Interest in Self-

    Regulation and Self-Regulatory Organizations (``SROs''), 72 FR 6936,

    6957 (Feb. 14, 2007); 71 FR 38740, 38748 (proposed Jul. 7, 2006).

    Most recently, the Commission adopted revisions to part 38 to

    implement the Dodd-Frank Act, estimating that the revisions would

    increase the information collection and reporting burden by an

    additional 70 hours per DCM. See Core Principles and Other

    Requirements for Designated Contract Markets, 77 FR 36612, 36662

    (Jun. 19, 2012). The average for purposes of the initial burden hour

    estimate for SEFs averages both initial estimates for DCMs with the

    other most recent estimates.

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

    Initial estimate of DTEF's annual burden: 200 hours per DTEF 890

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

    \890\ A New Regulatory Framework for Trading Facilities,

    Intermediaries and Clearing Organizations, 66 FR at 42268; 66 FR at

    14268.

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

    Initial estimate of SPDC ECM's annual burden: 233 hours per ECM 891

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

    \891\ Significant Price Discovery Contracts on Exempt Commercial

    Markets, 74 FR 12178, 12187 (Mar. 23, 2009); 73 FR 75888, 75902

    (proposed Dec. 12, 2008).

    In the SEF NPRM, the Commission estimated that 30 to 40 SEFs will

    register with the Commission as a result of the Dodd-Frank Act.\892\

    Therefore, the Commission estimated the annual aggregate hour burden

    for all respondents to be 10,780 hours.\893\ Based on an hourly rate of

    $52,\894\ the Commission estimated that respondents may expend up to

    $16,016 annually to comply with the proposed regulations.\895\ This

    would result in an aggregate cost across all SEF respondents of

    $560,560 per annum (35 respondents x $16,016).\896\ The SEF NPRM also

    provided the following summary of estimates:

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

    \892\ Core Principles and Other Requirements for Swap Execution

    Facilities, 76 FR at 1236. For hourly reporting requirements, an

    average of 35 SEFs was used for calculation purposes. Id. at 1236 n.

    125.

    \893\ Id. at 1236.

    \894\ In arriving at a wage rate for the hourly costs imposed,

    the Commission consulted the Management and Professional Earnings in

    the Securities Industry Report, published in 2010 by the Securities

    Industry and Financial Markets Association (SIFMA Report). The wage

    rate is a composite (blended) wage rate arrived at by averaging the

    mean annual salaries of an Assistant/Associate General Counsel, an

    Assistant Compliance Director, a Senior Programmer, and a Senior

    Treasury/Cash Management Manager as published in the SIFMA Report

    and dividing that figure by 2,000 annual work hours to arrive at the

    hourly rate of $52.

    \895\ Core Principles and Other Requirements for Swap Execution

    Facilities, 76 FR at 1236.

    \896\ Id.

    Estimated number of respondents: 35

    Annual responses by each respondent: 1

    Total annual responses: 35

    Quarterly responses by each respondent: 4

    Total quarterly responses: 140

    Estimated average hours per response: 308

    Aggregate annual reporting hours burden: 10,780 897

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

    \897\ 308 average hours per respondent x 35 respondents = 10,780

    total hours/year. Id.

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

    2. Summary of Comments and Commission Response

    While no commenter directly addressed the proposed aggregate burden

    hour estimate, the Commission did receive comments related to the costs

    of various recordkeeping and reporting requirements in the proposed

    rules.

    (a) Sec. 37.3--Requirements and Procedures for Registration

    WMBAA commented that the Commission could reduce the regulatory

    burden of the registration procedures by reconciling its Form SEF with

    the SEC's registration form such that a potential SEF will have to fill

    out only one form.\898\ Similarly, MarketAxess stated that it is costly

    and inefficient for a SEF that is required to be registered by both the

    Commission and SEC to go through two full registration processes, and

    that the Commission instead should permit ``notice'' or ``passport''

    registration of an SB-SEF already registered with the SEC.\899\ While

    the Commission acknowledges notice registration under section 5h(g) of

    the Act, it notes that the registration requirements for SEFs may

    differ from the registration requirements for SB-SEFs and thus the

    Commission must conduct an independent review of a SEF applicant's

    registration application to ensure that the potential SEF's proposed

    trading models and operations comply with the Commission's

    requirements. Given such differing requirements, the Commission also

    notes that Form SEF may differ from the SEC's registration form.

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

    \898\ WMBAA Comment Letter at 14 (Mar. 8, 2011).

    \899\ MarketAxess Comment Letter at 20-21 (Mar. 8, 2011).

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

    With respect to temporary registration, the Commission has

    eliminated the requirement from the SEF NPRM that an applicant provide

    transaction data that substantiates that the execution or trading of

    swaps has occurred and continues to occur on the applicant's trading

    system or platform at the time the applicant submits its temporary

    registration request. The Commission has also eliminated the

    certification requirement that an applicant believes that when it

    operates under temporary registration it will meet the requirements of

    part 37 of the Commission's regulations. Instead, the Commission has

    revised the temporary registration provisions to require a SEF

    applicant that is already operating a swaps-trading platform, in

    reliance upon either an exemption granted by the Commission or some

    form of no-action relief granted by the Commission staff, to include in

    the temporary registration notice a certification that it is operating

    pursuant to such exemption or no-action relief. The Commission believes

    that these revisions will not materially affect the proposed part 37

    information collection estimate.

    (b) Sec. 37.4--Procedures for Listing Products and Implementing Rules

    CME commented that the proposed product and rule certification

    process substantially increased the documentation burden, which in turn

    would increase the cost and amount of time it takes to list new

    products and implement new rules, with no corresponding benefit to the

    public.\900\ While CME cited the 8,300 additional aggregate hours that

    product and rule submissions were estimated to impose on all registered

    entities,\901\ the Commission notes that this figure was already

    accounted for in the Commission's information collection estimate in

    the part 40 rulemaking titled ``Provisions Common to Registered

    Entities.'' \902\ Therefore, the burden

    [[Page 33550]]

    associated with that information collection is not duplicated here.

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

    \900\ CME Comment Letter at 10, 13 (Feb. 22, 2011).

    \901\ Id. at 10.

    \902\ Provisions Common to Registered Entities, 76 FR 44776,

    44789 (Jul. 27, 2011). The Commission also notes that the annual

    burden hour estimate for DCMs that was used to calculate the annual

    burden hour estimate for SEFs in this part 37 rulemaking did not

    include the recordkeeping and reporting hours accounted for in the

    part 40 rulemaking's information collection estimate. Therefore,

    there is no double counting of hours for product and rule

    submissions. Furthermore, the Commission notes that, similar to the

    DCM rulemaking, many of the collection burdens associated with this

    part 37 rulemaking are covered by other existing or pending

    collections of information. Therefore, only those burdens that are

    not covered elsewhere are included in this collection of

    information.

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

    (c) Sec. 37.5(c)--Equity Interest Transfers

    CME commented that the ``level of immediacy'' contemplated by the

    24-hour timeframe for submitting agreements with the notification to

    the Commission of an equity interest transfer in proposed Sec. 37.5(c)

    may be unrealistic.\903\ CME further commented that the representation

    of compliance with the requirements of CEA section 5h and the

    Commission's regulations adopted thereunder would be more appropriate

    if required upon consummation of the equity interest transfer, rather

    than with the initial notification.\904\ In this final rulemaking, the

    Commission has revised proposed Sec. 37.5(c) to remove references to

    specific documents that must be provided with the equity transfer

    notification, and instead provided that the Commission may request

    supporting documentation. The Commission has also revised the proposed

    rule to increase the threshold of when a SEF must file an equity

    interest transfer notification with the Commission from ten percent to

    fifty percent and has extended the time period for a SEF to file the

    notification to up to ten business days from one business day under the

    proposed rule. In addition, the Commission has deleted the requirement

    for a SEF to provide a representation of compliance with section 5h of

    the Act and the Commission regulations thereunder with the equity

    interest transfer notification, as requested by CME. The Commission

    notes that these revisions should slightly reduce the burden of the

    information collection requirements for those respondents who are not

    requested to provide supporting documentation.

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

    \903\ CME Comment Letter at 13 (Feb. 22, 2011).

    \904\ Id.

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

    (d) Sec. 37.202(b)--Jurisdiction

    CME stated that it would be costly for a SEF to obtain every

    customer's consent to its regulatory jurisdiction as required by

    proposed Sec. 37.202(b).\905\ As noted in the preamble, the Commission

    believes that jurisdiction must be established by a SEF prior to

    granting members and market participants access to its markets in order

    to effectuate the statutory mandate of Core Principle 2 that a SEF

    shall have the capacity to detect, investigate, and enforce rules of

    the SEF. The Commission notes that any information collection costs

    associated with this rule is covered by the Commission's information

    collection estimate.

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

    \905\ Id. at 16.

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

    (e) Sec. 37.203(f)--Investigations and Investigation Reports

    CME stated that minor transgressions could be handled effectively

    through the issuance of a warning letter rather than a formal

    investigatory report.\906\ As explained in the preamble, the Commission

    clarifies that warning letters may be issued for minor transgressions;

    however, no more than one warning letter may be issued to the same

    person or entity found to have committed the same rule violation more

    than once within a rolling 12-month period. The Commission also

    clarifies that the limit on the number of warning letters is not

    applicable when a rule violation has not been found. The Commission

    believes that these clarifications will not materially affect the

    proposed part 37 information collection estimate.

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

    \906\ Id. at 22.

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

    (f) Sec. 37.205--Audit Trail

    WMBAA commented that the proposed audit trail requirement in Sec.

    37.205(b) to retain records of customer orders should not apply to

    indicative quotes because it would be burdensome and costly.\907\ As

    discussed in the preamble, the Commission believes that this

    requirement is necessary so that a SEF has a complete picture of all

    trading activity in order to carry out its statutory mandate to monitor

    its markets to detect abusive trading practices and trading rule

    violations. The Commission accounted for this recordkeeping requirement

    in the proposed burden hour estimate; therefore, the estimate remains

    unaffected.

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

    \907\ WMBAA Comment Letter at 23 (Mar. 8, 2011).

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

    (g) Sec. 37.404--Ability to Obtain Information

    WMBAA commented that the requirement for SEFs to mandate that

    traders maintain trading and financial records is not required under

    the Act.\908\ The Commission notes that market participants' trading

    records are an invaluable tool in its surveillance efforts and believes

    that a SEF should have direct access to such information in order to

    discharge its obligations under the SEF core principles. However, as

    noted in the preamble, the Commission states in the guidance that SEFs

    may limit the application of this requirement to those market

    participants who conduct substantial trading on their facility. The

    Commission notes that the requirement for market participants to keep

    such records is sound commercial practice, and that market participants

    are likely already maintaining such trading records; therefore, the

    Commission believes that the revision above will not materially affect

    the proposed part 37 information collection estimate.

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

    \908\ Id. at 26.

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

    (h) Sec. 37.703--Monitoring for Financial Soundness

    FXall commented that SEFs would be burdened by the ``onerous

    financial surveillance obligations'' of proposed Sec. 37.703, which

    include the routine review of members' financial records.\909\ The

    Commission agrees that burdensome financial surveillance obligations

    may lead to higher transaction costs; therefore, as discussed in the

    preamble, the Commission has revised the proposed rule to state that

    SEFs must monitor their market participants to ensure that they

    continue to qualify as ECPs. The Commission believes that this revision

    will not materially affect the proposed part 37 information collection

    estimate and is thus maintaining the estimate.

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

    \909\ FXall Comment Letter at 3 (Mar. 8, 2011).

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

    (i) Sec. 37.1306--Financial Resources Reporting to the Commission

    MarketAxess commented that the financial resources reporting

    requirements are unnecessary and burdensome and recommended that the

    Commission allow a senior officer of the SEF to represent to the

    Commission that it satisfies the financial resources requirements.\910\

    The Commission disagrees with MarketAxess and, as discussed in the

    preamble, believes that much of the information required by the reports

    should be readily available to a SEF in the ordinary course of

    business. The Commission's proposed burden hour estimate includes this

    reporting requirement.

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

    \910\ MarketAxess Comment Letter at 40 (Mar. 8, 2011).

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

    (j) Sec. 37.1401--System Safeguards Requirements

    CME commented that the requirements to notify the Commission staff

    of all system security-related events and all planned changes to

    automated systems that may impact the reliability, security, or

    scalability of the systems are overly burdensome.\911\ As noted in the

    preamble, the Commission has revised the rule to only require

    notification of material system malfunctions and material planned

    system changes. While

    [[Page 33551]]

    these revisions should decrease the regulatory burden imposed by the

    rule, the Commission believes that, given the infrequent nature of the

    information collection requirement as originally proposed, the effect

    of the revisions should be de minimis and therefore not affect the

    proposed burden hour estimate.

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

    \911\ CME Comment Letter at 36-37 (Feb 22, 2011).

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

    (k) Sec. 37.1501(e)--Preparation of Annual Compliance Report

    FXall commented that the information required by the proposed

    regulations to be included in the annual compliance report is too

    detailed and will be too costly to compile.\912\ The Commission is not

    persuaded by FXall's comment, and notes that the annual compliance

    report is meant to be the primary tool by which the Commission can

    evaluate the effectiveness of a SEF's compliance and self-regulatory

    programs, thus requiring a high level of detail. The Commission's

    proposed burden hour estimate includes the annual compliance report

    requirement.

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

    \912\ FXall Comment Letter at 16 (Mar. 8, 2011).

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

    3. Final Burden Estimate

    The final regulations require each respondent to file information

    with the Commission. For instance, SEF applicants must file

    registration applications with the Commission pursuant to Sec. 37.3.

    SEFs must record, report, and disclose information related to prices,

    trading volume, and other trading data for swaps pursuant to Core

    Principles 9 and 10 (``Timely Publication of Trading Information'' and

    ``Recordkeeping and Reporting''). In general, the collections of

    information are required to demonstrate a SEF's operational capability

    and are a tool by which both the SEF and the Commission can evaluate

    the effectiveness of a SEF's self-regulatory programs.

    The mandatory information collections are contained in several of

    the general provisions being adopted in subpart A, as well as in

    certain regulations implementing Core Principles 2, 3, 4, 5, 7, 8, 9,

    10, 13, 14, and 15. Generally, the information collections covered in

    this final part 37 rulemaking are not covered in other existing

    collections or collections that are being established in connection

    with other Dodd-Frank rulemakings, and pertain to the following general

    categories of recordkeeping and reporting: registration; submissions

    related to material changes in the SEF's operations or business

    structure; compliance; financial resources reports, and an annual

    report by the CCO related to the SEF's performance of its self-

    regulatory responsibilities.

    As discussed above, the methodology used to formulate the proposed

    estimate was an average of other registered entities. Due to the

    relatively low magnitude of changes made to the mandatory information

    collection provisions in this final part 37 rulemaking, the Commission

    has determined not to alter its proposed estimate of 308 hours per SEF

    respondent. By definition, averages are meant to serve as only a

    reference point; the Commission understands that due to both

    discretionary and mandatory requirements, some SEFs may go above the

    final estimate of 308 hours to complete mandatory information

    collection requirements, while others may stay below. The Commission

    is, however, adjusting the proposed estimate of annual and quarterly

    responses to clarify the Commission's original intent. In this regard,

    the Commission is adding an estimated average hours per response number

    below, which is based on 5 responses per year (1 annual response and 4

    quarterly responses) per respondent.

    Estimated number of respondents: 35

    Annual responses by each respondent: 1 \913\

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

    \913\ Under Sec. 37.1501, the SEF's CCO is required to submit

    to the Commission annually a compliance report.

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

    Total annual responses: 35

    Quarterly responses by each respondent: 1 \914\

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

    \914\ Under Sec. 37.1306, a SEF is required to submit to the

    Commission each fiscal quarter a report of its financial resources

    available to meet the financial resources requirements of Core

    Principle 13.

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

    Total quarterly responses: 140 \915\

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

    \915\ 1 quarterly response x 4 quarters per year x 35

    respondents.

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

    Estimated average hours per response: 62 \916\

    ---------------------------------------------------------------------------

    \916\ 308 average burden hours per respondent/5 responses total

    per year (1 annual response and 4 quarterly responses) = 61.6

    average hours per response.

    ---------------------------------------------------------------------------

    Aggregate annual reporting hours burden: 10,780

    Therefore, the Commission estimates that based on 35 registered

    SEFs, this final part 37 rulemaking will result in 10,780 information

    collection hours across all respondents.\917\

    ---------------------------------------------------------------------------

    \917\ 5 responses total per year x 61.6 average hours per

    response x 35 respondents.

    ---------------------------------------------------------------------------

    4. Aggregate Information Burden

    The Commission concludes that new information collection 3038-0074

    will result in each SEF respondent expending, on average, $16,632

    annually based on an hourly wage rate of $54 to comply with the

    recordkeeping and reporting requirements of this final part 37

    rulemaking.\918\ In aggregate, this will result in a cost to all SEF

    respondents of $582,120 per annum based on 35 expected respondents.

    This aggregate cost estimate has been adjusted from the estimate in the

    SEF NPRM to account for updated wage rate data.\919\

    ---------------------------------------------------------------------------

    \918\ See supra footnote 894 for a discussion of the wage rate.

    The Commission has revised the wage rate to $54 per hour based on

    data from the 2011 SIFMA Report.

    \919\ While the Commission recognizes that some estimates cited

    in the following cost-benefit consideration section suggest that

    reporting and recordkeeping requirements may result in a much higher

    aggregate cost to SEFs and market participants, it notes that all of

    the estimates provided therein account for more than pure

    recordkeeping and reporting costs subject to the PRA. Therefore, the

    Commission has not considered those estimates for purposes of

    reaching its final burden hour estimate and aggregate cost

    projection.

    ---------------------------------------------------------------------------

    C. Cost Benefit Considerations

    1. Introduction

    Section 15(a) of the Commodity Exchange Act (``CEA'' or ``Act'')

    mandates that the Commodity Futures Trading Commission (``Commission''

    or ``CFTC'') consider the costs and benefits of the regulations that it

    is adopting in this rulemaking to implement the statutory requirements

    for the registration and operation of swap execution facilities

    (``SEFs''), a new type of regulated marketplace for the trading and

    execution of financial derivative contracts known as swaps.\920\ In

    considering the costs and benefits of the final SEF regulations, the

    Commission has grouped the same into the following categories--SEF

    Market Structure, Registration, Recordkeeping and Reporting,

    Compliance, Monitoring and Surveillance, Financial Resources and

    Integrity, and Emergency Operations and System Safeguards.

    ---------------------------------------------------------------------------

    \920\ CEA section 15(a); 7 U.S.C. 19(a). A more complete

    explanation of this statutory requirement is provided below. See

    infra section 1(b) of this Cost Benefit Considerations section.

    Swaps, futures, and options are collectively referred to as

    derivatives--contracts used by market participants to hedge against

    the risk of a future change in prices, such as commodity prices,

    interest rates, and exchange rates.

    ---------------------------------------------------------------------------

    Several preliminary matters, however, provide background for the

    Commission's consideration of the costs and benefits of the rules

    adopted in this release. Discussed in this Introduction section, these

    preliminary matters are: (a) The circumstances and events that form the

    backdrop for the statutory requirements that this rulemaking

    implements; (b) the Commission's statutory mandate to consider costs

    and benefits and its methodology for doing so; and (c) the estimated

    aggregate costs of forming and operating a SEF.

    [[Page 33552]]

    (a) Background

    An appreciation of certain background elements is helpful to

    understand the costs and benefits of this rulemaking. These are: (i)

    The definition of the derivative financial transactions (i.e., swaps)

    that will be executed on SEFs; (ii) the execution and regulation of

    swaps prior to the Dodd-Frank Act; (iii) the 2008 financial crisis and

    the role of the over-the-counter (``OTC'') swaps market; (iv) the new

    regulatory regime to reform the swaps market in Title VII of the Dodd-

    Frank Act; and, more specifically, (v) the role and purpose of SEFs

    within the Title VII regulatory regime. Each of these background

    elements is discussed below.

    (1) The Definition of a Swap

    Congress defined the term ``swap'' in the Dodd-Frank Act.\921\ The

    statutory definition of the term ``swap'' includes, in part, any

    agreement, contract, or transaction ``that provides for any purchase,

    sale, payment, or delivery (other than a dividend on an equity

    security) that is dependent on the occurrence, nonoccurrence, or the

    extent of the occurrence of an event or contingency associated with a

    potential financial, economic, or commercial consequence.'' \922\ The

    statutory definition, among other things, generally includes options

    (other than options on futures) as well as transactions that now or in

    the future are commonly known to the trade as swaps.\923\ The

    definition also articulates a broad range of underlying interests upon

    which a swap may be based: ``1 or more interest or other rates,

    currencies, commodities, securities, instruments of indebtedness,

    indices, quantitative measures, or other financial or economic

    interests or property of any kind . . .'' \924\ or ``the occurrence,

    nonoccurrence, or the extent of the occurrence of any event or

    contingency associated with a potential financial, economic, or

    commercial consequence.'' \925\ In a joint rulemaking with the

    Securities and Exchange Commission (``SEC''), the Commission also

    adopted rules further defining the term ``swap.'' \926\

    ---------------------------------------------------------------------------

    \921\ See Dodd-Frank Act section 721(a)(21), adding CEA section

    1a(47). 7 U.S.C. 1a(47).

    \922\ CEA section 1a(47)(A)(ii); 7 U.S.C. 1a(47)(A)(ii).

    \923\ CEA section 1a(47)(A)(i) & (iv); 7 U.S.C. 1a(47)(A)(i) &

    (iv). Futures are not within the definition of swap and remain

    separately subject to requirements of the CEA. See CEA section

    1a(47)(B)(i); 7 U.S.C. 1a(47)(B)(i).

    \924\ CEA section 1a(47)(A)(i) & (iii); 7 U.S.C. 1a(47)(A)(i) &

    (iii).

    \925\ CEA section 1a(47)(A)(ii); 7 U.S.C. 1a(47)(A)(ii).

    \926\ See Further Definition of ``Swap,'' ``Security-Based

    Swap,'' and ``Security-Based Swap Agreement''; Mixed Swaps;

    Security-Based Swap Agreement Recordkeeping, 77 FR 48208 (Aug. 13,

    2012).

    ---------------------------------------------------------------------------

    (2) The Execution and Regulation of Swaps Prior to the Dodd-Frank Act

    Unlike futures contracts which are regulated by the Commission and

    are listed for trading on exchanges called designated contract markets

    (``DCMs''), swap transactions (excluding some exchange-traded options

    encompassed by the post-Dodd-Frank Act definition) evolved off-

    exchange--largely to provide customized solutions for unique risk

    management needs that exchange-traded products addressed less

    effectively--lending themselves to the often used label of ``OTC

    derivatives.'' Accordingly, many swap transactions prior to the Dodd-

    Frank Act were negotiated privately OTC between counterparties.\927\ In

    these situations, only the counterparties knew that the swap

    transaction was taking place, and regulators and other market

    participants lacked access to pricing information during the

    negotiation phase (pre-trade) and after the agreement was consummated

    (post-trade). While centralized exchanges permit multiple market

    participants to compare, assess, accept, or reject bids (offers to buy)

    and asks (offers to sell), the privately negotiated OTC market provided

    little, if any, pre- or post-trade transparency.\928\

    ---------------------------------------------------------------------------

    \927\ The Commission notes that privately negotiated swap

    transactions between counterparties is only one method to execute or

    trade a swap transaction in the OTC market. Counterparties in the

    OTC market may execute or trade swap transactions through many

    trading methods such as order books, RFQ systems, or systems that

    incorporate electronic and voice components.

    \928\ Absent a centralized trading mechanism such as a limit

    order book, buyers and sellers ``negotiated terms privately, often

    in ignorance of prices currently available from other potential

    counterparties and with limited knowledge of trades recently

    negotiated elsewhere in the market. OTC markets are thus said to be

    relatively opaque; investors are somewhat in the dark about the most

    attractive available terms and conditions and about whom to contact

    for attractive terms.'' Darrell Duffie, Dark Markets: Asset Pricing

    and Information Transmission in Over-the-Counter Markets 1

    (Princeton University Press) (2012).

    ---------------------------------------------------------------------------

    In a typical privately negotiated OTC swap transaction, a customer

    for a swap is likely to obtain a private quote from, and bilaterally

    negotiate contract terms with, one of a small number of market-making

    dealers. These dealers, often large financial institutions, may stand

    ready to take either a long position (if they want to buy) or a short

    position (if they want to sell), profiting from spreads (the difference

    between the bid and the offer price) and fees. Relative to their non-

    dealer (usually ``buy-side'') counterparties, these dealers enjoy

    asymmetric information advantages.\929\ The Commodity Futures

    Modernization Act of 2000 (``CFMA'')--which largely excluded swaps

    transacted between ``eligible contract participants'' \930\ from

    regulation under the CEA--reinforced this outcome.\931\ Swaps remained

    largely insulated from regulation prior to the enactment of the Dodd-

    Frank Act.\932\

    ---------------------------------------------------------------------------

    \929\ Asymmetric information exists when one party to a

    transaction has more or better information than the other. In the

    context of the swaps market, as dealers are always on one side of a

    large fraction of trades, it is highly likely that they will have

    better information on prevailing market conditions and valuations

    compared to their non-dealer counterparties. See Michael Fleming,

    John Jackson, Ada Li, Asani Sarkar & Patricia Zobel, ``An Analysis

    of OTC Interest Rate Derivatives Transactions: Implications for

    Public Reporting,'' Federal Reserve Bank of New York Staff Reports,

    No. 557, at 6 n. 14 (Mar. 2012), available at http://www.newyorkfed.org/research/staff_reports/sr557.pdf. Major

    derivatives dealer activity accounts for 89% of the total interest

    rate swap activity in notional terms. Id.

    \930\ CEA section 1a(18); 7 U.S.C. 1a(18).

    \931\ Under the CFMA, prior to the adoption of Title VII of the

    Dodd-Frank Act, swaps based on exempt commodities--including energy

    and metals--could be traded among eligible contract participants

    without CFTC regulation, but certain CEA provisions against fraud

    and manipulation continued to apply to these markets. No statutory

    exclusions were provided for swaps on agricultural commodities by

    the CFMA, although they could be traded under certain regulatory

    exemptions provided by the CFTC prior to its enactment. Swaps based

    on securities were subject to certain SEC enforcement authorities,

    but the SEC was prohibited from prophylactic regulation of such

    swaps. See Commodity Futures Modernization Act of 2000, Pub. L. 106-

    554, 114 Stat. 2763 (2000). The Financial Crisis Inquiry Commission

    majority found that the CFMA ``effectively shielded OTC derivatives

    from virtually all regulation or oversight,'' and ``OTC derivatives

    markets boomed'' in the law's wake, increasing ``more than

    sevenfold'' after the CFMA was enacted. See The 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 (Official Government Edition),

    at 48, 364 (2011) (hereinafter the ``FCIC Report''), available at

    http://www.gpo.gov/fdsys/pkg/GPO-FCIC/pdf/GPO-FCIC.pdf.

    \932\ Legislative history indicates that in enacting the Dodd-

    Frank Act, Congress recognized that OTC market opacity, combined

    with the availability of superior price information primarily to

    dealers, limited the ability of swaps customers ``to shop for the

    best price or rate.'' See Mark Jickling & Kathleen Ann Ruane, ``The

    Dodd-Frank Wall Street Reform and Consumer Protection Act: Title

    VII, Derivatives,'' Cong. Research Serv., R41398, at 7 (Aug. 30,

    2010). See also S. Rep. No. 111-176, at 30 (2010) (``Information on

    [OTC derivative contract] prices and quantities is opaque. . . .

    This can lead to inefficient pricing and risk assessment for

    derivatives users and leave regulators ill-informed about risks

    building up throughout the financial system''). Ben Bernanke,

    Chairman of the Board of Governors of the Federal Reserve System,

    stated, ``[a]t times [during the crisis], the complexity and

    diversity of derivatives instruments also posed problems. Financial

    firms sometimes found it quite difficult to fully assess their own

    net derivatives exposures or to communicate to counterparties and

    regulators the nature and extent of those exposures. The associated

    uncertainties helped fuel losses of confidence that contributed

    importantly to the liquidity problems I mentioned earlier. The

    recent legislation addresses these issues by requiring that

    derivatives contracts be traded on exchanges or other regulated

    trading facilities when possible and that they be centrally

    cleared.'' ``Too Big To Fail: Expectations and Impact of

    Extraordinary Government Intervention and the Role of Systemic Risk

    in the Financial Crisis: Hearing Before the Financial Crisis Inquiry

    Commission,'' 11 (Sep. 2, 2010) (statement of Ben Bernanke,

    Chairman, Board of Governors of the Federal Reserve System),

    available at http://fcic-static.law.stanford.edu/cdn_media/fcic-testimony/2010-0902-Bernanke.pdf.

    ---------------------------------------------------------------------------

    [[Page 33553]]

    From these beginnings, the unregulated swaps market has expanded

    exponentially over the last thirty years. According to the Bank for

    International Settlements (``BIS''), the global OTC derivatives market

    measures at over $647 trillion in notional size.\933\

    ---------------------------------------------------------------------------

    \933\ The Bank for International Settlements, Quarterly Review,

    at A 131 (Sep. 2012), available at http://www.bis.org/statistics/otcder/dt1920a.pdf.

    ---------------------------------------------------------------------------

    (3) The 2008 Financial Crisis and the Role of the OTC Swaps Market

    In the fall of 2008, the United States experienced a financial

    crisis that led to millions of Americans losing their jobs, millions of

    families losing their homes, and thousands of small businesses closing

    their doors. The BIS characterized 2008 as a year that escalated for

    ``what many had hoped would be merely . . . manageable market turmoil

    [to] a full-fledged global crisis.'' \934\ Faced with what policy

    makers at the time perceived as a grave threat that without immediate

    and unprecedented government action U.S. and global credit markets

    would freeze, the federal government mounted an extraordinary

    intervention at great cost to the American taxpayer to buttress the

    stability of the U.S. financial system.

    ---------------------------------------------------------------------------

    \934\ The Bank for International Settlements, 79th Annual

    Report, at 23 (2009), available at http://www.bis.org/publ/arpdf/ar2009e2.pdf, for a broader discussion of the development of the

    crisis.

    ---------------------------------------------------------------------------

    While there were multiple causes of the financial crisis,

    unregulated swaps played an important role. Swaps contributed

    significantly to the interconnectedness between banks, investment

    banks, hedge funds, and other financial entities. As the swaps market

    grew, additional participation added risk to the already highly-

    leveraged and interconnected market. Accordingly, swaps concentrated

    and heightened risks in the financial system and to the public.

    The crisis elevated concern among regulators that the opaque

    structure of the OTC swaps market and the consequent lack of

    information about swap prices and quantities would hinder efficient

    pricing, and that the lack of information about outstanding positions

    and exposures could ``leave regulators ill-informed about the risks

    building up in the financial system. . . . Lack of transparency in the

    massive OTC market intensified systemic fears during the crisis about

    interrelated derivatives exposures from counterparty risk.'' \935\ As

    regulators did not have a clear view into how OTC derivatives were

    being used, they also feared that ``the complexity and limited

    transparency of the market reinforced the potential for excessive risk-

    taking. . . .'' \936\

    ---------------------------------------------------------------------------

    \935\ S. Rep. No. 111-176, at 30 (2010).

    \936\ See Darrell Duffie, Ada Li & Theo Lubke, ``Policy

    Perspectives on OTC Derivatives Market Infrastructure,'' Federal

    Reserve Bank of New York Staff Reports, No. 424, at 1 (Mar. 2010),

    available at http://www.newyorkfed.org/research/staff_reports/sr424.pdf.

    ---------------------------------------------------------------------------

    (4) The New Regulatory Regime To Reform the Swaps Market in Title VII

    of the Dodd-Frank Act

    On July 21, 2010, President Obama signed the Dodd-Frank Act into

    law. Title VII of the Dodd-Frank Act established a comprehensive new

    regulatory framework for swaps and charged the Commission and the SEC

    with oversight of the more than $300 trillion domestic swaps

    market.\937\ The legislation was enacted, among other reasons, to

    promote market integrity within the financial system, reduce risk, and

    increase transparency, including by: (i) Providing for the registration

    and comprehensive regulation of swap dealers and major swap

    participants; (ii) imposing clearing and trade execution requirements

    on swaps; (iii) creating a rigorous recordkeeping and real-time

    reporting regime; and (iv) enhancing the rulemaking and enforcement

    authority of the Commission with respect to, among others, all

    registered entities, including SEFs. These various elements work in

    concert to provide the Commission with a comprehensive view of the

    entire swaps market, furthering the Commission's ability to monitor the

    market. Consistent with the view that the vulnerability of the OTC

    derivatives market during the financial crisis was not attributable to

    a single weakness, but a combination of several,\938\ Title VII does

    not provide for a single-dimensional fix. Rather, it weaves together a

    multidimensional regulatory construct designed to ``mitigate costs and

    risks to taxpayers and the financial system.'' \939\

    ---------------------------------------------------------------------------

    \937\ See Section 733 of the Dodd-Frank Act, which adopted CEA

    section 5h regarding registration, operation, and compliance

    requirements for SEFs. 7 U.S.C. 7b-3. See also Section 723(a)(3) of

    the Dodd-Frank Act, which amended CEA section 2(h) to add CEA

    section 2(h)(8) setting forth a trade execution requirement. 7

    U.S.C. 2(h)(8). Similarly, the Dodd-Frank Act authorized the SEC to

    regulate security-based swaps. See Section 763 of the Dodd-Frank

    Act, which amended the Securities and Exchange Act of 1934 to add

    section 3D of the Exchange Act, among other provisions.

    \938\ See FCIC Report at xxiv (listing uncontrolled leverage;

    lack of transparency, capital and collateral requirements;

    speculation; interconnection among firms; and concentrations of risk

    in the market as contributing factors).

    \939\ S. Rep. No. 111-176, at 92 (2010).

    ---------------------------------------------------------------------------

    (5) The Role and Purpose of SEFs Within the Title VII Regulatory Regime

    One of the most important goals of the Dodd-Frank Act is to bring

    transparency to the opaque OTC swaps market. It is generally accepted

    that when markets are open and transparent, prices are more competitive

    and markets are more efficient.\940\ The legislative history of the

    Dodd-Frank Act indicates that Congress viewed exchange trading as a

    mechanism to ``provide pre- and post-trade transparency for end users,

    market participants, and regulators.'' \941\ As such, exchange trading

    was intended as ``a price transparency mechanism'' that complements

    Title VII's separate central clearing requirement to mitigate

    counterparty risk.\942\ Additionally, legislative history reveals a

    Congressional expectation that, over time, exchange trading of swaps

    would reduce transaction costs, enhance market efficiency, and counter

    the ability of dealers to extract economic rents from higher bid/ask

    spreads at the expense of other market participants.\943\

    ---------------------------------------------------------------------------

    \940\ See academic research discussed below.

    \941\ S. Rep. No. 111-176, at 34 (2010).

    \942\ Id. at 33-34 (quoting former CFTC Chair Brooksley Born,

    the report states `` `[w]hile central clearing would mitigate

    counterparty risk, central clearing alone is not enough. . . .

    [e]xchange trading is also essential in order to provide price

    discovery, transparency, and meaningful regulatory oversight of

    trading and intermediaries.' '').

    \943\ Id. at 34 (quoting Stanford University Professor Darrel

    Duffie, `` `[t]he relative opaqueness of the OTC market implies that

    bid/ask spreads are in many cases not being set as competitively as

    they would be on exchanges. . . . [t]his entails a loss in market

    efficiency.' '').

    ---------------------------------------------------------------------------

    Consistent with this purpose, the Dodd-Frank Act amended the CEA to

    create SEFs, a new type of regulated marketplace, and promotes swap

    trading and execution on them. The statutory requirements for SEFs are

    similar to the requirements for the existing Commission-regulated

    futures market, which incorporates pre-trade and post-trade

    transparency aspects not present in the OTC swaps market. SEFs will

    allow buyers and sellers to meet in an open, centralized marketplace,

    where prices are publicly available. As statutorily defined, a SEF is

    ``a trading

    [[Page 33554]]

    system or platform in which multiple participants have the ability to

    execute or trade swaps by accepting bids and offers made by multiple

    participants in the facility or system, through any means of interstate

    commerce, including any trading facility, that (A) facilitates the

    execution of swaps between persons; and (B) is not a designated

    contract market.'' \944\

    ---------------------------------------------------------------------------

    \944\ CEA section 1a(50), as amended by section 721 of the Dodd-

    Frank Act. 7 U.S.C. 1a(50). ``Trading facility'' is also a

    statutorily defined term. See CEA section 1a(51); 7 U.S.C. 1a(51).

    ---------------------------------------------------------------------------

    With this rulemaking, in conjunction with the separate made

    available to trade rulemaking \945\ and the swaps block

    rulemaking,\946\ the Commission is implementing the Dodd-Frank Act's

    trade execution mandate.\947\ Pursuant to this trade execution

    requirement, transactions involving swaps subject to the clearing

    requirement in CEA section 2(h)(1) \948\ must be executed on a SEF or a

    DCM, unless no SEF or DCM ``makes the swap available to trade'' or the

    related transaction is subject to the clearing exception under CEA

    section 2(h)(7).\949\ Further, no facility may be operated for the

    trading or processing of swaps unless first registered as a SEF or

    DCM.\950\ SEFs are required to comply with 15 statutorily enumerated

    core principles,\951\ as well as any other requirements that the

    Commission prescribes by rule or regulation.\952\

    ---------------------------------------------------------------------------

    \945\ The Commission separately proposed rules to determine

    whether a swap is ``made available to trade'' for purposes of the

    trade execution requirement in CEA section 2(h)(8). Process for a

    Designated Contract Market or Swap Execution Facility To Make a Swap

    Available To Trade, 76 FR 77728 (proposed Dec. 14, 2011).

    \946\ The Commission separately proposed rules to determine

    minimum block trade sizes for swaps. Since the execution methods for

    Required Transactions excludes block trades, this rulemaking affects

    the scope of the trade execution mandate. See Procedures to

    Establish Appropriate Minimum Block Sizes for Large Notional Off-

    Facility Swaps and Block Trades, 77 FR 15460 (proposed Mar. 15,

    2012).

    \947\ See Section 723(a)(3) of the Dodd-Frank Act, which amended

    the CEA to add section 2(h)(8). 7 U.S.C. 2(h)(8).

    \948\ See Section 723(a)(3) of the Dodd-Frank Act, which amended

    the CEA to add section 2(h)(1). 7 U.S.C. 2(h)(1).

    \949\ See Section 723(a)(3) of the Dodd-Frank Act, which amended

    the CEA to add section 2(h)(7). 7 U.S.C. 2(h)(7). The Commission

    separately proposed rules to determine whether a swap is ``made

    available to trade'' for purposes of the trade execution requirement

    in CEA section 2(h)(8). Process for a Designated Contract Market or

    Swap Execution Facility To Make a Swap Available To Trade, 76 FR

    77728 (proposed Dec. 14, 2011).

    \950\ CEA section 5h(a)(1); 7 U.S.C. 7b-3(a)(1).

    \951\ CEA section 5h(f); 7 U.S.C. 7b-3(f).

    \952\ CEA section 5h(f)(1)(A); 7 U.S.C. 7b-3(f)(1)(A). Further,

    CEA section 5h(h) mandates that the Commission prescribe rules

    governing SEF regulation. 7 U.S.C. 7b-3(h).

    ---------------------------------------------------------------------------

    Taken together, these statutory provisions provide the framework

    that transforms the swaps market from one in which prices for

    bilaterally-negotiated contracts are privately quoted--often by dealers

    with an informational advantage--to one in which bid/offer prices for

    swap contracts are accessible to multiple market participants to

    compare, assess, accept, or reject. By improving price transparency,

    the new provisions should reduce information asymmetry and, in turn,

    the informational advantage enjoyed by a small number of dealers to the

    detriment of other market participants.\953\ These provisions benefit

    the financial system as a whole by creating more efficient market

    places, where market participants will take into account the price at

    which recent transactions have occurred when determining at what price

    to display quotes or orders.

    ---------------------------------------------------------------------------

    \953\ While the SEF rules focus on measures to promote pre-trade

    price transparency and trade execution, they complement other

    Commission rules pertaining to real-time reporting (part 43 of the

    Commission's regulations) and swap data recordkeeping and reporting

    (part 45 of the Commission's regulations). The addition of the CEA

    section 5h rules for registration, operation, and compliance of SEFs

    to this mix results in a suite of rules covering all critical

    aspects of the trading process--pre-trade, trade, and post-trade.

    ---------------------------------------------------------------------------

    As discussed, this rulemaking furthers Congress' goal of promoting

    transparency in the swaps market.\954\ The goal of pre-trade

    transparency on SEFs is statutorily mandated in the Dodd-Frank

    Act.\955\ Notwithstanding the fact that Congress directed the

    Commission to construe the statute in light of this goal, some

    commenters have questioned the benefits of the Commission's proposals

    in furtherance of that goal.\956\

    ---------------------------------------------------------------------------

    \954\ Pre-trade transparency is defined as ``the dissemination

    of current bid and ask quotations, depths, and information about

    limit orders away from the best prices. Post-trade transparency

    refers to the public and timely transmission of information on past

    trades, including execution time, volume and price.'' See Ananth

    Madhavan, David Porter & Daniel Weaver, ``Should securities markets

    be transparent?,'' 8 Journal of Financial Markets 265, 268 (Aug.

    2005). See also Larry Harris, Trading and Exchanges--Market

    Microstructure for Practitioners 102 (Oxford University Press)

    (2003) (hereinafter Harris, ``Trading and Exchanges'').

    \955\ See section 733 of the Dodd-Frank Act, adding CEA section

    5h. 7 U.S.C. 7b-3. Under section 5h, Congress provided an explicit

    rule of construction, stating that ``[t]he goal of this section is

    to promote the trading of swaps on swap execution facilities and to

    promote pre-trade price transparency in the swaps market.'' CEA

    section 5h(e); 7 U.S.C. 7b-3(e).

    \956\ See, e.g., ISDA Research Staff & NERA Economic Consulting,

    Costs and Benefits of Mandatory Electronic Execution Requirements

    for Interest Rate Products, ISDA Discussion Papers Series, Number

    Two, at 1, 4 (Nov. 2011) (added to the public comment file for the

    SEF rulemaking on Nov. 10, 2011) (hereinafter ``ISDA Discussion

    Paper''); ISDA/SIFMA Comment Letter at 5-6 (Mar. 8, 2011); MetLife

    Comment Letter at 2-3 (Mar. 8, 2011).

    ---------------------------------------------------------------------------

    In response to commenters who question the Congressionally-directed

    goal of pre-trade price transparency and the Commission's

    implementation of that goal, the Commission notes that there is a body

    of research that tends to be generally supportive, albeit based on

    experience in other markets, as discussed below. Although this research

    was not critical to or relied upon by the Commission in its decision-

    making of how to best implement Congress' goal of promoting pre-trade

    price transparency, it does provide a useful counterpoint to many of

    the general comments raised by commenters and therefore merits brief

    mention.

    While there are no studies on the effect of pre-trade transparency

    in the swaps market, empirical research on the likely effects of

    transparency on market participants exists in other markets, including

    the equity market, which has pre-trade transparency, and the corporate

    bond market, which has a similar market structure to the OTC swaps

    market and has post-trade transparency.\957\ While academics have a

    range of perspectives on market structure and transparency issues,\958\

    the empirical research discussed below and throughout this document

    supports the general proposition that a lack of pre- and post-trade

    transparency, which are characteristics of any dark, opaque market,

    generally increases search and transaction costs, and negatively

    impacts price discovery.

    ---------------------------------------------------------------------------

    \957\ The corporate bond markets are generally comparable to the

    OTC swap markets in terms of the large number of instruments traded,

    with potentially a large overlap of market participants.

    Additionally, any single issuer will have multiple bonds

    outstanding, with different maturity dates and coupons. Some

    potential SEF registrants will likely be firms operating trading

    platforms for corporate bonds.

    \958\ For example, Larry Harris notes that market participants

    might be ``ambivalent about transparency,'' and explains that

    traders ``favor transparency when it allows them to see more of what

    other traders are doing, but they oppose it when it requires that

    they reveal more of what they are doing. Generally, those who know

    the least about market conditions most favor transparency. Those who

    know the most oppose transparency because they do not want to give

    up their informational advantages.'' The Commission also recognizes

    that there is a continuum of markets occupying ``various points

    between high and low transparency.'' See Harris, ``Trading and

    Exchanges,'' at 101. See also ISDA Research Notes, ``Transparency

    and over-the-counter derivatives: The role of transaction

    transparency,'' No. 1, at 2-3 (2009), available at http://www2.isda.org/attachment/MTY4NA==/ISDA-Research-Notes1.pdf.

    ---------------------------------------------------------------------------

    While some commenters contend that pre-trade price transparency

    requirements would increase costs for market participants, there is

    academic support for the general proposition that increased

    transparency will actually

    [[Page 33555]]

    lower costs for market participants,\959\ ``help them predict future

    price changes, to predict when their orders will execute, and to

    evaluate their brokers' performance,'' \960\ and will improve the

    quality of execution they receive from the marketplace.\961\ Greater

    transparency in general can increase market liquidity by reducing

    information asymmetry between informed and less informed market

    participants, and greater pre-trade transparency also helps improve

    price discovery by promoting competition among liquidity

    providers.\962\

    ---------------------------------------------------------------------------

    \959\ Discussing the trade-off between higher costs to liquidity

    providers and the lower costs to institutional investors from

    greater post-trade transparency in the corporate bond markets,

    Bessembinder & Maxell conclude that while ``[T]raders employed by

    insurance companies and investment management firms bear costs

    associated with decreases in service provided by bond dealers . . .

    these higher costs are offset by lower trade execution costs that .

    . . benefit the investors who ultimately own the bonds transacted. .

    .'' See Hendrik Bessembinder & William Maxwell, ``Markets:

    Transparency and the Corporate Bond Market,'' 22 Journal of Economic

    Perspectives 217, 232-33 (Spring 2008) (hereinafter Bessembinder &

    Maxwell, ``Transparency'').

    \960\ Harris, ``Trading and Exchanges,'' at 101.

    \961\ It is instructive to note the view that transparency is

    ``not an objective per se but rather a means for ensuring the proper

    functioning of the market.'' See Marco Avellaneda & Rama Cont,

    ``Transparency in Credit Default Swap Markets,'' Finance Concepts,

    at 3 (Jul. 2010), available at http://www.finance-concepts.com/images/fc/CDSMarketTransparency.pdf.

    \962\ Pagano & R[ouml]ell explain the regulatory policy support

    for pre-trade transparency as a means ``to enable ordinary traders

    to check for themselves whether they have gotten a fair price.''

    Comparing the price formation in auction and dealer markets, they

    find that greater transparency generates lower trading costs for

    uninformed traders on average, although not necessarily for every

    trade size. See Marco Pagano & Ailsa R[ouml]ell, ``Transparency and

    Liquidity: A Comparison of Auction and Dealer Markets with Informed

    Trading,'' 51 Journal of Finance 579 (Jun. 1996). Research

    referenced later in the release has found that such competition can

    reduce revenues and increase costs and risks for liquidity

    providers, thus causing them to reduce their participation in the

    markets.

    ---------------------------------------------------------------------------

    Academic research supports the view that a lack of pre-trade

    transparency affects trading costs because it contributes to frictions

    in the search process, which in turn can translate into higher

    transaction costs and impact equilibrium prices and allocations. Given

    the lack of pre-trade transparency and the absence of centralized

    markets (i.e., exchanges) in the OTC swaps market, market participants

    will likely contact multiple dealers sequentially by phone or by some

    other electronic means of communication.\963\ Bessembinder and Maxwell

    explain that the take-it-or-leave-it aspect of the negotiation process

    in the bond markets (which is also present in the OTC swaps market)

    ``limits one's ability to obtain multiple quotations before committing

    to trade.'' \964\

    ---------------------------------------------------------------------------

    \963\ Many of the existing electronic trading platforms for

    bonds and for swaps display indicative quotes, but the Commission is

    not aware of research on the quality of these indicative quotes, and

    of their likely impact on price discovery and market quality in

    terms of transaction costs.

    \964\ See Bessembinder & Maxwell, ``Transparency,'' at 223

    (explaining that in addition to the cost of conducting the search,

    market participants are exposed to the additional cost from the fact

    that a dealer's quote is only good ``as long as the breath is

    warm''). Comparing execution cost in the equity and corporate bond

    markets, Edwards, Harris & Piwowar theorize that despite the fact

    that corporate bonds are less risky than equity (in the same

    company), differences in pre- and post-trade transparency between

    the two markets contribute to higher transaction costs in the bond

    markets. See Amy Edwards, Lawrence Harris & Michael Piwowar,

    ``Corporate Bond Market Transactions Costs and Transparency,'' 62

    Journal of Finance 1421, 1438 (Jun. 2007) (hereinafter Edwards et

    al., ``Transaction Costs and Transparency'').

    ---------------------------------------------------------------------------

    More generally, this area of research, also called search and

    matching theory, ``offers a framework for studying frictions in real-

    world transactions and has led to new insights into the working of

    markets.'' \965\ This research shows that ``even with very minor search

    costs and with a large number of sellers, a search and matching

    environment would deliver a rather large departure from the outcome

    under perfect competition (which would prevail if the search costs were

    zero).'' \966\ This ``Diamond paradox'' \967\ is of relevance to this

    rulemaking because given search costs, no matter how small, the

    presence of multiple dealers can result in trades being transacted at

    the single monopoly price.\968\ This highlights the importance of

    reducing the costs that exist when a market is dominated by a small

    number of dealers--in other words, an oligopoly.\969\

    ---------------------------------------------------------------------------

    \965\ See ``Markets with Search Frictions,'' The Royal Swedish

    Academy of Sciences, at 1 (Oct. 11, 2010), available at http://www.nobelprize.org/nobel_prizes/economics/laureates/2010/advanced-economicsciences2010.pdf.

    \966\ Id. at 5.

    \967\ See Peter Diamond, ``A Model of Price Adjustment,'' 3

    Journal of Economic Theory 156 (Jun. 1971).

    \968\ See Darrell Duffie, Nicolae G[acirc]rleanu & Lasse Heje

    Pedersen, ``Valuation in Over-the-Counter Markets,'' 20 The Review

    of Financial Studies 1865, 1888-89 (Nov. 2007) (hereinafter Duffie

    et al., ``Valuation in OTC Markets'') for a series of examples of

    markets where search costs impact price discovery, adversely

    resulting in prices diverging from competitive market outcomes.

    \969\ An oligopoly is a market form in which a market or

    industry is dominated by a small number of sellers (oligopolists)--

    dealers or market makers in the context of the OTC swaps markets.

    While the traditional research into oligopolistic behavior has

    focused on attempts by firms to collude, which could potentially

    result in non-competitive or monopoly pricing for the rest of the

    market, the search literature explains that the monopoly pricing is

    due to the presence of search costs. Indicative of the potential

    impact of such oligopolistic behavior by dealers in an environment

    with low pre-trade transparency, Hendershott & Madhavan reference

    research comparing transactions costs between equity and corporate

    and municipal bond markets. See Terrence Hendershott & Ananth

    Madhavan, ``Click or Call? Auction versus Search in the Over-the-

    Counter Market,'' Working Paper, at 2 (Mar. 19, 2012) (hereinafter

    Hendershott & Madhavan, ``Click or Call''). They explain that

    despite improvements in the post-trade transparency in both

    corporate and municipal bond markets, transaction costs are higher

    compared to equivalent-sized equity trades due to ``the lack of pre-

    trade transparency that confers rents to dealers.'' Id.

    ---------------------------------------------------------------------------

    Academic research into the impact of pre-trade transparency on

    market quality in the context of the equity markets is an active area

    of research. As buy and sell interest at the best bid and offer price

    is widely available to all market participants in these markets, they

    are not necessarily analogous to the OTC swap markets, where such

    information is simply not available. Nevertheless, research in this

    area is notable because the equity markets have pre-trade transparency,

    and Congress has mandated pre-trade transparency on SEFs. Various

    research papers examine the impact of changes in relative levels of

    pre-trade transparency within a specific trading venue or exchange, and

    depending on the specific circumstances of each such event, market

    participants' behavior can be influenced, which in turn can impact

    liquidity and costs.\970\

    ---------------------------------------------------------------------------

    \970\ Empirical research evaluating the impact of transparency

    on market quality are typically in the context of natural

    experiments when there is a change in the set of trading rules in a

    particular market. Madhavan, Porter & Weaver examined the outcomes

    when the Toronto Stock Exchange increased transparency levels for

    stocks traded on the floor and on the screen, and found that it

    reduced the earnings of specialists (or liquidity providers); lower

    order flows from them in turn reduced market depth and caused the

    market to exhibit increased price volatility and higher transaction

    costs. See Ananth Madhavan, David Porter & Daniel Weaver, ``Should

    securities markets be transparent?,'' 8 Journal of Financial Markets

    265 (Aug. 2005). Eom, Ok & Park focus on the impact of changes in

    the display in the level of depth of the limit order book in the

    Korean equity market and find evidence of positive effects on market

    quality measured in terms of depth, volume and quoted spreads, but

    beyond a point, these effects taper-off, and can even become

    negative. See Kyong Shik Eom, Jinho Ok & Jong Ho Park, ``Pre-trade

    transparency and market quality,'' 10 Journal of Financial Markets

    319 (Nov. 2007). In another paper, Boehmer, Saar & Yu present

    evidence that when the New York Stock Exchange took specific steps

    to display limit-order book information to traders off the exchange

    floor, ``an increase in pre-trade transparency affects investors'

    trading strategies and can improve certain dimensions of market

    quality.'' See Ekkehart Boehmer, Gideon Saar & Lei Yu, ``Lifting the

    Veil: An Analysis of Pre-trade Transparency at the NYSE,'' 60 The

    Journal of Finance 783 (Apr. 2005). Additionally, in a paper

    highlighting the impact of pre-trade transparency on price

    discovery, and highlighting the risks of driving trading activity to

    competing markets, Hendershott & Jones found that when the Island

    electronic communications network stopped displaying its limit order

    book in certain exchange-traded funds (``ETFs''), ETF prices

    adjusted more slowly, and there was ``substantial price discovery

    movement from ETFs to the futures market.'' See Terrence Hendershott

    & Charles M. Jones, ``Island Goes Dark: Transparency, Fragmentation,

    and Regulation,'' 18 The Review of Financial Studies 743 (Fall

    2005).

    ---------------------------------------------------------------------------

    [[Page 33556]]

    While the literature from the equity markets referenced above

    focuses on changes in relative levels of pre-trade transparency,

    research from the corporate bond markets also directly addresses the

    benefits from bringing post-trade transparency into dark markets.

    Edwards, Harris, and Piwowar examine trading costs in the corporate

    bond market using a record of every corporate bond trade reported on

    the TRACE \971\ system between January 2003 and January 2005.\972\ In

    their paper, they find evidence that post-trade transparency through

    TRACE has lowered transaction costs in the corporate bond market and

    that higher post-transparency has helped improve liquidity in this

    market.\973\ Summarizing findings from studies by other researchers on

    the impact of TRACE on market participants, Bessembinder and Maxwell

    confirm that it has helped provide a level playing field--in the

    context of information regarding current prices at which various

    corporate bonds are being traded.\974\

    ---------------------------------------------------------------------------

    \971\ The Trade Reporting and Compliance Engine (``TRACE'') is

    operated by the Financial Industry Regulatory Authority (``FINRA''),

    and facilitates the mandatory reporting of OTC secondary market

    transactions in eligible fixed income securities. All broker/dealers

    who are FINRA member firms have an obligation to report transactions

    in corporate bonds to TRACE under an SEC-approved set of rules. See

    http://www.finra.org/Industry/Compliance/MarketTransparency/TRACE/for further details.

    \972\ See Edwards et al., ``Transaction Costs and

    Transparency,'' at 1426. As with OTC swaps, given that there is no

    pre-trade transparency in the corporate bond markets, bid-ask

    spreads, a key determinant of transaction costs, have to be

    estimated using specialized econometric techniques. In this paper,

    they assume that there has been no change in the market structure

    (in terms of execution methods) before and after TRACE.

    \973\ In a related paper on the impact of higher transparency on

    liquidity, research examining the impact of higher post-trade

    transparency on the liquidity of the BBB-rated corporate bond market

    shows that ``overall, adding transparency has either a neutral or a

    positive effect on liquidity.'' Id. at 1438.

    \974\ Bessembinder & Maxwell point out that prior to the

    introduction of TRACE, ``customers found it difficult to know

    whether their trade price reflected market conditions . . . . With

    transaction reporting, customers are able to assess the

    competitiveness of their own trade price by comparing it to recent

    and subsequent transactions in the same and similar issues.''

    Bessembinder & Maxwell, ``Transparency,'' at 226.

    ---------------------------------------------------------------------------

    (b) The Statutory Mandate To Consider the Costs and Benefits of the

    Commission's Action: Section 15(a) of the CEA

    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.\975\ CEA 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.\976\ The Commission considers below the costs

    and benefits resulting from its discretionary determinations with

    respect to the section 15(a) factors.

    ---------------------------------------------------------------------------

    \975\ CEA section 15(a); 7 U.S.C. 19(a).

    \976\ Id.

    ---------------------------------------------------------------------------

    To aid the Commission in its consideration of the costs and

    benefits resulting from its regulations, the Commission requested in

    the SEF NPRM that commenters provide data and supporting information

    which quantify or qualify the costs and benefits of the proposed

    rules.\977\ While a number of industry commenters expressed the general

    view that implementing and complying with the proposed rules would come

    at considerable cost and that the proposed rules would be

    burdensome,\978\ the Commission only received one comment quantifying

    the costs that may result from the proposed regulations.\979\ In

    meetings requested by potential SEF registrants during the comment

    period, the Commission staff invited those entities to provide specific

    data to support general assertions that the proposed regulations would

    be costly. Again, no such information was provided. In another effort

    to gather such data, the Commission staff initiated follow-up contacts

    with certain potential SEFs regarding their projected expenses in light

    of the Commission's proposed regulations. The product of these

    conversations is reflected in the cost estimates included in this

    release.

    ---------------------------------------------------------------------------

    \977\ See Core Principles and Other Requirements for Swap

    Execution Facilities, 76 FR 1214, 1237 (proposed Jan. 7, 2011).

    \978\ See, e.g., FXall Comment Letter at 2-4 (Mar. 8, 2011); CME

    Comment Letter at 2 (Mar. 8, 2011).

    \979\ See ISDA Discussion Paper (Nov. 2011).

    ---------------------------------------------------------------------------

    While certain costs are amenable to quantification, other costs are

    not easily monetized, such as the costs to the public of another

    financial crisis. The Commission's final regulations are intended to

    mitigate that risk, and, therefore, serve an important if

    unquantifiable public benefit. While the benefits of effective

    regulation are difficult to value in dollar terms, the Commission

    believes that they are no less important to consider given the

    Commission's mission to protect both market users and the public.

    Additionally, where appropriate, in response to the cost concerns

    of some commenters, the Commission, as discussed below, adopted cost-

    mitigating alternatives presented by commenters where doing so would

    still achieve the goals of the Dodd-Frank Act.

    The discussion of costs and benefits that follows begins with an

    informational discussion of the aggregate estimated costs of forming

    and operating a SEF. Although these costs are mostly attributable to

    Congress' mandate that there be SEFs, they provide useful context for

    the costs and benefits attributable to the Commission's action of

    implementing that mandate in this rulemaking. Relatedly, the Commission

    believes that many of the costs that arise from the application of the

    final rules are a consequence of the Congressional trade execution

    mandate of section 2(h)(8) of the CEA, as well as the Congressional

    goals to promote the trading of swaps on SEFs and to promote pre-trade

    price transparency in the swaps market in section 5h(e) of the CEA. For

    example, those market participants who are not eligible for the CEA

    section 2(h)(7) end user exception will no longer have the option to

    execute Required Transactions bilaterally even when they consider it

    more costly or less convenient to execute trades on a SEF (or a DCM).

    As described more fully below, the Commission has considered these

    costs in adopting these final rules, and has, where appropriate,

    attempted to mitigate the costs while observing the express direction

    of Congress in CEA sections 2(h)(8) and 5h(e).

    After the discussion of the aggregate costs of forming and

    operating a SEF, the Commission's consideration of costs and benefits

    is organized into seven categories: (1) SEF Market Structure; (2)

    Registration; (3) Recordkeeping and Reporting; (4) Compliance; (5)

    Monitoring and Surveillance; (6) Financial Resources and Integrity; and

    (7) Emergency Operations and System Safeguards. For each category,\980\

    the

    [[Page 33557]]

    Commission summarizes the final regulations; describes and responds to

    comments discussing the costs and benefits; \981\ assesses

    alternatives, including those raised by commenters; and considers the

    costs and benefits in light of the five factors set out in CEA section

    15(a), which expressly requires the Commission to consider the costs

    and benefits of ``the action of the Commission.'' \982\ In this regard,

    as with the aggregate costs of forming and operating a SEF attributable

    to Congress, where the Commission merely codifies a statutory

    requirement, the Commission believes that there is no act of discretion

    for consideration under CEA section 15(a). For example, for each core

    principle, the first section of the Commission's regulations is a

    codification of the statutory language of the core principle as a rule

    and, accordingly, there is no Commission act of discretion and thus no

    costs and benefits for the Commission to consider under section 15(a).

    In other cases, such as Core Principle 1, the rule simply codifies the

    text of the core principle, and thus will not be discussed as it is

    outside the scope of section 15(a).

    ---------------------------------------------------------------------------

    \980\ The costs and benefits of Core Principle 12 are discussed

    in connection with a separate proposed rulemaking entitled

    Requirements for Derivatives Clearing Organizations, Designated

    Contract Markets, and Swap Execution Facilities Regarding the

    Mitigation of Conflicts of Interest, 75 FR 63732 (proposed Oct. 18,

    2010).

    \981\ The Commission notes that a number of these regulations

    also refer to requirements that are contained in other rulemakings,

    some that have been finalized and others that have not. The costs

    and benefits of these regulations have been, or will be, discussed

    in those other rulemakings.

    \982\ CEA section 15(a); 7 U.S.C. 19(a).

    ---------------------------------------------------------------------------

    The Commission expects that the costs and benefits will vary based

    on the specific circumstances of the individual entity seeking

    registration as a SEF. For example, some SEF-like execution platforms

    that currently operate in the OTC marketplace may generally already

    have the infrastructure to comply with the Commission's regulations

    without the need for sizeable additional expenditures. For these

    potential SEF registrants, the regulations may occasion minimal

    incremental costs above their existing cost structure. In contrast,

    potential SEF registrants that are not currently operating in the OTC

    marketplace, registered as a DCM, or operating as an exempt board of

    trade will likely lack existing infrastructure and may incur costs, at

    times significant, in both physical and human capital to meet the

    requirements of the regulations.\983\ Accordingly, where appropriate

    and possible to account for these differences, the Commission has

    attempted to express costs and benefits as a range, sometimes one that

    is wide.

    ---------------------------------------------------------------------------

    \983\ The Commission notes that these registrants will also

    incur costs to meet the statutory requirements.

    ---------------------------------------------------------------------------

    Finally, in some instances, quantification of costs to certain

    market participants is not reasonably feasible because costs will

    depend on the size, structure, and product offering of a SEF, which are

    likely to have considerable variation, or because required information

    or data will not exist until after a SEF commences operation as a

    registrant. In other instances--for example with respect to protection

    of market participants and the public--suitable metrics to quantify

    costs and benefits simply do not exist. Notwithstanding the above-

    mentioned limitations, the Commission identifies and considers the

    costs and benefits of these rules in qualitative terms.

    (c) Estimated Aggregate Costs of Forming and Operating a SEF

    In its discussion paper, ISDA estimated the cost of establishing a

    new SEF to be $7.4 million,\984\ and estimated ongoing operating costs

    to be nearly $12 million per year.\985\ ISDA based its cost estimates

    on a survey of groups which included a ``small number of (large) Buy-

    Side firms and the 16 largest dealers.'' \986\ ISDA's estimate is based

    on a trading architecture that includes an order matching engine, and a

    Request for Quote system or other means of interstate commerce that

    will allow members to show (and see) bids and offers.\987\ In addition,

    ISDA's estimate includes costs associated with: systems to capture and

    retain data necessary to create an audit trail for at least 5 years; an

    electronic analysis capability and the ability to collect and evaluate

    market data on a daily basis; a real-time electronic monitoring system

    to detect and deter manipulation, distortion, and market disruption;

    reporting transaction information to the Commission and data

    repositories using unique product identifiers; a Chief Compliance

    Officer; and disaster recovery.\988\ ISDA also identified major

    operating costs to include the cost of compensation and benefits for

    staff, leasing office space, maintaining and upgrading operational

    infrastructure and systems, maintaining sufficient financial resources

    to cover operating costs for at least one year, maintaining an

    independent board of governors, and maintaining emergency backup

    facilities.\989\

    ---------------------------------------------------------------------------

    \984\ ISDA Discussion Paper at 30-31 (Nov. 2011). While the ISDA

    discussion paper is largely concerned with the costs and benefits

    resulting from the statute and regulations implemented by other

    rulemakings, relevant portions are discussed in this release. ISDA's

    estimate includes the costs of: registering with the Commission;

    developing an electronic system capable of providing market

    participants with the ability to make bids and offers to multiple

    participants and capable of maintaining safe storage capacity;

    developing and maintaining electronic analysis, reporting, and

    monitoring software; developing new products; drafting contractual

    arrangements with SEF users and vendors; drafting market rules and

    policies; and developing emergency backup procedures and systems.

    \985\ Id. at 31-32. This estimate includes the cost of

    compensation and benefits for staff, leasing office space,

    maintaining and upgrading operational infrastructure and systems,

    maintaining sufficient financial resources to cover operating costs

    for at least one year, maintaining an independent board of

    governors, and maintaining emergency backup facilities.

    \986\ Id. at 31, 34.

    \987\ Id. at 29.

    \988\ Id. at 30.

    \989\ Id. at 31.

    ---------------------------------------------------------------------------

    In another comment letter, MarketAxess stated that the SEC's cost

    estimates in its proposed rulemaking for security-based SEFs (``SB-

    SEFs''), were ``generally realistic and accurate estimates of the costs

    of establishing and operating a SB-SEF'' and that these estimates would

    be ``comparable to, and thus relevant for, calculation of costs for a

    SEF.'' \990\

    ---------------------------------------------------------------------------

    \990\ MarketAxess Comment Letter at 5 (Jun. 3, 2011).

    ---------------------------------------------------------------------------

    The SEC estimated that the cost of forming an SB-SEF is

    approximately $15-20 million, including the first year of

    operation.\991\ These costs included a software and product development

    estimate of $6.5-10 million for the first year and ongoing technology

    and maintenance costs of $2-4 million.\992\ The SEC also estimated that

    it would cost approximately $50,000-$3 million for an operator of an

    existing platform to modify its platform to conform to the statute and

    the SEC's proposed rules, depending on the enhancements that would be

    required by the final regulations.\993\

    ---------------------------------------------------------------------------

    \991\ Registration and Regulation of Security-Based Swap

    Execution Facilities, 76 FR 10948, 11041 (proposed Feb. 28, 2011).

    \992\ Id.

    \993\ Id.

    ---------------------------------------------------------------------------

    In the Commission staff's follow-up conversations, potential SEFs

    stated that the costs associated with the SEF NPRM may differ from the

    SEC's cost estimates in various areas. For example, one commenter

    estimated first-year software and product development costs of $4

    million rather than the $6.5-10 million estimated by the SEC. Another

    commenter stated that existing entities will be able to leverage

    existing technology at minimal cost, and that there is no real cost

    associated with the rulemaking from a technology perspective if an

    entity is not a startup. As stated above, ISDA's estimates also

    differed from those of the SEC, including estimated initial software

    development costs of $1 million and

    [[Page 33558]]

    initial product development costs of $1.25 million.\994\

    ---------------------------------------------------------------------------

    \994\ ISDA Discussion Paper at 32 (Nov. 2011). ISDA's paper also

    contained a discussion of the costs likely to be faced by dealers

    and buy-side users of interest rate swaps that must be executed on

    regulated exchanges. Some of these costs result from statutory

    requirements that were not the product of Commission discretion,

    while other costs are likely to derive from regulations being

    implemented in other rulemakings. Other costs simply reflect the

    cost of doing business and are not directly imposed by Commission

    regulations. Accordingly, these costs are beyond the scope of this

    rulemaking and will not be discussed in this release.

    ---------------------------------------------------------------------------

    In the Commission staff's follow-up conversations, potential SEFs

    stated that total ongoing costs would range from $3.5 million to $5

    million per year. These potential SEFs also told the Commission staff

    that it would cost them approximately $2 million to conform to the

    statute and the Commission's proposed rules, including contracting with

    the National Futures Association (``NFA'') to perform regulatory

    services.

    While the Commission believes that the various cost estimates

    (including those for SB-SEFs and those reflecting costs imposed by

    statute) can be used as a rough guide to the costs that would be

    incurred to establish and operate a SEF, the Commission notes that the

    majority of these costs are necessary to establish and operate any

    platform for the trading of swaps, as a number of firms had already

    done prior to the enactment of the Dodd-Frank Act. The Commission

    believes that the additional costs of modifying a platform to comply

    with the Commission's regulations to implement the statute represent a

    relatively modest proportion of these costs.

    (1) Regulatory Costs

    Pursuant to final Sec. 37.204 adopted in this release, SEFs may

    utilize a regulatory service provider for assistance in performing

    certain self-regulatory functions, including, among others, trade

    practice surveillance, market surveillance, real-time market

    monitoring, investigations of possible rule violations, and

    disciplinary actions.\995\ The costs described in this cost benefit

    consideration section reflect the costs that a SEF is likely to face if

    it does not choose to utilize the services of a regulatory service

    provider. To the extent that utilizing a regulatory service provider is

    more cost-effective for a SEF than performing the functions

    independently, the quantitative and qualitative cost discussions in

    this release may overstate the costs of complying with the rules. Based

    on the Commission staff's follow-up discussions with potential SEFs, it

    appears that most SEFs will be entering into agreements with regulatory

    service providers for the provision of these functions. In fact, the

    Commission understands that many potential SEFs have already entered

    into formal agreements with a regulatory service provider. The

    Commission notes that competition among regulatory service providers,

    including NFA and the Financial Industry Regulatory Authority, may

    result in additional cost savings for SEFs that choose to outsource

    compliance obligations.

    ---------------------------------------------------------------------------

    \995\ Rule 37.204 permits SEFs to contract with a regulatory

    service provider for the provision of services to assist in

    compliance with the core principles, as approved by the Commission.

    ---------------------------------------------------------------------------

    2. SEF Market Structure

    (a) Background

    (1) Minimum Trading Functionality (Order Book)

    Final Sec. 37.3(a)(2) requires that each SEF provide its market

    participants with a minimum trading functionality referred to as an

    Order Book,\996\ which the Commission believes is consistent with the

    SEF definition and promotes the goals provided in section 733 of the

    Dodd-Frank Act.\997\ As noted in the preamble, the Commission is

    withdrawing the proposed requirement that SEFs offer indicative quote

    functionality because the Commission believes that, at this time, such

    a requirement is unnecessary.\998\

    ---------------------------------------------------------------------------

    \996\ An Order Book means: (i) An electronic trading facility,

    as that term is defined in section 1a(16) of the Act; (ii) a trading

    facility, as that term is defined in section 1a(51) of the Act; or

    (iii) a trading system or platform in which all market participants

    in the trading system or platform have the ability to enter multiple

    bids and offers, observe or receive bids and offers entered by other

    market participants, and transact on such bids and offers. See Final

    Sec. 37.3(a)(3) of the Commission's regulations.

    \997\ CEA section 1a(50) defines a SEF as ``a trading system or

    platform in which multiple participants have the ability to execute

    or trade swaps by accepting bids and offers made by multiple

    participants in the facility or system, through any means of

    interstate commerce . . .'' 7 U.S.C. 1a(50). In section 5h(e) of the

    Act, Congress provided a ``rule of construction'' to guide the

    Commission's interpretation of certain SEF provisions (stating that

    the goals of section 5h of the Act are to ``promote the trading of

    swaps on [SEFs] and to promote pre-trade price transparency in the

    swaps market''). 7 U.S.C. 7b-3(e).

    \998\ See Minimum Trading Functionality discussion above under

    Sec. 37.3--Requirements for Registration in the preamble.

    ---------------------------------------------------------------------------

    (2) Methods of Execution on a SEF

    Final Sec. 37.9 governs the execution methods that are available

    on a SEF and classifies transactions executed on a SEF as either

    Required Transactions (i.e., any transaction involving a swap that is

    subject to the trade execution requirement in section 2(h)(8) of the

    Act \999\) or Permitted Transactions (i.e., any transaction not

    involving a swap that is subject to the trade execution requirement in

    section 2(h)(8) of the Act).

    ---------------------------------------------------------------------------

    \999\ Transactions that are subject to the trade execution

    requirement of CEA section 2(h)(8) are subject to the clearing

    requirement of CEA section 2(h)(1) and are ``available to trade'' on

    a SEF or DCM. See Process for a Designated Contract Market or Swap

    Execution Facility To Make a Swap Available To Trade, 76 FR 77728

    (proposed Dec. 14, 2011).

    ---------------------------------------------------------------------------

    Pursuant to final Sec. 37.9(a)(2), market participants may only

    execute Required Transactions using either the SEF's Order Book or an

    RFQ System that will transmit a request for a quote to at least three

    market participants and that operates in conjunction with the Order

    Book. In contrast, while SEFs must offer an Order Book for Permitted

    Transactions, market participants may execute Permitted Transactions on

    a SEF using any method of execution.\1000\

    ---------------------------------------------------------------------------

    \1000\ The SEF NPRM provided that Permitted Transactions may be

    executed by an Order Book, RFQ System, Voice-Based System, or any

    such other system for trading as may be permitted by the Commission.

    Core Principles and Other Requirements for Swap Execution

    Facilities, 76 FR at 1241.

    ---------------------------------------------------------------------------

    (3) Request for Quote (``RFQ'') System for Required Transactions

    The RFQ System definition in final Sec. 37.9(a)(3) requires that

    each market participant transmit a request for a quote to at least

    three market participants, with each of these market participants being

    given the opportunity to respond. As described in greater detail in the

    preamble, permitting RFQ requesters to send RFQs to a single market

    participant would undermine the multiple participant to multiple

    participant requirement in the SEF definition and the goal of pre-trade

    price transparency.\1001\ The three market participant requirement will

    help the RFQ requester benefit from price competition among multiple

    RFQ responders and thus promotes price discovery. In addition, final

    Sec. 37.9(a)(3) requires that any firm bid or offer pertaining to the

    same instrument resting on any of the SEF's Order Books must be

    communicated to the RFQ requester at the same time the first responsive

    bid or offer is received by such requester.

    ---------------------------------------------------------------------------

    \1001\ See RFQ System Definition and Transmission to Five Market

    Participants discussion above under Sec. 37.9(a)(1)(ii)--Request

    for Quote System in the preamble.

    ---------------------------------------------------------------------------

    (4) Time Delay Requirement

    Final Sec. 37.9(b)(1) sets forth a time delay requirement for a

    broker or dealer who has the ability to execute against its

    [[Page 33559]]

    customer's order or to execute two of its customers' orders against

    each other. These orders (i.e., price, size, and other terms) are

    subject to a 15-second time delay between the entry of the two orders,

    such that one side of the potential transaction is disclosed and made

    available to other market participants before the second side of the

    potential transaction is submitted for execution. This time delay

    requirement is similar to certain timing delays applicable to futures

    transactions executed on DCMs, which are also designed to promote pre-

    trade transparency by allowing other market participants the

    opportunity to participate in the transaction and thus prevent any two

    market participants from crossing a bilaterally (off-exchange)

    negotiated trade. The Commission notes that the 15-second requirement

    is a default time delay; the final rule also permits SEFs to adjust

    this time delay requirement based upon a swap's liquidity or other

    product-specific characteristics.

    (b) Costs

    (1) Costs to SEFs

    (i) Minimum Trading Functionality (Order Book) and Methods of Execution

    on a SEF

    In the Commission staff's follow-up conversations with potential

    SEFs, one commenter noted that it would cost approximately $250,000 to

    upgrade its existing system to provide the required minimum trading

    functionality, while another stated that there is no real cost

    associated with the rulemaking from a technology perspective if an

    entity is already operating a trading platform, and that an existing

    platform could become compliant with the rule by leveraging existing

    technology at minimal cost. The Commission believes that these

    estimates are reasonable for existing platforms. Though the Commission

    is not requiring that systems be upgraded once they have achieved

    compliance with the rules, it expects that SEFs may have business

    incentives to incur ongoing programming costs to upgrade their systems.

    ISDA/SIFMA noted that the minimum trading functionality may limit

    competition by increasing costs to applicants that would otherwise

    prefer to offer solely RFQ functionality.\1002\ As discussed in the

    preamble to this release,\1003\ the Commission believes that the

    minimum trading functionality is consistent with the SEF definition and

    promotes the statutory goals of pre-trade price transparency and

    trading on SEFs provided in section 733 of Dodd-Frank.\1004\

    Nevertheless, the Commission has adopted cost-mitigating alternatives

    identified by commenters, including: (1) Deleting the requirement that

    indicative bids and offers must be posted on a SEF's Order Book; (2)

    allowing work-up sessions \1005\ where the original counterparties to a

    trade and other market participants can trade additional quantities of

    a swap at the previously executed price; and (3) allowing SEFs to use

    any means of interstate commerce in providing the execution methods for

    Required Transactions in Sec. 37.9(a)(2)(i)(A) or (B) of this final

    rulemaking (i.e., Order Book or RFQ System that operates in conjunction

    with an Order Book). Not having to display indicative quotes will

    likely reduce the programming costs for SEFs, since they will not need

    to program that functionality into the platform. The Commission

    believes the requirement to communicate any firm bid or offer will

    marginally add to the programming costs for SEFs and is included in the

    $250,000 estimate provided above. As commenters have described, work-up

    sessions are part of current OTC market practice, and the Commission

    believes that this additional flexibility for market participants to

    execute transactions in the SEF context will promote the trading of

    swaps on SEFs consistent with CEA section 5h(e).

    ---------------------------------------------------------------------------

    \1002\ ISDA/SIFMA Comment Letter at 5-6 (Mar. 8, 2011).

    \1003\ See Minimum Trading Functionality discussion above under

    Sec. 37.3--Requirements for Registration in the preamble.

    \1004\ In section 5h(e) of the Act (as adopted by section 733 of

    the Dodd-Frank Act), Congress provided a ``rule of construction'' to

    guide the Commission's interpretation of certain SEF provisions

    (stating that the goals of section 5h of the Act are to ``promote

    the trading of swaps on [SEFs] and to promote pre-trade price

    transparency in the swaps market''). 7 U.S.C. 7b-3(e).

    \1005\ As described earlier, a work-up session refers to a

    practice wherein once a trade has been executed, one of the

    counterparties to the trade can express an interest in transacting

    additional volume at the same price.

    ---------------------------------------------------------------------------

    (ii) Time Delay Requirement

    A SEF will incur some additional programming costs as a result of

    the requirement that a SEF must provide for a 15-second time delay in

    certain circumstances. The Commission did not receive any specific

    estimates of these programming costs and notes that the rule permits a

    SEF to adjust the minimum time delay requirement based upon a swap's

    liquidity or other product-specific characteristics. For example, less

    liquid contracts may need a longer time delay than more liquid

    contracts.

    (2) Costs to Market Participants

    (i) General Costs

    In its discussion paper, ISDA described what it asserted would be

    the likely costs and benefits of what it labeled the ``electronic

    execution mandate,'' that is, mandating the execution of interest rate

    swaps on DCMs or on SEFs.\1006\ According to ISDA, ``[t]he study

    indicates that the EE mandate [electronic execution mandate], in all

    likelihood, will bring little benefit to the market while adding

    significantly to the costs of using derivatives.''\1007\ ISDA stated

    that the electronic execution mandate will result in higher bid/ask

    spreads and significant operational, technological, and compliance

    costs for those transacting in interest rate swaps.\1008\ ISDA further

    stated that these costs will be borne by end users and may force some

    participants to withdraw from the market with ``virtually no effect on

    small end users.'' \1009\ ISDA stated that the electronic execution

    mandate is both unnecessary and counterproductive as electronic trading

    is already developing rapidly as users take advantage of the existing

    choice in execution venues.\1010\

    ---------------------------------------------------------------------------

    \1006\ ISDA Discussion Paper at 20-21 (Nov. 2011).

    \1007\ Id. at 1.

    \1008\ Id. at 4.

    \1009\ Id.

    \1010\ Id.

    ---------------------------------------------------------------------------

    According to ISDA, the electronic execution mandate will take away

    users' choice, create inefficiencies, and discourage innovation.\1011\

    ISDA stated that the electronic execution mandate will impose new costs

    because:

    ---------------------------------------------------------------------------

    \1011\ Id.

    SEFs themselves need to be established, licensed and operated.

    Buy-Side users will face significant technology and operational

    challenges as well as increased regulatory reporting requirements.

    Dealers will have to upgrade infrastructure to deal with automated

    trading and comply with increased regulatory reporting and record-

    keeping. All participants will face increased reconciliations,

    oversight and reporting requirements as well. Finally, regulators

    will need additional staff to properly oversee the new

    markets.\1012\

    ---------------------------------------------------------------------------

    \1012\ Id. at 24.

    According to ISDA, the aggregate market-wide ``set up costs are

    estimated to exceed $750 million and annual costs may run to $250

    million.''\1013\

    ---------------------------------------------------------------------------

    \1013\ Id. at 4.

    ---------------------------------------------------------------------------

    In terms of benefits, ISDA concluded that:

    Transparency and market access may improve marginally for small

    financial entities that use IRS [interest rate swaps] but any

    benefit they receive will be very modest relative to the added costs

    of execution.

    [[Page 33560]]

    Indeed, the imposition of clearing and the higher fees that will

    result from the EE Mandate [electronic execution mandate] and other

    provisions of DFA [Dodd-Frank Act] may cause these and other

    participants to reduce their activity or even withdraw from the IRS

    market.\1014\

    ---------------------------------------------------------------------------

    \1014\ Id. at 36.

    ISDA asserted that transaction costs for OTC trades in interest

    rate swaps are already low with levels of transparency that market

    participants consider sufficient, and that trading in a regulated

    market or on an exchange does not guarantee a more efficient market

    because traders often get better execution off-exchange.\1015\ ISDA

    further asserted that liquidity in OTC interest rate swaps is at least

    as good as liquidity in exchange-traded futures contracts, especially

    outside of the most liquid futures contract months, and that market

    participants predicted that bid-ask spreads in interest rate swaps

    would increase after the execution mandate takes effect.\1016\

    ---------------------------------------------------------------------------

    \1015\ Id. at 20-21.

    \1016\ Id. at 2-4, 20-21.

    ---------------------------------------------------------------------------

    ISDA also estimated that the market as a whole will need to absorb

    at least an additional $400 million in annual expenses as a result of

    the changes implemented in connection with the Dodd-Frank Act, and that

    assuming SEFs will execute 1,000 trades a day (comparable to what ISDA

    states is the current number of transactions in the OTC market), this

    will amount to execution costs of $1,280 per trade.\1017\ As a result,

    ISDA stated that dealer costs will be passed on to end users and will

    cause participants to withdraw from the market, discouraging

    innovation.\1018\

    ---------------------------------------------------------------------------

    \1017\ Id. at 35.

    \1018\ Id. at 4.

    ---------------------------------------------------------------------------

    The Commission notes that a majority of the costs identified by

    ISDA result from statutory requirements that were not the product of

    Commission discretion. For example, the requirements that certain swaps

    must be executed on a SEF or DCM,\1019\ and that no person may operate

    a facility for the trading or processing of swaps unless the facility

    is registered as a SEF or as a DCM,\1020\ are statutory requirements.

    Additionally, CEA section 5h(e) contains a rule of construction that

    states ``[t]he goal of this section is to promote the trading of swaps

    on swap execution facilities and to promote pre-trade price

    transparency in the swaps market.'' \1021\ The interest rate swaps

    discussed by ISDA are included in these statutory requirements.

    Moreover, notwithstanding ISDA's use of the term ``electronic execution

    mandate,'' this rulemaking does not require that market participants

    execute swaps in Required Transactions electronically, since SEFs will

    be allowed to use any means of interstate commerce in providing the

    execution methods for such transactions as described in Sec.

    37.9(a)(2)(ii). Nevertheless, the Commission addresses below many of

    ISDA's comments regarding the statutory trading mandate for interest

    rate swaps.

    ---------------------------------------------------------------------------

    \1019\ CEA section 2(h)(8); 7 U.S.C. 2(h)(8).

    \1020\ CEA section 5h(a)(1); 7 U.S.C. 7b-3(a)(1).

    \1021\ CEA section 5h(e); 7 U.S.C. 7b-3(e).

    ---------------------------------------------------------------------------

    Further, while commenters did not submit any data to support or

    refute ISDA's estimates, during follow-up calls with potential SEFs,

    one commenter stated that the U.S. credit default swap market

    experiences approximately 1,350 trades per day. If interest rate swaps

    and other swaps are included, the total number of trades per day is

    likely to be a much higher figure. In turn, this would imply that the

    execution costs per trade are likely to be lower than ISDA's estimate,

    which was based on only 1,000 trades per day.

    The Commission notes that while SEFs are expected to list for

    trading a wide variety of swaps, ISDA's comment addresses only the

    costs and benefits applicable to the interest rate swap market. The

    interest rate swap market is one of the most liquid swap markets and is

    characterized by relatively tight bid-ask spreads, a high level of

    notional principal, and relatively high volume compared to other swap

    markets, including credit default swaps. Most other swap markets,

    especially many of the instruments like credit derivatives which

    contributed to the financial crisis, are less liquid than the interest

    rate swap market and thus will benefit more from the enhanced pre-trade

    and post-trade price transparency and centralized marketplaces that

    will be available on SEFs.

    While it may be true, as ISDA asserts, that some buy-side users

    contend that current levels of price transparency in the interest rate

    swap market are adequate, the Commission notes that an increase in pre-

    trade transparency benefits the public because it will allow all market

    participants (not just those with a strong business relationship with a

    particular swap dealer) \1022\ to transact in the market on a level

    playing field, and will likely enhance price discovery in the swaps

    market. Moreover, as noted, section 5h(e) of the CEA states that a

    purpose of SEFs is to promote pre-trade transparency in the swaps

    market.\1023\

    ---------------------------------------------------------------------------

    \1022\ The ISDA comment ignores the liquidity risk inherent in

    the current bilateral interest rate swap market. It addresses the

    cost of entering into a new position, but not of unwinding it. If a

    buy-side firm wishes to unwind a swap in the OTC market, it will

    typically have to complete the unwind trade with the original

    counterparty or swap dealer. Given that the dealer is aware of the

    true trading interest of the buy-side firm, the quote might be one-

    sided favoring the dealer. Assuming sufficient liquidity, any

    anonymous trading platform will pose a lower unwind risk/cost to

    most non-dealer or buy-side firms.

    \1023\ CEA section 5h(e); 7 U.S.C. 7b-3(e).

    ---------------------------------------------------------------------------

    According to ISDA, market participants asserted that bid-ask

    spreads in interest rate swaps will widen after SEFs begin

    trading.\1024\ The Commission notes that such predictions are

    speculative and are not based on data, which does not yet exist because

    SEFs have yet to begin trading. Moreover, during the Commission staff's

    follow-up conversations, other market participants (potential SEFs)

    shared information illustrating that after the financial crisis,

    participation by dealers or liquidity providers increased on their

    trading platforms. These sources stated that in some instances, new

    entrants now account for over a quarter of the total business

    transacted on such platforms. The Commission believes that, holding all

    else constant, increased participation and competition among liquidity

    providers should result in tighter spreads and greater depth, both key

    components of improved liquidity.\1025\

    ---------------------------------------------------------------------------

    \1024\ ISDA Discussion Paper at 2-4 (Nov. 2011).

    \1025\ See Hendershott & Madhavan, ``Click or Call,'' at 2;

    Darrell Duffie, Nicolae G[acirc]rleanu & Lasse Heje Pedersen,

    ``Over-the-Counter Markets,'' 73 Econometrica 1815 (Nov. 2005)

    (hereinafter Duffie et al., ``OTC Markets'').

    ---------------------------------------------------------------------------

    However, to promote the trading of swaps on SEFs, the Commission's

    final rules, as mentioned above, further increase the flexibility

    regarding the trading platforms that a SEF may offer for Required

    Transactions (which the Commission expects will include many interest

    rate swap contracts).\1026\ In addition, as discussed above,\1027\

    work-up sessions will allow market participants to continue using

    certain existing market practices, which will help facilitate the

    transition of swap markets to SEFs.

    ---------------------------------------------------------------------------

    \1026\ See, e.g., Minimum Trading Functionality discussion above

    under Sec. 37.3--Requirements for Registration in the preamble and

    ``Through Any Means of Interstate Commerce'' Language in the SEF

    Definition discussion above under Sec. 37.9(b)(1) and (b)(4)--

    Execution Methods for Required Transactions in the preamble.

    \1027\ See ``Through Any Means of Interstate Commerce'' Language

    in the SEF Definition discussion above under Sec. 37.9(b)(1) and

    (b)(4)--Execution Methods for Required Transactions in the preamble.

    ---------------------------------------------------------------------------

    To support its comments on the potentially adverse impact of moving

    interest rate swaps to centralized execution platforms, ISDA provided

    data on bid-offer spreads from both interest rate swap markets and

    [[Page 33561]]

    exchange-traded futures markets.\1028\ The Commission notes that

    interest rate swap dealers use exchange-traded interest rate futures,

    primarily the Eurodollar futures, to hedge the exposures that arise

    from their interest rate swap dealing activity. A dealer seeking to

    hedge an interest rate swap using Eurodollar futures will typically

    trade a strip of Eurodollar futures.\1029\ In its comparisons of

    typical bid-offer spreads in exchange-traded interest rate futures and

    in OTC interest rate swaps, ISDA provided spreads in the front month

    Treasury bond and Treasury note futures contracts and the relatively

    illiquid interest rate swap futures contracts, but not the highly

    liquid Eurodollar futures contract.\1030\ As noted, the Eurodollar

    futures contract is the primary vehicle used by interest rate swap

    dealers to hedge their residual interest rate exposure. Therefore, the

    Commission believes that Eurodollar futures bid-offer spreads are a

    more appropriate metric for comparison to interest rate swap bid-ask

    spreads than the interest rate swap futures contracts bid-ask spreads

    used by ISDA. Likewise, Eurodollar futures are more closely related to

    the OTC interest rate swap market and more useful for hedging interest

    rate swap positions than Treasury futures contracts. Thus, Eurodollar

    futures are also a better metric for comparison to interest rate swaps

    than Treasury futures.

    ---------------------------------------------------------------------------

    \1028\ ISDA Discussion Paper at 12-20 (Nov. 2011).

    \1029\ A strip of Eurodollar futures contracts is a position

    consisting of a sequence of contract months, for example, a position

    consisting of the March 2013, June 2013, September 2013, and

    December 2013 Eurodollar futures contracts. This position is

    economically equivalent to a one year interest rate swap with

    quarterly payment dates on the futures expiration dates.

    \1030\ According to the CME Group Web site, during the first

    eight months of 2012, Eurodollar futures contracts had a total

    volume of approximately 2300 million contracts. During that same

    period, the combined volume of CME Group's interest rate swap

    futures contracts was only about 312,000 contracts, approximately 1/

    10 of one percent of the volume in Eurodollar futures contracts. See

    http://www.cmegroup.com/wrappedpages/web_monthly_report/Web_Volume_Report_CMEG.pdf, updated monthly and viewed in September

    2012.

    ---------------------------------------------------------------------------

    Underlying ISDA's comment is an implicit assumption that moving

    swaps to electronic trading platforms will not result in any major

    changes to the number of transactions that occur. In computing its cost

    estimates, ISDA assumes that the number of trades on SEFs will be

    comparable to the number of trades that occur in the OTC market today.

    As noted above, ISDA states that, assuming SEFs will execute 1,000

    trades a day, total execution costs will amount to $1,280 per

    trade.\1031\ However, transaction volume has increased dramatically in

    securities markets and DCM futures markets that have migrated to

    electronic trading platforms (such as order books) from open outcry and

    other non-electronic trading environments. This volume increase is due

    to a tendency for typical transaction sizes to be much smaller on

    electronic order book markets and also because order books attract

    participation from new and alternate sources of liquidity, including

    participants using automated trading strategies.\1032\ Transactions

    levels increased in the securities and futures markets when trading

    moved to electronic platforms, and the Commission believes that it is

    likely that the number of transactions in the swap markets will

    increase as swap trading migrates to SEFs and DCMs. The Commission is

    unaware of any comments or studies indicating that transaction sizes in

    the swap markets will remain unchanged when they move to electronic

    platforms.

    ---------------------------------------------------------------------------

    \1031\ See ISDA Discussion Paper at 35 (Nov. 2011). A recent

    paper by the New York Federal Reserve estimated 2,500 trades/day in

    the interest rate swap market. See Michael Fleming, John Jackson,

    Ada Li, Asani Sarkar, & Patricia Zobel, ``An Analysis of OTC

    Interest Rate Derivatives Transactions: Implications for Public

    Reporting,'' Federal Reserve Bank of New York Staff Reports, No.

    557, at 2 (Mar. 2012), available at http://www.newyorkfed.org/research/staff_reports/sr557.pdf.

    \1032\ See, e.g., George H. K. Wang & Aysegul Ates, ``When Size

    Matters: The Case of Equity Index Futures,'' EFMA 2004 Basel

    Meetings Paper (Dec. 2003); Samarth Shah & B. Wade Brorsen,

    ``Electronic vs. Open Outcry: Side-by-Side Trading of KCBT Wheat

    Futures,'' 36 Journal of Agricultural and Resource Economics 48

    (Apr. 2011).

    ---------------------------------------------------------------------------

    (ii) RFQ-5 Market Participant Requirement

    Several commenters stated that the five market participant

    requirement in proposed Sec. 37.9(a)(1)(ii) is likely to increase

    costs, but commenters did not provide any data to support this

    assertion.\1033\ MetLife stated that disclosure of a large expected

    trade by RFQ to five swap dealers would likely result in a material

    widening of bid/ask spreads and increased hedging costs, as swap

    dealers will pass on to their customers the cost of protecting

    themselves against potential adverse price movements due to the

    required pre-trade transparency.\1034\ Some commenters specifically

    noted that these adverse price movements would be due to non-executing

    market participants receiving the RFQ front-running the transaction in

    anticipation of the executing market participant's forthcoming and

    offsetting transactions.\1035\ Commenters additionally stated that the

    risks associated with the five market participant requirement would be

    most pronounced in illiquid swaps or large-sized trades (i.e.,

    transactions approaching the block trade threshold).\1036\ Some

    commenters also stated that the five market participant requirement

    would negatively impact liquidity.\1037\

    ---------------------------------------------------------------------------

    \1033\ See RFQ System Definition and Transmission to Five Market

    Participants discussion above under Sec. 37.9(a)(1)(ii)--Request

    for Quote System in the preamble.

    \1034\ MetLife Comment Letter at 2-3 (Mar. 8, 2011).

    \1035\ See RFQ System Definition and Transmission to Five Market

    Participants discussion above under Sec. 37.9(a)(1)(ii)--Request

    for Quote System in the preamble.

    \1036\ Id.

    \1037\ Id.; ISDA Discussion Paper at 2 (Nov. 2011).

    ---------------------------------------------------------------------------

    While the Commission believes that the five market participant

    requirement promotes the statutory goal of pre-trade transparency

    because the RFQ requester will have access to quotes from a larger

    group of potential responders, the Commission is sensitive to

    commenters' concerns about this requirement, such as the potential for

    increased trading costs and information leakage to the non-executing

    market participants in the RFQ. To address these concerns, while still

    complying with the statutory SEF definition and promoting the goals

    provided in section 733 of the Dodd-Frank, the Commission is revising

    final Sec. 37.9(a)(3) so that a market participant must transmit an

    RFQ to no less than three market participants.

    As noted in the preamble, the Commission believes that the three

    market participant requirement is consistent with current market

    practice where, in certain markets, many market participants already

    choose to send an RFQ to multiple market participants, while still

    complying with the statutory SEF definition and promoting the goal of

    pre-trade transparency.

    Additionally, the Commission believes that adopting a minimum

    market participant requirement of fewer than three (e.g., a minimum of

    two market participants) will expose market participants to a higher

    risk of not receiving multiple responses to their RFQs. The receipt of

    multiple responses increases the likelihood that the requestor will

    execute at the best possible price. The Commission has learned that

    business or technology reasons may prevent any given market participant

    from responding to a specific RFQ. For example, DCM market maker

    programs typically require participants to quote two-sided markets for

    75 to 85 percent of the trading day. Therefore, if the Commission

    established a minimum market

    [[Page 33562]]

    participant requirement of two, there could be instances where one

    market participant does not respond to the RFQ, leaving the RFQ

    requester with only a single response. While there is no guarantee that

    even a minimum of three market participants will ensure that multiple

    responses are available for all RFQs at all times, it increases the

    probability that the goal of pre-trade price transparency is achieved

    and that a competitive market is created for market participants.

    In response to the concerns raised by commenters about increased

    trading costs, the Commission also notes that research in the corporate

    bond market supports the view that RFQ systems in general increase

    search options for investors, and that the competition that ensues

    among market participants results in lower bid-ask spreads.\1038\ One

    paper by Hendershott and Madhavan provides evidence that by allowing a

    market participant to negotiate simultaneously with multiple

    participants, and thus not be constrained by the limitations of the

    sequential search process as discussed above, RFQ systems contribute to

    a statistically significant reduction in transaction costs for quote

    requesters.\1039\

    ---------------------------------------------------------------------------

    \1038\ See Hendershott & Madhavan, ``Click or Call,'' at 10-12.

    \1039\ Id. at 10.

    ---------------------------------------------------------------------------

    Specifically, the authors compare transaction costs across two

    different market structures, one with an RFQ and one with a traditional

    OTC structure, and find that investors are more likely to use RFQ

    systems when their costs are high because increased RFQ participation

    reduces their transaction costs.\1040\ This is so because competition

    among dealers lowers costs.\1041\ While Hendershott and Madhavan's

    estimates for transaction costs in the corporate bond market are

    consistent with those reported by others,\1042\ access to RFQ market

    data, plus their choice of econometric model, help them obtain deeper

    insights into the reasons for differences in costs across different

    types of bonds.\1043\ This research in the debt markets supports the

    final rules' three market participant requirement because it

    demonstrates that unless multiple market participants receive the RFQ,

    the quote requester will not be able to generate a minimal level of

    competition sufficient to reduce the quoted bid-ask spread.

    ---------------------------------------------------------------------------

    \1040\ Id. at 14.

    \1041\ Id. at 17.

    \1042\ See, e.g., Edwards et al., ``Transaction Costs and

    Transparency,'' 1421-51.

    \1043\ Hendershott & Madhavan, ``Click or Call,'' at 1-4.

    ---------------------------------------------------------------------------

    As stated by commenters, in a market with high levels of pre-trade

    transparency, concerns about leakage of trading interest typically grow

    with trade size; a market participant posting a bid or offer in the

    order book, or sending a request for a quote to multiple dealers, will

    typically be concerned that information about their trading interest

    will adversely impact the market price. However, empirical research by

    Hendershott and Madhavan demonstrates that standard-sized (as opposed

    to large size) trades are more likely to be traded on an RFQ

    system.\1044\ For these trade sizes, market participants believe that

    the benefits from lowering search costs mitigate concerns about

    information leakage.\1045\ On the other hand, for larger trades (i.e.,

    block trades), leakage concerns could dominate any expected savings in

    search costs from participating in the order book or RFQ system, and

    larger trades are more likely to be executed though a bilateral

    bargaining process. The Commission's understanding of this potential

    trade-off between lower search costs and higher leakage risk is

    generally consistent with the results from Hendershott and Madhavan

    described above. These findings are relevant for the final rules'

    exclusion of block-sized trades from the execution methods for Required

    Transactions.

    ---------------------------------------------------------------------------

    \1044\ Id. at 15, 18, 28.

    \1045\ Id. A market participant sending an order to the market

    is likely to be concerned about others in the market being able to

    glean information through the order. In the context of a firm

    sending a large size trade, one substantially bigger than the

    typical trade size, there will always be concern that the size of

    the order will be interpreted as containing information, and elicit

    responses from other market participants. Firms will typically be

    interested in ensuring that the size of the order does not have an

    adverse impact on the order price, or the quotes from liquidity

    providers. Accordingly, while looking to execute such orders, firms

    will take steps to avoid leakage of the information of their trading

    interest beyond a very small group of potential counterparties.

    ---------------------------------------------------------------------------

    While some commenters stated that the five market participant

    requirement would result in excessive and costly disclosure, other

    commenters argued that the requirement would result in insufficient

    transparency, comparing the proposed requirement to the current status

    quo of private OTC markets, where large swap dealers can choose to only

    interact with one another.\1046\ According to Mallers et al., because

    the SEF NPRM would permit a market participant to interact with a

    limited number of market participants (i.e., less than the entire

    market), the proposal would allow ``semi-private side deals'' to take

    place, and that in light of the 2008 financial crisis, the ``costs and

    risks of permitting private RFQ markets [remained] high.'' \1047\

    ---------------------------------------------------------------------------

    \1046\ Mallers et al. Comment Letter at 3-5 (Mar. 21, 2011).

    \1047\ Id. at 5.

    ---------------------------------------------------------------------------

    As noted above, the Commission agrees that a broader group of

    potential responders will encourage price competition and provide a

    fairer assessment of market value; however, the Commission is mindful

    of concerns that the five RFQ recipient model may impose additional

    costs, especially for illiquid and bespoke swaps. Following the

    practice for futures on DCMs, the Commission could have required that

    RFQs be disseminated to all market participants.\1048\ However, the

    Commission recognizes that swaps tend to be less standardized than

    futures; therefore, the rules pertaining to the execution methods for

    SEFs should provide the requisite flexibility to market participants

    trading swaps. As such, the Commission is implementing the minimum

    three market participant requirement. The Commission also believes that

    the three market participant requirement reflects the more flexible

    statutory provisions for SEFs as compared to DCMs.

    ---------------------------------------------------------------------------

    \1048\ The Commission notes that a SEF market participant may

    send an RFQ to the entire market. Core Principles and Other

    Requirements for Swap Execution Facilities, 76 FR at 1220. Based on

    its experience with RFQ-to-all functionality offered by DCMs, the

    Commission notes that there are two distinct differences between

    these and the requirements finalized in this release. First, RFQs

    submitted to DCMs are disseminated to all market participants.

    Second, the responses to the RFQs take the form of executable bids

    or offers that are entered into the DCM's order book or other

    centralized market, such that orders from any market participant,

    not just the one submitting the RFQ, can be matched against such

    responsive bids or offers.

    ---------------------------------------------------------------------------

    While commenters have not submitted any data on the potential

    impact of the proposed five market participant requirement from the

    potential information leakage and front-running risks, the Commission

    believes that the three market participant requirement adopted in this

    final release does not necessarily introduce a new source of risk for

    market participants as these risks to the extent that they exist are

    present in the current OTC market. The Commission also believes that

    the prices of bids and offers made in response to RFQs will reflect any

    subsequent hedging risks by the responders, and the potential winner's

    curse to the extent one exists will, if at all, be realized only if the

    market participant does not price this risk fully into its quote.

    Nonetheless, the revision from five to three market participants should

    help to mitigate this potential

    [[Page 33563]]

    risk, while still complying with the statutory SEF definition and

    promoting pre-trade price transparency and price competition.

    Furthermore, regarding comments concerns' about the potential

    winner's curse for illiquid swaps, the Commission notes that the three

    market participant requirement will only apply to transactions in swaps

    that are subject to the CEA section 2(h)(8) trade execution mandate

    (i.e., transactions in more liquid swaps, which are subject to the

    clearing mandate and made available to trade, and not to illiquid and

    bespoke swaps).\1049\ The Commission also notes that the interest rate

    swaps and credit default swaps that the Commission has determined are

    required to be cleared under CEA section 2(h)(1) (and are likely to be

    subject to the trade execution mandate of CEA section 2(h)(8)) are some

    of the most liquid swaps.\1050\ Additionally, 77 swap dealers have

    registered with the Commission and nearly all of them make markets in

    such swaps.\1051\ SEFs may offer RFQ systems without the three market

    participant requirement for Permitted Transactions (i.e., transactions

    not involving swaps that are subject to the trade execution mandate of

    CEA section 2(h)(8)). In response to commenters' concerns about the

    potential winner's curse for large-sized trades, the Commission notes

    that block-sized transactions would not be subject to the execution

    methods for Required Transactions, including the three market

    participant requirement.\1052\ Therefore, excluding block-sized

    transactions from the execution methods for Required Transactions will

    address the potential risk of a winner's curse for large-sized trades.

    ---------------------------------------------------------------------------

    \1049\ Clearing Requirement Determination Under Section 2(h) of

    the CEA, 77 FR 74284 (Dec. 13, 2012); Process for a Designated

    Contract Market or Swap Execution Facility To Make a Swap Available

    To Trade, 76 FR 77728 (proposed Dec. 14, 2011).

    \1050\ Clearing Requirement Determination Under Section 2(h) of

    the CEA, 77 FR 74284. The Commission notes that these swaps already

    went through a Commission determination process that included a five

    factor review, including a liquidity review. Id. ISDA, in its letter

    requesting interpretive relief regarding the obligation to provide a

    pre-trade mid-market mark, recognized that many of the swaps that

    the Commission has determined are required to be cleared under CEA

    section 2(h)(1) are ``highly-liquid, exhibit narrow bid-ask spreads

    and are widely quoted by SD/MSPs in the marketplace . . .'' ISDA

    Comment Letter at 2 (Nov. 30, 2012).

    \1051\ The Commission recognizes that not all swap dealers will

    be active in all Required Transactions. The Commission also notes

    that of the 77 swap dealers, 35 swap dealers are not affiliated with

    any of the 77 swap dealers.

    \1052\ See definition of block trade in Sec. 43.2 of the

    Commission's regulations.

    ---------------------------------------------------------------------------

    As noted in the preamble, the three market participants may not be

    affiliated with or controlled by the RFQ requester and may not be

    affiliated with or controlled by each other, and the Commission is

    revising final Sec. 37.9(a)(3) to clarify this point. The Commission

    believes that for an RFQ requester to send an RFQ to another entity who

    is affiliated with or controlled by the RFQ requester would undermine

    the benefits of the requirement.

    The costs associated with the no-affiliate rule may include, for

    example, the costs that a SEF would incur to upgrade its systems to

    create filters that would prevent RFQs from being sent to affiliated

    parties, but these costs could be mitigated or eliminated by, for

    example, the SEF requiring market participants accepting RFQs to

    disclose their affiliations to potential RFQ requestors before a

    request is transmitted. Another possibility is for a SEF to monitor

    RFQs and cancel trades that it determines are made pursuant to RFQs

    between affiliated parties. Yet another possibility is for the SEF to

    include in its rules a requirement that market participants must not

    transmit RFQs to their affiliates or to market participants who are

    affiliated with each other.

    The primary benefit of this no-affiliate rule is to ensure that

    RFQs are sent to three unaffiliated parties who can be expected to

    provide truly independent quotes. If an RFQ requester were to transmit

    an RFQ to one non-affiliate and two affiliates or if an RFQ requester

    transmits an RFQ to three requestees who are affiliates of each other,

    then the goal of pre-trade price transparency would be undermined

    (since the quotes might be coordinated or otherwise not independent)

    and the RFQ could effectively turn into an RFQ-to-one, which is

    contrary to the statutory SEF definition. The Commission also notes

    that such an outcome could disincentivize entities from responding to

    an RFQ, which would reduce price competition and liquidity.\1053\

    ---------------------------------------------------------------------------

    \1053\ As any trades emanating from an RFQ will be subject to

    real time reporting, if a non-affiliated respondent to an RFQ

    observes trades happening away from better or equal prices quoted by

    it, such respondents might be discouraged from responding to future

    RFQ requests, thus hurting market integrity.

    ---------------------------------------------------------------------------

    The Commission clarifies that SEFs are not required to: (1) Display

    RFQs to market participants not participating in the RFQ, (2) disclose

    RFQ responses to all market participants, or (3) disclose the identity

    of the RFQ requester. The Commission also clarifies that an acceptable

    RFQ System may allow for a transaction to be consummated if the

    original request to three potential counterparties receives fewer than

    three responses. Moreover, Sec. 37.9(a)(2)(ii) clarifies that in

    providing either one of the execution methods for Required Transactions

    (i.e., an Order Book or an RFQ System that operates in conjunction with

    an Order Book), a swap execution facility may for purposes of execution

    and communication use any means of interstate commerce, including, but

    not limited to, the mail, internet, email, and telephone, provided that

    the chosen execution method satisfies the requirements provided in

    Sec. 37.3(a)(3) for Order Books or in Sec. 37.9(a)(3) for Request for

    Quote Systems. Finally, in order to provide market participants, SEFs,

    and the swaps industry generally with additional time to adapt to the

    new SEF regime, the Commission is phasing-in the three market

    participant requirement so that from the effective date of the SEF rule

    until one year after the compliance date for the SEF rule, RFQ

    requesters may transmit RFQs to no less than two market participants

    (rather than three). These provisions will likely significantly

    mitigate the likelihood and magnitude of the potential costs noted by

    commenters.

    (iii) Time Delay Requirement

    Some commenters stated that the rule requiring a 15-second time

    delay before crossing a trade between two customers should be

    eliminated because it may impact liquidity or result in increased

    costs.\1054\ FHLB stated that this requirement would likely increase

    the bid-ask spread, because ``by waiting for 15 seconds before entering

    into an offsetting transaction, brokers will be exposed to risks

    associated with market fluctuations and will have to pass the costs of

    these risks along to its customer.'' \1055\ No commenter provided

    dollar estimates or data regarding these costs.

    ---------------------------------------------------------------------------

    \1054\ See Time Delay Requirement discussion above under Sec.

    37.9--Permitted Execution Methods in the preamble.

    \1055\ FHLB Comment Letter at 13 (Jun. 13, 2011).

    ---------------------------------------------------------------------------

    The time delay requirement (which only applies to a SEF's Order

    Book and not to its RFQ System) supports the Congressional goal of pre-

    trade transparency on SEFs by allowing other market participants the

    opportunity to participate in a trade where dealer internalization or a

    dealer crossing customers' orders would otherwise reduce such pre-trade

    price transparency.\1056\ The Commission

    [[Page 33564]]

    believes that this requirement will minimize the possibility of dealer

    internalization and incentivize competition between market

    participants. Absent this requirement, market participants would be

    free to conduct pre-execution communications away from the centralized

    market and then ensure that the orders from such private negotiations

    are matched by coordinating their submission to the SEF.

    ---------------------------------------------------------------------------

    \1056\ Dealer internalized or cross-trades are not open and

    competitive and may result in inferior execution for one of the

    parties compared to situations where the bid or offer is exposed to

    the market. Accordingly, DCM rules typically require that an order

    be exposed to an order book or trading pit before it can be crossed

    with another order.

    ---------------------------------------------------------------------------

    Further, the Commission notes that the costs outlined by commenters

    are speculative, since SEFs have not yet begun operation. Moreover, the

    time delay requirement is similar to certain timing delays adopted by

    DCMs, and the Commission is not aware of evidence that those DCM rules

    are imposing significant costs on participants in those markets.\1057\

    Nevertheless, the Commission's final rules recognize that a one-size-

    fits-all approach to the time delay requirement is not appropriate for

    all swap products and markets on a SEF. Accordingly, the Commission is

    revising the proposed rule to allow a SEF to adjust the duration of the

    time delay requirement based upon a swap's liquidity or other product-

    specific characteristics. SEFs therefore will have the ability to

    reduce the costs described by the commenters, if they arise.

    ---------------------------------------------------------------------------

    \1057\ See, e.g., NYMEX rule 533, which provides for a 5-second

    delay for futures and a 15-second delay for options, available at

    http://www.cmegroup.com/rulebook/NYMEX/1/5.pdf.

    ---------------------------------------------------------------------------

    (c) Benefits

    As a whole, the minimum trading functionality (i.e., Order Book)

    and permissible execution methods established by Sec. Sec. 37.3 and

    37.9 advance the Congressional goals of promoting pre-trade price

    transparency in the swaps market and promoting trading of swaps on

    SEFs.\1058\

    ---------------------------------------------------------------------------

    \1058\ CEA section 5h(e); 7 U.S.C. 7b-3(e).

    ---------------------------------------------------------------------------

    (1) Promotion of Pre-Trade Price Transparency

    The order book requirement is designed to ensure a base level of

    pre-trade transparency to all market participants by providing for live

    executable bids and offers in Required Transactions. This requirement

    gives all market participants (and potential market participants)

    access to the same key information that swap dealers have, including

    current information about the price of a particular swap, at the same

    time. An order book with executable bids and offers will ensure that

    prior to placing an order or executing a trade, a market participant

    will be able to view other bids and offers submitted to the SEF,

    including prices, quantities, and order book depth.\1059\ Access to

    such information allows market participants to make informed trading

    decisions involving variables such as price, size, and timing, and to

    better assess the quality of execution effected by their

    intermediaries.

    ---------------------------------------------------------------------------

    \1059\ See Duffie et al., ``OTC Markets,'' at 1827 (presenting

    results showing that bid-ask spreads are lower if investors can find

    each other more easily).

    ---------------------------------------------------------------------------

    Intermediaries will know that their market participants have

    information to assess the quality of executions and can send their

    business elsewhere if they are not satisfied with their executions.

    Thus, intermediaries will have greater incentive to provide efficient

    execution to their customers at competitive prices.

    In addition, an order book is an efficient method of execution of

    transactions for swaps that are subject to the CEA section 2(h)(8)

    trade execution mandate because it provides prompt and fast executions

    of marketable orders at market prices, while providing for a variety of

    functionalities such as limit orders and stop-loss orders. The order

    book functionality for such transactions will introduce core levels of

    pre-trade transparency without hindering the ability of SEFs and market

    participants to deploy other market structures depending on the needs

    of the individual products and markets.

    As discussed above, the benefits of pre-trade (and post-trade)

    transparency generally flow from reducing information

    asymmetries.\1060\ In transparent markets, all market participants (and

    potential market participants) have timely access to the same public

    pricing information that insiders or professionals have, reducing

    potential negotiating advantages. Also, in a transparent market, market

    participants can better assess the quality of executions effected by

    their intermediaries by comparing execution prices against quotations

    and other transactions. A potential entrant can view current price

    quotations as well as prices of recent trades in an instrument, and can

    thereby assess whether it can offer a better price. Market transparency

    can thus provide incentives for new participants to enter the market,

    increasing competition, reducing concentration, and narrowing spreads.

    ---------------------------------------------------------------------------

    \1060\ See, e.g., Transparency of Structured Finance Products

    (Final Report), Technical Committee of the International

    Organization of Securities Commissions, at 17, 21 (Jul. 2010),

    available at http://www.iosco.org/library/pubdocs/pdf/IOSCOPD326.pdf.

    ---------------------------------------------------------------------------

    The 15-second time delay requirement is intended to limit dealer

    internalization of trades (cross trades) and to incentivize competition

    between market participants. This requirement will also promote pre-

    trade price transparency of swaps executed on SEFs by allowing other

    market participants the opportunity to participate in the trade. The

    Commission's final rules also recognize that a one-size-fits-all

    approach to the time delay requirement is not appropriate for all swap

    products on a SEF. Therefore, the final rules provide SEFs with an

    appropriate level of discretion to adjust the minimum time delay

    requirement based upon a swap's liquidity or other product-specific

    characteristics. Moreover, the Commission has clarified that the time

    delay requirement does not apply to the RFQ System.

    The Commission recognizes commenters' concerns, as discussed in

    this section, that there may be certain circumstances in which pre-

    trade price transparency may reduce overall market liquidity.

    Therefore, the Commission has taken certain steps in the final

    regulations to mitigate such benefit-reducing effects (such as

    excluding block trades, tying the time-delay requirement to a swap's

    liquidity, clarifying the subset of swaps that are Required

    Transactions, and allowing SEFs to offer any method of execution for

    Permitted Transactions).

    (2) Promotion of Trading on SEFs

    While the statutory goal of pre-trade price transparency is

    reflected in the minimum trading functionality (i.e., Order Book)

    requirement, the regulations also provide a SEF with additional

    flexibility for offering the trading and execution of swaps by

    providing additional execution methods (e.g., RFQ Systems along with

    the discretion to offer any method of execution for Permitted

    Transactions). The Commission believes that these additional

    functionalities will provide flexibility in methods of execution that

    will promote the trading of swaps on SEFs, which in turn will promote

    price transparency.

    For example, execution methods and market structures in general can

    vary depending on the product--simple or complex, the state of

    development of the market--established or new, market participants--

    retail or institutional, and other related factors. The Commission

    anticipates that the order book method will typically work well for

    liquid Required Transactions (i.e., transactions involving swaps that

    are subject to the trade execution requirement under CEA section

    2(h)(8)), but for less liquid

    [[Page 33565]]

    Required Transactions, RFQ systems are expected to help facilitate

    trading. RFQ systems are currently used by market participants in the

    OTC swap market, many in conjunction with order book functionality. By

    providing a SEF with the flexibility to offer alternate execution

    methods to its market participants, the Commission is leveraging best

    practices from current swap trading platforms. The additional

    flexibility offered for the trading and execution of Permitted

    Transactions will allow a SEF to offer new, innovative market

    structures to facilitate trading in these swaps that are not subject to

    the trade execution requirement under CEA section 2(h)(8), and thus may

    help to promote the trading of these swaps on SEFs.

    Additionally, the RFQ system communication requirement helps

    promote the trading of swaps on SEFs and enhances price competition and

    pre-trade price transparency by ensuring that RFQ requesters have

    access to competitive prices, and that competitive resting bids and

    offers left by market participants on the SEF will be transmitted to

    the RFQ requester for possible execution.

    (3) Facilitating Search

    The Duffie, G[acirc]rleanu, and Pedersen (``DGP'') approach

    reflects the typical search process, which involves approaching

    intermediaries sequentially (similar to making phone calls to different

    dealers asking for quotes); strategic bargaining then ensues--prices

    negotiated reflect each investor's or the dealer's alternatives to

    trade.\1061\ DGP's results show that both traded prices as well as

    transaction costs depend on investors' search abilities, access to

    market makers, and investors' bargaining powers.\1062\ DGP's results

    show that bid-ask spreads are lower if investors can find each other

    more easily, through market structures designed to allow them to

    negotiate simultaneously, instead of sequentially, with multiple,

    competing liquidity providers.\1063\ Contrary to what commenters have

    stated, DGP reason that improvements in an investor's ability to search

    for alternate counterparties forces dealers to improve on their quoted

    prices and spreads.\1064\ Further, they demonstrate that those with

    better access to market makers (or liquidity providers) receive tighter

    bid-ask spreads.\1065\

    ---------------------------------------------------------------------------

    \1061\ See Duffie et al., ``OTC Markets,'' at 1818-20.

    \1062\ Id. at 1815.

    \1063\ Id. at 1827.

    \1064\ Id. at 1817.

    \1065\ Id.

    ---------------------------------------------------------------------------

    The final rules establishing a market structure for SEFs, including

    the provisions governing Order Books and RFQ Systems are designed to

    deliver improved search capabilities to investors and better access to

    market makers. These provisions will facilitate the shifting of trading

    to the centralized SEF market structure from the bilateral OTC market

    structure where investors may have limited ability to find one another.

    The importance of facilitating investors' ability to find each

    other more easily is highlighted by evidence in the DGP paper of

    another dealer-centric market--the one prevailing at Nasdaq until the

    mid-1990s, where all trades had to be routed to a dealer.\1066\

    Notwithstanding competition among the dealers, and the fact that there

    was both pre- and post-trade transparency in the equity markets,

    spreads at Nasdaq at that time were wider than at the New York Stock

    Exchange.\1067\ Though the latter had ``a single specialist for each

    stock, floor brokers can find and trade among themselves, and outside

    brokers can find each other and trade `around' the specialist with

    limit orders.'' \1068\ Along these lines, the final rules provide for

    an anonymous but transparent order book that will facilitate trading

    among market participants directly without having to route all trades

    through dealers.

    ---------------------------------------------------------------------------

    \1066\ Id. at 1834-35.

    \1067\ Id.; see also Hendrik Bessembinder & Herbert M. Kaufman,

    ``A Comparison of Trade Execution Costs for NYSE and NASDAQ-Listed

    Stocks,'' 32 The Journal of Financial and Quantitative Analysis 287

    (Sep. 1997).

    \1068\ Duffie et al., ``OTC Markets,'' at 1834-35.

    ---------------------------------------------------------------------------

    (d) Consideration of Alternatives

    Some commenters recommended that the Commission modify the proposed

    five market participant requirement from no less than five market

    participants to either ``one or more'' \1069\ or to all market

    participants.\1070\ Other commenters recommended an alternative that

    would include some level of order interaction between the SEF's order

    book functionality and RFQ systems, including the order interaction

    model proposed by the SEC for SB-SEFs.\1071\ MFA recommended that the

    Commission expand the definition of Permitted Transaction to include

    other transactions, such as exchanges of swaps for physicals, exchanges

    of swaps for swaps, and linked or packaged transactions.\1072\ Each of

    these alternatives is discussed below.

    ---------------------------------------------------------------------------

    \1069\ See, e.g., Rosen et al. Comment Letter at 11 (Apr. 5,

    2011).

    \1070\ Mallers et al. Comment Letter at 4 (Mar. 21, 2011); AFR

    Comment Letter at 4-5 (Mar. 8, 2011).

    \1071\ Rosen et al. Comment Letter at 12-14 (Apr. 5, 2011); JP

    Morgan Comment Letter at 5-6 (Mar. 8, 2011); FXall Comment Letter at

    9-10 (Mar. 8, 2011); Tradeweb Comment Letter at 8 (Mar. 8, 2011);

    FSR Comment Letter at 5 (Mar. 8, 2011); MetLife Comment Letter at 3

    (Mar. 8, 2011); SIFMA AMG Comment Letter at 9 (Mar. 8, 2011);

    MarketAxess Comment Letter at 32 (Mar. 8, 2011); Barclays Comment

    Letter at 7 (Mar. 8, 2011); ABC/CIEBA Comment Letter at 6-7 (Mar. 8,

    2011); ISDA/SIFMA Comment Letter at 3-4; Evolution Comment Letter at

    5-6 (Mar. 8, 2011).

    \1072\ MFA Comment Letter at 8 (Mar. 8, 2011).

    ---------------------------------------------------------------------------

    (1) Modification to the Number of RFQ Requests

    Numerous commenters recommended that the Commission adopt the SEC's

    proposed approach for SB-SEFs by allowing RFQs to be sent to one or

    more market participants (while not recommending that the Commission

    adopt the SEC's proposed order interaction requirement), instead of

    requiring that RFQs be sent to at least five market participants.\1073\

    The benefit of this approach, cited favorably by some commenters, would

    be to protect proprietary trading strategies and mitigate hedging

    costs.\1074\

    ---------------------------------------------------------------------------

    \1073\ See RFQ System Definition and Transmission to Five Market

    Participants discussion above under Sec. 37.9(a)(1)(ii)--Request

    for Quote System in the preamble. Under the SEC's interpretation of

    the SB-SEF definition, such an RFQ system would provide multiple

    participants with the ability, but not the obligation, to transact

    with multiple other participants. Registration and Regulation of

    Security-Based Swap Execution Facilities, 76 FR at 10953.

    \1074\ See, e.g., Rosen et al. Comment Letter at 11 (Apr. 5,

    2011).

    ---------------------------------------------------------------------------

    Other commenters, however, stated that only requiring RFQs to be

    sent to one or more market participants would preserve the single-

    dealer status quo, would diminish the transparency and efficiency of

    the regulated swaps markets, and would be inconsistent with the goals

    of the Dodd-Frank Act.\1075\ These commenters supported another

    alternative under which an RFQ must be transmitted to all participants

    on the SEF.\1076\ In particular, one commenter stated that participants

    would not be disadvantaged by disclosing an RFQ to the entire market

    for transactions below the block trade threshold, which would not move

    the market.\1077\ In this commenter's view, the proposed five market

    participant requirement would still allow a participant to conduct

    semi-private deals with a few favored participants to the exclusion of

    other market participants, which would ultimately decrease liquidity

    and create a

    [[Page 33566]]

    substantial barrier to entry into the swaps market.\1078\

    ---------------------------------------------------------------------------

    \1075\ See, e.g., Mallers et al. Comment Letter at 3-5 (Mar. 21,

    2011).

    \1076\ Id.

    \1077\ Id. at 4.

    \1078\ Id.

    ---------------------------------------------------------------------------

    The Commission considered the costs and benefits of the above

    alternatives, but believes that neither alternative would satisfy the

    objectives of the Dodd-Frank Act. As noted by one commenter, only

    requiring that RFQs be sent to one market participant would preserve

    the status quo,\1079\ while requiring that RFQs be sent to the entire

    market may not be feasible for certain less liquid swaps. Nevertheless,

    in light of the comments, the Commission is reducing the required

    minimum number of recipients for RFQs in the final rule from five to

    three. The Commission expects that this will mitigate the concerns of

    commenters as discussed above, while continuing to satisfy the

    objectives of the Dodd-Frank Act. As discussed above in connection with

    the RFQ to three market participant requirement, the Commission views

    three RFQ recipients as appropriately balancing between ensuring

    liquidity in the swaps market and promoting pre-trade price

    transparency. The Commission further notes that the three RFQ recipient

    model will provide a more reliable indicator of market value than a

    quote from a single RFQ responder.

    ---------------------------------------------------------------------------

    \1079\ IECA Comment Letter at 3 (May 24, 2011).

    ---------------------------------------------------------------------------

    (2) Order Interaction

    Another alternative was to allow for one-to-one RFQs, but to

    mandate full order interaction.\1080\ However, according to commenters,

    an order interaction requirement across trading platforms would impose

    significant architectural and operational costs on SEFs.\1081\ In

    particular, potential SEFs were concerned that they would incur

    significant expenses by having to create the technological capabilities

    necessary to ensure that market participants execute against the best

    price.

    ---------------------------------------------------------------------------

    \1080\ Under the SEC's SB-SEF NPRM, an RFQ requester must

    execute against the best-priced orders of any size within and across

    an SB-SEF's modes of execution. See Registration and Regulation of

    Security-Based Swap Execution Facilities, 76 FR at 10953-54, 10971-

    74.

    \1081\ See, e.g., Tradeweb Comment Letter at 6 (Mar. 8, 2011).

    ---------------------------------------------------------------------------

    The Commission did not propose this type of order interaction and

    has declined to impose such a requirement herein. Accordingly, the

    final regulations respond to concerns regarding a transacting party's

    ability to take into consideration factors other than price when

    choosing a counterparty or clearing entity, by, for example, offsetting

    an existing position cleared through the Derivatives Clearing

    Organization (``DCO'') through which the position was entered into,

    even though a slightly better price may exist for the same instrument

    at a different DCO. This flexibility will allow market participants to

    execute swap transactions in accordance with the unique execution

    requirements of each transaction.

    (3) Expand Definition of Permitted Transaction

    Another alternative is to expand the definition of Permitted

    Transaction to include other transactions, such as exchanges of swaps

    for physicals, exchanges of swaps for swaps, and linked or packaged

    transactions. The Commission interprets MFA's comment suggesting this

    alternative to be a request that the Commission create through

    rulemaking an exception to the CEA section 2(h)(8) trade execution

    mandate similar to the centralized market trading exception established

    by DCM Core Principle 9 for certain exchange of futures for related

    positions (``EFRPs'').\1082\

    ---------------------------------------------------------------------------

    \1082\ See CEA section 5(d)(9); 7 U.S.C. 7(d)(9). The Commission

    notes that DCM Core Principle 9 does not explicitly permit DCMs to

    offer exchange of swaps for physicals or exchange of swaps for

    swaps.

    ---------------------------------------------------------------------------

    The Commission has determined not to adopt this alternative,

    because a broad exception for the off-exchange transactions described

    by MFA could undermine the trade execution requirement by allowing

    market participants to execute swaps subject to the trade execution

    requirement bilaterally rather than on a SEF or DCM. The Commission

    notes that market participants with a bona fide business purpose for

    executing exchange of swaps for physicals in physical commodity swaps

    (should such swaps become subject to the trade execution mandate) are

    likely to be eligible for the end-user exception. The Commission is not

    currently aware of any bona fide business purpose for executing such

    transactions in financial swaps subject to the trade execution mandate.

    In light of the end-user exception, the Commission expects that the

    costs associated with the Commission's determination will be minimal.

    The Commission is aware that the swaps market will evolve in ways that

    it does not currently anticipate and is open to revisiting this issue

    should a bona fide business purpose arise to execute swaps that are

    subject to the trade execution mandate in a manner recommended by the

    commenter.

    (e) Section 15(a) Factors

    (1) Protection of Market Participants and the Public

    The final regulations, specifically the provisions requiring a

    minimum trading functionality (i.e., Order Book) and the communication

    of any firm bid or offer along with responses to the RFQ, promote the

    protection of market participants and the public by promoting the

    statutory goals of increased pre-trade transparency and trading on

    SEFs. Taken together, these final rules should reduce the likelihood

    that market participants and SEFs execute swaps at non-market prices,

    thus protecting traders and members of the public that rely on the

    prices of swaps facilitated or executed on SEFs. The rules should

    benefit market participants by reducing the potential rents extracted

    by dealers from customers in opaque markets, ``and more so from less

    informed customers.'' \1083\

    ---------------------------------------------------------------------------

    \1083\ Bessembinder & Maxwell, ``Transparency,'' at 226. Their

    conclusions in the context of post-trade transparency introduced by

    the TRACE system can be generalized to the improvement in pre-trade

    transparency introduced through the minimum trading functionality

    (i.e., Order Book) and the ability to negotiate simultaneously with

    multiple market participants through the RFQ system.

    ---------------------------------------------------------------------------

    The Commission mitigates the costs to market participants by

    minimizing the risk of information leakage to other market participants

    by clarifying that SEFs are not required to: (1) Display RFQs to market

    participants not participating in the RFQ, (2) disclose RFQ responses

    to all market participants, or (3) disclose the identity of the RFQ

    requester.

    As discussed above, the Commission anticipates that the

    requirements in Sec. 37.9 will result in better pricing and liquidity

    and increased participation on SEFs because market participants will be

    able to trade on flexible platforms without compromising on pre- and

    post-trade transparency. The final regulations also provide information

    and pricing benefits to market participants using an RFQ System because

    market participants seeking liquidity will have access to additional

    pricing information after disseminating an RFQ. The final regulations

    increase the likelihood that RFQ requesters will receive competing

    quotes from a larger group of responders. The Commission notes that

    competition between multiple quote providers should result in tighter

    bid-offer spreads for the RFQ requesters.

    The rules promoting trading on SEFs protect the public by

    encouraging trading on regulated SEFs rather than on unregulated OTC

    markets. Moreover,

    [[Page 33567]]

    some market participants may be end users that provide goods and

    services to the public (e.g., airlines or electric utilities). To the

    extent that these end users obtain better pricing due to these rules

    and are able to pass those cost savings to their customers and

    shareholders, the public would gain additional benefits from the pre-

    trade transparency and promotion of trading on SEFs.

    (2) Efficiency, Competitiveness, and Financial Integrity of the Markets

    \1084\

    ---------------------------------------------------------------------------

    \1084\ The Commission notes that CEA Sec. 15(a)(2)(B) requires

    the Commission to consider the costs and benefits of its actions in

    light of ``considerations of the efficiency, competitiveness, and

    financial integrity of futures markets.'' The Commission is also

    considering the costs and benefits of these rules in light of

    considerations of the efficiency, competitiveness, and financial

    integrity of ``swap markets.''

    ---------------------------------------------------------------------------

    The final regulations will improve the efficiency, competitiveness,

    and financial integrity of the swaps market by providing a SEF with the

    flexibility to offer several execution methods for Required

    Transactions to meet the needs of market participants, including RFQ

    Systems, as well as the flexibility to offer any execution method for

    Permitted Transactions. This flexibility reflects the fact that there

    is a continuum of markets occupying ``various points between high and

    low transparency'' \1085\ and will allow participants to efficiently

    execute trades using various methods of execution depending on the

    liquidity levels in particular products. For example, participants may

    execute more liquid products on an Order Book, while executing less

    liquid products using RFQ functionality. Final Sec. 37.9, specifically

    the provisions related to RFQ Systems (including the minimum RFQ to

    three requirement) and the 15 second time delay requirement for cross

    trades, should also facilitate an increase in the number of market

    participants that provide liquidity on SEFs by providing greater

    opportunities for those market participants, which will contribute to

    the competitiveness of the swaps market.

    ---------------------------------------------------------------------------

    \1085\ See ISDA Research Notes, ``Transparency and over-the-

    counter derivatives: The role of transaction transparency,'' No. 1,

    at 2-3 (2009), available at http://www2.isda.org/attachment/MTY4NA==/ISDA-Research-Notes1.pdf.

    ---------------------------------------------------------------------------

    Research by Hendershott and Madhavan supports the benefits of

    increased competition facilitated by RFQ systems.\1086\ By enabling

    market participants to meet each other directly (without being forced

    to go through an intermediary as is the case in the current OTC market

    structure), and by providing them a facility (via the RFQ system) to

    simultaneously negotiate with multiple market participants, the rules

    reduce the search costs inherent in the current OTC market structure as

    described by Duffie, G[acirc]rleanu, and Pedersen,\1087\ and thus

    promote a more efficient and competitive market structure for the swaps

    markets. In another paper, Zhu addresses the requirement for a minimum

    of five quote providers as a means to ``increase direct trading among

    `end-users' and reduce the fraction of trading volume that is conducted

    through intermediaries.'' \1088\ Similarly, Avellaneda and Cont

    emphasize the importance of market transparency as ``not an objective

    per se but rather a means for ensuring the proper functioning of the

    market.'' \1089\

    ---------------------------------------------------------------------------

    \1086\ See Hendershott & Madhavan, ``Click or Call,'' at 3

    (stating that ``[T]he evolution of bilateral, sequential trading

    into an auction type framework'' (their definition of the RFQ

    system), ``offers a path from an over-the-counter market to

    centralized, continuous trading'').

    \1087\ Duffie et al., ``OTC Markets,'' at 1815.

    \1088\ Haoxiang Zhu, ``Finding a Good Price in Opaque Over-the-

    Counter Markets,'' 25 The Review of Financial Studies 1255, 1264

    (Apr. 2012).

    \1089\ Marco Avellaneda & Rama Cont, ``Transparency in Credit

    Default Swap Markets,'' Finance Concepts, at 3 (Jul. 2010),

    available at http://www.finance-concepts.com/images/fc/CDSMarketTransparency.pdf.

    ---------------------------------------------------------------------------

    (3) Price Discovery

    The final rules provide for pre-trade transparency and promote

    trading on SEFs, both of which will enhance price discovery on a SEF.

    The minimum trading functionality will allow non-dealer firms with

    access to the SEF to compete with dealers by also placing bids and

    offers on the SEF. The 15 second time delay requirement will ensure a

    minimum level of pre-trade transparency by allowing other market

    participants the opportunity to participate in a privately negotiated

    trade before it is crossed. The broader participation and pre-trade

    transparency could increase market depth and improve price discovery.

    Research by Zhu shows that execution methods similar to the RFQ system

    can help improve the dispersion of quote information across a broader

    cross-section of market participants, the sensitivity of quoted prices

    to information, and the ability of the market to aggregate information

    distributed among multiple participants.\1090\ These conclusions

    support findings from research by Duffie, G[acirc]rleanu, and Pedersen

    that ``[s]earch frictions affect not only the average levels of asset

    prices but also the asset market's resilience to aggregate shocks[,]''

    both of which are critical elements of any efficient and effective

    price discovery process.\1091\

    ---------------------------------------------------------------------------

    \1090\ Haoxiang Zhu, ``Finding a Good Price in Opaque Over-the-

    Counter Markets,'' 25 The Review of Financial Studies 1255, 1257-58

    (Apr. 2012).

    \1091\ Duffie et al., ``Valuation in OTC Markets,'' at 1881.

    ---------------------------------------------------------------------------

    The differentiation in execution methods for Required and Permitted

    Transactions, and the ability to use ``any means of interstate

    commerce'' in providing the execution methods for Required Transactions

    as described in Sec. 37.9(a)(2)(ii), will allow a SEF to adjust its

    market structures for emerging and less liquid markets by using a

    variety of means of communication in providing the execution methods

    for Required Transactions and using any execution method the SEF deems

    appropriate for Permitted Transactions. This approach reflects the

    Commission's belief that the price discovery process varies across

    markets and products.

    (4) Sound Risk Management Practices

    Centralized trading platforms have multiple checks and balances

    built into their systems designed to reduce operational risks (such as

    human error) inherent in order submission, matching, and confirmation.

    The Commission believes that adoption of centralized trading platforms

    for swaps trading on a SEF will contribute to a system-wide reduction

    in operational risks, and will help standardize risk management

    practices in the marketplace. This in turn will reduce overall

    transaction costs, and will, along with pre-trade transparency and the

    prospects for improved price discovery discussed earlier, encourage

    market participants to trade swaps on SEFs and thus aid in the

    development of the swaps market. As markets are interlinked, the growth

    of the swaps market will likely drive growth of the futures and other

    derivatives markets through the liquidity externality mechanism, which

    in turn will improve the ability of a broader range of market

    participants to measure, hedge, and transfer their risks through such

    contracts.\1092\

    ---------------------------------------------------------------------------

    \1092\ See Yakov Amihud, Haim Mendelson, & Beni Lauterbach,

    ``Market microstructure and securities values: Evidence from the Tel

    Aviv Stock Exchange,'' 45 Journal of Financial Economics 365, 378-80

    (Sep. 1997) (discussing liquidity externalities in trading).

    ---------------------------------------------------------------------------

    (5) Other Public Interest Considerations

    The Commission has not identified any effects that these rules will

    have on other public interest considerations other than those

    enumerated above.

    3. Registration

    (a) Background

    Section 5h(a)(1) of the Act provides that no person may operate a

    facility for

    [[Page 33568]]

    the trading or processing of swaps unless the facility is registered as

    a SEF or a DCM.\1093\ The SEF definition in CEA section 1a(50) defines

    a SEF as ``a trading system or platform in which multiple participants

    have the ability to execute or trade swaps by accepting bids and offers

    made by multiple participants in the facility or system, through any

    means of interstate commerce, including any trading facility, that--(A)

    Facilitates the execution of swaps between persons; and (B) is not a

    designated contract market.'' \1094\ In accordance with these

    provisions, the Commission has clarified that a facility would be

    required to register as a SEF if it offers a trading system or platform

    in which more than one market participant has the ability to execute or

    trade swaps with more than one other market participant on the system

    or platform.\1095\ In response to comments, the Commission also

    provides examples of how it would interpret the registration

    requirement for certain entities.

    ---------------------------------------------------------------------------

    \1093\ CEA section 5h(a)(1); 7 U.S.C. 7b-3(a)(1).

    \1094\ CEA section 1a(50); 7 U.S.C. 1a(50).

    \1095\ See Requirements for Registration discussion above under

    Sec. 37.3--Requirements for Registration in the preamble for

    further details.

    ---------------------------------------------------------------------------

    Section 37.3(a)(1) codifies this statutory registration requirement

    and Sec. 37.3(b) requires, among other things, that applicants

    requesting approval of registration as a SEF must file a complete Form

    SEF, which consists of general questions and a list of exhibits that

    will enable the Commission to determine whether the applicant complies

    with the core principles and the Commission's regulations. Form SEF

    standardizes the information that an applicant must provide to the

    Commission and includes comprehensive instructions that will guide

    applicants through the process.\1096\ Section 37.3(b)(5) requires the

    Commission to review any application for registration as a SEF

    submitted two years or later after the effective date of part 37

    pursuant to the 180-day timeframe and procedures specified in CEA

    section 6(a).

    ---------------------------------------------------------------------------

    \1096\ Sections 37.3(d)-(g) provide procedures for other actions

    involving registration, including reinstating a dormant

    registration, requesting a transfer of registration, withdrawal of

    an application for registration, and vacation of registration. These

    procedures will further the ability of the Commission to efficiently

    monitor SEFs' compliance with the core principles, and will result

    in minimal administrative costs for SEFs.

    ---------------------------------------------------------------------------

    Under Sec. 37.3(c), SEF applicants may submit a notice to the

    Commission requesting temporary registration, allowing them to operate

    during the pending application process once a notice granting temporary

    registration from the Commission has been received. The SEF NPRM

    required these applicants to submit transaction data substantiating

    that they are trading swaps. In response to comments, the Commission is

    eliminating this requirement from the final rule and is also extending

    the termination date of the proposed temporary registration provision

    by one year. In addition, the Commission is shortening the proposed

    effective date of the regulations from 90 days to 60 days subsequent to

    publication in the Federal Register. In connection with this change,

    the Commission is also using its discretion to establish alternative

    dates for the commencement of its enforcement of regulatory provisions

    and is setting a general compliance date of 120 days subsequent to

    Federal Register publication.

    (b) Costs

    In its discussion paper, ISDA estimated the average cost of

    registration would be $333,000.\1097\ Based on the Commission staff's

    follow-up discussions with commenters, the Commission estimates that

    the total cost of completing and filing a registration application with

    the Commission will be between $333,000 and $500,000. This range

    accounts for the time that will be expended to prepare and file Form

    SEF.\1098\

    ---------------------------------------------------------------------------

    \1097\ ISDA Discussion Paper at 32 (Nov. 2011).

    \1098\ The Commission notes that the SEC estimated that the one-

    time registration burden to prepare and file Form SB-SEF will be

    approximately 100 hours for each new and existing entity. See

    Registration and Regulation of Security-Based Swap Execution

    Facilities, 76 FR at 11024. The SEC based this estimate on its

    experience with the registration process for national securities

    exchanges, having last estimated the average time it should take to

    fill out the securities exchange registration form (Form 1) to be 47

    hours. Id. The SEC adjusted this figure upwards to account for the

    greater resources that would be required initially in lieu of an

    established framework and familiarity of the industry in order to

    gather supporting documentation and complete Form SB-SEF.

    ---------------------------------------------------------------------------

    As noted above, based on the statute as interpreted by the

    Commission, a facility that meets the SEF definition would be required

    to register as a SEF and would incur the costs of registration. These

    facilities would also be required to meet the minimum trading

    functionality and other requirements of Sec. 37.9. The costs and

    benefits of those requirements are discussed above. The 180-day review

    period for SEF applications submitted two years or later after the

    effective date of part 37 is not expected to impose significant costs

    on applicants who submit their applications sooner since they will be

    eligible for two years of temporary registration and will not need to

    await final Commission approval before commencing SEF operation.

    (c) Benefits

    As discussed above, based on the statute as interpreted by the

    Commission, a facility that meets the SEF definition would be required

    to register as a SEF. These facilities will, as registered SEFs, have

    the benefit of being able to offer Required Transactions for execution,

    while alternative entities that are not required to register as SEFs,

    including one-to-many systems or platforms, will only be able to offer

    Permitted Transactions for execution. This will ensure, consistent with

    the statute, a level playing field, that all Required Transactions are

    executed on registered SEFs. This will provide market participants in

    Required Transactions with the benefits associated with the minimum

    trading functionality, core principles, and other requirements set out

    in this release.

    Additionally, the Commission's interpretation of the registration

    requirement through a set of examples helps to clarify which facilities

    must register as a SEF. The Commission believes that providing examples

    of how it would interpret the CEA section 5h(a)(1) registration

    requirement will ensure that a consistent set of metrics is available

    to market participants while evaluating the applicability of the

    registration requirements. Providing specific examples will also

    mitigate the costs potential registrants may incur in seeking advice on

    issues pertaining to registration.

    Form SEF is designed to ensure that only applicants that comply

    with the Act and the Commission's regulations are registered as SEFs.

    Form SEF is expected to minimize the amount of time the Commission

    staff will need to review applications and reduce the need for the

    Commission staff to request, and applicants to provide, supplementary

    information, which, in turn, benefits potential SEFs by reducing the

    time it takes to become fully registered. This standardized

    registration process will provide applicants with legal certainty

    regarding the type of information that is required and will ensure that

    no applicant is given a competitive advantage in the application

    process.

    Further, granting temporary registration for up to two years will

    improve market continuity by allowing the Commission ample time to

    review applications without jeopardizing an applicant's ability to

    operate pending Commission review. By withdrawing the existing trading

    activity requirement in proposed Sec. 37.3(b)(1)(ii), all SEF

    [[Page 33569]]

    applicants, not only those operating existing platforms, may apply for

    temporary registration. The withdrawal of the trading activity

    requirement should promote competition between SEFs by providing

    opportunities for new entities to establish trading operations that

    compete with existing platforms. The 180-day review period for SEF

    applications submitted two years or later after the effective date of

    part 37 will provide any later SEF applicants with the same review

    period as is applicable under the CEA to DCMs and will provide greater

    certainty for SEF applicants regarding the time period for the

    Commission's review of their applications.

    (d) Consideration of Alternatives

    Several commenters stated that the Commission should harmonize its

    registration procedures with the SEC in order to avoid unnecessary cost

    and duplication for SEFs.\1099\ In particular, Tradeweb stated that SEF

    applicants should not have to file separate applications for each mode

    of execution, and that where a SEF is offering both swaps and security-

    based swaps, the SEF should only be required to file one application

    for both agencies.\1100\

    ---------------------------------------------------------------------------

    \1099\ See Application Procedures discussion above under Sec.

    37.3--Requirements for Registration in the preamble.

    \1100\ Tradeweb Comment Letter at 3-4 (Jun. 3, 2011).

    ---------------------------------------------------------------------------

    The Commission recognizes that substantially similar registration

    forms and procedures could facilitate compliance and reduce regulatory

    costs for SEFs seeking dual registrations. The Commission notes,

    however, that it must comprehensively review and understand a SEF's

    proposed trading models and operations, which will facilitate trading

    for a more diverse universe of financial instruments and underlying

    commodities than SB-SEFs. Accordingly, the Commission is not permitting

    notice registration to SEC-registered SB-SEFs. Additionally, in

    response to comments raised, the Commission clarified in the preamble

    that a SEF applicant does not need to file separate applications for

    each mode of execution, but that its application must describe each

    mode of execution offered. This should allay concerns that multiple

    costly applications must be filed with the Commission.

    (e) Section 15(a) Factors

    (1) Protection of Market Participants and the Public

    The interpretation of the registration provision to apply to

    facilities that meet the SEF definition will ensure that market

    participants transacting any swap on these platforms, whether or not

    they are subject to the trade execution requirement, will benefit from

    the core principles and other requirements for SEFs (including the pre-

    trade transparency available on SEFs), especially those designed to

    protect market participants and the public. Furthermore, given the

    critical role that SEFs will play in the financial markets, it is

    essential that the Commission conduct a comprehensive and thorough

    review of all SEF applications for registration. Such a review is

    important for the protection of market participants and the public

    because it ensures that only qualified applicants who satisfy the

    statutory requirements and the Commission's regulations thereunder can

    operate as SEFs. Form SEF will enable the Commission to efficiently and

    accurately determine whether an applicant meets such requirements.

    (2) Efficiency, Competitiveness, and Financial Integrity of the Markets

    The Commission's interpretation of the registration provision to

    apply to facilities that meet the SEF definition, along with the

    minimum trading functionality requirement, will promote competition in

    the swaps market by providing a level playing field for entities that

    meet the SEF definition.

    The standardized registration procedures and Form SEF will create

    an efficient process that will reduce the resources associated with

    submitting and reviewing completed applications. The final rules

    promote market competition by not discriminating between new and

    existing platforms applying to register as SEFs. For example, the

    elimination of the proposed existing trading activity requirement for

    temporary registration will ensure that new entities wishing to qualify

    for temporary registration will not be placed at a competitive

    disadvantage to existing entities. The required information in Form SEF

    (Exhibits I-K--Financial Information and M and T--Compliance) will

    allow the Commission to evaluate each applicant's ability to operate a

    financially-sound SEF and to appropriately manage the risks associated

    with its role in the financial markets.

    (3) Price Discovery

    The Commission has not identified any effects that these procedures

    will have on price discovery.

    (4) Sound Risk Management Practices

    The registration procedures will require SEF applicants to examine

    their proposed risk management program through a series of detailed

    exhibits and submissions. These risks include risks associated with the

    SEF applicant's financial resources and operational and market risks

    associated with trading on the SEF platform. The submission of exhibits

    relating to risk management, including Exhibits I-K (Financial

    Information) and M, O, and T (Compliance), will provide data and

    information that will aid the Commission staff's analysis and

    evaluation of an applicant's ability to comply with the core

    principles.

    (5) Other Public Interest Considerations

    The Commission has not identified any effects that these procedures

    will have on other public interest considerations other than those

    enumerated above.

    4. Recordkeeping and Reporting

    (a) Background

    This release finalizes a series of provisions governing the

    recordkeeping and reporting responsibilities of SEFs and market

    participants.\1101\ Among other requirements, these rules require each

    SEF to: (1) Provide the Commission with information about its business

    as a SEF (Sec. Sec. 37.5(a), 37.503), provide a written demonstration

    of compliance with any core principle (Sec. 37.5(b)), and provide

    notice of any transaction involving the transfer of at least fifty

    percent of the equity interest in the SEF (Sec. 37.5(c)); (2) provide

    each counterparty to a swap on the SEF with a written record of all of

    the terms of the transaction (Sec. 37.6(b)); \1102\ and (3) maintain

    records of all business activities, including a complete audit trail,

    investigatory files, and disciplinary files, in a form and manner

    acceptable to the Commission for at least 5 years (Sec. 37.1001).

    ---------------------------------------------------------------------------

    \1101\ For example, section 37.901 states that SEFs must report

    swap data as specified in parts 43 and 45 and meet the requirements

    of part 16. This provision references other Commission regulations,

    the costs and benefits of which are discussed in connection with

    those rulemakings.

    \1102\ The discretionary costs and benefits specific to the

    confirmation process are discussed in the part 23 rulemaking for new

    confirmation standards.

    ---------------------------------------------------------------------------

    A SEF must also: (1) Have the ability to obtain the information

    necessary to perform its self-regulatory responsibilities, including

    the authority to examine books and records (Sec. Sec. 37.501, 37.502);

    (2) share information with other regulatory organizations, data

    repositories, and third-party data reporting services as required by

    the Commission (Sec. 37.504); (3) demonstrate that it has access to

    sufficient information to assess whether

    [[Page 33570]]

    trading is being used to affect prices in its market (Sec. 37.404(a));

    and (4) require market participants to keep records of their trading

    and make such records available to the SEF or the SEF's regulatory

    service provider, and the Commission, upon request (Sec. 37.404(b)).

    The final rules also govern a SEF's use of data and records

    obtained from market participants, and prohibit a SEF from using for

    business or marketing purposes proprietary or personal information that

    it collects from any person unless the person clearly consents to the

    use of its information in such a manner (Sec. 37.7).

    (b) Costs

    The costs associated with responding to requests for information or

    demonstrations of compliance under recordkeeping rules in Sec. 37.5

    will include the staff hours required to prepare exhibits, draft

    responses, and submit materials. These costs will vary among SEFs

    depending upon the nature and frequency of Commission inquiries.

    The Commission is reducing the reporting burden associated with

    final Sec. 37.5(c) (equity interest transfers) by raising the

    threshold of when a SEF must file a notification with the Commission

    from 10 percent to 50 percent, by increasing the time frame for

    submitting such notification to 10 days rather than the next business

    day, and by eliminating the proposed requirement that SEFs must provide

    a series of documents and a representation along with the notification

    of an equity transfer interest. Under the final rules, the Commission,

    upon receiving a notification of an equity interest transfer, may

    request appropriate documentation of the transfer, but all the

    documentation should already be in the possession of the SEF.

    Accordingly, a SEF that enters into agreements that could result in

    equity interest transfers of 50 percent of more will incur one-time

    costs associated with preparing and submitting the required

    notification for each event.

    Further, final Sec. 37.1001 (requirement to maintain business

    records including audit trail, investigatory, and disciplinary files)

    codifies the substantive requirements found in Core Principle 10.

    Accordingly, most, if not all, of the costs associated with this rule

    are attributable to statutory mandate. Commenters did not mention any

    specific costs with respect to this rule. In addition, Sec. Sec.

    37.501 and 37.503 (establish and enforce rules and provide information

    to the Commission) codify requirements that appear in the statute and

    impose no additional costs on SEFs or market participants beyond those

    attributable to Congressional mandate.

    Final Sec. 37.502 requires each SEF to have rules that allow it to

    collect information or examine books and records of participants, but

    imposes no affirmative obligations on SEFs to do so. Accordingly, the

    only direct costs associated with Sec. 37.502 are the de minimis costs

    associated with writing such rules.

    Final Sec. 37.504 (information sharing agreements) codifies and

    implements the Core Principle 5 requirement that a SEF have the

    capacity to carry out international information-sharing agreements as

    the Commission may require. Accordingly, SEFs will bear the cost of

    responding to Commission requests to share information with other

    regulatory organizations, data repositories, and third-party data

    reporting services. The cost of responding to Commission requests to

    share information will vary depending on the frequency and nature of

    the requests. To the extent that it is necessary for a SEF to enter

    into an information sharing agreement, the SEF may face additional

    costs such as negotiating such agreement. However, these costs are

    unlikely to be significant and will only be incurred should a SEF

    determine that it is necessary to enter into an information sharing

    agreement.

    A market participant's cost to maintain records under Sec. 37.404

    (ability to obtain information) should be minimal if, as expected, it

    is part of its normal business practice. As a result, a market

    participant's additional cost to provide records to the SEF, and the

    SEF's cost to request and process the records, will be nominal if,

    based upon the Commission's experience with DCMs, such requests are

    infrequent and targeted to specific and significant market situations.

    Additionally, the Commission has moved to guidance the requirement

    from proposed Sec. 37.404(b) that a SEF require customers engaging in

    intermediated trades to use a comprehensive large-trader reporting

    system or be able to demonstrate that they can obtain position data

    from other sources. This change should mitigate costs by providing SEFs

    with greater flexibility to identify particular methods of compliance

    that suit their markets and business structures.

    The Commission is also amending Sec. 37.7 (use of proprietary or

    personal information) to allow SEFs to use certain information for

    business or marketing purposes if the person consents to the use of

    such information. The costs imposed by this provision are limited to

    the cost a SEF might incur in obtaining such person's consent to use

    its information for the purposes described above. The Commission does

    not prescribe the method by which a SEF must obtain such consent, which

    provides flexibility to SEFs.

    (c) Benefits

    The Dodd-Frank Act created a robust recordkeeping regime in order

    to reduce risks associated with swaps trading, increase transparency,

    and promote market integrity. Taken as a whole, the recordkeeping and

    reporting regulations adopted in this release will provide a SEF and

    the Commission with access to information that will enhance a SEF's

    ability to oversee its platforms and markets and enable the Commission

    to determine whether a SEF is operating in compliance with the statute

    and the Commission's regulations. The information-sharing requirement

    in Sec. 37.504 will also provide cost-savings across market regulators

    by allowing the SEF to serve as the focal point for collecting certain

    data instead of each regulator duplicating efforts and collecting the

    information independently.

    The confirmation requirement in Sec. 37.6(b) will provide market

    participants with the certainty that transactions entered into on or

    pursuant to the rules of a SEF will be legally enforceable on all

    parties to the transaction. The requirement that a SEF provide each

    counterparty with a confirmation at the same time as execution will

    support the policy goal of straight-through processing to ensure that

    counterparties do not encounter gaps in their records as to their

    exposure level with other counterparties. This will also reduce the

    costs and risks involved in resolving disputes between counterparties

    to a trade; given dependency across trades, for example, if a

    participant has already unwound a position or taken a position via a

    trade under dispute or hedged it, any delays or uncertainties in the

    confirmation will result in higher costs from having to further unwind

    such linked trades.

    The prohibition on the use by a SEF of proprietary or personal

    information for business purposes without consent (Sec. 37.7) will

    ensure that information provided to a SEF for regulatory purposes will

    not be used to advance the commercial interests of the SEF. The rule

    does, however, afford market participants the flexibility to consent to

    a SEF's use of their personal information for commercial purposes, if

    they so desire.

    [[Page 33571]]

    (d) Section 15(a) Factors

    (1) Protection of Market Participants and the Public

    The recordkeeping and reporting rules will protect market

    participants and the public by improving a SEF's and the Commission's

    ability to detect manipulative or disruptive activity. This, in turn,

    may deter SEFs and market participants from engaging in practices that

    may harm other market participants and harm the public by placing the

    larger economy at risk. Additionally, certification of continued

    compliance with the core principles will enable the Commission to

    ensure that performance of SEF functions is limited to only those

    entities that have adequately demonstrated an ability to comply with

    the Act and accompanying regulations. This will protect the public by

    promoting trading on regulated SEFs rather than OTC markets. While SEFs

    and the Commission may at times require access to market participants'

    information for regulatory purposes, the rules also protect market

    participants by stipulating that information they provide to SEFs for

    regulatory purposes is not used inappropriately to advance the

    commercial interests of the SEF without their consent.

    (2) Efficiency, Competitiveness, and Financial Integrity of the Markets

    The recordkeeping and reporting rules promote financial integrity

    as they ensure that the Commission and SEFs will have access to

    information to ensure that trading is conducted pursuant to the

    regulatory requirements, and that SEFs have sufficient documentation to

    detect, enforce, and deter potential rule violations.

    (3) Price Discovery

    The Commission has not identified any effects that these rules will

    have on price discovery considerations.

    (4) Sound Risk Management Practices

    Requiring that SEFs maintain audit trail, investigatory files,

    disciplinary, and other records will provide the Commission with access

    to data that will allow it to assess whether market participants are

    manipulating or otherwise disrupting trading in the swaps market. The

    Commission and SEFs can then take action to mitigate these risks.

    (5) Other Public Interest Considerations

    The Commission has not identified any effects that these rules will

    have on other public interest considerations other than those

    enumerated above.

    5. Compliance

    (a) Rule Writing and Enforcement

    Under Core Principle 2, a SEF must implement a number of rule-

    writing and enforcement-related provisions. Among other requirements, a

    SEF must: (1) Establish a rulebook that addresses critical areas of

    market protection (Sec. 37.201), including rules prohibiting certain

    abusive trading practices (Sec. 37.203(a)), rules ensuring impartial

    access to the SEF's trading system (Sec. 37.202), and rules governing

    internal disciplinary procedures (Sec. 37.206); and (2) have resources

    for effective rule enforcement, including sufficient compliance staff

    and resources (Sec. 37.203(c)), authority to collect information and

    examine books and records (Sec. 37.203(b)), and procedures for

    conducting investigations into possible rule violations (Sec.

    37.203(f)). The Commission is also clarifying that a SEF must establish

    and enforce rules for its employees that are reasonably designed to

    prevent violations of the Act and the rules of the Commission.

    Additionally, Sec. 37.204 provides SEFs with the option to choose

    to contract with a regulatory service provider for the provision of

    services to assist in complying with the CEA and Commission

    regulations, provided that the SEF supervise the regulatory service

    provider and retain exclusive authority with respect to all substantive

    decisions made by the regulatory service provider on the SEF's behalf.

    (1) Costs

    The costs associated with the rule-writing and enforcement

    provisions outlined above will consist mostly of one-time

    administrative outlays such as wages paid to attorneys and other

    compliance personnel for time spent drafting, reviewing, implementing,

    and updating rules. While new entities seeking to become SEFs would

    need to develop a rulebook, existing entities that already have written

    rules would only incur the incremental expense of updating them.

    SEFs will also incur the initial and recurring costs associated

    with investing in the resources and staff necessary to provide

    effective rule enforcement. A SEF must have sufficient staff and

    resources, including resources to collect information and examine books

    and records, as well as automated systems to assist the compliance

    staff in carrying out the SEF's self-regulatory responsibilities. One

    commenter stated that these requirements are overly burdensome, but did

    not provide any data in support.\1103\

    ---------------------------------------------------------------------------

    \1103\ State Street Comment Letter at 5 (Mar. 8, 2011).

    ---------------------------------------------------------------------------

    The Commission believes that having a minimum level of resources in

    place for rule enforcement purposes is a critical element of a

    sufficient compliance program, and is necessary pursuant to the

    statutory mandate of Core Principle 2, which requires SEFs to have the

    capacity to detect, investigate, and enforce its rules.\1104\ SEFs may

    be able to reduce these costs by contracting with a regulatory service

    provider. In addition, the Commission reduced the costs of the final

    rules by eliminating the requirement in proposed Sec. 37.203(c)(2)

    that a SEF monitor the size and workload of its compliance staff on an

    ongoing basis and, on at least an annual basis, formally evaluate the

    need to increase its compliance resources and staff. The Commission

    believes that the final rulemaking provides greater flexibility to SEFs

    in determining their approach to monitoring their compliance resources.

    ---------------------------------------------------------------------------

    \1104\ CEA section 5h(f)(2)(B); 7 U.S.C. 7b-3(f)(2)(B).

    ---------------------------------------------------------------------------

    With respect to the use of a third-party regulatory service

    provider as permitted under Sec. 37.204 (Regulatory services provided

    by a third party), two commenters in follow-up conversations indicated

    to the Commission staff that they each may contract (or have already

    contracted) with a regulatory service provider to perform various

    compliance functions at a cost of between $540,000 and $720,000 per

    year. This estimate represents the total cost of contracting a SEF's

    compliance functions to a regulatory service provider. Additionally,

    ISDA estimates an assessment on SEFs of $45,000 per year to contract

    with a regulatory service provider and $635,000 per year in dues for

    membership to the regulatory service provider.\1105\ Section 37.204 is

    intended to be a cost-saving provision that mitigates the burden placed

    on SEFs by the rule enforcement program and, as stated by one

    commenter, this rule may reduce a SEF's overall costs by at least

    thirty percent.

    ---------------------------------------------------------------------------

    \1105\ ISDA Discussion Paper at 28 (Nov. 2011).

    ---------------------------------------------------------------------------

    SEFs that choose to contract with a regulatory service provider

    will need to hire sufficient compliance staff to supervise the quality

    and effectiveness of the services provided by the regulatory service

    provider, including the cost of holding regular meetings with the

    regulatory service provider to review and assess the adequacy of the

    services provided. SEFs will also incur the cost of documenting any

    instances

    [[Page 33572]]

    in which their decisions differ from those recommended by their

    regulatory service provider.

    (2) Benefits

    Establishing a rulebook and an effective rule enforcement program

    will ensure that SEFs have specific and transparent procedures for

    addressing critical areas of market protection, and that SEFs will have

    the resources needed to implement those procedures. In particular, the

    requirements that a SEF offer impartial access, provide a fair and

    competitive market free of abusive trading practices, have sufficient

    resources to oversee and monitor the market, promptly investigate rule

    violations, establish disciplinary procedures that will deter abuses,

    and provide respondents with adequate safeguards will foster greater

    confidence that SEFs will provide a fair and competitive market free of

    trading abuses. This confidence is likely to result in increased

    trading of swaps on SEFs, improving liquidity and resulting in more

    competitive quotes.

    According to conversations with commenters, SEFs that contract-out

    certain regulatory functions to a regulatory service provider are

    likely to realize significant cost savings from economies of scale--one

    commenter stated that contracting with a regulatory service provider

    would reduce a SEF's overall costs by at least thirty percent.

    According to NFA's Web site, it appears that many potential SEFs have

    already contracted with, or are in the process of contracting with, a

    regulatory service provider.\1106\ Additionally, the rule governing the

    use of regulatory service providers ensures that SEFs will have

    sufficient staff to adequately supervise their regulatory service

    providers. By requiring that SEFs oversee the services provided by the

    regulatory service provider, the rule will likely result in cost

    savings to the SEF, as the failure of a service provider to adequately

    fulfill its duties may result in costs to SEFs for not meeting

    compliance obligations.

    ---------------------------------------------------------------------------

    \1106\ See, e.g., ``NFA Signs Agreement with ICAP to provide

    Regulatory Services to ICAP's Swap Execution Facility'' (Mar. 20,

    2012), available at http://www.nfa.futures.org/NFA-regulation/regulationNewsRel.asp?ArticleID=3996.

    ---------------------------------------------------------------------------

    (3) Consideration of Alternatives

    As referenced above, one of a SEF's rule-writing obligations is to

    develop rules governing internal disciplinary procedures, including

    rules governing disciplinary panels. CME stated that the Commission

    should not provide a prescriptive approach to disciplinary panels in

    proposed Sec. 37.206(b) by requiring a ``hearing panel'' to be

    separate from a ``review panel.'' \1107\ In response, the Commission

    removed the proposed requirement to establish separate hearing and

    review panels, instead allowing a SEF to establish one or more

    disciplinary panels, which will, among other things, issue notices of

    charges, conduct hearings, render written decisions, and impose

    disciplinary sanctions. The final rule will continue to achieve the

    goals of the proposed regulations by deterring violations of SEF rules,

    preventing recidivist behavior, and protecting respondents and

    customers harmed by violations of exchange rules. The procedures will

    achieve these goals while also providing SEFs with greater flexibility

    to structure their disciplinary bodies in a manner that best suits

    their business models and markets. The final rule is unlikely to impose

    additional personnel expenditures on SEFs, as the Commission

    anticipates that SEFs, like DCMs, will rely upon unpaid disciplinary

    panel members. The Commission anticipates that any actual costs

    associated with the disciplinary panel will be limited to de minimis

    administrative expenses for convening hearings over which the panel

    presides, such as postage, facility rentals, and printing.

    ---------------------------------------------------------------------------

    \1107\ CME Comment Letter at 35 (Feb. 22, 2011).

    ---------------------------------------------------------------------------

    The Commission notes that it has provided additional flexibility to

    SEFs by delaying the effective date of proposed Sec. 37.206(o) to 1

    year from the effective date of the SEF rules.\1108\ Where a rule

    violation is found to have occurred, this provision limits the number

    of warning letters to one per rolling twelve month period for the same

    violation. The delay in the effective date of this provision is likely

    to mitigate costs for persons and entities so that they may adapt to

    the new SEF regime.

    ---------------------------------------------------------------------------

    \1108\ The Commission is renumbering proposed Sec. 37.206(o) to

    Sec. 37.206(f). The Commission is also retitling this section as

    ``Warning letters.''

    ---------------------------------------------------------------------------

    As recommended by commenters, the Commission has also adopted cost-

    mitigating alternatives that will provide SEFs with additional

    flexibility and discretion to implement disciplinary and other

    enforcement programs in the manner they find most suited to their

    market. In particular, the Commission has: eliminated the requirement

    that an investigation report include the member or market participant's

    disciplinary history at the SEF; removed the requirement that SEFs

    include a copy of a warning letter in an investigation report; amended

    the standard for commencing an investigation from a ``possible basis''

    to a ``reasonable basis'' that a violation may have occurred or will

    occur; and deleted several provisions.\1109\

    ---------------------------------------------------------------------------

    \1109\ Deleted provisions include proposed Sec. 37.203(c)(2)

    (ongoing monitoring of compliance staff and resources), the second

    sentence of proposed Sec. 37.206(a) (annual review of enforcement

    staff), the majority of proposed Sec. 37.206(c) (timely review of

    investigation reports), the last sentence of proposed Sec.

    37.206(h) (denial of charges and right to a hearing), and proposed

    Sec. 37.206(j)(1)(vii) (cost of transcribing the record to be borne

    by the respondent).

    ---------------------------------------------------------------------------

    The Commission has also moved part or all of several provisions to

    guidance.\1110\ By moving these provisions to guidance, entities will

    have the flexibility to tailor compliance programs to varying business

    models and trading platforms as well as unanticipated technological

    innovation or behavioral changes. While the Commission's pairing of

    guidance and regulations provides for a broad and flexible regulatory

    framework, it also promotes uniformity of safe and sound operation such

    that market participants and the public receive comparable levels of

    protection irrespective of the particular SEF on which they transact.

    ---------------------------------------------------------------------------

    \1110\ See second part of proposed Sec. 37.206(a) (enforcement

    staff), proposed Sec. 37.206(d) (notice of charges), proposed Sec.

    37.206(e) (right to representation), proposed Sec. 37.206(f)

    (answer to charges), proposed Sec. 37.206(g) (admission or failure

    to deny charges), proposed Sec. 37.206(h) (denial of charges and

    right to hearing), proposed Sec. 37.206(i) (settlement of offers),

    the majority of proposed Sec. 37.206(j) (hearings), proposed Sec.

    37.206(l) (right to appeal), proposed Sec. 37.206(m) (final

    decisions), proposed Sec. 37.206(o) (summary fines for violations

    of rules regarding timely submission of records), and proposed Sec.

    37.206(p) (emergency disciplinary actions).

    ---------------------------------------------------------------------------

    (4) Section 15(a) Factors (Rule Writing and Enforcement)

    (i) Protection of Market Participants and the Public

    Together, the rule-writing and enforcement provisions described

    above ensure that SEFs adopt and enforce operational rules that protect

    market participants and the public through orderly SEF-traded markets

    that are better protected from manipulative and disruptive conduct than

    pre-Dodd Frank OTC markets.

    Rules prohibiting abusive trade practices such as wash trades and

    front-running are intended to deter such disruptive practices, and will

    protect market participants transacting on the SEF, as well as the

    general public, who may rely on prices derived from the market and who

    may be customers or shareholders of market participants.

    The requirement that a SEF have the capacity to detect and

    investigate rule violations, including adequate compliance staff and

    resources to conduct automated trade surveillance

    [[Page 33573]]

    and real-time monitoring (or contract with a regulatory service

    provider that has the capacity to perform these functions on its behalf

    while maintaining ultimate responsibility), will improve a SEF's

    ability to discover, sanction, and prevent violations and trading

    practices that could harm market participants and, indirectly, the

    public.

    SEF-initiated investigations are a chief tool in protecting market

    participants and the public because they provide the first opportunity

    to respond to rule violations. Rules allowing the SEF to obtain

    information and inspect books and records will not only deter potential

    abusive trading practices, but will also enable the SEF to detect any

    manipulative or fraudulent activity quickly and efficiently. Prompt and

    thorough investigations are essential to detecting and remedying

    violations and ensuring that the violations do not harm market

    participants, result in price distortions, or contribute to systemic

    risks that can harm the economy.

    In the event of demonstrated customer harm, restitution damages are

    generally required to make that customer whole again. Meaningful

    sanctions will serve as a general deterrent by discouraging others from

    engaging in violative conduct.

    Impartial access requirements protect market participants from

    discriminatory treatment by prohibiting similarly situated market

    participants from receiving different access terms and fee structures.

    The requirement that SEFs establish and enforce rules for its

    employees will protect market participants and the public by helping to

    ensure that employees operate in conformance with the Act and the rules

    of the Commission.

    (ii) Efficiency, Competitiveness, and Financial Integrity of the

    Markets

    The requirement that a SEF have the capacity to detect and mitigate

    rule and trade practice violations, including the ability to collect

    relevant information and examine books and records, and the requirement

    to establish and enforce rules for its employees will increase

    confidence in the financial integrity of the market by confirming to

    market participants that their orders and trades are handled pursuant

    to the posted rules of the SEF.

    In addition, impartial access requirements will eliminate a

    potential impediment to participation, resulting in a more competitive

    market. At a minimum, as required by section 2(e) of the Act, market

    participants must meet the definition of an ECP, which ensures that

    only those participants with a sufficient level of sophistication and

    financial resources are able to participate. Similarly, requiring a SEF

    to maintain minimum level of enforcement resources will promote

    financial integrity by ensuring that a SEF has sufficient resources to

    investigate wrongdoing and make aggrieved market participants whole

    again. Moreover, markets where wrongdoing is detected and deterred will

    operate more efficiently.

    (iii) Price Discovery

    Many of the same rule provisions previously discussed that serve to

    increase efficiency, liquidity, and competitiveness will, by extension,

    improve price discovery, because the combination of increases in

    liquidity and competition will help create a marketplace in which the

    forces of supply and demand reflect more accurate pricing.

    Timely investigations will increase the likelihood that

    manipulation is detected early-on and quickly remedied so that price

    discovery is not impaired. Additionally, a system of meaningful

    sanctions will deter disruptive and manipulative trade practices,

    providing a stable and competitive trading environment more likely to

    foster price discovery.

    (iv) Sound Risk Management Practices

    The requirement that SEF participants confirm to the SEF that they

    meet the definition of an ECP helps assure the market that participants

    in SEF-traded markets have the skill, knowledge, and/or financial

    resources necessary to enter into financially-sound transactions and

    understand sound risk management practices.

    (v) Other Public Interest Considerations

    The Commission has not identified any effects that these rules will

    have on other public interest considerations other than those

    enumerated above.

    (b) Chief Compliance Officer

    Section 37.1501 implements Core Principle 15 and requires each SEF

    to designate an individual to serve as Chief Compliance Officer

    (``CCO'') and to provide its CCO with the authority and resources to

    develop and enforce such policies and procedures as are necessary for

    the CCO to fulfill its statutory and regulatory duties.\1111\ While the

    proposed rule prohibited the CCO from serving as a member of the SEF's

    legal department or as the SEF's general counsel, the Commission has

    eliminated this restriction from the final rule.

    ---------------------------------------------------------------------------

    \1111\ There are no costs associated with Sec. 37.1501(a),

    which simply defines ``board of directors.''

    ---------------------------------------------------------------------------

    The final rule also outlines the procedures for oversight authority

    over the CCO and for appointing and removing the CCO. The CCO must meet

    with the board of directors at least annually and the Regulatory

    Oversight Committee (``ROC'') at least quarterly. The CCO must also

    prepare an annual compliance report containing a detailed account of

    the SEF's compliance with the CEA and Commission regulations, as well

    as a detailed account of the SEF's self-regulatory program, and submit

    it to the SEF's board of directors for review and to the Commission.

    SEFs must maintain records pertaining to, among other things, code of

    ethics and conflict of interest policies, copies of all materials

    created in furtherance of the CCO's duties, and any records relevant to

    the SEF's annual compliance report.

    (1) Costs

    Several commenters stated that the proposed requirement that the

    CCO may not be a member of the SEF's legal department and may not serve

    as its general counsel is prescriptive and unnecessary.\1112\ In

    response to these comments, the Commission has eliminated the proposed

    prohibition on who may serve as CCO. Accordingly, a SEF may use its

    general counsel or a member of its legal department to serve as CCO.

    This change to the final rule should significantly reduce the expense

    imposed by the proposed rule, which would have necessitated the hiring

    of an individual specifically to serve as CCO at an estimated annual

    cost of $181,394.\1113\ The cost of assigning the role of CCO to an

    existing employee will be significantly less.

    ---------------------------------------------------------------------------

    \1112\ ICE Comment Letter at 6-7 (Mar. 8, 2011); WMBAA Comment

    Letter at 6-7 (Mar. 8, 2011); MarketAxess Comment Letter at 27 (Mar.

    8, 2011); CME Comment Letter at 12-13 (Mar. 8, 2011).

    \1113\ This estimate is derived from the 2010 edition of SIFMA's

    annual report on Management and Professional Earnings in the

    Securities Industry (hereinafter ``SIFMA Report''). This figure

    reflects the median total annual compensation (including base salary

    and bonus) for a CCO in the securities industry. The Commission

    notes that this estimate only includes the cost of hiring a CCO.

    Although not required by statute or rule, SEFs may also choose to

    hire additional staff at additional cost in order to support the

    CCO.

    ---------------------------------------------------------------------------

    Several commenters requested that the Commission grant SEFs more

    flexibility in determining how a CCO is appointed, compensated,

    supervised, and removed.\1114\ In response to these comments, the

    Commission has removed the requirement in proposed

    [[Page 33574]]

    Sec. 37.1501(c)(1) that a CCO's appointment and compensation requires

    a majority vote of directors, as well as the requirements in proposed

    Sec. 37.1501(c)(3) that the SEF explain to the Commission the reason

    for the CCO's removal upon departure and that the SEF immediately

    appoint an interim CCO and permanent CCO as soon as reasonably

    practicable thereafter. The Commission notes that these revisions will

    provide the board of directors or senior officer of the SEF with a

    degree of flexibility to appoint, compensate, and remove the CCO in the

    manner that the SEF deems most appropriate.

    ---------------------------------------------------------------------------

    \1114\ Tradeweb Comment Letter at 12 (Mar. 8, 2011); WMBAA

    Comment Letter II at 7 (Mar. 8, 2011); MarketAxess Comment Letter at

    26 (Mar. 8, 2011).

    ---------------------------------------------------------------------------

    Several commenters also stated that the proposed requirement that

    CCOs ensure ``compliance with the Act and Commission regulations'' is

    impracticable and overly burdensome, as one individual cannot ensure

    compliance of an entire organization.\1115\ In response, the Commission

    is modifying Sec. 37.1501(d)(4) to state that one of the CCO's duties

    shall include ``taking reasonable steps to ensure compliance with the

    Act and Commission regulations.'' This modification should also reduce

    potential costs resulting from this rule without diminishing its

    benefits.

    ---------------------------------------------------------------------------

    \1115\ Tradeweb Comment Letter at 6-7 (Jun. 3, 2011); WMBAA

    Comment Letter II at 5-6 (Mar. 8, 2011); MarketAxess Comment Letter

    at 26 (Mar. 8, 2011); Tradeweb Comment Letter at 12 (Mar. 8, 2011);

    CME Comment Letter at 4 (Feb. 7, 2011).

    ---------------------------------------------------------------------------

    (2) Benefits

    The rule ensures that each SEF has a central figure responsible for

    overseeing major areas of compliance with the CEA and Commission

    regulations. The annual compliance report will enable a SEF and the

    Commission to evaluate the effectiveness of the SEF's self-regulatory

    programs and compliance with core principles, and to take remedial

    actions and make recommendations to improve the SEF's self-regulatory

    programs in order to ensure that the SEF remains in compliance with the

    core principles.

    (3) Consideration of Alternatives

    With respect to the annual compliance report requirement in

    proposed Sec. 37.1501(e), FXall stated that compiling the required

    information and preparing the report in a timely manner annually will

    consume considerable resources.\1116\ FXall proposed an alternative

    report that would request fewer pieces of information.\1117\ Similarly,

    CME stated that the Commission should specify key areas that should be

    discussed in the annual report, rather than requiring the report to

    describe in detail the registrant's compliance with respect to each of

    the numerous components of the CEA and Commission regulations.\1118\

    ---------------------------------------------------------------------------

    \1116\ FXall Comment Letter at 16 (Mar. 8, 2011).

    \1117\ Id. at 17.

    \1118\ CME Comment Letter at 7 (Feb. 7, 2011).

    ---------------------------------------------------------------------------

    After weighing the comments and alternative proposals from FXall

    and CME, the Commission has determined to adopt the rules as proposed,

    subject to certain revisions detailed in the preamble.\1119\ The

    Commission declines to adopt commenters' proposed alternatives because

    without the detailed information required by statute in the annual

    compliance report (including a self-assessment of policies and

    procedures designed to ensure compliance with each core principle, a

    discussion of areas for improvement, and a description of the SEF's

    self-regulatory program's staffing, structure, and cataloguing of

    disciplinary actions), the Commission would not have access to the

    information it needs to ensure that each SEF is in compliance with the

    CEA and Commission regulations.

    ---------------------------------------------------------------------------

    \1119\ See discussion above under Sec. 37.1501(e)--Annual

    Compliance Report Prepared by Chief Compliance Officer in the

    preamble.

    ---------------------------------------------------------------------------

    (4) Section 15(a) Factors (Chief Compliance Officer)

    (i) Protection of Market Participants and the Public

    The requirements that a CCO oversee the SEF's compliance with the

    Act and Commission regulations and supervise the SEF's self-regulatory

    program will ensure that the SEF monitors compliance with key

    provisions of the CEA designed to protect market participants and the

    public (including provisions governing trade practice and market

    surveillance, real-time market monitoring, and financial reporting). To

    the extent that the Commission's regulations impose more specific or

    supplemental requirements when compared to those requirements

    explicitly imposed by section 5h(f)(15) of the CEA, those incremental

    costs are not likely to be significant. While it is possible that those

    incremental costs will be passed along to market participants, the size

    of those costs is likely to be negligible.

    The Commission believes the CCO rules will protect market

    participants and the public by promoting compliance with the core

    principles and Commission regulations through the designation and

    effective functioning of the CCO, and the establishment of a framework

    for preparation of a meaningful annual review of a SEF's compliance

    program. The annual compliance report will allow the SEF and the

    Commission to periodically assess, and evaluate where necessary, the

    SEF's ability to comply with the core principles. Upon review of the

    compliance report, the SEF and the Commission will be better able to

    determine whether the SEF has appropriate programs in place to protect

    market participants and the public from market abuses.

    Maintaining records as required under Sec. 37.1501 regarding a

    CCO's efforts toward ensuring that the SEF complies with core

    principles provides a check against what is reported in the annual

    compliance report. Access to these records will assist the Commission

    in its determination of whether a SEF's self-regulatory program

    complies with the core principles and the Commission's regulations. If

    the Commission determines the self-regulatory program is not

    sufficient, the Commission will be able to use information required by

    the rule to take steps to remedy the shortcomings and to prevent

    disruptions that could harm market participants and the public.

    (ii) Efficiency, Competitiveness, and Financial Integrity of the

    Markets

    An effective CCO will implement measures that enhance the stability

    and efficiency of SEFs. Reliable and financially-sound SEFs are

    essential for the stability of the derivatives markets they serve. The

    CCO's oversight of self-regulatory programs and the annual compliance

    report will provide both the SEF and the Commission with an opportunity

    to assess the effectiveness of the SEF's self-regulatory programs and

    will help to detect and deter rule violations, increasing participation

    and competition in the markets.