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2010-31130

  • Federal Register, Volume 75 Issue 244 (Tuesday, December 21, 2010)[Federal Register Volume 75, Number 244 (Tuesday, December 21, 2010)]

    [Proposed Rules]

    [Pages 80174-80218]

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

    [FR Doc No: 2010-31130]

    [[Page 80173]]

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    Part III

    Commodity Futures Trading Commission

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    17 CFR Part 1

    Securities and Exchange Commission

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    17 CFR Part 240

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

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

    and ``Eligible Contract Participant''; Proposed Rule

    Federal Register / Vol. 75 , No. 244 / Tuesday, December 21, 2010 /

    Proposed Rules

    [[Page 80174]]

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    COMMODITY FUTURES TRADING COMMISSION

    17 CFR Part 1

    RIN 3038-AD06

    SECURITIES AND EXCHANGE COMMISSION

    17 CFR Part 240

    [Release No. 34-63452; File No. S7-39-10]

    RIN 3235-AK65

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

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

    Participant'' and ``Eligible Contract Participant''

    AGENCY: Commodity Futures Trading Commission; Securities and Exchange

    Commission.

    ACTION: Joint proposed rule; proposed interpretations.

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    SUMMARY: In accordance with Section 712(d)(1) of Title VII of the Dodd-

    Frank Wall Street Reform and Consumer Protection Act of 2010 (``Dodd-

    Frank Act''), the Commodity Futures Trading Commission (``CFTC'') and

    the Securities and Exchange Commission (``SEC'') (collectively, the

    ``Commissions''), in consultation with the Board of Governors of the

    Federal Reserve System, are proposing rules and interpretative guidance

    under the Commodity Exchange Act (``CEA''), 7 U.S.C. 1 et seq., and the

    Securities Exchange Act of 1934 (``Exchange Act''), 15 U.S.C. 78a et

    seq., to further define the terms ``swap dealer,'' ``security-based

    swap dealer,'' ``major swap participant,'' ``major security-based swap

    participant,'' and ``eligible contract participant.''

    DATES: Submit comments on or before February 22, 2011.

    ADDRESSES: Comments may be submitted by any of the following methods:

    CFTC:

    Agency Web site, via its Comments Online process: http://comments.cftc.gov. Follow the instructions for submitting comments

    through the Web site.

    Mail: David A. Stawick, Secretary, Commodity Futures

    Trading Commission, Three Lafayette Centre, 1155 21st Street, NW.,

    Washington, DC 20581.

    Hand Delivery/Courier: Same as mail above.

    Federal eRulemaking Portal: Comments also may be submitted

    at http://www.regulations.gov. Follow the instructions for submitting

    comments. ``Definitions'' must be in the subject field of responses

    submitted via e-mail, and clearly indicated on written submissions. All

    comments must be submitted in English, or if not, accompanied by an

    English translation. All comments provided in any electronic form or on

    paper will be published on the CFTC Web site, without review and

    without removal of personally identifying information. All comments are

    subject to the CFTC Privacy Policy.

    SEC

    Electronic Comments

    Use the Commission's Internet comment form (http://www.sec.gov/rules/proposed.shtml);

    Send an e-mail to rule-comments@sec.gov. Please include

    File Number S7-39-10 on the subject line; or

    Use the Federal eRulemaking Portal (http://www.regulations.gov). Follow the instructions for submitting comments.

    Paper Comments

    Send paper comments in triplicate to Elizabeth M. Murphy,

    Secretary, Securities and Exchange Commission, 100 F Street, NE.,

    Washington, DC 20549-1090.

    All submissions should refer to File Number S7-39-10. This file number

    should be included on the subject line if e-mail is used. To help us

    process and review your comments more efficiently, please use only one

    method. The Commission will post all comments on the Commission's

    Internet Web site (http://www.sec.gov/rules/proposed.shtml). Comments

    are also available for Web site viewing and printing in the

    Commission's Public Reference Room, 100 F Street, NE., Washington, DC

    20549, on official business days between the hours of 10 a.m. and 3

    p.m. All comments received will be posted without change; we do not

    edit personal identifying information from submissions. You should

    submit only information that you wish to make available publicly.

    FOR FURTHER INFORMATION CONTACT: CFTC: Mark Fajfar, Assistant General

    Counsel, at 202-418-6636, mfajfar@cftc.gov, Julian E. Hammar, Assistant

    General Counsel, at 202-418-5118, jhammar@cftc.gov, or David E. Aron,

    Counsel, at 202-418-6621, daron@cftc.gov, Office of General Counsel,

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

    Street, NW., Washington, DC 20581; SEC: Joshua Kans, Senior Special

    Counsel, Jeffrey Dinwoodie, Attorney Advisor, or Richard Grant,

    Attorney Advisor, at 202-551-5550, Division of Trading and Markets,

    Securities and Exchange Commission, 100 F Street, NE., Washington, DC

    20549-7010.

    SUPPLEMENTARY INFORMATION:

    I. Background

    On July 21, 2010, President Obama signed the Dodd-Frank Act into

    law.\1\ Title VII of the Dodd-Frank Act \2\ established a comprehensive

    new regulatory framework for swaps and security-based swaps. The

    legislation was enacted, among other reasons, to reduce risk, increase

    transparency, and promote market integrity within the financial system,

    including by: (1) Providing for the registration and comprehensive

    regulation of swap dealers, security-based swap dealers, major swap

    participants and major security-based swap participants; (2) imposing

    clearing and trade execution requirements on swaps and security-based

    swaps, subject to certain exceptions; (3) creating rigorous

    recordkeeping and real-time reporting regimes; and (4) enhancing the

    rulemaking and enforcement authorities of the Commissions with respect

    to, among others, all registered entities and intermediaries subject to

    the Commissions' oversight.

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    \1\ See Dodd-Frank Wall Street Reform and Consumer Protection

    Act, Public Law 111-203, 124 Stat. 1376 (2010). The text of the

    Dodd-Frank Act may be accessed at http://www.cftc.gov./

    LawRegulation/OTCDERIVATIVES/index.htm.

    \2\ Pursuant to Section 701 of the Dodd-Frank Act, Title VII may

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

    2010.''

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    More specifically, the Dodd-Frank Act provides that the CFTC will

    regulate ``swaps,'' and the SEC will regulate ``security-based swaps.''

    The Dodd-Frank Act also adds to the CEA and Exchange Act definitions of

    the terms ``swap dealer,'' ``security-based swap dealer,'' ``major swap

    participant,'' ``major security-based swap participant,'' and

    ``eligible contract participant.'' These terms are defined in Sections

    721 and 761 of the Dodd-Frank Act and, with respect to the term

    ``eligible contract participant,'' in Section 1a(18) of the CEA,\3\ as

    re-designated and amended by Section 721 of the Dodd-Frank Act.

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    \3\ See 7 U.S.C. 1a(18).

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    Section 712(d)(1) of the Dodd-Frank Act provides that the CFTC and

    the SEC, in consultation with the Board of Governors of the Federal

    Reserve System, shall jointly further define the terms ``swap,''

    ``security-based swap,'' ``swap dealer,'' ``security-based swap

    dealer,'' ``major swap participant,'' ``major security-based swap

    participant,'' ``eligible contract participant,'' and ``security-based

    swap agreement.''

    [[Page 80175]]

    Further, Section 721(c) of the Dodd-Frank Act requires the CFTC to

    adopt a rule to further define the terms ``swap,'' ``swap dealer,''

    ``major swap participant,'' and ``eligible contract participant,'' and

    Section 761(b) of the Dodd-Frank Act permits the SEC to adopt a rule to

    further define the terms ``security-based swap,'' ``security-based swap

    dealer,'' ``major security-based swap participant,'' and ``eligible

    contract participant,'' with regard to security-based swaps, for the

    purpose of including transactions and entities that have been

    structured to evade Title VII of the Dodd-Frank Act.\4\

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    \4\ The definitions of the terms ``swap,'' ``security-based

    swap,'' and ``security-based swap agreement,'' and regulations

    regarding mixed swaps are the subject of a separate rulemaking by

    the Commissions.

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    In light of the requirements in the Dodd-Frank Act noted above, the

    CFTC and the SEC issued a joint Advance Notice of Proposed Rulemaking

    (``ANPRM'') on August 13, 2010, requesting public comment regarding the

    definitions of ``swap,'' ``security-based swap,'' ``security-based swap

    agreement,'' ``swap dealer,'' ``security-based swap dealer,'' ``major

    swap participant,'' ``major security-based swap participant,'' and

    ``eligible contract participant'' in Title VII of the Dodd-Frank

    Act.\5\ The Commissions reviewed more than 80 comments in response to

    the ANPRM. The Commissions also informally solicited comments on the

    definitions on their respective Web sites.\6\ In addition, the staffs

    of the CFTC and the SEC have met with many market participants and

    other interested parties to discuss the definitions.\7\

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    \5\ See Definitions Contained in Title VII of Dodd-Frank Wall

    Street Reform and Consumer Protection Act, Exchange Act Rel. No. 34-

    62717, 75 FR 51429 (Aug. 20, 2010). The comment period for the ANPRM

    closed on September 20, 2010.

    \6\ Comments were solicited by the CFTC at http://www.cftc.gov/LawRegulation/DoddFrankAct/OTC_2_Definitions.html and the SEC at

    http://www.sec.gov/spotlight/regreformcomments.shtml/.

    \7\ The views expressed in the comments in response to the

    ANPRM, in response to the Commissions' informal solicitation, and at

    such meetings are collectively referred to as the views of

    ``commenters.''

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    In this release, the Commissions propose to further define ``swap

    dealer,'' ``security-based swap dealer,'' ``major swap participant,''

    ``major security-based swap participant'' and ``eligible contract

    participant,'' and propose related rules, and also discuss certain

    factors that are relevant to market participants when determining their

    status with respect to the defined terms. In developing these

    proposals, the Commissions have been mindful that the markets for swaps

    and security-based swaps are evolving, and that the rules that we adopt

    will, as intended by the Dodd-Frank Act, significantly affect those

    markets. The rules not only will help determine which entities will be

    subject to comprehensive regulation of their swap and security-based

    swap activities, but may also cause certain entities to modify their

    activities to avoid being subject to the regulations. As a result, we

    are aware of the importance of crafting these rules carefully to

    maximize the benefits of the regulation imposed by the Dodd-Frank Act,

    and to do so in a way that is flexible enough to respond to market

    developments. While we preliminarily believe that these proposals, if

    adopted, would appropriately effect the intent of the Dodd-Frank Act,

    we are very interested in commenters' views as to whether we have

    achieved this purpose, and, if not, how to improve these proposals.\8\

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    \8\ In addition, we recognize that the appropriateness of these

    proposals also should be considered in light of the substantive

    requirements that will be applicable to dealers and major

    participants, including capital, margin and business conduct

    requirements, which are the subject of separate rulemakings. For

    example, whether the definition of a major participant is too broad

    or too narrow may well depend in part on the substantive

    requirements applicable to such entities, and whether those

    substantive requirements are themselves appropriate may in turn

    depend in part on the scope of the major participant definition. We

    therefore encourage comments that take into account the interplay

    between the proposed definitions and these substantive requirements.

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    II. Definitions of ``Swap Dealer'' and ``Security-Based Swap Dealer''

    The Dodd-Frank Act defines the terms ``swap dealer'' and

    ``security-based swap dealer'' in terms of whether a person engages in

    certain types of activities involving swaps or security-based swaps.\9\

    Persons that meet either of those definitions are subject to statutory

    requirements related to, among other things, registration, margin,

    capital and business conduct.\10\

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    \9\ See Section 721 of the Dodd-Frank Act (defining ``swap

    dealer'' in new Section 1a(49) of the CEA, 7 U.S.C. 1a(49)) and

    Section 761 of the Dodd-Frank Act (defining ``security-based swap

    dealer'' in new Section 3(a)(71) of the Exchange Act, 15 U.S.C.

    78c(a)(71)).

    \10\ The Dodd-Frank Act excludes from the Exchange Act

    definition of ``dealer'' persons who engage in security-based swap

    transactions with eligible contract participants. See Section

    3(a)(5) of the Exchange Act, 15 U.S.C. 78c(a)(5), as amended by

    Section 761(a)(1) of the Dodd-Frank Act.

    The Dodd-Frank Act does not include comparable amendments for

    persons who act as brokers in swaps and security-based swaps.

    Because security-based swaps are a type of security, persons who act

    as brokers in connection with security-based swaps must, absent an

    exemption, register with the SEC as a broker pursuant to Exchange

    Act section 15(a), and comply with the Exchange Act's requirements

    applicable to brokers.

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    The two definitions in general encompass persons that engage in any

    of the following types of activity:

    (i) Holding oneself out as a dealer in swaps or security-based

    swaps,

    (ii) Making a market in swaps or security-based swaps,

    (iii) Regularly entering into swaps or security-based swaps with

    counterparties as an ordinary course of business for one's own account,

    or

    (iv) Engaging in activity causing oneself to be commonly known in

    the trade as a dealer or market maker in swaps or security-based

    swaps.\11\

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    \11\ See CEA section 1a(49)(A); Exchange Act section

    3(a)(71)(A).

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    The definitions are disjunctive, in that a person that engages in

    any of the enumerated dealing activities is a swap dealer or security-

    based swap dealer even if the person does not engage in any of the

    other enumerated activities.

    The definitions, in contrast, do not include a person that enters

    into swaps or security-based swaps ``for such person's own account,

    either individually or in a fiduciary capacity, but not as a part of a

    regular business.'' \12\ The Dodd-Frank Act also instructs the

    Commissions to exempt from designation as a dealer an entity that

    ``engages in a de minimis quantity of [swap or security-based swap]

    dealing in connection with transactions with or on behalf of its

    customers.'' \13\ Moreover, the definition of ``swap dealer'' (but not

    the definition of ``security-based swap dealer'') provides that an

    insured depository institution is not to be considered a swap dealer

    ``to the extent it offers to enter into a swap with a customer in

    connection with originating a loan with that customer.'' \14\

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    \12\ See CEA section 1a(49)(C); Exchange Act section

    3(a)(71)(C).

    \13\ See CEA section 1a(49)(D); Exchange Act section

    3(a)(71)(D).

    \14\ CEA section 1a(49)(A).

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    The definitions also provide that a person may be designated as a

    dealer for one or more types, classes or categories of swaps, security-

    based swaps, or activities without being designated a dealer for other

    types, classes or categories or activities.\15\

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    \15\ See CEA section 1a(49)(B); Exchange Act section

    3(a)(71)(B).

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    The Commissions are proposing rules to further define certain

    aspects of the meaning of ``swap dealer'' and ``security-based swap

    dealer,'' and are providing guidance on how the Commissions propose to

    interpret these terms. This release specifically addresses: (A) The

    types of activities that would cause a person to be a swap dealer or

    security-based swap dealer, including differences in how those two

    definitions should be applied; (B) the statutory provisions requiring

    the Commissions to exempt persons from the dealer

    [[Page 80176]]

    definitions in connection with de minimis activity; (C) the exception

    from the ``swap dealer'' definition in connection with loans by insured

    depository institutions; (D) the possibility that a person may be

    considered a dealer for some types, classes or categories of swaps,

    security-based swaps, or activities but not others; and (E) certain

    interpretative issues that arise in particular situations. The

    Commissions request comment on all aspects of the proposals, including

    the particular points noted in the discussion below.

    A. Swap and Security-Based Swap Dealing Activity

    1. Comments Regarding Dealing Activities

    Commenters provided numerous examples of conduct they viewed as

    dealing activities--as well as conduct they did not view as dealing

    activities. For example, many of the commenters stated that dealers

    provide ``bid/ask'' or ``two-way'' prices for swaps on a regular basis,

    or regularly participate in both sides of the swap market. Some

    commenters indicated that dealers perform an intermediary function.

    Other commenters stated that a person holds itself out as a dealer if

    it consistently and systematically markets itself as a swap dealer to

    third parties. Some commenters described market makers in the swap

    markets as persons that stand ready to buy or sell swaps at all times,

    are open to doing swaps business on both sides of a market, or make

    bids to buy and offers to sell swaps or a type of swap at all times.

    Commenters stated that a person should be included in the definition of

    dealer if its sole or dominant line of business is swaps activity. One

    commenter urged the Commissions to adopt a swap association's

    definition of a primary member as the definition of dealer.

    Some commenters stated that the definition of dealer should be read

    narrowly. For example, some commenters suggested that the market maker

    concept should not encompass persons that provide occasional quotes or

    that do not make bids or offers consistently or at all times. Another

    commenter stated that a willingness to buy or sell a swap or security-

    based swap at a particular time does not constitute market making

    absent the creating of a two-way market. One commenter suggested that

    solely acting as a market maker should not cause a person to be a

    dealer, since firms may have commercial purposes for offering two-way

    trades. Another commenter stated that an entity that ``holds itself

    out'' as a dealer should qualify as a swap dealer only if it

    ``consistently and systematically markets itself as a dealer to third-

    parties.'' \16\

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    \16\ See letter from Eric Dennison, Sr. Vice President and

    General Counsel, Stephanie Miller, Assistant General Counsel--

    Commodities, and Bill Hellinghausen, Director of Regulatory Affairs,

    EDF Trading, dated September 20, 2010 (distinguishing transactions

    that the commenter enters into as part of energy management

    services).

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    Many commenters called for the exclusion of particular types of

    persons from the definition of swap dealer or security-based swap

    dealer. Several commenters maintained that commercial end-users of

    swaps or security-based swaps that enter into swaps or security-based

    swaps to hedge or mitigate commercial risk should be excluded from the

    definitions. Another commenter stated the definitions should exclude

    persons who use swaps or security-based swaps for bona fide hedging.

    Other commenters indicated that cooperatives that enter into swaps in

    connection with the business of their members should be excluded.

    Commenters also stated that if all of a person's swaps are cleared on

    an exchange or derivatives clearing organization, the person should not

    be deemed to be a dealer. One commenter stated competitive power

    suppliers should be excluded, and another stated that the dealer

    definition should not apply to futures commission merchants that act

    economically like brokers.

    Commenters, particularly those in the securities industry, urged

    the Commissions to interpret the definitions of swap dealer and

    security-based swap dealer consistently with precedent that

    distinguishes between dealers in securities and traders in securities.

    However, one commenter also noted that some concepts from the

    securities and commodities laws may not easily be applied to these

    markets.

    2. Application of the Core Tests to ``Swap Dealers'' and ``Security-

    Based Swap Dealers''

    The Dodd-Frank Act defines the terms ``swap dealer'' and

    ``security-based swap dealer'' in a functional manner, encompassing how

    a person holds itself out in the market, the nature of the conduct

    engaged in by the person, and how the market perceives the person's

    activities. This suggests that the definitions should not be

    interpreted in a constrained or overly technical manner. Rigid

    standards would not provide the necessary flexibility to respond to

    evolution in the ways that dealers enter into swaps and security-based

    swaps. The different types of swap and security-based swap markets are

    diverse, and there does not appear to be a single set of criteria that

    can be determinative in all markets.

    At the same time, we note that there may be certain distinguishing

    characteristics of swap dealers and security-based swap dealers,

    including that:

    Dealers tend to accommodate demand for swaps and security-

    based swaps from other parties;

    Dealers are generally available to enter into swaps or

    security-based swaps to facilitate other parties' interest in entering

    into those instruments;

    Dealers tend not to request that other parties propose the

    terms of swaps or security-based swaps; rather, dealers tend to enter

    into those instruments on their own standard terms or on terms they

    arrange in response to other parties' interest; and

    Dealers tend to be able to arrange customized terms for

    swaps or security-based swaps upon request, or to create new types of

    swaps or security-based swaps at the dealer's own initiative.

    We also recognize that the principles relevant to identifying

    dealing activity involving swaps can differ from comparable principles

    associated with security-based swaps. These differences are due, in

    part, to differences in how those instruments are used. For example,

    because security-based swaps may be used to hedge or gain economic

    exposure to underlying securities (while recognizing distinctions

    between securities-based swaps and other types of securities, as

    discussed below), there is a basis to build upon the same principles

    that are presently used to identify dealers for other types of

    securities. Accordingly, we separately address how the core tests would

    apply to swap dealers and to security-based swap dealers.

    a. Application to Swap Dealers

    The definition of swap dealer should be informed by the differences

    between swaps, on the one hand, and securities and commodities, on the

    other. Transactions in cash market securities and commodities generally

    involve purchases and sales of tangible or intangible property. Swaps,

    in contrast, are notional contracts requiring the performance of agreed

    terms by each party.\17\ Thus, many of the concepts cited by

    commenters, such as whether a person buys and sells swaps or makes a

    two-sided market in swaps or trades within a bid/offer spread, cannot

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    necessarily be applied to all types of swaps to determine if the person

    is a swap dealer. We understand that market participants do use this

    terminology colloquially to describe the process of entering into a

    swap. For example, a person seeking a fixed/floating interest rate swap

    may inquire as to the fixed rates, spread above the floating rate and

    other payments that another person would require in order to enter into

    a swap. But, while these persons may discuss bids, offers, prices and

    so forth, the parties are negotiating the terms of a contract, they are

    not negotiating the price at which they will transfer ownership of

    tangible or intangible property. Accordingly, these concepts are not

    determinative of whether a person is a ``swap dealer.''

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    \17\ As discussed below, however (see note 42, infra), the Dodd-

    Frank Act amended the Exchange Act definitions of ``buy,''

    ``purchase,'' ``sale'' and ``sell'' to apply to particular actions

    involving security-based swaps.

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    Instead, persons who are swap dealers may be identified by the

    functional role they fulfill in the swap markets. As noted above, swap

    dealers tend to accommodate demand and to be available to enter into

    swaps to facilitate other parties' interest in swaps (although swap

    dealers may also advance their own investment and liquidity objectives

    by entering into such swaps). In addition, swap dealers can often be

    identified by their relationships with counterparties. Swap dealers

    tend to enter into swaps with more counterparties than do non-dealers,

    and in some markets, non-dealers tend to constitute a large portion of

    swap dealers' counterparties. In contrast, non-dealers tend to enter

    into swaps with swap dealers more often than with other non-

    dealers.\18\ The Commissions can most efficiently achieve the purposes

    underlying Title VII of the Dodd-Frank Act--to reduce risk and to

    enhance operational standards and fair dealing in the swap markets--by

    focusing their attention on those persons whose function is to serve as

    the points of connection in those markets. The definition of swap

    dealer, construed functionally in the manner set forth above, will help

    to identify those persons.

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    \18\ Some of the commenters appeared to suggest that significant

    parts of the swap markets operate without the involvement of swap

    dealers. We believe that this analysis is likely incorrect, and that

    the parties that fulfill the function of dealers should be

    identified and are likely to be swap dealers.

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    Clause (A)(iii) of the statutory definition of swap dealer, which

    includes any person that ``regularly enters into swaps with

    counterparties as an ordinary course of business for its own account,''

    \19\ has been the subject of significant uncertainty among commenters.

    The commenters point out that its literal terms could encompass many

    parties who regularly enter into swaps without engaging in any form of

    swap dealing activity. In this regard, clause (A)(iii) of the

    definition should be read in combination with the express exception in

    subparagraph (C) of the swap dealer definition, which excludes ``a

    person that enters into swaps for such person's own account, either

    individually or in a fiduciary capacity, but not as a part of a regular

    business.'' Thus, the difference between the inclusion in clause

    (A)(iii) and the exclusion in subparagraph (C) is whether or not the

    person enters into swaps as a part of, or as an ordinary course of, a

    ``regular business.'' \20\ We believe that persons who enter into swaps

    as a part of a ``regular business'' are those persons whose function is

    to accommodate demand for swaps from other parties and enter into swaps

    in response to interest expressed by other parties. Conversely, persons

    who do not fulfill this function should not be deemed to enter into

    swaps as part of a ``regular business'' and are not likely to be swap

    dealers.

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    \19\ We interpret this reference to a person entering into swaps

    ``with counterparties * * * for its own account'' to refer to a

    person entering into a swap as a principal, and not as an agent. A

    person who entered into swaps as an agent for customers (i.e., for

    the customers' accounts) would be required to register as either a

    Futures Commission Merchant, Introducing Broker, Commodity Pool

    Operator or Commodity Trading Advisor, depending on the nature of

    the person's activity.

    \20\ The definition of ``security-based swap dealer'' is

    structured similarly, and should be interpreted similarly.

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    In sum, to determine if a person is a swap dealer, we would

    consider that person's activities in relation to the other parties with

    which it interacts in the swap markets. If the person is available to

    accommodate demand for swaps from other parties, tends to propose

    terms, or tends to engage in the other activities discussed above, then

    the person is likely to be a swap dealer. Persons that rarely engage in

    such activities are less likely to be deemed swap dealers.

    We request comment on this interpretive approach for identifying

    whether a person is a swap dealer.

    b. Application to Security-Based Swap Dealers

    The definition of ``security-based swap dealer'' has parallels to

    the definition of ``dealer'' under the Exchange Act.\21\ In addition,

    security-based swaps may be used to hedge risks associated with the

    ownership of certain other types of securities,\22\ and security-based

    swaps may be used to gain economic exposure akin to ownership of

    certain other types of securities.\23\ As a result, the SEC would

    consider the same factors that are relevant to determining whether a

    person is a ``dealer'' under the Exchange Act as also generally

    relevant to the analysis of whether a person is a security-based swap

    dealer.

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    \21\ The Exchange Act in relevant part defines ``dealer'' to

    mean ``any person engaged in the business of buying and selling

    securities (not including security-based swaps, other than security-

    based swaps with or for persons that are not eligible contract

    participants) for such person's own account through a broker or

    otherwise,'' but with an exception for ``a person that buys or sells

    securities (not including security-based swaps, other than security-

    based swaps with or for persons that are not eligible contract

    participants) for such person's own account, either individually or

    in a fiduciary capacity, but not as a part of a regular business.''

    Exchange Act sections 3(a)(5)(A) and (B), 15 U.S.C. 78c(a)(5)(A) and

    (B), as amended by Section 761(a)(1) of the Dodd-Frank Act.

    \22\ For example, an entity that owns a particular security may

    use a security-based swap to hedge the risks of that security.

    Conversely, an entity may seek to offset exposure involving a

    security-based swap by using another security as a hedge.

    \23\ For example, an entity may enter into a security-based swap

    to gain economic exposure akin to a long or short position in a

    stock or bond, without having to engage in a cash market transaction

    for that instrument.

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

    The Exchange Act has been interpreted to distinguish between

    ``dealers'' and ``traders.'' In this context, the SEC previously has

    noted that the dealer-trader distinction:

    Recognizes that dealers normally have a regular clientele, hold

    themselves out as buying or selling securities at a regular place of

    business, have a regular turnover of inventory (or participate in

    the sale or distribution of new issues, such as by acting as an

    underwriter), and generally provide liquidity services in

    transactions with investors (or, in the case of dealers who are

    market makers, for other professionals).\24\

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

    \24\ Securities Exchange Act Release No. 47364 (Feb. 13, 2003)

    (footnotes omitted).

    Other non-exclusive factors that are relevant for distinguishing

    between dealers and non-dealers can include the receipt of customer

    property and the furnishing of incidental advice in connection with

    transactions.

    The markets involving security-based swaps are distinguishable in

    certain respects from markets involving cash market securities--

    particularly with regard to the concepts of ``inventory'' (which

    generally appears inapplicable in this context) \25\ and ``regular

    place of business.'' For example, the suggestion that dealers are more

    likely to operate at a ``regular place of business'' than traders

    should not be construed in a way that ignores the reality of how the

    security-based swap markets operate (or that

    [[Page 80178]]

    ignores evolution in dealing practices involving other types of

    securities). Dealers may use a variety of methods to communicate their

    availability to enter into security-based swaps with other market

    participants. The dealer-trader distinction should not be applied to

    the security-based swap markets without taking those distinctions into

    account.\26\ Even in light of those differences, however, we believe

    that the dealer-trader distinction provides an important analytical

    tool to assist in determining whether a person is a ``security-based

    swap dealer.''

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

    \25\ In particular, an analysis that considers dealers to differ

    from traders in part because dealers have regular turnover in

    ``inventory'' appears not to apply in the context of security-based

    swaps, given that those instruments are created by contract between

    two market counterparties, rather than reflecting financial rights

    issued by third-parties.

    \26\ The definition of ``security-based swap dealer,'' unlike

    the Exchange Act's definition of ``dealer,'' does not specifically

    refer to ``buying'' and ``selling.'' We do not believe that this

    language difference is significant, however, as the Dodd-Frank Act

    amended the Exchange Act definitions of ``buy'' and ``purchase,''

    and the Exchange Act definitions of ``sale'' and ``sell,'' to

    encompass the execution, termination (prior to its scheduled

    maturity date), assignment, exchange or similar transfer or

    conveyance of, or extinguishing of rights or obligations under, a

    security-based swap. See Dodd-Frank Act sections 761(a)(3), (4)

    (amending Exchange Act sections 3(a)(13), (14)).

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

    Commenters have raised concerns that the ambit of the security-

    based swap dealer definition could encompass end-users that use

    security-based swaps for hedging their business risks. Deeming those

    entities to be security-based swap dealers due to their hedging

    activities could discourage their use of hedging transactions or

    subject them to a regulatory framework that was not intended to address

    their businesses and could subject them to unnecessary costs. Under the

    dealer-trader distinction, however, we would expect entities that use

    security-based swaps to hedge their business risks, absent other

    activity, likely would not be dealers.\27\ Also, as discussed below,

    both the ``security-based swap dealer'' definition and the dealer-

    trader distinction in part turn on whether a person holds itself out as

    a dealer.

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

    \27\ Of course, if a person's other activities satisfy the

    definition of security-based swap dealer, it must comply with the

    applicable requirements with regard to all of its security-based

    swap activities, absent an order to the contrary, as discussed

    below. Also, as discussed below, we would expect end-users to use

    security-based swaps for hedging purposes less commonly than they

    use swaps for hedging purposes.

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

    We request comment on the application of the dealer-trader

    distinction as part of the analysis of whether a person is a security-

    based swap dealer.

    c. Issues Common to Both Definitions

    i. Holding Oneself Out as, and Being Commonly Known in the Trade as, a

    Swap Dealer or Security-Based Swap Dealer

    As noted above, the application of these definitions to persons

    that ``hold themselves out'' as dealers or that are ``commonly known in

    the trade'' as dealers highlights the need for a functional

    interpretation of the dealer definitions. We believe that factors that

    may reasonably indicate that a person is holding itself out as a dealer

    or is commonly known in the trade as a dealer may include (but are not

    limited to) the following:

    Contacting potential counterparties to solicit interest in

    swaps or security-based swaps,

    Developing new types of swaps or security-based swaps

    (which may include financial products that contain swaps or security-

    based swaps) and informing potential counterparties of the availability

    of such swaps or security-based swaps and a willingness to enter into

    such swaps or security-based swaps with the potential counterparties,

    Membership in a swap association in a category reserved

    for dealers,

    Providing marketing materials (such as a Web site) that

    describe the types of swaps or security-based swaps that one is willing

    to enter into with other parties, or

    Generally expressing a willingness to offer or provide a

    range of financial products that would include swaps or security-based

    swaps.

    Notably, holding oneself out as a security-based swap dealer would

    likely encompass a situation in which a person that is a ``dealer'' in

    another type of security enters into a security-based swap with a

    customer.\28\ Another example of holding oneself out as a security-

    based swap dealer would likely be an entity expressing its availability

    to provide liquidity to counterparties that seek to enter into

    security-based swaps, regardless of the ``direction'' of the

    transaction or across a broad spectrum of risks (e.g., credit default

    swaps related to a variety of issuers).

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

    \28\ For example, if a person that is a dealer in securities

    that are not security-based swaps enters into a security-based swap

    transaction with one of its cash market customers, the person would

    appear to be engaged in security-based swap dealing activity with

    that customer. In that circumstance, the customer reasonably would

    be expected to view the person as a dealer for purposes of the

    security-based swap, making the applicable business conduct

    requirements particularly important.

    The determination of who is commonly known in the trade as a swap

    dealer or security-based swap dealer may appropriately reflect, among

    other factors, the perspective of persons with substantial experience

    with and knowledge of the swap and security-based swap markets,

    regardless of whether an entity is known as a dealer by persons without

    that experience and knowledge.

    ii. Making a Market in Swaps or Security-Based Swaps

    A number of commenters suggested that the market making component

    of the definitions should apply only to persons that quote a two-sided

    market consistently or at all times. Some commenters also suggested

    that a person's willingness to buy or to sell a swap or security-based

    swap at any particular time should not be deemed to be market making

    activity. While continuous two-sided quotations and a willingness to

    stand ready to buy and sell a security are important indicators of

    market making in the equities markets,\29\ these indicia may not be

    appropriate in the context of the swap or security-based swap markets,

    given that parties do not enter into many types of swaps or security-

    based swaps on a continuous basis, and that parties may use a variety

    of methods for communicating their willingness to enter into swaps or

    security-based swaps. Any analysis that would impute to the definitions

    a ``continuous'' activity requirement may cause certain persons that

    engage in non-continuous dealing activities not to be regulated as swap

    dealers or security-based swap dealers. We have not identified anything

    in the statutory text or legislative history of the Dodd-Frank Act to

    suggest that Congress intended such a result.

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

    \29\ See Exchange Act Release No. 58875 (Oct. 14, 2008), 73 FR

    61690 (Oct. 17, 2008) (``Although determining whether or not a

    market maker is engaged in bona-fide market making would depend on

    the facts and circumstances of the particular activity, factors that

    indicate a market maker is engaged in bona-fide market making

    activities may include, for example, whether the market maker incurs

    any economic or market risk with respect to the securities (e.g., by

    putting their own capital at risk to provide continuous two-sided

    quotes in markets).'').

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

    iii. No Predominance Test

    Although some commenters suggested that a person should be a swap

    dealer or security-based swap dealer only if such activity is the

    person's sole or predominant business, the statutory definition does

    not contain a predominance test or otherwise depend upon the level of

    the person's dealing activity, other than the de minimis exception

    discussed below. A predominance standard would not

    [[Page 80179]]

    provide a workable test of dealer status because many of the parties

    that are commonly acknowledged as swap or security-based swap dealers

    also engage in other businesses that often outweigh their swap or

    security-based swap dealing business in terms of transaction volume or

    other measures. Based on the plain meaning of the statutory definition,

    so long as a person engages in dealing activity that is not de minimis,

    as discussed below, the person is a swap dealer or security-based swap

    dealer.\30\

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

    \30\ As one example, a non-financial company that engages in

    both swap dealing and other commercial activities would fall within

    the definition of swap dealer because of its swap dealing

    activities, notwithstanding that it also engages in other commercial

    activities.

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

    iv. Application of the Definition to New Types of Swaps and New

    Activities

    The Commissions intend to apply the definitions of swap dealer and

    security-based swap dealer flexibly when the development of innovative

    business models is accompanied by new types of dealer activity. As

    discussed above, the Commissions generally intend to follow a ``facts-

    and-circumstances'' approach with respect to identifying dealing

    activities. The dealer definitions must be flexible enough to cover

    appropriate persons as the swap markets evolve.

    v. Request for Comment

    The Commissions request comment on these interpretations of holding

    oneself out as a dealer and being commonly known in the trade as a

    dealer, as well as the lack of a predominance test, and the application

    of the definitions to new types of swaps and new activities. Commenters

    particularly are requested to address the relevance, to the dealer

    analysis, of activities such as an entity's membership in a swap

    execution facility (``SEF'') or a security-based SEF, or use of

    facilities that may not be SEFs or security-based SEFs. Are there

    factors that would lead entities to become members of SEFs that would

    not make membership relevant to the dealer analysis? Commenters also

    are requested to generally address how the dealer analysis should

    appropriately apply the requirements applicable to dealers (e.g.,

    capital, margin and business conduct requirements) to the entities that

    should be subject to those requirements. In addition, commenters are

    requested to address how the dealer definitions should be applied to

    entities such as, for example, Federal home loan banks subject to

    restrictions limiting their dealing activities to particular types of

    counterparties. Finally, commenters are requested to address whether

    additional guidance is advisable to help identify dealer activity and

    to promote effective enforcement of the requirements applicable to swap

    dealers and security-based swap dealers.

    3. Designation of a Person as a Swap Dealer

    The Dodd-Frank Act has amended the CEA and the Exchange Act to

    require a person that meets either of the definitions to register as a

    swap dealer and/or security-based swap dealer,\31\ and the Commissions

    are proposing separate rules regarding this registration requirement.

    In connection with the registration requirement, market participants

    are in a position to assess their activities to determine whether they

    function in the manner described in the definitions. In addition, the

    Commissions have the authority to take enforcement actions in response

    to a dealer's failure to register. In determining whether a person

    meets the applicable definitions, the Commissions may use information

    from other regulators, swap data repositories, registered clearing

    agencies, derivatives clearing organizations and other sources.

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

    \31\ See CEA section 4s(a)-(b); Exchange Act section 15F(a)-(b).

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

    4. Application of the Swap Dealer Definition to Agricultural

    Commodities

    Section 723(c)(3)(B) of the Dodd-Frank Act provides that swaps in

    agricultural commodities shall be subject to such terms and conditions

    as the CFTC may prescribe. In a separate rulemaking, the CFTC has

    proposed a definition of the term ``agricultural commodity.'' \32\

    Acting under the authority in Section 723(c)(3)(B), the CFTC may

    develop particular terms and conditions for the interpretation of the

    swap dealer definition when it is applied to dealing in swaps in

    agricultural commodities. Any such terms and conditions would not be

    applicable to the definition of security-based swap dealer. The CFTC

    requests comment on the application of the swap dealer definition to

    dealers, including potentially agricultural cooperatives, that limit

    their dealing activity primarily to swaps in agricultural commodities.

    The CFTC may consider any comments on this topic for both the

    definition of swap dealer and also for any rulemaking regarding swaps

    in agricultural commodities.

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

    \32\ See 75 FR 65586 (Oct. 26, 2010).

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

    B. De Minimis Exemption to the Definitions

    The Dodd-Frank Act requires that the Commissions exempt, from

    designation as a ``swap dealer'' or ``security-based swap dealer,'' a

    person who ``engages in a de minimis quantity of [swap or security-

    based swap] dealing in connection with transactions with or on behalf

    of its customers.'' \33\ The statutory definitions do not require that

    the Commissions fix a specific level of swap activity that will be

    considered de minimis, but instead require that the Commissions

    ``promulgate regulations to establish factors with respect to the

    making of this determination to exempt.''

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

    \33\ See CEA section 1a(49)(D); Exchange Act section

    3(a)(71)(D).

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

    1. Comments Regarding the De Minimis Exemption

    Some commenters asserted that the de minimis exemption should be

    linked to systemic risk concerns, stating that persons engaged in

    dealing activities that do not pose systemic risk should be able to

    take advantage of the exemption. Other commenters suggested that a

    person's dealing activities should be considered de minimis if they do

    not pose undue risks to the person. Commenters also expressed the view

    that the application of the exemption should be based on quantitative

    criteria.

    2. Proposed Rule Regarding the De Minimis Exemption

    The Commissions preliminarily believe that the ``de minimis''

    exemption should be interpreted to address amounts of dealing activity

    that are sufficiently small that they do not warrant registration to

    address concerns implicated by the regulations governing swap dealers

    and security-based swap dealers.\34\ In other words, the exemption

    should apply only when an entity's dealing activity is so minimal that

    applying dealer regulations to the entity would not be warranted.

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

    \34\ The Title VII requirements applicable to swap and security-

    based swap dealers include, for example: requirements that dealers

    conform to regulatory standards relating to the confirmation,

    processing, netting, documentation and valuation of swaps and

    security-based swaps (CEA section 4s(i), Exchange Act section

    15F(i)); requirements that dealers disclose, to regulators,

    information concerning terms and conditions of swaps or security-

    based swaps, as well as information concerning trading practices,

    financial integrity protections and other trading information (CEA

    section 4s(j)(3), Exchange Act section 15F(j)(3)); conflicts of

    interest provisions (CEA section 4s(j)(5), Exchange Act section

    15F(j)(5)); and chief compliance officer requirements (CEA section

    4s(k), Exchange Act section 15F(k)).

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

    We thus preliminarily do not agree with those commenters that

    argued that

    [[Page 80180]]

    a de minimis quantity of dealing should be measured in relation to the

    level of the person's other activities (or other swap or security-based

    swap activities). Aside from the fact that the statute does not

    explicitly call for a relative test, such an approach would lead to the

    result that larger and more active companies, which presumably would be

    more able to influence the swap markets, would be more likely to

    qualify for the exemption than smaller and less active companies. Also,

    a relative test not only would require a means of measuring the

    person's dealing activities, but also would require a means of

    measuring the larger scope of activities to which its swap dealing or

    security-based swap dealing activities are to be compared, thus

    introducing unnecessary complexity to the exemption's application.

    Our proposed factors for the de minimis exemption seek to focus the

    availability of the exemption toward entities for which registration

    would not be warranted from a regulatory point of view in light of the

    limited nature of their dealing activities. At the same time, we

    recognize that this focus does not appear to readily translate into

    objective criteria. Thus, while the proposed factors discussed below

    reflect our attempt to delimit the de minimis exemption appropriately,

    we recognize that a range of alternative approaches may be reasonable,

    and we are particularly interested in commenters' suggestions as to the

    appropriate factors.

    The first proposed factor is that the aggregate effective notional

    amount, measured on a gross basis, of swaps or security-based swaps

    that an entity enters into over the prior 12 months in connection with

    its dealing activities \35\ could not exceed $100 million.\36\ We

    understand that in general the notional size of a small swap or

    security-based swap is $5 million or less, and this proposed threshold

    would reflect 20 instruments of that size. Given the customer

    protection issues raised by swaps and security-based swaps--including

    the risks that counterparties may not fully appreciate when entering

    into swaps or security-based swaps--we believe that this notional

    amount reflects a reasonable limit for identifying those entities that

    engage in a de minimis level of dealing activity.\37\ This standard

    would measure an entity's quantity of dealing on a gross basis (without

    consideration of the market risk offsets associated with combining long

    and short positions) to reflect the entity's overall amount of dealing

    activity. Similarly, the proposed notional threshold would not account

    for the amount of collateral held by or provided by the entity, nor

    other risk mitigating factors, in determining whether it engages in a

    de minimis quantity of dealing, given that dealer status focuses on an

    entity's absolute level of activity, and is not directly based on the

    risks that an entity poses or faces.\38\

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

    \35\ The de minimis exemption specifically places limits on a

    person's dealing activity involving swaps or security-based swaps.

    Thus, these limits would not apply to swap or security-based swap

    activity that does not itself constitute dealing activity, such as

    activity in which a person hedges or mitigates a commercial risk of

    its business that is unrelated to a dealing business (i.e., as

    discussed above, when the person did not accommodate demand from the

    other party, respond to the other party's interest in swaps or

    security-based swaps, solicit the other party, propose economic

    terms, intermediate between parties, provide liquidity, or engage in

    other dealing activities). See part II.A.2, supra.

    \36\ See proposed CEA rule 1.3(ppp)(4)(ii); proposed Exchange

    Act rule 3a71-2(a). To the extent that the stated notional amount of

    a swap or security-based swap is leveraged or enhanced by its

    structure, the calculation shall be based on the effective notional

    amount of the swap or security-based swap rather than on its stated

    notional amount.

    \37\ We preliminarily believe that activity above this amount

    would be sufficient to warrant dealer registration to bring about

    the benefits of such registration.

    \38\ Also, allowing offsets for collateral would result in a de

    minimis standard that could encompass positions of virtually

    unlimited size.

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

    In addition, the aggregate effective notional amount of such swaps

    or security-based swaps, in which the person's counterparty is a

    ``special entity'' (as that term is defined in CEA Section 4s(h)(2)(C)

    and Exchange Act Section 15F(h)(2)(C)),\39\ that an entity enters into

    over the prior 12 months could not exceed $25 million.\40\ The Dodd-

    Frank Act provided special protections to special entities in

    connection with swaps and security-based swaps, and we preliminarily

    believe that this lower proposed threshold reasonably reflects the

    special protections afforded to those entities.

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

    \39\ The term ``special entity'' encompasses: Federal agencies;

    States, State agencies and political subdivisions (including cities,

    counties and municipalities); ``employee benefit plans'' as defined

    under the Employee Retirement Income Security Act of 1974

    (``ERISA''); ``governmental plans'' as defined under ERISA; and

    endowments.

    \40\ See proposed CEA rule 1.3(ppp)(4)(ii); proposed Exchange

    Act rule 3a71-2(b).

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

    In addition, to take advantage of the de minimis exemption, the

    proposed rule would provide that the entity could not have entered into

    swaps or security-based swaps (as applicable) as a dealer with more

    than 15 counterparties, other than security-based swap dealers, over

    the prior 12 months.\41\ The Commissions preliminarily believe that an

    entity that enters into swaps or security-based swaps, in a dealer

    capacity, with a larger number of counterparties should be registered

    to help achieve Title VII's orderly market goals, and thus cannot be

    said to engage in a de minimis quantity of dealing (even if the

    aggregate effective notional amount of the swaps or security-based

    swaps is less than the thresholds noted above).\42\ For purposes of

    determining the number of counterparties, we preliminarily believe that

    counterparties who are members of an affiliated group would generally

    count as one counterparty, given that the purpose of the limit is to

    measure the scope of dealer's interaction with separate

    counterparties.\43\

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

    \41\ See proposed CEA rule 1.3(ppp)(4)(iii); proposed Exchange

    Act rule 3a71-2(c). That these tests measure the entity's activities

    over the prior 12 months provides certainty. As of the end of each

    month, the entity will know whether it may qualify for the exemption

    during the following month.

    \42\ Similarly, because all the de minimis factors must be

    satisfied, a person who enters into only a single swap or security-

    based swap, as a swap dealer, with a single counterparty could not

    qualify for the de minimis exemption if that swap or security-based

    swap exceeds the effective notional amount threshold.

    \43\ For this purpose, an affiliated group would be defined as

    any group of entities that is under common control and that reports

    information or prepares its financial statements on a consolidated

    basis.

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

    Finally, the proposed rule would provide that, to take advantage of

    the de minimis exemption, the entity could not have entered into more

    than 20 swaps or security-based swaps (as applicable) as a dealer

    during the prior 12 months.\44\ As is the case for the limitation on

    the number of counterparties, the Commissions preliminarily believe

    that an entity that enters into a larger number of swaps or security-

    based swaps, in a dealer capacity, would, if registered, help achieve

    Title VII's orderly market goals, and thus cannot be said to engage in

    a de minimis quantity of dealing. For these purposes, we would expect

    that each separate transaction the entity enters into under a swap or

    security-based swap master agreement in general would count as entering

    into a swap or security-based swap, but that an amendment of an

    existing swap or security-based swap in which the counterparty remained

    the same and the underlying item remained substantially the same would

    not count as a new swap or security based swap.\45\

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

    \44\ See proposed CEA rule 1.3(ppp)(4)(iv); proposed Exchange

    Act rule 3a71-2(d).

    \45\ For these purposes only, an amendment to an existing swap

    or security-based swap would not need to be counted as a new swap or

    security-based swap if the underlying item is substantially the same

    as the original item. This may occur, for example, to reflect the

    effect of a corporate action such as a merger. An amendment would be

    counted as a new swap or security-based swap, however, to the extent

    that the change in the underlying item modifies the economic risk

    reflected by the swap or security-based swap.

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

    [[Page 80181]]

    The proposed rule would not distinguish between different types of

    swaps or security-based swaps into which entities may enter (e.g., rate

    swaps versus other commodity swaps, or credit default swaps versus

    equity swaps). The Commissions preliminarily do not believe that the

    ceiling for distinguishing de minimis dealing activities from other

    dealing activities appropriately turns upon the particular type of swap

    or security-based swap.\46\

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

    \46\ The Exchange Act's definition of ``dealer'' does not

    include a de minimis exemption. Thus, an entity that engages in

    dealing activity involving securities (other than security-based

    swaps with eligible contract participants) would be required to

    register as a ``dealer'' under the Exchange Act, and comply with the

    Exchange Act's requirements applicable to dealers, absent some other

    exception or exemption from registration.

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

    The Commissions request comment on the proposed rule regarding the

    de minimis exemption. Commenters particularly are requested to address

    whether certain of the proposed factors should be modified or

    eliminated; for example, should the proposed $100 million limit on

    annual notional swaps or security-based swaps entered into in a dealer

    capacity be raised or lowered to better implement the intended scope of

    the de minimis exemption--i.e., to exclude entities for which dealer

    regulation would not be warranted? Should we adopt different thresholds

    that would appropriately limit the exemption so it encompasses only

    those entities whose dealing activities are such that dealer regulation

    is not warranted? To what extent would certain entities be expected to

    reduce or otherwise adjust their dealing activity to fall within the

    scope of the de minimis exemption? Would there be any adverse

    implications for market participants if this happens? To what extent

    could the proposed factors potentially reduce dealing activity, and in

    doing so reduce the liquidity available in the swap or security-based

    swap market?

    Commenters also are requested to address whether the rule should

    seek to identify only certain types of counterparties with which a

    person could engage in dealing activities under the exemption. We also

    particularly request comment on the proposed $25 million notional

    threshold for dealer transactions with ``special entities,'' including

    whether that proposed threshold should be raised or lowered, and

    whether an entity that enters into dealing transactions with ``special

    entities'' should be able to take advantage of the exemption at all. In

    addition, we request comment on whether the proposed threshold for

    transactions with ``special entities'' would provide a disincentive to

    dealers entering into transactions with such entities.

    Commenters further are requested to address whether the factors may

    appropriately account for the size of the swap or security-based swap

    activities compared to the size of the entity; how an entity's swaps or

    security-based swaps with affiliated counterparties should be treated

    for purposes of the test; and whether the exemption's factors should

    vary depending on the type of swap or security-based swap at issue.

    In addition, commenters are requested to address the significance

    of the fact that the statutory de minimis exemption specifically

    references transactions with or on behalf of a customer. Does that mean

    the exemption was intended to specifically address dealing activity as

    an accommodation to an entity's customers? If so, should the exemption

    be conditioned on the presence of an existing relationship between the

    entity and the counterparty that does not entail swap or security-based

    swap dealing activity, and if so, which types of relationships should

    be treated as creating a ``customer'' relationship?

    Commenters also are requested to address whether the de minimis

    exemption should excuse an entity from having to comply with certain

    regulatory requirements imposed on swap dealers or security-based swap

    dealers, while also mandating compliance with other dealer

    requirements. In addition, commenters are requested to address whether,

    in lieu of the self-executing approach proposed here, the Commissions

    instead should require that entities which seek relief under this de

    minimis exemption must submit exemptive requests to the relevant agency

    for the agency's consideration and action. Commenters further are

    requested to address whether the proposed notional threshold for the de

    minimis exception should be subject to a formula that permits automatic

    periodic adjustments to the threshold, such as to reflect changes in

    market size or in the size of typical contracts.

    C. Statutory Exclusion for Swaps in Connection With Originating a Loan

    The ``swap dealer'' definition excludes an insured depository

    institution (``IDI'') ``to the extent it offers to enter into a swap

    with a customer in connection with originating a loan with that

    customer.'' \47\ This exclusion does not appear in the definition of

    ``security-based swap dealer.''

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

    \47\ See CEA section 1a(49)(A).

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

    1. Comments Regarding the Exclusion for Swaps in Connection With Loans

    Three IDIs commented on this aspect of the definition, stating that

    the exclusion should encompass any swap entered into contemporaneously

    with a loan that is related to any of the borrower's activities that

    affect the ability to repay the loan and can be hedged. Thus, in their

    view, the exclusion should cover exchange rate and physical commodity

    swaps in addition to interest rate swaps. The IDIs also said the

    exclusion should apply to amendments, restructurings and workouts of

    loans, and to lenders that act through a syndicate.

    Another commenter expressed similar views, and also asked for

    clarification whether the exclusion applies to all aspects of the

    definition, or if it applies only to whether a person is commonly known

    in the trade as a swap dealer. The CFTC preliminarily believes the

    exclusion applies to all aspects of the swap dealer definition.

    2. Proposed Rule Regarding the Exclusion for Swaps in Connection With

    Loans

    The CFTC preliminarily interprets the word ``offer'' in this

    exclusion to include scenarios where the IDI requires the customer to

    enter into a swap, or the customer asks the IDI to enter into a swap,

    specifically in connection with a loan made by that IDI. Also, the

    proposed rule provides that, in order to prevent evasion, the statutory

    exclusion does not apply where (i) The purpose of the swap is not

    linked to the financial terms of the loan; (ii) the IDI enters into a

    ``sham'' loan; or (iii) the purported ``loan'' is actually a synthetic

    loan such as a loan credit default swap or loan total return swap.

    The proposed rule would apply the statutory exclusion only to swaps

    that are connected to the financial terms of the loan, such as, for

    example, its duration, interest rate, currency or principal amount.

    Although commenters urged that this exclusion be extended to other

    aspects of the lending relationship, we preliminarily believe that it

    would not be appropriate that this exclusion from the swap dealer

    definition encompass swaps that are connected to the borrower's other

    business activities, even if the loan agreement requires that the

    borrower enter into such swaps or otherwise refers to them. We

    preliminarily believe that a broader reading of the exclusion could

    encompass all swap activity

    [[Page 80182]]

    between an IDI and its borrowers, which we do not think is intended.

    The origination of commercial loans is a complex process, and the

    CFTC preliminarily believes that this exclusion should be available to

    all IDIs that are a source of funds to a borrower. For example, all

    IDIs that are part of a loan syndicate providing a loan to a borrower

    could claim this exclusion with respect to swaps entered into with the

    borrower that are connected to the financial terms of the loan.

    Similarly, the proposed exclusion could be claimed with respect to such

    swaps entered into by any IDI that participates in or obtains a

    participation in such loan by means of a transfer or otherwise.\48\

    Also, an IDI that is a source of funds for the refinancing of a loan

    (whether directly or through a syndicate, participation or otherwise)

    could claim the exclusion if it enters into a swap with the refinancing

    borrower.

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

    \48\ The CFTC preliminarily believes that the proposed exclusion

    could be claimed by any IDI that participates in a loan through any

    means that involves a payment to a lender to take the place of that

    lender, including an ``English style'' participation.

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

    We emphasize that this proposed exclusion, by its statutory terms,

    is available only to IDIs. If an IDI were to transfer its participation

    in a loan to a non-IDI, then the non-IDI would not be able to claim

    this exclusion, regardless of the terms of the loan or the manner of

    the transfer. Similarly, a non-IDI that is part of a loan syndicate

    with IDIs would not be able to claim the exclusion.

    In sum, the proposed exclusion may be claimed by a person that

    meets the following three conditions: (i) The person is an IDI; (ii)

    the person is the source of funds to a borrower in connection with a

    loan (either directly or through syndication, participation,

    refinancing or otherwise); and (iii) the person enters into a swap with

    the borrower that is connected to the financial terms of the loan (so

    long as the loan is not a sham or a synthetic loan).

    The CFTC requests comment on the proposed rule relating to the

    statutory exclusion for swaps in connection with originating a loan,

    and in particular on whether this statutory exclusion should be

    extended beyond swaps that are connected to the financial terms of the

    loan, and if so, why. The CFTC also requests comment on whether this

    exclusion should apply only to swaps that are entered into

    contemporaneously with the IDI's origination of the loan (and if so,

    how ``contemporaneously'' should be defined for this purpose), or

    whether this exclusion should also apply to swaps entered into during

    part or all of the duration of the loan.

    D. Designation as a Dealer for Certain Types, Classes, or Categories of

    Swaps, Security-Based Swaps, or Activities

    The statutory definitions include a provision stating that a person

    may be designated as a dealer for one or more types, classes or

    categories of swaps, security-based swaps, or activities without being

    considered a swap dealer or security-based swap dealer for other types,

    classes or categories of swaps, security-based swaps, or activities.

    This provision is permissive and does not require the Commissions to

    designate persons as dealers for only a limited set of types, classes

    or categories of swaps, security-based swaps, or activities.

    1. Comments Regarding Limited Designation as a Swap Dealer or Security-

    Based Swap Dealer

    One commenter stated that the Commissions should allow a person to

    register as a swap dealer or security-based swap dealer for only a

    limited set of types, classes or categories of swaps or security-based

    swaps. Another commenter expressed the view that a person designated as

    a swap dealer or security-based swap dealer should be designated as

    such for all types of swaps or security-based swaps, respectively.

    2. Proposed Rule Regarding Limited Designation as a Swap Dealer or

    Security-Based Swap Dealer

    In general, the Commissions propose that a person that satisfies

    the definition of swap dealer or security-based swap dealer would be a

    dealer for all types, classes or categories of swaps or security-based

    swaps, or activities involving swaps or security-based swaps, in which

    the person engages.\49\ Thus, the person would be subject to all

    regulatory requirements applicable to dealers for all swaps or

    security-based swaps into which it enters. We propose this approach

    because it may be difficult for swap dealers and security-based swap

    dealers to separate their dealing activities from their other

    activities involving swaps or security-based swaps.\50\

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    \49\ See proposed CEA rule 1.3(ppp)(3); proposed Exchange Act

    rule 3a71-1(c).

    \50\ For example, in order to efficiently impose the dealer

    requirements on only the person's dealing activities, it may be

    necessary for the person to have separate books and records and a

    separate compliance regime for its dealing activities.

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

    The proposed rule also states, however, that the Commissions may

    provide for a person to be designated as a swap dealer or security-

    based swap dealer for only specified categories of swaps, security-

    based swaps, or activities, without being classified as a dealer for

    all categories.\51\ This proposed rule would afford persons an

    opportunity to seek, on an appropriate showing, a limited designation

    based on facts and circumstances applicable to their particular

    activities. The Commissions anticipate that a swap dealer could seek a

    limited designation at the same time as, or at a later time subsequent

    to, the person's initial registration as a swap dealer.

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

    \51\ CEA section 1a(49)(B); Exchange Act section 3(a)(71)(B). As

    discussed below, the Commissions preliminarily believe that there

    are four major categories of swaps and two major categories of

    security-based swaps. See part IV.A, infra. The designation as a

    swap dealer or security-based swap dealer may, for example, be

    limited in terms of these categories or in terms of particular

    activities of the person.

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

    The CFTC understands that there may potentially be non-financial

    entities, such as physical commodity firms, that conduct swap dealing

    activity through a division of the entity, and not a separately-

    incorporated subsidiary. In these instances, the entity's swap dealing

    activity would not be a core component of the entity's overall

    business. If this type of entity registered as a swap dealer, the CFTC

    anticipates that certain swap dealer requirements would apply to the

    swap dealing activities of the division, but not necessarily to the

    swap activities of other parts of the entity.

    The Commissions request comment on the proposed rules regarding

    limited designation as a swap dealer or security-based swap dealer.

    Commenters particularly are requested to address the circumstances in

    which such limited purpose designations would be appropriate, the

    factors that the Commissions should consider when addressing such

    requests, and the type of information requestors should provide in

    support of their request. For example, would it be appropriate to grant

    such limited purpose designations only to entities that do not

    otherwise fall within the definition of a financial entity, and whose

    dealing activity is below a defined threshold of the entity's overall

    activity? At what level should the Commissions set such a threshold?

    Which of the requirements applicable to dealers should or should not

    apply to such entity's non-dealing activities in swaps and security-

    based swaps?

    In addition, commenters are requested to address whether the

    Commissions should provide for limited purpose designations of swap

    dealers or security-based swap dealers through some other mechanism as

    an alternative to, or in

    [[Page 80183]]

    addition to, case-by-case evaluations of individual applications. If

    so, what criteria and procedures would be appropriate for making

    limited purpose designations through this type of approach? Also,

    should the limited purpose designation apply on a provisional basis

    starting at the time that the entity makes an application for a limited

    purpose designation?

    Finally, commenters also are asked to address whether such limited

    purpose designations should be conditioned in any way, such as by the

    provision of information of the type that would be required with

    respect to an entity's swaps or security-based swaps involving the

    particular category or activity for which they are not designated as a

    dealer.

    E. Certain Interpretative Issues

    1. Affiliate Issues

    We preliminarily believe that the word ``person'' in the swap

    dealer and security-based swap dealer definitions should be interpreted

    to mean that the designation applies with respect to a particular legal

    person. That is, for example, we would not view a trading desk or other

    discrete business unit that is not a separately organized legal person

    as a swap dealer; rather, the legal person of which it is a part would

    be the swap dealer. Also, an affiliated group of legal persons under

    common control could include more than one dealer. Within such a group,

    any legal person that engages in swap or security-based swap dealing

    activities would be a swap dealer or security-based swap dealer, as

    applicable.

    In determining whether a particular legal person is a swap dealer

    or security-based swap dealer, we preliminarily believe it would be

    appropriate for the person to consider the economic reality of any

    swaps and security-based swaps it enters into with affiliates (i.e.,

    legal persons under common control with the person at issue), including

    whether those swaps and security-based swaps simply represent an

    allocation of risk within a corporate group.\52\ Swaps and security-

    based swaps between persons under common control may not involve the

    interaction with unaffiliated persons that we believe is a hallmark of

    the elements of the definitions that refer to holding oneself out as a

    dealer or being commonly known as a dealer. To the extent, however,

    that an entity seeks to use transactions between persons under common

    control to avoid one of the dealer definitions, the Commissions have

    the authority to prohibit practices designed to evade the requirements

    applicable to swap dealers and security-based swap dealers.\53\

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

    \52\ Such swaps and security-based swaps should be considered in

    this way only for purposes of determining whether a particular

    person is a swap dealer or security-based swap dealer and does not

    necessarily apply in the context of the Exchange Act's general

    definition of ``dealer.'' The swaps and security-based swaps,

    moreover, would continue to be subject to all laws and requirements

    applicable to such swaps and security-based swaps.

    \53\ See Dodd-Frank Act sections 721(b)(2), 761(b)(3). For

    example, it would not be permissible for an entity that provides

    liquidity on one side of the market to use affiliated entities to

    provide liquidity on the other side in an attempt to avoid having to

    register as a swap or security-based swap dealer.

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

    The Commissions invite comment as to how the swap dealer and

    security-based swap dealer definitions should be applied to members of

    an affiliated group. Commenters particularly are invited to address how

    the Commissions should interpret common control for these purposes, and

    whether this interpretation should be limited to wholly-owned

    affiliates.

    2. Application to Particular Swap Markets

    The swap markets are diverse and encompass a variety of situations

    in which parties enter into swaps with each other. We believe it is

    helpful to the understanding of the rule to discuss some of these

    situations, particularly those that have been raised by commenters,

    here. The situations discussed below include persons who enter into

    swaps as aggregators, as part of their participation in physical

    markets, or in connection with the generation and transmission of

    electricity. We invite comment as to what aspects of the parties'

    conduct in these situations should, or should not, be considered swap

    dealing activities, and whether the parties involved in these

    situations are swap dealers.

    a. Aggregators

    Commenters explained that some persons enter into swaps with other

    parties in order to aggregate the swap positions of the other parties

    into a size that would be more amenable to entering into swaps in the

    larger swap market, or otherwise to make entering into such swaps more

    efficient. For example, certain cooperatives enter into swaps with

    smaller cooperatives, smaller businesses or their members in order to

    establish a position in a commodity that is large enough to be traded

    on a swap or futures market. Similarly, one smaller financial

    institution explained that it enters into swaps with counterparties

    whose swap positions would not be large enough to be of interest to

    larger financial institutions. This institution stated that it enters

    into offsetting swaps with larger financial institutions so that it is

    in a neutral position between the counterparties and the larger

    financial institutions.

    The result of these arrangements is that such persons engage in

    activities that are similar in many respects to those of a swap dealer

    as set out in the definition--the person enters into swaps to

    accommodate demand from other parties, it enters into swaps with a

    relatively large number of non-dealers, and it holds itself out as

    willing to enter into swaps. It may be that the swap dealing activities

    of these aggregators would not exceed the de minimis threshold, and

    therefore they would not be swap dealers. The CFTC, in particular,

    requests comment as to how the de minimis threshold would apply to such

    persons. If their activity would exceed the de minimis threshold set

    forth in the proposed rule, the Commissions request comment on the

    application of the swap dealer definition to their activity.

    b. Physical Market Participants

    The markets in physical commodities such as oil, natural gas,

    chemicals and metals are complex and varied. They involve a large

    number of market participants that, over time, have developed highly

    customized transactions and market practices that facilitate

    efficiencies in their market in unique ways. Some of these transactions

    would be encompassed by the statutory definition of ``swap,'' and some

    participants in these markets engage in swap dealing activities that

    are above the proposed de minimis threshold. The Commissions invite

    comment as to any different or additional factors that should be

    considered in applying the swap dealer definition to participants in

    these markets.

    c. Electricity Generation and Transmission

    The use of swaps in the generation and transmission of electricity

    is highly complex because electricity cannot be stored and therefore is

    generated, transmitted and used on a continuous, real-time basis. Also,

    the number and variety of participants in the electricity market is

    very large and some electricity services are provided as a public good

    rather than for profit. Nevertheless, some participants engage in swap

    dealing activities as described above that are above the de minimis

    threshold set forth in the proposed rule. The Commissions invite

    comment as to any different or additional factors that should be

    considered in applying the

    [[Page 80184]]

    swap dealer definition to participants in the generation and

    transmission of electricity. Specifically, the Commissions invite

    comment on whether there are special considerations, including without

    limitation special considerations arising from section 201(f) of the

    Federal Power Act, related to non-profit, public power systems such as

    rural electric cooperatives and entities operating as political

    subdivisions of a State, and the applicability of the exemptive

    authority in section 722(f) of the Dodd-Frank Act to address those

    considerations.

    III. Amendments to Definition of Eligible Contract Participant

    A. Overview

    The Commodity Futures Modernization Act of 2000 (``CFMA'') \54\

    generally excluded or exempted transactions between eligible contract

    participants (``ECPs'') from most provisions of the CEA.\55\ Section

    723(a)(1)(A) of the Dodd-Frank Act repeals those exclusions and

    exemptions. ECP status remains important, however, because Section

    723(a)(2) of the Dodd-Frank Act renders it unlawful for a non-ECP to

    enter into a swap other than on, or subject to the rules of, a

    designated contract market (``DCM'').\56\ Section 763(e) of the Dodd-

    Frank Act also renders it unlawful for a non-ECP to enter into a

    security-based swap unless such transaction is effected on a national

    securities exchange registered pursuant to Section 6(b) of the Exchange

    Act.\57\ In addition, Section 768(b) of the Dodd-Frank Act makes it

    unlawful for a non-ECP to enter into a security-based swap unless a

    registration statement is in effect. While this means that non-ECPs

    cannot enter into swaps on SEFs or on a bilateral, off-exchange basis,

    it also opens swaps to non-ECPs, so long as the swaps are entered into

    on, or subject to the rules of, a DCM. Similarly, while non-ECPs cannot

    enter into security-based swaps unless the transaction is effected on a

    national securities exchange and the security-based swap has an

    effective registration statement, it also opens security-based swaps to

    non-ECPs.

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

    \54\ Public Law 106-554, 114 Stat. 2763 (Dec. 21, 2000).

    \55\ See CEA sections 2(d) (Excluded Derivative Transactions),

    2(e) (Excluded Electronic Trading Facilities), 2(g) (Excluded Swap

    Transactions) and 2(h) (Legal Certainty for Certain Transactions in

    Exempt Commodities) (7 U.S.C. 2(d), (e), (g), (h)). The CFMA also

    excluded swap agreements from the definitions of ``security'' in

    Section 3(a)(10) of the Exchange Act and Section 2(a)(1) of the

    Securities Act. See Section 3A of the Exchange Act, 15 U.S.C. 78c-1,

    and Section 2A of the Securities Act, 15 U.S.C. 77b-1 (both of which

    have been modified by the Dodd-Frank Act). The CFMA, however,

    provided that the SEC had antifraud authority over security-based

    swap agreements.

    \56\ Section 723(a)(2) of the Dodd-Frank Act adds new subsection

    (e) to CEA section 2 (7 U.S.C. 2(e)). New CEA section 2(e) provides

    that ``[i]t shall be unlawful for any person, other than an eligible

    contract participant, to enter into a swap unless the swap is

    entered into on, or subject to the rules of, a board of trade

    designated as a contract market under section 5.''

    \57\ Section 763(e) of the Dodd-Frank Act adds paragraph (l) to

    Exchange Act section 6. New Exchange section 6(l) provides that

    ``[i]t shall be unlawful for any person to effect a transaction in a

    security-based swap with or for a person that is not an eligible

    contract participant, unless such transaction is effected on a

    national securities exchange registered pursuant to subsection

    (b).''

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

    Congress also amended \58\ the ECP definition in Section 721(a)(9)

    of the Dodd-Frank Act by: (1) Raising a threshold that governmental

    entities may use to qualify as ECPs, in certain situations, from $25

    million in discretionary investments to $50 million in such

    investments; and (2) replacing the ``total asset'' standard for

    individuals to qualify as ECPs with a discretionary investment

    standard.\59\

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

    \58\ The changes to the ECP definition made by the Dodd-Frank

    Act originated in the Administration's ``White Paper'' on financial

    regulatory reform. See Financial Regulatory Reform, A New

    Foundation: Rebuilding Financial Supervision and Regulation,

    available at http://www.financialstability.gov/docs/regs/FinalReprot_web.pdf, at 48-49 (June 17, 2009) (``Current law seeks

    to protect unsophisticated parties from entering into inappropriate

    derivatives transactions by limiting the types of counterparties

    that could participate in those markets. But the limits are not

    sufficiently stringent.'').

    \59\ The monetary component of ECP status for individuals

    remains the same under the amended ECP definition: More than $10

    million (but now in discretionary investments, not in total assets),

    or $5 million if the transactions for which ECP status is necessary

    are for risk management of an asset or liability the individual owns

    or incurs, or is reasonably likely to own or incur.

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

    B. Commenters' Views

    The ECP definition elicited comment from nine commenters. The

    comments ranged from requests not to increase the monetary thresholds

    for governmental employee benefit plans in certain instances to

    suggestions to dramatically raise them across the board, and from

    requests not to change the definition in a way that would limit the

    commenter's access to swaps to specific proposals to address such

    otherwise limited access.

    In the Dodd-Frank Act, Congress addressed aspects of the ECP

    definition that it found to be of particular concern regarding

    governmental entities and individuals. Otherwise, though, persons who

    qualified for exclusions or exemptions to enter into bilateral, off-

    exchange swaps prior to the Dodd-Frank Act will still qualify to do so

    with respect to non-standardized swaps under the Dodd-Frank Act, with

    the exceptions discussed below. We have not identified any legislative

    history suggesting that Congress intended the Commissions to undertake

    a wholesale revision of the ECP definition. Accordingly, the

    Commissions are limiting the further definition of the term ECP to the

    discrete issues discussed below.

    C. New ECP categories

    The CEA definition of ECP generally is comprised of regulated

    persons; \60\ entities defined as ECPs based on a total asset test

    (e.g., a corporation, partnership, proprietorship, organization, trust,

    or other entity with total assets exceeding $10 million) \61\ or an

    alternative monetary test coupled with a non-monetary component (e.g.,

    an entity with a net worth in excess of $1 million and engaging in

    business-related hedging; \62\ or certain employee benefit plans, the

    investment decisions of which are made by one of four enumerated types

    of regulated entities \63\); and certain governmental entities and

    individuals that meet defined thresholds.\64\

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

    \60\ CEA section 1a(18)(A)(i), (ii), (iii), (iv), (viii), (ix),

    (x) (7 U.S.C. 1a(18)(A)(i), (ii), (iii), (iv), (viii), (ix), (x)),

    as redesignated by Section 721(a)(9) of the Dodd-Frank Act.

    \61\ CEA section 1a(18)(A)(v)(I) (7 U.S.C. 1a(18)(A)(v)(I)), as

    redesignated by Section 721(a)(9) of the Dodd-Frank Act.

    \62\ CEA section 1a(18)(A)(v)(III) (7 U.S.C. 1a(18)(A)(v)(III)),

    as redesignated by Section 721(a)(9) of the Dodd-Frank Act.

    \63\ CEA section 1a(18)(A)(vi) (7 U.S.C. 1a(18)(A)(vi)), as

    redesignated by Section 721(a)(9) of the Dodd-Frank Act.

    \64\ CEA sections 1a(18)(A)(vii) and (xi) (7 U.S.C.

    1a(18)(A)(vii) and (xi), as redesignated by Section 721(a)(9) of the

    Dodd-Frank Act.

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

    Persons in the new major swap participant, major security-based

    swap participant, swap dealer and security-based swap dealer categories

    are likely to be among the most active and largest users of swaps and

    security-based swaps. Accordingly, the Commissions propose to further

    define the term ECP to include these new categories, which will permit

    such persons to enter into swaps and security-based swaps on SEFs and

    on a bilateral basis (where otherwise permitted under the Dodd-Frank

    Act and regulations thereunder).

    We seek comment on this proposed expansion of the ECP definition.

    D. Relationship Between Retail Foreign Currency and ECP Status in the

    Context of a Commodity Pool

    Prior to the Dodd-Frank Act, clause (A)(iv) of the ECP definition

    provided that a commodity pool was an ECP if the pool and its operator

    met certain requirements (i.e., the commodity pool has $5 million in

    total assets and is operated by a commodity pool operator regulated

    under the CEA or subject to

    [[Page 80185]]

    foreign regulation), regardless of whether each pool participant was

    itself an ECP.\65\ Section 741(b)(10) of the Dodd-Frank Act amended

    clause (A)(iv) of the ECP definition to provide that a commodity pool

    engaging in retail foreign currency transactions of the type described

    in CEA sections 2(c)(2)(B) or 2(c)(2)(C) ; \66\ (``retail forex'' and

    such pools, ``Retail Forex Pools'') no longer qualifies as an ECP for

    those purposes if any participant in the pool is not independently an

    ECP. The Commissions believe that in some cases commodity pools unable

    to satisfy the conditions of clause (A)(iv) of the ECP definition may

    rely on clause (A)(v) to qualify as ECPs instead for purposes of retail

    forex. Clause (A)(v) of the ECP definition applies to business entities

    irrespective of their form of organization (i.e., corporations,

    partnerships, proprietorships, organizations, trusts and other

    entities), and contains a $1 million net worth test where such an

    entity ``enters into an agreement, contract, or transaction in

    connection with the conduct of the entity's business or to manage the

    risk associated with an asset or liability owned or incurred or

    reasonably likely to be owned or incurred by the entity in the conduct

    of the entity's business.'' \67\

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    \65\ CEA section 1a(12)(A)(iv) (7 U.S.C. 1a(12)(A)(iv)).

    \66\ 7 U.S.C. 2(c)(2)(B) and (C). See generally ``Regulation of

    Off-Exchange Retail Foreign Exchange Transactions and

    Intermediaries,'' 75 FR 55410 (Final Rule; Sept. 10, 2010)

    (discussing the new CFTC retail forex regulatory regime);

    ``Regulation of Off-Exchange Retail Foreign Exchange Transactions

    and Intermediaries,'' 75 FR 3282 (Proposed Rule; Jan. 20, 2010)

    (providing historical background on the regulation of retail forex

    transactions).

    \67\ CEA section 1a(18)(A)(v) (7 U.S.C. 1a(18)(A)(v), as

    redesignated by Section 721(a)(9) of the Dodd-Frank Act.

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

    The Commissions believe that permitting Retail Forex Pools with one

    or more non-ECP participants to achieve ECP status by relying on clause

    (A)(v) of the ECP definition would frustrate the intent of Congress in

    denying ECP status to Retail Forex Pools under clause (A)(iv).

    Consequently, the Commissions propose to further define the term ECP to

    preclude a Retail Forex Pool with one or more non-ECP participants from

    qualifying as an ECP by relying on clause (A)(v) of the ECP definition

    if such Retail Forex Pool is not an ECP due to the language added to

    clause (A)(iv) of the ECP definition by section 741(b)(10) of the Dodd-

    Frank Act (i.e., because the pool contains one or more non-ECP

    participants). Because commodity pools can be structured in various

    ways and can have one or more feeder funds and/or pools, many with

    their own participants, the Commissions propose to preclude a Retail

    Forex Pool from being an ECP pursuant to clause (A)(iv) of the ECP

    definition if there is a non-ECP participant at any investment level

    (e.g., a participant in the pool itself (a direct participant), an

    investor or participant in a fund or pool that invests in the pool in

    question (an indirect participant), an investor or participant in a

    fund or pool that invests in that investor fund or pool (also an

    indirect participant), etc.).

    Similarly, the Commissions believe that some commodity pools unable

    to satisfy the total asset or regulated status components of clause

    (A)(iv) of the ECP definition may rely on clause (A)(v) to qualify as

    ECPs instead. The Commissions are of the view that a commodity pool

    that cannot satisfy the monetary and regulatory status conditions

    prescribed in clause (A)(iv) should not qualify as an ECP in reliance

    on clause (A)(v) of the ECP definition. Therefore, the Commissions

    propose to further define the term ECP to prevent such an entity from

    qualifying as an ECP pursuant to clause (A)(v) of the ECP definition.

    E. Request for comment

    The Commissions request comment on all aspects of the proposed

    amendments to the definition of ``eligible contract participant.'' Are

    the proposed interpretations with respect to Retail Forex Pools and

    other commodity pools appropriate? Do entities described in the various

    enumerated ECP categories (other than commodity pools) rely on clause

    (A)(v) to qualify as ECPs? If so, should an entity that would be

    described in one of the clauses of paragraph (A) of the ECP definition,

    but cannot satisfy the conditions prescribed in that clause, be

    prohibited from relying on clause (A)(v) of the ECP definition?

    In addition, should the Commissions further narrow any or all of

    the ECP categories? Why or why not? If so, what additional conditions

    would be appropriate? Should the Commissions define the term

    ``discretionary basis,'' as requested by one commenter, either solely

    for purposes of clause (A)(vii) or clause (A)(xi), or for both clauses?

    Alternatively, should the Commissions add any additional categories of

    ECPs, such as the following categories suggested by commenters:

    Commercial real estate developers; energy or agricultural cooperatives

    or their members; or firms using swaps as hedges pursuant to the terms

    of the CFTC's Swap Policy Statement? If so, which ones and why?

    IV. Definitions of ``Major Swap Participant'' and ``Major Security-

    Based Swap Participant''

    The definitions of ``major swap participant'' and ``major security-

    based swap participant'' (also jointly referred to as the ``major

    participant'' definitions) respectively focus on the market impacts and

    risks associated with an entity's swap and security-based swap

    positions. In this respect, the major participant definitions differ

    from the definitions of ``swap dealer'' and ``security-based swap

    dealer,'' which focus on an entity's activities and account for the

    amount or significance of those activities only in the context of the

    de minimis exception.

    Despite those differences in focus, persons that meet the major

    participant definitions in large part must follow the same statutory

    requirements that apply to swap dealers and security-based swap

    dealers.\68\ In this way, the statute applies comprehensive regulation

    to entities whose swap or security-based swap activities do not cause

    them to be dealers, but nonetheless could pose a high degree of risk to

    the U.S. financial system generally.\69\

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

    \68\ In particular, under CEA section 4s and Exchange Act

    section 15F, dealers and major participants in swaps or security-

    based swaps generally are subject to the same types of margin,

    capital, business conduct and certain other requirements, unless an

    exclusion applies. See CEA section 4s(h)(4), (5); Exchange Act

    section 15F(h)(4), (5).

    \69\ As discussed below, the tests of the major participant

    definitions use terms--particularly ``systemically important,''

    ``significantly impact the financial system'' or ``create

    substantial counterparty exposure''--that denote a focus on entities

    that pose a high degree of risk through their swap and security-

    based swap activities. In addition, the link between the major

    participant definition and risk was highlighted during the

    Congressional debate on the statute. See 156 Cong. Rec. S5907 (daily

    ed. July 15, 2010) (dialogue between Senators Hagen and Lincoln,

    discussing how the goal of the major participant definition was to

    ``focus on risk factors that contributed to the recent financial

    crisis, such as excessive leverage, under-collateralization of swap

    positions, and a lack of information about the aggregate size of

    positions'').

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

    The major participant definitions are similar in their key

    provisions, although one exception, as discussed below, is available

    only in connection with the ``major swap participant'' definition. Both

    major participant definitions encompass persons that satisfy any of

    three alternative tests: \70\

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

    \70\ Also, neither major participant definition encompasses an

    entity that meets the respective swap dealer or security-based swap

    dealer definition. See CEA section 1a(33)(A); Exchange Act section

    3(a)(67)(A)(i).

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

    The first test encompasses persons that maintain a

    ``substantial position'' in any of the ``major'' categories of swaps or

    security-based swaps, as those categories are determined by the CFTC

    [[Page 80186]]

    or SEC as applicable. This test excludes both ``positions held for

    hedging or mitigating commercial risk,'' and positions maintained by or

    contracts held by any employee benefit plan (as defined in paragraphs

    (3) and (32) of section 3 of ERISA (29 U.S.C. 1002)) for the primary

    purpose of hedging or mitigating risks directly associated with the

    operation of the plan.\71\

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

    \71\ See CEA section 1a(33)(A)(i); Exchange Act section

    3(a)(67)(A)(ii)(I).

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

    The second test encompasses persons whose outstanding

    swaps or security-based swaps create ``substantial counterparty

    exposure that could have serious adverse effects on the financial

    stability of the United States banking system or financial markets.''

    \72\

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

    \72\ See CEA section 1a(33)(A)(ii); Exchange Act section

    3(a)(67)(A)(ii)(II).

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

    The third test encompasses any ``financial entity'' that

    is ``highly leveraged relative to the amount of capital such entity

    holds and that is not subject to capital requirements established by an

    appropriate Federal banking agency'' and that maintains a ``substantial

    position'' in swaps or security-based swaps for any of the ``major''

    categories of swaps or security-based swaps.\73\

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

    \73\ See CEA section 1a(33)(A)(iii); Exchange Act section

    3(a)(67)(A)(ii)(III).

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

    The statute directs the CFTC or the SEC to define ``substantial

    position'' for the respective definition at the threshold that it

    determines to be ``prudent for the effective monitoring, management,

    and oversight of entities that are systemically important or can

    significantly impact the financial system of the United States.'' The

    definitions further provide that when defining ``substantial

    position,'' the CFTC or SEC ``shall consider the person's relative

    position in uncleared as opposed to cleared [swaps or security-based

    swaps] and may take into consideration the value and quality of

    collateral held against counterparty exposures.'' \74\

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

    \74\ See CEA Section 1a(33)(B); Exchange Act section

    3(a)(67)(B).

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

    Both major participant definitions provide that a person may be

    designated as a major participant for one or more categories of swaps

    or security-based swaps without being classified as a major participant

    for all classes of swaps or security-based swaps.\75\

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

    \75\ See CEA section 1a(33)(C); Exchange Act section

    3(a)(67)(C).

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

    Finally, the definition of ``major swap participant''--but not the

    definition of ``major security-based swap participant''--includes an

    exception for any ``entity whose primary business is providing

    financing, and uses derivatives for the purpose of hedging underlying

    commercial risks related to interest rate and foreign currency

    exposures, 90 percent or more of which arise from financing that

    facilitates the purchase or lease of products, 90 percent or more of

    which are manufactured by the parent company or another subsidiary of

    the parent company.'' \76\

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

    \76\ See CEA section 1a(33)(D).

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

    Although the two major participant definitions are similar, they

    address instruments that reflect different types of risks and that can

    be used by end-users and other market participants for different

    purposes. Interpretation of the definitions must appropriately account

    for those differences.

    The Commissions are proposing rules to further define the ``major

    swap participant'' and ``major security-based swap participant''

    definitions, by specifically addressing: (a) The ``major'' categories

    of swaps or securities-based swaps; (b) the meaning of ``substantial

    position''; (c) the meaning of ``hedging or mitigating commercial

    risk''; (d) the meaning of ``substantial counterparty exposure that

    could have serious adverse effects on the financial stability of the

    United States banking system or financial markets''; and (e) the

    meanings of ``financial entity'' and ``highly leveraged.'' We also are

    proposing rules to specify the use of a daily average methodology for

    identifying whether a person meets one of the major participant

    definitions, provide for a reevaluation period for certain entities

    that exceed the relevant daily average by a small amount, and provide

    for a minimum length of time before a person may no longer be deemed a

    major participant.

    We further propose that the CFTC or SEC may limit an entity's

    designation as a major participant to only certain types, classes or

    categories of swaps or security-based swaps. We also address certain

    additional interpretive issues that commenters have raised. Finally,

    while the Commissions also are not proposing any exclusions from the

    major participant definitions, we are soliciting comment as to whether

    certain types of entities should be excluded from the definitions'

    application.\77\

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

    \77\ In light of the significant and novel issues raised by the

    major participant definitions, the Commissions recognize the

    importance of monitoring the swap and security-based swap markets

    following adoption of major participant rules. This will help us

    evaluate whether the rules appropriately reflect how market

    participants use these instruments, and will help us consider the

    impact of market evolution and the ways in which market participants

    may change their practices in response to the rules, so we may

    identify potential improvements to the rules or other actions to

    enhance enforcement of major participant regulation.

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

    A. ``Major'' Categories of Swaps and Securities-Based Swaps

    The first and third tests of the statutory major participant

    definitions encompass entities that have a substantial position in a

    ``major'' category of swaps or security-based swaps. The Commissions

    are responsible for designating these ``major'' categories.\78\

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

    \78\ See CEA section 1a(33)(A)(i), (iii); Exchange Act section

    3(a)(67)(a)(2)(i), (iii). One commenter suggested that we determine

    these categories by reference to the types of instruments

    specifically listed in the statutory definition of ``swap.'' See

    Northwestern Mutual letter (suggesting that, for regulatory

    consistency, each type of swap listed in the definition and options

    on each of those swaps should be considered to be an individual

    major category). The statutory definition of ``swap'' lists 22

    different types of swaps.

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

    The Commissions propose to designate ``major'' categories of swaps

    and security-based swaps in a manner that reflects the risk profiles of

    these various instruments and the different purposes for which end-

    users make use of the various instruments. We preliminarily believe

    that it is important not to parse these ``major'' categories so finely

    as to base the ``substantial position'' thresholds on unduly narrow

    risks that would reduce those thresholds' effectiveness as risk

    measures. The ``major'' categories will apply only for purposes of the

    major participant definitions and are not necessarily determinative

    with respect to any other provision of the Dodd-Frank Act or the

    regulations adopted thereunder.

    1. Major Categories of Swaps

    We propose to designate four ``major'' categories of swaps for

    purposes of the ``major swap participant'' definition. The four

    categories are rate swaps, credit swaps, equity swaps and other

    commodity swaps.\79\ The first category would encompass any swap which

    is primarily based on one or more reference rates, such as swaps of

    payments determined by fixed and floating interest rates, currency

    exchange rates, inflation rates or other monetary rates. The second

    category would encompass any swap that is primarily based on

    instruments of indebtedness, including but not limited to any swap

    primarily based on one or more indices related to debt instruments, or

    any swap that is an index credit default swap or total return

    [[Page 80187]]

    swap on one or more indices of debt instruments. The third category

    would encompass any swap that is primarily based on equity securities,

    such as any swap primarily based on one or more indices of equity

    securities, or any total return swap on one or more equity indices. The

    fourth category would encompass any swap not included in any of the

    first three categories. This fourth category would generally include,

    for example and not by way of limitation, any swap for which the

    primary underlying item is a physical commodity or the price or any

    other aspect of a physical commodity.\80\

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

    \79\ See proposed CEA rule 1.3(rrr). For the avoidance of doubt,

    the term ``swap'' as it is used in the definitions of the major swap

    categories in rule 1.3(rrr) has the meaning set forth in section

    1a(47) of the CEA and the rules promulgated thereunder.

    \80\ The term ``commodity'' as defined in Section 1a(9) of the

    CEA, 7 U.S.C. 1a(9), and CFTC Rule Sec. 1.3(e), 17 CFR 1.3(e)

    includes interest rates, foreign exchange rates, and equity and debt

    indices as well as physical commodities. Thus, the fourth category

    of swaps is entitled ``other commodity swaps'' because it includes

    any swap not included in the other three categories.

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

    The four major categories of swaps are intended to cover all swaps.

    Each swap would be in the category that most closely describes the

    primary item underlying the swap. If a swap is based on more than one

    underlying item of different types, the swap would be in the category

    that describes the underlying item that is likely to have the most

    significant effect on the economic return of the swap. The proposed

    categories are consistent with market statistics that distinguish

    between these general types of swaps, as well as market infrastructures

    that have been established for these types of swaps.

    We request comment on this proposed method of allocating swaps

    among ``major'' categories. Commenters particularly are asked to

    address whether there are any types of swaps that would have unclear

    status under this proposal, as well as whether all swaps instead should

    be placed into a single ``major'' category for purposes of the ``major

    swap participant'' definition, or whether there should be additional

    ``major'' categories of swaps. Commenters are also asked to address

    whether the rate swap category should be divided into two separate

    categories--one for swaps based on rates of exchange between different

    currencies, and another for swaps based on interest rates, inflation

    rates and other monetary rates--and if so, in which category cross-

    currency rate swaps should be included. Also, should the major swap

    category for other commodity swaps be divided into two separate

    categories--one for swaps based on agricultural commodities, and

    another for swaps based on all other commodities not included in the

    other categories?

    2. Major Categories of Security-Based Swaps

    We propose to designate two ``major'' categories of security-based

    swaps for purposes of the ``major security-based swap definition.'' The

    first category would encompass any security-based swap that is based,

    in whole or in part, on one or more instruments of indebtedness

    (including loans), or a credit event relating to one or more issuers or

    securities, including but not limited to any security-based swap that

    is a credit default swap, total return swap on one or more debt

    instruments, debt swap, debt index swap, or credit spread.\81\ The

    second category would encompass any other security-based swaps not

    included in the first category; this category would include, for

    example, equity swaps.\82\

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

    \81\ This category does not encompass a security-based swap that

    is based on an instrument of indebtedness solely in connection with

    the swap's financing leg.

    \82\ See proposed Exchange Act rule 3a67-2.

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

    The proposed categories reflect the fact that entities that

    transact in security-based swaps for non-speculative purposes would be

    expected to use the respective instruments for different purposes. For

    example, swaps based on instruments of indebtedness, such as credit

    derivatives, can be used to hedge the risks associated with the default

    of a counterparty or debt obligation. Equity swaps can be used, among

    other ways, to hedge the risks associated with equity ownership or gain

    synthetic exposure to equities.\83\ The proposed categories also are

    consistent with market statistics that currently distinguish between

    those general types of security-based swaps, as well as market

    infrastructures, including separate trade warehouses, that have been

    established for credit default swaps and equity swaps.

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

    \83\ At the same time, we note that the distinctions between

    these proposed ``major'' categories of ``security-based swaps''

    arguably are less significant than the distinctions among the

    proposed major categories of ``swaps'' (such as, for example, the

    distinction between other commodity swaps and rate swaps).

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

    We request comment on this proposed method of allocating security-

    based swaps between two ``major'' categories. In particular, we request

    comment on whether there are any types of security-based swaps that

    would have unclear status under this proposal, as well as whether all

    security-based swaps instead should be placed into a single ``major''

    category for purposes of the ``major security-based swap participant''

    definition, or whether there should be additional ``major'' categories

    of security-based swaps.

    B. ``Substantial Position''

    As noted above, the Commissions are required to define the term

    ``substantial position'' as a threshold that is ``prudent for the

    effective monitoring, management, and oversight of entities that are

    systemically important or can significantly impact the financial system

    of the United States.'' \84\ This raises two fundamental issues: (i)

    What types of measures should be used to identify the risks posed by an

    entity's swap or security-based swap positions; and (ii) for each of

    those measures, how much risk should be required to evidence a

    ``substantial position''?

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

    \84\ See CEA section 1a(33)(B); Exchange Act section

    3(a)(67)(B).

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

    1. Commenters' Views

    Commenters have expressed diverse views as to what should

    constitute a substantial position. A number of commenters suggested the

    use of a test based on the current uncollateralized mark-to-market

    exposure posed by an entity's swap or security-based swap positions,

    after taking bilateral netting agreements into account. Two commenters

    suggested specific dollar amounts of uncollateralized exposure to use

    as the substantial position threshold.\85\ Several commenters expressed

    the view that positions subject to central clearing should be entirely

    excluded from the analysis, or at least should be discounted for

    purposes of the analysis.\86\

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

    \85\ See letter from Timothy W. Cameron, Esq., Managing

    Director, SIFMA Asset Management Group, dated September 20, 2010

    (``SIFMA AMG letter'') (suggesting a standard of $2.5 billion

    average exposure in any calendar quarter based on the entity's

    entire portfolio of swaps and security-based swaps, other than

    foreign exchange swaps and forwards); letter from Gus Sauter, Chief

    Investment Officer, Vanguard, dated September 20, 2010 (``Vanguard

    letter'') (suggesting that the applicable threshold be $500 million

    in uncollateralized exposure for any single major swap category or

    $1 billion aggregate exposure across all major categories).

    \86\ See letter from Jennifer J. Kalb, Associate General

    Counsel, Metropolitan Life Insurance Company, dated September 20,

    2010 (``MetLife letter'') (suggesting that cleared trades be subject

    to a lesser ``charge'' for purposes of the substantial position

    calculation, or be excluded entirely).

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

    Some commenters opposed using the notional amount of swap or

    security-based swap positions to set the threshold, stating that the

    notional amount is not indicative of the risks associated with a

    position. Some commenters similarly opposed using measures of swap or

    security-based swap volume to set the threshold,

    [[Page 80188]]

    contending that the number of trades does not reflect risk.\87\

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

    \87\ But see letter from Christopher A. Klem, Ropes & Gray,

    dated September 2, 2010 (test should account for frequency of

    trading and frequency of trading with non-dealers).

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

    A few commenters addressed the possibility that the threshold could

    take into account the potential future risks associated with a

    position, in addition to the risks associated with uncollateralized

    current exposure.\88\ Some commenters suggested that the threshold take

    into account the potential riskiness of the particular type of

    instrument at issue. Some commenters maintained that the threshold

    should take into account the number of counterparties an entity has,

    the size of an entity's positions compared to the size of the market,

    the size of an entity's swap or security-based swap positions compared

    to the entity's ability to absorb losses of that magnitude, or the

    financial strength of an entity's counterparties. Several commenters

    stated that the threshold should be based on an average measure over

    time, so that short-term spikes in measures such as exposure would not

    by themselves cause an entity to meet the major participant

    definitions. Some commenters suggested that the substantial position

    threshold should reflect an amount of ``systemic risk.'' \89\

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

    \88\ See letter from Andrew Baker, Chief Executive Officer,

    Alternative Investment Management Association, dated September 24,

    2010 (``AIMA letter'') (discussing possible methods of estimating

    the maximum risk of loss related to positions); letter from Warren

    Davis, Of Counsel, Sutherland Asbill & Brennan LLP on behalf of the

    Federal Home Loan Banks, dated September 20, 2010 (in addressing

    ``substantial counterparty exposure'' test, noting the possibility

    of accounting for the potential exposure of a portfolio).

    \89\ See letter from Edward J. Rosen, Cleary Gottlieb Steen &

    Hamilton LLP, dated September 21, 2010 (``Cleary letter'')

    (suggesting that the threshold should be akin to the amount that is

    required for a non-financial entity to be designated as systemically

    important under Title I of the Dodd-Frank Act).

    Section 113 of the Dodd-Frank Act provides that the Financial

    Stability Oversight Council (``FSOC'') may determine that a non-bank

    financial company shall be supervised by the Federal Reserve Board,

    subject to prudential standards, if the FSOC ``determines that

    material financial distress at the U.S. nonbank financial company,

    or the nature, scope, size, scale, concentration,

    interconnectedness, or mix of the activities of the U.S. nonbank

    financial company, could pose a threat to the financial stability of

    the United States.'' In making that determination, the FSOC is to

    consider: Leverage; off-balance sheet exposures; transactions and

    relationships with other significant non-bank financial companies

    and bank holding companies; importance as a source of credit and

    liquidity; extent to which assets are managed rather than owned; the

    nature, scope, size, scale, concentration, interconnectedness and

    mix of activities; presence of a primary financial regulator; assets

    and liabilities; and any other appropriate risk-related factors.

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

    2. Proposed Substantial Position Thresholds

    The Commissions recognize that it is important for the substantial

    position thresholds to be set using objective numerical criteria.

    Objective criteria should permit regulators, market participants and

    entities that may be subject to the regulations to readily evaluate

    whether swap or security-based swap positions meet the thresholds, and

    should promote the predictable application and enforcement of the

    requirements governing major participants.

    In determining the substantial position thresholds--in light of

    what is ``prudent for the effective monitoring, management, and

    oversight'' of entities that are systemically important or can

    significantly impact the U.S. financial system--the Commissions are

    mindful that tests based on current uncollateralized exposure and tests

    based on potential future exposure both have respective advantages and

    disadvantages. We thus are proposing tests that would account for both

    types of exposure.

    A test that focuses solely on the current uncollateralized exposure

    associated with an entity's swap and security-based swap positions

    should provide a reasonable measure of the theoretical amount of

    potential risk that an entity would pose to its counterparties if the

    entity currently were to default.\90\ Such a test also should be

    relatively clear-cut for market entities to implement, and would be

    based on calculations that we expect that market entities would perform

    as a matter of course.

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

    \90\ In practice, however, this measure may underestimate the

    amount of risk that an entity poses to its counterparties, given

    that it may take multiple days to liquidate a defaulting entity's

    swap or security-based swap positions, during which time prices may

    move against the defaulting entity.

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

    At the same time, a focus solely on current uncollateralized

    exposure could be overly narrow by failing to identify risky entities

    until some time after they begin to pose the level of risk that should

    subject them to regulation as major participants. Because exposure can

    change significantly over short periods of time, and a swap or

    security-based swap position that may pose large potential exposures

    nonetheless would often have a mark-to-market exposure of zero at

    inception, an entity's positions may already pose significant risk to

    counterparties and to the market even before its uncollateralized mark-

    to-market exposure increases up to the applicable threshold. A test

    that focuses solely on current uncollateralized exposure thus would not

    appear to be sufficient to satisfy the systemic importance standard

    required by the statute.

    Tests based on measures of potential future exposure--which would

    address an estimate of how much the value of a swap or security-based

    swap might change against an entity over the remaining life of the

    contract--could address the gap left by a current uncollateralized

    exposure test. Potential future exposure tests, however, would reflect

    only an estimate of that type of risk, and would only be as effective

    as the factors used by the test.

    While we have considered several other types of tests that could be

    used to determine the substantial position threshold, we preliminarily

    do not believe that the advantages of those tests justify their

    disadvantages. For example, while a threshold based on the number of an

    entity's counterparties could help identify highly interconnected

    entities (a factor that some have argued is important for identifying

    an entity's systemic risk), it also has been argued that a large number

    of counterparties could mean that the losses associated with that

    entity's default would be divided and absorbed by many counterparties

    without broader market effects.\91\ While a threshold that is based on

    an entity's financial strength would help account for the possibility

    of an entity's default as well as the effects of such a default, it

    would not address swap-related risks to the market that are not

    directly linked to the entity's default. In other words, an entity that

    has large out-of-the-money swap or security-based swap positions and

    faces a margin call may cause significant price movements in the swaps

    or security-based swaps and in the related reference entities or assets

    if the entity chooses to unwind its positions, even if the entity

    itself does not appear to present a large threat of default. These

    movements may be exacerbated if other entities have similar positions.

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

    \91\ See AIMA letter (``An entity that has only a small number

    of counterparties may only affect a small number of entities

    directly, should it fail, but the impact could be significant if the

    position is large and the counterparty is a systemically important

    entity. A diversified exposure to multiple entities could affect

    more entities but is likely to be smaller and thus shares the losses

    in the industry and having less systemic impact.'').

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

    Moreover, although substantial position thresholds based on the

    financial strength of an entity's counterparties would help measure the

    potential that an entity's default would have a broader impact, such

    thresholds could result in disparate results between two entities with

    identical positions,

    [[Page 80189]]

    and also could encourage concentration of exposure or potential future

    exposure within a few counterparties. While tests that are based on the

    volume of an entity's swaps or security-based swaps may be helpful in

    identifying significant swap or security-based swap activity, such

    tests would not directly be germane to the current or potential future

    exposure posed by an entity's swap and security-based swap positions.

    Finally, while we have considered the feasibility of tests that take

    specific contract features into account (e.g., triggers that require

    the payment of mark-to-market margin if an entity's credit rating is

    lowered), we preliminarily believe that simpler tests of exposure can

    more efficiently identify the risks associated with particular swap or

    security-based swap positions.

    After considering these alternatives, the Commissions are proposing

    two tests to define ``substantial position.'' One test would focus

    exclusively on an entity's current uncollateralized exposure; the other

    would supplement a current uncollateralized exposure measure with an

    additional measure that estimates potential future exposure. A position

    that satisfies either test would be a ``substantial position.''

    The Commissions, however, request comment on whether it would be

    appropriate to use other types of approaches for determining whether an

    entity has a substantial position--as an alternative to, or in addition

    to, the two proposed tests.

    a. Proposed Current Exposure Test

    The proposed first substantial position test, which would focus

    solely on current uncollateralized exposure, in general would set the

    substantial position threshold by reference to the sum of the

    uncollateralized current exposure, obtained by marking-to-market using

    industry standard practices, arising from each of the person's

    positions with negative value in each of the applicable ``major''

    category of swaps or security-based swaps (other than positions

    excluded from consideration, such as positions for the purpose of

    ``hedging or mitigating commercial risk'').\92\

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

    \92\ See proposed CEA rule 1.3(sss)(2); proposed Exchange Act

    rule 3a67-3(b)(1). In other words, the test would measure the

    portion of the exposure that is not offset by the posting of

    collateral. If a position was collateralized only partially, the

    value of the collateral posted would be offset against the total

    exposure, and the test would measure the residual part of the

    exposure. We recognize that there may be operational delays between

    changes in exposure and the resulting exchanges of collateral, and

    in general we would not expect that operational delays associated

    with the daily exchange of collateral would be considered to lead to

    uncollateralized exposure for these purposes.

    As noted above, the statutory definitions require us to consider

    the presence of central clearing in setting the substantial position

    threshold. This test would account for the risk-mitigating effects

    of central clearing in that centrally cleared swaps and security-

    based swaps are subject to mark-to-market margining that would

    largely eliminate the uncollateralized exposure associated with a

    position, effectively resulting in cleared positions being excluded

    from the analysis.

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

    A person would apply this proposed substantial position test on a

    major category-by-major category basis, examining its positions with

    each counterparty with which the person has swaps or security-based

    swaps in the particular category. For each counterparty, the person

    would determine the dollar value of the aggregate current exposure

    arising from each of its swap or security-based swap positions with

    negative value (subject to the netting provisions described below) in

    that major category by marking-to-market using industry standard

    practices, and deduct from that amount the aggregate value of the

    collateral the person has posted with respect to the swap or security-

    based swap positions. The aggregate uncollateralized outward exposure

    would be the sum of those uncollateralized amounts over all

    counterparties with which the person has entered into swaps or

    security-based swaps in the applicable major category.\93\

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

    \93\ See proposed CEA rule 1.3(sss)(2); proposed Exchange Act

    rule 3a67-3(b)(2).

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

    The proposed test would not prescribe any particular methodology

    for measuring current exposure or the value of collateral posted,\94\

    and instead would provide that the method should be consistent with

    counterparty practices and industry practices generally.\95\

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

    \94\ Depending on the particular circumstances of the swap or

    security-based swap, such collateral may be posted to a third-party

    custodian, directly to the counterparty, or in accordance with the

    rules of a derivatives clearing organization or clearing agency.

    \95\ Consistent with industry practices, we would expect that

    entities may value exposure based on measures that take into account

    the amounts that would be payable if the transaction were

    terminated. Also, to the extent the valuation of collateral posted

    in connection with swaps or security-based swaps is subject to other

    rules or regulations, we would expect that the valuation of

    collateral for purposes of the major participant calculations would

    be consistent with those applicable rules.

    At the same time, we recognize that there can be disputes or

    uncertainty as to an entity's exposure in connection with swap and

    security-based swap positions, and as to the valuation of the

    collateral it has posted in connection with those positions. In some

    circumstances this could lead to uncertainty as to whether the

    entity is a major participant. As addressed below, we are requesting

    comment as to the potential significance of these issues, and as to

    whether we should set forth additional guidance or mandate the use

    of specific standards with respect to these valuations.

    Also, it is important to recognize that while we expect that

    other regulatory requirements applicable to the valuation of swap or

    security-based swap positions and collateral would be relevant to

    certain calculations relating to major participant status, our

    proposed rules would not be relevant for other purposes, such as in

    the context of capital and margin requirements.

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

    This proposed test would account for the risk mitigating effects of

    netting agreements \96\ by permitting an entity to calculate its

    exposure on a net basis, by applying the terms of master netting

    agreements entered into between the entity and a single

    counterparty.\97\ When calculating the net exposure the entity may take

    into account offsetting positions with that particular counterparty

    involving swaps, security-based swaps and securities financing

    transactions (consisting of securities lending and borrowing,

    securities margin lending and repurchase and reverse repurchase

    agreements) to the extent that is consistent with the offsets provided

    by the master netting agreement.\98\

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    \96\ Section 362(b)(17) of the United States Bankruptcy Code

    generally provides derivatives contracts with a safe harbor from the

    Bankruptcy Code's automatic stay, thus allowing parties to these

    contracts to enforce their contractual rights, including those

    associated with netting and offsets, even after a counterparty has

    filed for bankruptcy.

    In addition, Section 210(c)(8)(A) of the Dodd-Frank Act

    reaffirms the enforceability of netting and offset provisions in

    certain derivatives contracts with insolvent counterparties that

    have been placed under the receivership of the Federal Deposit

    Insurance Corporation (``FDIC''). However, the Dodd-Frank Act also

    places certain limitations on the timing by which netting rights may

    be exercised when the FDIC has been appointed as the receiver of an

    insolvent counterparty. See Dodd-Frank Act section 210(c)(10)(B).

    \97\ To the extent that the two counterparties maintain multiple

    netting agreements (e.g., separate agreements for dollar-denominated

    and euro-denominated instruments), the calculation would account

    only for the netting permitted under the netting agreement that is

    relevant to the swap or security-based swap at issue.

    \98\ See proposed CEA rule 1.3(sss)(2)(iii)(A); proposed

    Exchange Act rule 3a67-3(b)(3)(A). As is the case for the proposed

    rules on valuation, the proposed rules regarding possible offsets of

    various positions are for purposes of determining major participant

    status only. Other rules proposed by the Commissions may address the

    extent to which, if any, persons such as dealers and major

    participants may offset positions for other purposes.

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

    The Commissions preliminarily believe that this approach is

    appropriate because it avoids identifying a position's exposure as

    being ``uncollateralized'' when there is no current counterparty risk

    associated with it due to offsets under a netting agreement with the

    counterparty.\99\ In

    [[Page 80190]]

    calculating current uncollateralized exposure, however, the entity may

    not take into account the market risk offsets associated with holding

    positions with multiple counterparties.\100\ Also, the entity may not

    ``double count'' any offset or collateral--once any item of collateral

    or any position with positive value has been applied against current

    exposure, the same item cannot be applied for purposes of this test

    against any other exposure.

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

    \99\ If, for example, an entity was $X out of the money in

    connection with a security-based swap, but was $X in the money with

    the same counterparty in connection with a swap, there would be no

    economic need for the entities to exchange collateral in connection

    with those offsetting positions. A test that fails to account for

    this netting of exposure could lead the entities to engage in

    needless offsetting exchanges of collateral.

    \100\ See proposed CEA rule 1.3(sss)(2)(iii)(C); proposed

    Exchange Act rule 3a67-3(b)(2)(iii). While recognizing that

    offsetting positions of that type would reduce the market risk

    facing the entity, the offsets would not be expected to directly

    mitigate the risks that the entity's counterparties would face if

    the entity were to default.

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

    The proposal to permit this type of netting, however, raises

    questions as to how an entity's net out-of-the-money exposure with a

    counterparty, and the collateral posted with respect to its positions

    with the counterparty, should be allocated among swap positions,

    security-based swap positions and other positions specified in the

    rule.\101\ In particular, when an entity has not fully collateralized

    its net current exposure to a particular counterparty with which it has

    a netting agreement, there may be questions regarding how to attribute

    the net out-of-the-money positions and associated collateral to its

    swap or security-based swap positions. We preliminarily believe that an

    entity that has net uncollateralized exposure to a counterparty should,

    for purposes of the test, allocate that net uncollateralized exposure

    pro rata in a manner that reflects the exposure associated with each of

    its out-of-the-money swap positions, security-based swap positions and

    non-swap positions.\102\ This allocation would be intended to cause the

    measure of uncollateralized exposure connected with swaps or security-

    based swaps for purposes of the test to reasonably reflect the relative

    contribution of those instruments to an entity's total overall

    uncollateralized exposure.

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

    \101\ This issue does not arise to the extent that an entity's

    net positions with a counterparty are fully collateralized.

    \102\ In other words, if an entity's out-of-the-money rate swap

    positions have $W exposure, its out-of-the-money other commodity

    swap positions have $X exposure, its out-of-the-money security-based

    swap positions have $Y exposure, and its other out-of-the money

    positions covered by that netting agreement have $Z exposure,

    fractions of the collateral equal to W/(W+X+Y+Z) should be allocated

    to the rate swap positions, X/(W+X+Y+Z) to the other commodity swap

    positions and Y/(W+X+Y+Z) to the security-based swap positions. A

    similar process should be used for allocating net out-of-the-money

    exposure across the categories of swaps and security-based swaps

    that have out-of-the-money exposure when one or more categories are

    in-the-money.

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

    For purposes of the definition of ``major swap participant,'' the

    Commissions are proposing to set the current uncollateralized exposure

    threshold at a daily average of $1 billion in the applicable major

    category of swaps, except that the threshold for the rate swap category

    would be a daily average of $3 billion. For purposes of the definition

    of ``major security-based swap participant,'' this threshold would be

    based on a daily average of $1 billion in the applicable major category

    of security-based swaps.\103\ We preliminarily believe that these

    proposed thresholds are appropriate for identifying entities that,

    through their swap and security-based swap activities, have a

    significant potential to pose the systemic importance or risks to the

    U.S. financial system that the major participant definition and

    associated statutory requirements were intended to address, but we also

    recognize that it is possible that the appropriate threshold should be

    higher or lower. In proposing these specific thresholds, we have sought

    to take into account several factors: (i) The ability of the financial

    system to absorb losses of a particular size; \104\ (ii) the

    appropriateness of setting ``prudent'' thresholds that are materially

    below the level that could cause significant losses to the financial

    system as it would not be appropriate for the substantial position test

    to encompass entities only after they pose significant risks to the

    market through their swap or security-based swap activity; \105\ and

    (iii) the need to account for the possibility that multiple market

    participants may fail close in time, rather than focusing narrowly on

    the potential impact of a single participant's default.\106\ Based on

    these factors, we preliminarily believe that the proposed substantial

    position thresholds would reasonably be expected to apply to entities

    that have the potential of satisfying the statutory criteria of

    systemic importance or significant impact to the U.S. financial system.

    As discussed below, however, we welcome comments on the appropriateness

    of the proposed threshold.

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

    \103\ See proposed CEA rule 1.3(sss)(1); proposed Exchange Act

    rule 3a67-3(a)(1).

    \104\ In this regard, the Commissions preliminarily believe that

    the ``Tier 1'' capital of major dealer banks provides relevant

    information about the ability of the financial system to absorb

    losses of a particular size. We note that, among U.S. banks that are

    dealers in credit derivatives, the six largest banks account for the

    vast majority of dealing activities. We understand that the most

    liquid ``Tier 1'' regulatory capital for those six banks ranges from

    $14 billion to $113 billion.

    \105\ In other words, the proposed thresholds are intended to be

    low enough to provide for the appropriately early regulation of an

    entity whose swap or security-based swap positions have a reasonable

    potential of posing significant counterparty risks and risks to the

    market that stress the financial system, while being high enough

    that it would not unduly burden entities that are materially less

    likely to pose these types of risks.

    \106\ For example, the proposed $1 billion threshold for swaps

    and security-based swaps would reflect a potential loss of $3

    billion if three large swap or security-based swap entities were to

    fail close in time. That $3 billion could represent a significant

    impairment of the ability of some major dealers to absorb losses, as

    reflected by their Tier 1 capital.

    We also are mindful of the views expressed by the two commenters

    that suggested particular dollar values for the threshold. See note

    85, supra.

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

    These proposed thresholds would be evaluated by reference to a

    calculation of the mean of an entity's uncollateralized exposure

    measured at the close of each business day, beginning on the first

    business day of each calendar quarter and continuing through the last

    business day of that quarter.\107\ In this regard, the Commissions have

    taken into account commenters' concerns that an entity's exposure

    should not be evaluated based on a single point in time, as short-term

    market fluctuations may not fairly reflect the risks of the entity's

    positions. The use of a daily average approach should help address

    commenters' concerns about the impact of short-term price fluctuations,

    and also help preclude the possibility that an entity may seek to use

    short-term transactions to distort the measure of exposure.

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

    \107\ See proposed CEA rule 1.3(sss)(4); proposed Exchange Act

    rule 3a67-3(d).

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

    The Commissions request comment on the proposed current

    uncollateralized exposure test. Commenters particularly are requested

    to address whether the proposed threshold amounts of current

    uncollateralized exposure are appropriate, and, if not, what

    alternative higher or lower threshold amounts would appropriately

    identify entities that pose the types of risks that the definition was

    intended to address. In this regard, commenters specifically are

    requested to address whether bank Tier 1 capital provides a good

    indicative reference of the ability of major dealers to absorb losses

    of a particular size, or whether alternative reference points for the

    analysis (e.g., the size of the swap market or security-based swap

    market) would also be applied. Commenters are requested to address

    whether uncollateralized mark-to-market exposure is the appropriate way

    to measure current exposure, and if not, what alternative approach is

    more appropriate, and why. Commenters also are requested to address

    whether the

    [[Page 80191]]

    proposed thresholds reasonably address the need to set the threshold at

    a prudent level so as to avoid the possibility that the substantial

    position test would encompass entities only after they pose significant

    risks to the market, whether the proposed thresholds reasonably address

    the possibility that multiple market entities could fail close in time,

    and whether the proposed thresholds reasonably address the fact that

    swap or security-based swap activities would comprise only part of the

    risks to the market posed by an entity. To what extent would this

    proposed definition of ``substantial position'' have an effect on the

    activities of entities that potentially may be deemed to be major

    participants? What impact could these types of effects have on

    liquidity, on risk-taking or risk-reducing activities, or on other

    aspects of the relevant markets?

    Also, more fundamentally, we request comment on whether the

    substantial position analysis also should encompass a test that does

    not account for the collateral posted in connection with an entity's

    exposure, given that tests that account for the posting of collateral

    would not encompass entities that have very large swap or security-

    based swap positions that are fully collateralized (either by the

    posting of bilateral collateral or by virtue of central clearing). In

    that light, should the analysis seek to capture entities that have very

    large positions in light of potential market disruptions such entities

    could cause, regardless of whether the positions are collateralized?

    Commenters further are requested to address whether such thresholds

    should also account for entities that have large in-the-money positions

    that may indicate their potential significance to the market. In this

    regard, commenters also are asked to address whether the thresholds

    should specifically address entities with large in-the-money positions

    that lead them to receive large amounts of collateral posted by their

    counterparties, particularly to the extent that such collateralized in-

    the-money positions could later turn and lead the entity to incur

    losses.

    In addition, commenters are requested to address whether and how it

    would be appropriate to adjust the threshold amounts over time,

    including whether these proposed current uncollateralized exposure

    thresholds should periodically be adjusted by formula to reflect

    changes in the ability of the market to absorb losses over time, or

    changes in other criteria over time. Commenters further are requested

    to address whether the test will be practical for potential major

    participants to use. Moreover, commenters are requested to address

    whether the proposed current exposure test should be modified to

    account for the risks associated with the expected time lag between an

    entity's default and the liquidation of its swap or security-based swap

    positions.

    Commenters also are requested to address whether we should set

    forth additional guidance or mandate the use of specific standards with

    respect to the measure of exposure or valuing collateral posted, or

    should specify particular procedures in the event of valuation

    disputes. What particular industry standard documentation and other

    methodologies could be used to measure exposure and value collateral?

    Also, how could regulatory requirements applicable to the valuation of

    collateral be relevant to the valuation of collateral for purposes of

    the major participant definitions?

    Commenters are invited to address whether the rule should provide

    that, in measuring their current uncollateralized exposure, entities

    must value collateral in a way that is at least as conservative as such

    collateral would be valued according to applicable haircuts or other

    adjustments dictated by applicable regulations. Commenters further are

    requested to address whether the test should exclude certain types of

    collateral that cannot readily be valued. Also, commenters are

    requested to address whether the proposed method of evaluation--the

    mean of an entity's uncollateralized exposure measures at the close of

    each business day, beginning on the first business day of each calendar

    quarter and continuing through the last business day of that quarter--

    would be unduly burdensome or potentially subject to gaming or evasion.

    Should the proposed approach for measuring uncollateralized current

    exposure be amended or supplemented, such as by establishing

    requirements for how exposure should be measured or collateral should

    be valued in certain circumstances (e.g., requiring the valuation of

    certain types of collateral to be conservative during times of rapid

    price changes in the relevant asset class)? Should current exposure and

    collateral be required to be valued in accordance with US generally

    accepted accounting principles? Would measurement according to such

    principles differ in any respects from measurement under the proposal,

    and, if so, how?

    In addition, commenters are requested to address the proposed

    netting provisions of this test, including: whether the proposed test

    would reasonably permit the measure of uncollateralized exposure to

    account for bilateral netting agreements; whether additional types of

    positions should be included within the netting provisions; whether the

    proposal appropriately takes into account the netting of exposures and

    collateral involving positions in financial instruments other than

    swaps, security-based swaps and securities financing transactions and

    if so, whether any limitations to such offsetting would be necessary or

    appropriate; whether the netting provisions should accommodate

    offsetting positions involving the net equity balance in an entity's

    securities account (e.g., free credit balances, other credit balances,

    and fully paid securities), and if so, whether any limitations to such

    offsetting would be necessary or appropriate; whether the netting

    provisions should accommodate offsets for exposures, or collateral

    connected with the positions that an entity has with the affiliate of a

    counterparty; and whether the proposed method of allocating the

    uncollateralized portion of exposures among the different types of

    financial instruments that are all subject to a single netting

    agreement is appropriate.

    Commenters also are requested to address whether the proposed

    current uncollateralized exposure test would pose significant

    monitoring burdens upon entities that have swap or security-based swap

    positions that are significant enough to potentially meet the current

    uncollateralized exposure threshold. Should we provide guidance as to

    policies and procedures that such an entity should be able to follow to

    demonstrate that it does not meet the applicable thresholds?

    b. Proposed Current Exposure Plus Potential Future Exposure test

    The second proposed test would account both for current

    uncollateralized exposure (as discussed above) and for the potential

    future exposure associated with swap or security-based swap positions

    in the applicable ``major'' category of swaps or security-based swaps.

    This additional test would allow the major participant analysis to take

    into account estimates of how the value of an entity's swap or

    security-based swap positions may move against the entity over time.

    The potential future exposure portion of this proposed test would

    be based on an entity's ``aggregate potential outward exposure,'' which

    would reflect the potential exposure of the entity's swap or security-

    based swap positions in the applicable ``major'' category of swap or

    security-based swaps, subject to certain adjustments. Bank capital

    standards also

    [[Page 80192]]

    make use of this type of test,\108\ and this proposal builds upon those

    standards but modifies them to focus on the risk that an entity poses

    to its counterparties (rather than on the risk that counterparties pose

    to an entity). In doing so, this proposal seeks to use a test that can

    be implemented by a range of market participants, and that can be

    expected to lead to reproducible results across market participants

    with identical swap or security-based swap portfolios, rather than

    relying on alternative tests (e.g., value at risk measures or stress

    testing methodologies) that may be costly for market participants to

    implement and that would not be expected to lead to reproducible

    results across participants.

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

    \108\ See 12 CFR part 3, app. C, section 32 (Office of the

    Comptroller of the Currency bank capital standards).

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

    The exposure measures in general would be based on the total

    notional principal amount of those positions, adjusted by certain risk

    factors that reflect the type of swap or security-based swap at issue

    and the duration of the position.\109\ For positions in which the

    stated notional amount is leveraged or enhanced by the particular

    structure, this calculation would be based on the position's effective

    notional amount.\110\

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

    \109\ For example, consistent with the bank standards, the

    multiplier for equity swaps would range from 0.06 for equity swaps

    of one year or less to 0.10 for equity swaps with a maturity of more

    than five years. See proposed Exchange Act rule 3a67-3(c)(2)(i)(A).

    For security-based swaps based on the credit of a reference entity,

    the multiplier would be 0.1.

    The current bank capital standards contain a distinction based

    on whether the credit derivative is on ``investment grade'' or

    ``non-investment grade'' reference entities, providing a 0.1

    multiplier for the former and a lower 0.05 multiplier for the

    latter. We preliminarily do not believe that a test that

    distinguishes among reference entities by reference to their credit

    ratings would be appropriate for purposes of these definitions,

    particularly in light of the fact that the Dodd-Frank Act mandates

    the substitution of credit ratings with other standards of

    creditworthiness in U.S. regulations. See Dodd-Frank Act section

    939A.

    The multipliers in part will be a function of the remaining

    maturity of the swap or security-based swap. If the swap or

    security-based swap, however, is structured such that on specified

    dates the outstanding exposure is settled and the terms are reset so

    the market value is zero, the remaining maturity would equal the

    time until the next reset date.

    Although we recognize that these risk multipliers may suggest a

    lower than expected volatility of credit or equity derivatives of

    that duration, this may be offset by the fact that the proposed

    calculations of potential future exposure do not directly account

    for portfolio netting or collateral updates that could mitigate

    future exposure. We preliminarily believe that the use of these

    thresholds (and proposed related calculations) for purposes of

    identifying major participants are consistent with similar bank

    capital standards and are therefore suitable for use as an estimate

    of potential future exposure. We are also cognizant that requiring a

    more complete calculation of potential future exposure may be costly

    and burdensome for participants, especially those who would

    otherwise not meet the thresholds for major swap or security-based

    swap participant and would not have systems in place to perform a

    more complete calculation.

    \110\ See proposed CEA rule 1.3(sss)(3)(ii); proposed Exchange

    Act rule 3a67-3(c)(2)(i)(B). For purposes of this rule, in the case

    of positions that represent the sale of an option on a swap or

    security-based swap (other than the sale of an option permitting the

    person exercising the option to purchase a credit default swap), we

    would view the effective notional amount of the option as being

    equal to the effective notional amount of the underlying swap or

    security-based swap, and we would view the duration used for

    purposes of the formula as being equal to the sum of the duration of

    the option and the duration of the underlying swap or security-based

    swap.

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

    At the same time, the proposed measures would contain adjustments

    for certain types of positions that pose relatively lower potential

    risks.\111\ In addition, the general risk-adjusted notional measures of

    potential future exposure would be reduced to reflect the risk

    mitigation effects of master netting agreements, in a manner consistent

    with bank capital standards.\112\

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

    \111\ The analysis would exclude swap or security-based swap

    positions that constitute the purchase of an option, such that the

    person has no additional payment obligations under the position, as

    well as other positions on which the person has prepaid or otherwise

    satisfied all of its payment obligations. See proposed Exchange Act

    rule 3a67-3(c)(2)(i)(C).

    For similar reasons, the potential outward exposure associated

    with a position by which a person buys credit protection using a

    credit default swap would be capped at the net present value of the

    unpaid premiums. See proposed CEA rule 1.3(sss)(3)(ii)(A)(4);

    proposed Exchange Act rule 3a67-3(c)(2)(i)(D).

    \112\ In particular, for swaps or security-based swaps subject

    to master netting agreements the potential exposure associated with

    the person's swap or security-based swaps with each counterparty

    would equal a weighted average of the potential exposure in the

    applicable ``major'' category of swaps or security-based swaps with

    a particular counterparty as calculated without reference to

    netting, and that amount reduced by the ratio of net current

    replacement cost to gross current replacement cost of all swap and

    security-based swap positions with that counterparty, consistent

    with the following equation: PNet = 0.4 x PGross + 0.6 x NGR x

    PGross.

    Under this formula, PNet is the potential exposure in the

    applicable ``major'' category of swaps or security-based swaps

    adjusted for bilateral netting; PGross is the potential exposure in

    that category without adjustment for bilateral netting; and NGR is

    the ratio of net current replacement cost to gross current

    replacement cost. See proposed CEA rule 1.3(sss)(3)(ii)(B); proposed

    Exchange Act rule 3a67-3(c)(2)(ii).

    The ``NGR'' ratio is intended to serve as a type of proxy for

    the impact of netting on potential future exposure, but does not

    serve as a precise indicator of future changes in net exposure

    relative to gross exposure, as the ratio and potential exposure can

    be influenced by many idiosyncratic properties of individual

    portfolios. See Basle Committee on Banking Supervision, ``The

    Treatment of the Credit Risk Associated with Certain Off-Balance-

    Sheet Items'' (July 1994).

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

    The proposed measures of potential future exposure would contain

    further downward adjustments to account for the risk mitigation effects

    of central clearing and mark-to-market margining. In particular, if the

    swap or security-based swap positions are cleared by a registered

    clearing agency or subject to daily mark-to-market margining,\113\ the

    measures of potential future exposure would further be adjusted to

    equal twenty percent of the potential future exposure calculated using

    the methodology described above.\114\ The Commissions preliminarily

    believe that a significant downward adjustment would be appropriate

    because clearing and daily mark-to-market margining would be expected

    to reduce the potential future risks posed by an entity's swap or

    security-based swap positions. Also, it is appropriate to incentivize

    the use of central clearing and daily mark-to-market margining as

    practices for helping to control risks. We are not proposing to

    entirely eliminate such cleared and margined positions from the

    analysis of potential future exposure, however, because clearing may

    not entirely eliminate the risks posed by an entity's potential

    default,\115\ and daily mark-to-market margining would not eliminate

    the risks associated with large intra-day price movements. While the

    proposed amount of the adjustment seeks to balance these

    [[Page 80193]]

    competing factors, we recognize that alternative higher or lower

    downward adjustments may also be appropriate.

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

    \113\ For these purposes, a swap or security-based swap would be

    considered to be subject to daily mark-to-market margining if, and

    for as long as, the counterparties follow the daily practice of

    exchanging collateral to reflect changes in exposure (after taking

    into account any other positions addressed by a netting agreement

    between the parties). If a person is permitted to maintain an

    uncollateralized ``threshold'' amount under the agreement, that

    amount (regardless of actual exposure) would be considered current

    uncollateralized exposure for purposes of the test. Also, if the

    agreement provides for a minimum transfer amount in excess of $1

    million, the entirety of that amount would be considered current

    uncollateralized exposure. See proposed CEA rule

    1.3(sss)(3)(iii)(B); proposed Exchange Act rule 3a67-3(c)(3)(ii).

    In this way, the measure of potential future exposure would

    reflect for the risk mitigating benefits of daily margining, while

    specifically accounting for industry practices that limit those

    benefits. Of course, to take advantage of this adjustment it is not

    enough to the agreement to provide for daily mark-to-market

    margining--the parties must actually follow that practice.

    \114\ See proposed CEA rule 1.3(sss)(3)(iii)(A); proposed

    Exchange Act rule 3a67-3(c)(3).

    \115\ For example, the central counterparties that clear credit

    default swaps do not necessarily become the counterparties of their

    members' customers (although even absent direct privity those

    central counterparties benefit customers by providing for protection

    of collateral they post as margin, and by providing procedures for

    the portability of the customer's positions in the event of a

    dealer's default). As a result, central clearing may not eliminate

    the counterparty risk that the customer poses to the dealer. Even

    then, however, required mark-to-market margining should help control

    that risk, and central clearing thus would be expected to reduce the

    likelihood that an entity's default would lead to broader market

    impacts.

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

    For purposes of the ``major swap participant'' definition, the

    substantial position threshold would be $2 billion in daily average

    current uncollateralized exposure plus aggregate potential outward

    exposure in the applicable major swap category, except that the

    threshold for the rate swap category would be a daily average of $6

    billion. For purposes of the ``major security-based swap participant''

    definition, the substantial position threshold would be $2 billion in

    daily average current uncollateralized exposure plus aggregate

    potential outward exposure in any major security-based swap

    category.\116\ These proposed amounts reflect the same factors

    discussed above in the context of the current uncollateralized exposure

    test,\117\ but are raised to reflect the fact that potential future

    exposure is a measure of potential risk over time, and hence is less

    likely to pose a direct, immediate impact on the markets than current

    measures of uncollateralized exposure. We recognize that alternative

    risk thresholds may also be appropriate, and we welcome comment on

    potential alternatives.

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

    \116\ See proposed Exchange Act rule 3a67-3(a)(2).

    \117\ See notes 103 to 106, supra, and accompanying text.

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

    In light of the amount of this threshold and the underlying risk

    adjustments, we preliminarily do not believe that an entity would need

    to calculate its potential future exposure for purposes of the test

    unless the entity has large notional positions. For example, in light

    of the proposed risk adjustment of 0.10 for credit derivatives, an

    entity that does not have any uncollateralized current exposure would

    have to have notional positions of at least $20 billion to potentially

    meet the $2 billion threshold, even before accounting for the discounts

    associated with netting agreements. If those swaps or security-based

    swaps are cleared or subject to mark-to-market margining, the

    additional 20 percent risk adjustment would mean that the entity

    without current uncollateralized exposure would have to have cleared

    notional positions of at least $100 billion to possibly meet that

    threshold.\118\

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

    \118\ Based on these thresholds, we preliminarily believe that

    only relatively few entities would regularly have to perform these

    potential future exposure calculations with regard to their

    security-based swaps. See notes 181 and 182, infra, and accompanying

    text.

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

    The Commissions request comment on this proposed use of a current

    exposure plus potential future exposure test to determine the

    substantial position threshold. Commenters particularly are requested

    to address the appropriateness of using potential exposure risk

    adjustments derived from bank capital rules; and the appropriateness of

    using bank capital methodologies for addressing positions subject to

    netting agreements. Also, should this test be supplemented by a test

    that accounts for the notional amount of an entity's swap or security-

    based swap positions without risk-adjustments, to focus on entities

    that have very large swap or security-based swap positions?

    Commenters are requested to address whether the proposed threshold

    amounts for the proposed current exposure plus potential future

    exposure test are appropriate, and if not, what alternative threshold

    amounts would be more appropriate, and why. In addition, commenters are

    requested to address the proposed method of discounting the potential

    future exposure associated with cleared positions or positions subject

    to daily mark-to-market margining to equal 20 percent of what the

    measure of potential future exposure would be otherwise. Would a larger

    or smaller discount be appropriate? Is there data available that may

    assist with reaching the appropriate discount factor? Also, in that

    regard, should both sets of discounts be equal, or should cleared

    positions be subject to more of a discount than uncleared positions

    subject to daily mark-to-market margining? Commenters also are invited

    to address whether the proposed discounts for cleared positions or

    positions that are marked-to-market would make it unnecessary or

    duplicative for this test separately to account for netting agreements.

    Also, if an entity currently has posted excess collateral in connection

    with a position, should the amount of that current

    overcollateralization be deducted from its measure of potential future

    exposure?

    Commenters also are requested to address whether the proposed test

    in connection with purchases of credit protection--which would cap the

    measure of exposure at the net present value of unpaid premiums--would

    raise problems in implementation, and whether we should propose any

    particular discount rate to be used in conducting the calculation (and,

    if so, what discount rate should be appropriate). Also, should the

    measure of potential future exposure in connection with purchases of

    credit protection and options also account for collateral that a

    counterparty has posted in connection with an entity's in-the-money

    positions, given that such collateralized in-the-money positions could

    later turn and cause losses to an entity? In addition, for positions

    that represent the sale of options on swaps or security-based swaps,

    would the effective notional amount of the option for purposes of the

    calculation properly be deemed to be the notional amount of the

    underlying instrument (or should the notional amount of the option vary

    based on the link between the changes in the value of the option and

    changes in the value of the underlying), and would the duration of the

    option properly be deemed to be the sum of the duration of the option

    and the duration of the underlying swap or security-based swap?

    Commenters also are requested to address whether the risk

    adjustment for credit derivatives should reflect the riskiness of the

    underlying reference entity, and, if so, how should that be

    accomplished in a way that does not rely on the use of credit ratings.

    The proposed test of potential future exposure is based in part on

    the application of fixed multipliers to the notional amounts, or

    effective notional amounts, of swaps and security-based swaps. In this

    regard, commenters are invited to discuss whether there are alternative

    tests that would be more effective to determine potential future

    exposure or otherwise to supplement an uncollateralized current

    exposure test, and whether such alternative tests may be more

    effectively developed in the near future, when additional data

    regarding swap and security-based swap positions are likely to be

    available. In particular, commenters are requested to identify any

    tests based on non-proprietary risk models that could be uniformly

    applied by all potential major participants to measure potential future

    exposure. Commenters who propose alternative tests are asked to address

    how the tests would provide consistent results across different types

    of swaps and security-based swaps, including customized instruments, in

    the different major categories. Commenters are also invited to address,

    on the other hand, whether a single test based on uncollateralized

    current exposure (i.e., without any test of potential future exposure)

    would be adequate for identifying entities whose swap or security-based

    swap positions pose a relatively high degree of risk to counterparties

    and to the markets. In addition, commenters are invited to identify any

    tests or thresholds below which a party would be deemed not to be a

    major swap participant, without needing to calculate the exposure tests

    set forth in the proposed rule.

    [[Page 80194]]

    Commenters further are requested to address whether and how it

    would be appropriate to adjust the threshold amounts over time,

    including whether these proposed thresholds should periodically be

    adjusted by formula to reflect changes in the ability of the market to

    absorb losses over time, or changes in other criteria over time. In

    addition, commenters are requested to address whether the proposed use

    of a daily average measure for purposes of this test would be

    burdensome for potential major participants to implement, and, if so,

    how often should potential participants have to measure these amounts.

    Commenters also are requested to address whether any such tests should

    seek to reflect the maximum level of exposure associated with a

    position, rather than risk-adjusted estimates of exposure proposed

    here.

    In addition, commenters are requested to address whether this

    proposed test would pose significant monitoring burdens upon entities

    that have swap or security-based swap positions that are significant

    enough to potentially meet the combined current uncollateralized

    exposure and potential future exposure test. Should we provide guidance

    as to policies and procedures that such an entity should be able to

    follow to be able to demonstrate that it does not meet the applicable

    thresholds?

    C. ``Hedging or Mitigating Commercial Risk''

    The first test of the major participant definitions excludes

    positions held for ``hedging or mitigating commercial risk'' from the

    substantial position analysis.\119\

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

    \119\ See CEA section 1a(33)(A)(i)(I); Exchange Act section

    3(a)(67)(A)(i)(I).

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

    Commenters took the position that this exclusion from the major

    participant definitions should encompass a variety of uses of swaps and

    security-based swaps to hedge risks faced by non-financial

    entities.\120\ Some commenters also suggested that the exclusion should

    be interpreted to address risks such as ``balance sheet risk,'' the

    ``risk of under-diversification,'' and hedges undertaken on a portfolio

    basis. Some commenters favored interpreting this exclusion to permit

    its use by insurers and banks. One commenter emphasized the need to

    avoid taking interpretations that would encourage commercial entities

    not to manage risks that they otherwise would manage.\121\ Commenters

    also took the position that the addition of the word ``mitigating'' was

    intended to expand the exclusion beyond what would have been

    encompassed had only the term ``hedging'' been used.\122\

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

    \120\ See, e.g., letter from Coalition for Derivatives End-

    Users, dated September 20, 2010 (discussing, inter alia, a

    supplier's use of credit derivatives in connection with a cash

    receivable, and a company's use of equity derivatives in connection

    with a stock repurchase program).

    \121\ See Cleary letter (also urging inclusion of ``all risks''

    arising in connection with a company's business activities,

    including risks incidental to a company's ordinary course of

    business).

    \122\ See MetLife letter (addition of mitigation ``plainly

    indicates that this exclusion intends an expansive definition of

    hedging and can also encompass non-speculative derivatives positions

    used to manage economic risk, including potentially diversification

    and synthetic asset strategies, such as the conservative

    `replication' strategy permitted under State insurance laws'');

    letter from Joanne R. Medero, Managing Director, BlackRock, dated

    September 20, 2010 (addressing the parallel context of the exclusion

    for ERISA plan positions).

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

    1. Proposed Interpretation

    In interpreting the meaning of ``hedging or mitigating commercial

    risk'' for purposes of the first test of the major participant

    definitions, the Commissions first note that virtually identical

    language is found in the Dodd-Frank provisions granting an exception

    from the mandatory clearing requirement to non-financial entities that

    are using swaps or security-based swaps to hedge or mitigate commercial

    risk.\123\ Because Congress used virtually identical language in both

    instances, the Commissions intend to interpret the phrase ``hedging or

    mitigating commercial risk'' with respect to the participant

    definitions in the same manner as the phrase ``hedge or mitigate

    commercial risk'' in the exception from the mandatory clearing

    requirement.\124\ The Commissions also note that although only non-

    financial entities that are using swaps or security-based swaps to

    hedge or mitigate commercial risk generally may qualify for the

    clearing exemption, no such statutory restriction applies with respect

    to the exclusion for hedging positions in the first major participant

    test. Accordingly, with respect to the first major participant test, it

    appears that positions established to hedge or mitigate commercial risk

    may qualify for the exclusion, regardless of the nature of the entity--

    i.e., whether a financial entity (including a bank) or a non-financial

    entity.\125\

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

    \123\ See CEA section 2(h)(7)(A); Exchange Act section

    3C(g)(1)(B) (exception from mandatory clearing requirements when one

    or more counterparties are not ``financial entities'' and are using

    swaps or security-based swaps ``to hedge or mitigate commercial

    risk''). The definition of commercial risk here is for purposes of

    only the major participant definitions and, to the extent the

    interpretation is similar, for purposes of the end-user exception

    from the mandatory clearing requirement. The concept of commercial

    risk may be interpreted differently for other purposes under the CEA

    and the Exchange Act.

    \124\ There is a technical difference in the way those

    provisions use the concept of hedging and mitigating commercial

    risk--in that the major participant definitions specifically refer

    to ``positions held for hedging and mitigating commercial risk''

    while the end-user exception refers to a counterparty that ``is

    using [swaps or security-based swaps] to hedge or mitigate

    commercial risk.'' That difference is consistent with the different

    language used in the two places (particularly the use of

    ``substantial position'' in the major participant definitions) and

    we do not see a reason why the use of the term in the context of the

    major participant definitions should be construed differently than

    its use in the comparable clearing exception.

    \125\ The presence of the third major participant test suggests

    that financial entities generally may not be precluded from taking

    advantage of the hedging exclusion in the first test. The third

    test, which does not account for hedging, specifically applies to

    non-bank financial entities that are highly leveraged and have a

    substantial position in a major category of swaps or security-based

    swaps. That test would be redundant if the hedging exclusion in the

    first major participant test were entirely unavailable to financial

    entities.

    Also, had the statute intended the phrase ``hedge or mitigate

    commercial risk'' to apply only to activities of or positions held

    by non-financial entities, it would not have been necessary to

    include an additional provision in the statute generally restricting

    the availability of the clearing exception to non-financial

    entities.

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

    In general, we are premising the proposed exclusion on the

    principle that swaps or security-based swaps necessary to the conduct

    or management of a person's commercial activities should not be

    included in the calculation of a person's substantial position.\126\ In

    this regard, the Commissions preliminarily believe that whether an

    activity is commercial should not be determined solely by the person's

    organizational status as a for-profit company, a non-profit

    organization or a governmental entity. Rather, the determinative factor

    should be whether the underlying activity to which the swap relates is

    commercial in nature.\127\

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

    \126\ The scope of the proposed exclusion is based on our

    understanding that when a swap or security-based swap is used to

    hedge an entity's commercial activities, the gains or losses

    associated with the swap or security-based swap itself will be

    offset by losses or gains in the entity's commercial activities, and

    hence the risks posed by the swap or security-based swap to

    counterparties or the industry generally will be mitigated.

    \127\ We do not concur with the suggestion that the use of the

    word ``mitigating'' within the major participant definitions was

    intended to mean something significantly more than hedging. Other

    provisions of the Dodd-Frank Act appear to use the terms ``hedging''

    and ``mitigating'' interchangeably; for example, certain provisions

    of the Dodd-Frank Act refer to ``risk-mitigating hedging

    activities.'' See Dodd-Frank Act section 619 (adding Section 13 to

    the Bank Holding Company Act of 1956); Dodd-Frank Act section 619

    (adding Section 27B to the Securities Act of 1933). Title VII also

    refers to ``[h]edging and other similar risk mitigating

    activities.'' Dodd-Frank Act section 716(d)(1).

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

    [[Page 80195]]

    a. Proposed Exclusion in the ``Major Swap Participant'' Definition

    As a general matter, the CFTC preliminarily believes that whether a

    position hedges or mitigates commercial risk should be determined by

    the facts and circumstances at the time the swap is entered into, and

    should take into account the person's overall hedging and risk

    mitigation strategies. At the same time, the swap position could not be

    held for a purpose that is in the nature of speculation, investing or

    trading. Although the line between speculation, investing or trading,

    on the one hand, and hedging, on the other, can at times be difficult

    to discern, the statute nonetheless requires such determinations.\128\

    The CFTC expects that a person's overall hedging and risk management

    strategies will help inform whether or not a particular position is

    properly considered to hedge or mitigate commercial risk. Although the

    definition includes swaps that are recognized as hedges for accounting

    purposes or as bona fide hedging for purposes of an exemption from

    position limits under the CEA, the swaps included within the proposed

    exclusion are not limited to those categories. Rather, the proposal

    covers swaps hedging or mitigating any of a person's business risks,

    regardless of their status under accounting guidelines or the bona fide

    hedging exemption.

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

    \128\ We preliminarily believe that swap positions that are held

    for the purpose of speculation or trading are, for example, those

    positions that are held primarily to take an outright view on the

    direction of the market, including positions held for short term

    resale, or to obtain arbitrage profits. Swap positions that hedge

    other positions that themselves are held for the purpose of

    speculation or trading are also speculative or trading positions.

    We preliminarily believe that swap positions that are held for

    the purpose of investing are, for example, those positions that are

    held primarily to obtain an appreciation in value of the swap

    position itself, without regard to using the swap to hedge an

    underlying risk. In contrast, a swap position related to a non-swap

    investment (such as the purchase of an asset that a commercial

    enterprise will use to produce income or otherwise advance its

    commercial interests) may be a hedging position if it otherwise

    qualifies for the definition of hedging or mitigating commercial

    risk.

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

    The CFTC invites comment on whether swaps qualifying for the

    hedging or risk mitigation exclusion should be limited to swaps where

    the underlying hedged item is a non-financial commodity. Commenters may

    also address whether swaps subject to this exception should hedge or

    mitigate commercial risk on a single risk or an aggregate risk basis,

    and on a single entity or a consolidated basis. The CFTC also invites

    comment on whether risks such as the foreign exchange, currency, or

    interest rate risk relating to offshore affiliates, should be covered;

    whether industry-specific rules on hedging, or rules that apply only to

    certain categories of commodity or asset classes are appropriate at

    this time; whether swaps facilitating asset optimization or dynamic

    hedging should be included; and whether hedge effectiveness should be

    addressed. Commenters are requested to discuss both the policy and

    legal bases underlying their comments.

    b. Proposed Exclusion in the ``Major Security-Based Swap Participant''

    Definition

    The proposed meaning of ``hedging or mitigating commercial risk''

    for purposes of the ``major security-based swap participant''

    definition would require that a security-based swap position be

    economically appropriate to the reduction of risks in the conduct and

    management of a commercial enterprise, where they arise from the

    potential change in the value of assets, liabilities and services

    connected with the ordinary course of business of the enterprise.\129\

    This standard is intended to exclude from the first major participant

    test security-based swaps that pose limited risk to the market and to

    counterparties because the positions would be substantially related to

    offsetting risks from an entity's commercial operations.\130\ The

    security-based swaps included within the proposed rule would not be

    limited to those recognized as hedges for accounting purposes; rather,

    the proposal has been drafted to cover security-based swaps used in the

    broader range of transactions commonly referred to as economic hedges,

    regardless of their status under accounting guidelines.

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

    \129\ See proposed Exchange Act rule 3a67-4(a). The concept of

    ``economically appropriate'' already is found in rules under the CEA

    pertaining to the definition of ``bona fide hedging'' for purposes

    of an exemption from position limits. See CEA rule 1.3(z). In the

    context of the definition of ``major security-based swap

    participant,'' we may take into account existing interpretations of

    that term under the CEA, but only to the extent that such

    interpretations would appropriately be applied to the use of

    security-based swaps for hedging.

    The SEC preliminarily plans to interpret the concept of

    ``economically appropriate'' based on whether a reasonably prudent

    person would consider the security-based swap to be appropriate for

    managing the identified commercial risk. The SEC also preliminarily

    believes that for a security-based swap to be deemed ``economically

    appropriate'' in this context, it should not introduce any new

    material quantum of risks (i.e., it cannot reflect over-hedging that

    could reasonably have a speculative effect) and it should not

    introduce any basis risk or other new types of risk (other than the

    counterparty risk that is attendant to all security-based swaps)

    more than reasonably necessary to manage the identified risk.

    \130\ These hedging positions would include activities, such as

    the management of receivables, that arise out of the ordinary course

    of an entity's commercial operations, including activities that are

    incidental to those operations.

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

    At the same time, the security-based swap position could not be

    held for a purpose that is in the nature of speculation or

    trading.\131\ In addition, the security-based swap position could not

    be held to hedge or mitigate the risk of another security-based swap

    position or swap position unless that other position itself is held for

    the purpose of hedging or mitigating commercial risk as defined by the

    rule or CEA rule 1.3(ttt).\132\

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

    \131\ See proposed Exchange Act rule 3a67-4(b)(1). For these

    purposes, we preliminarily believe that security-based swap

    positions that are held for the purpose of speculation or trading

    are those positions that are held intentionally for short-term

    resale and/or with the intent of benefiting from actual or expected

    short-term price movements or to lock in arbitrage profits, as well

    as security-based swap positions that hedge other positions that

    themselves are held for the purpose of speculation or trading. Thus,

    for example, positions that would be part of a ``trading book'' of

    an entity such as a bank would not constitute hedging positions that

    may be excluded for purposes of the first major participant test.

    \132\ See proposed Exchange Act rule 3a67-4(b)(2).

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

    We look forward to commenters' views on whether the proposed

    standard strikes an appropriate balance in determining which positions

    may be excluded for purposes of the first major participant test. We

    recognize that there are other reasonable views as to what positions

    may appropriately be considered to be for the purposes of hedging or

    mitigating commercial risk. We also recognize the importance of

    providing as clear guidance as possible as to what is or is not a

    hedging position for these purposes.

    The proposal also would condition the entity's ability to exclude

    these security-based swap positions on the entity engaging in certain

    specified activities related to documenting the underlying risks and

    assessing the effectiveness of the hedge in connection with the

    positions.\133\ These activities are intended to help ensure that

    positions excluded for purposes of the

    [[Page 80196]]

    first major participant test would not extend to positions that are not

    entered into to reduce or hedge commercial risks, or that at a later

    time no longer substantially serve to reduce or mitigate such

    risks.\134\

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

    \133\ See proposed Exchange Act rule 3a67-4(a)(3). The proposal

    particularly would require the person to: Identify and document the

    risks that are being reduced by the security-based swap position;

    establish and document a method of assessing the effectiveness of

    the security-based swap as a hedge; and regularly assess the

    effectiveness of the security-based swap as a hedge.

    We expect that market participants that have security-based swap

    activities significant enough that they may be major participants

    would already engage in risk assessment activities for their hedging

    positions, either formally or informally, and thus we do not believe

    that the proposed requirements would disrupt existing business

    practices. Instead, the proposal is intended to create standards

    that will allow market participants to confirm their compliance with

    the rule by formalizing risk assessment activities that should

    already be part of an effective hedging program.

    \134\ This condition does not mandate that an entity follow a

    particular set of procedures to take advantage of the exclusion. We

    would expect that an entity that already engages in these types of

    risk assessment procedures in connection with its existing business

    activities to be able to rely on those procedures to satisfy the

    condition. These conditions also could be satisfied by the entity's

    use of a third-party to assist with these risk assessment

    activities.

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

    We preliminarily believe that this proposed approach would

    facilitate the following types of security-based swap positions:

    Positions established to manage the risk posed by a

    customer's, supplier's or counterparty's potential default in

    connection with: financing provided to a customer in connection with

    the sale of real property or a good, product or service; a customer's

    lease of real property or a good, product or service; a customer's

    agreement to purchase real property or a good, product or service in

    the future; or a supplier's commitment to provide or sell a good,

    product or service in the future; \135\

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

    \135\ The references here to customers and counterparties do not

    include swap or security-based swap counterparties.

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

    Positions established to manage the risk posed by a

    financial counterparty (different from the counterparty to the hedging

    position at issue) in connection with a separate transaction (including

    a position involving a credit derivative, equity swap, other security-

    based swap, interest rate swap, commodity swap, foreign exchange swap

    or other swap, option, or future that itself is for the purpose of

    hedging or mitigating commercial risk pursuant to the rule or CEA rule

    1.3(ttt));

    Positions established to manage equity or market risk

    associated with certain employee compensation plans, including the risk

    associated with market price variations in connection with stock-based

    compensation plans, such as deferred compensation plans and stock

    appreciation rights;

    Positions established to manage equity market price risks

    connected with certain business combinations, such as a corporate

    merger or consolidation or similar plan or acquisition in which

    securities of a person are exchanged for securities of any other person

    (unless the sole purpose of the transaction is to change an issuer's

    domicile solely within the United States), or a transfer of assets of a

    person to another person in consideration of the issuance of securities

    of such other person or any of its affiliates;

    Positions established by a bank to manage counterparty

    risks in connection with loans the bank has made; and

    Positions to close out or reduce any of those positions.

    2. Request for Comments

    We request comment on the proposed definition of ``hedging or

    mitigating commercial risk'' for purposes of both the ``major swap

    participant'' and the ``major security-based swap participant''

    definitions. Commenters particularly are requested to address whether

    the proposed definitions would adequately limit the types of swaps or

    security-based swaps that are encompassed by the definition, such that

    the definitions do not encompass positions that serve speculative,

    trading or other non-hedging purposes. In this regard, do the proposed

    definitions appropriately exclude from the scope of the definition

    swaps and security-based swaps that would be less likely to pose risks

    to counterparties and the market, by virtue of gains or losses on those

    swaps being offset by losses or gains associated with an entity's

    commercial operations? Commenters further are requested to address

    whether the proposed ``economically appropriate'' standard would

    effectively limit the positions encompassed by the definition. If not,

    what alternative standards (e.g., standards derived from accounting

    principles) would more effectively identify hedging positions and

    distinguish those from positions held for other purposes? In that

    regard, is the concept of ``economically appropriate'' well-understood,

    and, if not, is there another concept that would more effectively

    delimit the nature of the relationship between the swap or security-

    based swap position and the risk being hedged or mitigated? Also, in

    the context of the definition of this term for purposes of security-

    based swaps, should existing interpretive guidance pertaining to the

    concept of ``economically appropriate'' with respect to the CEA's bona

    fide hedging exemption for position limits be considered, and, if so,

    to what extent? We further request comment on possible alternative

    approaches to the test identifying positions entered into for the

    purpose of hedging or mitigating commercial risk. For example, should

    the test require the entity excluding a position to have a reasonable

    basis to believe, and to actually believe, that the excluded swap would

    be a ``highly effective,'' ``reasonably effective'' or ``economically

    appropriate'' hedge of a specified commercial risk? Should the test be

    generally identical to the proposed test, but with the substitution of

    the phrase ``highly effective'' or ``reasonably effective'' (or another

    standard) for ``economically appropriate''? Should the test be based on

    accounting principles for hedging treatment (i.e., a quantitative test

    requiring the hedge to be within a certain band of effectiveness)?

    Commenters also are requested to address the proposed restrictions

    on positions in the nature of speculation or trading. Is it appropriate

    not to permit any speculative or trading positions from being deemed

    for the purpose of hedging or mitigating commercial risk? What would be

    the impact of such an interpretation on an entity's risk mitigation

    practices? Also, is the dividing line between speculative and trading

    positions on the one hand, and positions eligible to be considered to

    be hedging positions on the other hand, sufficiently clear? Is such a

    line appropriately based on whether the position is intended to be held

    for the short-term versus long-term intent? Would some alternative

    criteria be preferable in terms of setting forth objective standards

    for identifying risk reducing hedging positions and distinguishing them

    from other positions? Also, would additional standards or other

    guidance be appropriate to help ensure that positions used in

    connection with speculative or trading purposes do not fall within the

    definition?

    We further request comment on the proposal that a swap or security-

    based swap would not fall within the definition of ``hedging or

    mitigating commercial risk'' if it is held to hedge or mitigate the

    risk of another swap or security-based swap, unless that other position

    itself is held for the purpose of hedging or mitigating commercial

    risk. One consequence of this approach might be that a particular swap

    or security-based swap hedging a particular type of risk would be

    included or excluded based solely on whether that risk arises from

    another swap or security-based swap or from a different type of

    transaction.\136\ Is this the appropriate approach? What would be the

    consequences of this approach for

    [[Page 80197]]

    different types of entities? How would the proposed approach affect the

    risk management practices of entities that are close to the proposed

    threshold? Is it appropriate to include both positions within the major

    participant calculations? If this general approach in the proposed rule

    were adopted, should there be any exceptions to the approach? What

    alternative approaches might be considered? For example, would it be

    appropriate to exclude a swap or security-based swap that hedges

    another swap or security-based swap from the calculation? What would be

    the advantages and disadvantages of this approach?

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

    \136\ For example, under this proposal an entity may exclude

    from the first major participant test a security-based swap used to

    manage the credit risk posed by a customer's default in connection

    with financing that an entity provides to that customer. The entity

    may not exclude an identical security-based swap, however, if that

    security-based swap is used to hedge the credit risk associated with

    a second swap or security-based swap that itself is not for the

    purpose of hedging or mitigating commercial risk.

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

    Moreover, commenters are requested to address whether the

    definition should encompass a quantitative test that would limit the

    total value of swaps and security-based swaps that an entity may

    include under this rule to be no more than the total value of

    underlying risk identified by such entity. If so, what measurement

    should be used for determining an entity's total value of swaps and

    security-based swaps and total value of underlying risk, and what

    methods or procedures should entities be required to follow when

    calculating and comparing the two values?

    In addition, commenters are requested to address whether the

    proposed procedural requirements, in the context of this definition for

    purposes of the ``major security-based swap participant'' analysis, are

    appropriate. In this regard, commenters are requested to discuss

    whether there are any advantages or disadvantages to providing more

    specific procedural requirements; whether the proposed procedural

    requirements will alter business practices to the extent that a

    transition period is necessary before they are implemented; and whether

    specific guidance is required to address how the proposed procedural

    requirements will affect existing positions. In addition, commenters

    are requested to address whether the proposed procedural requirements

    should include a requirement to quantify the underlying risk and the

    effectiveness of the hedge, and whether such quantitative assessments

    would impose significant systems costs or other costs. Also, should an

    assessment of hedging effectiveness be required at all, in light of the

    costs that may be associated with such a requirement?

    More generally, would the proposed standards for identifying

    positions for the purpose of hedging or mitigating commercial risk

    suffice to allow a person holding a security-based swap position to

    identify and document the commercial risks that are being hedged or

    mitigated by that position, and if not, what additional requirements

    are needed? Should additional guidance be provided regarding whether

    components of risks (in assets, liabilities or services) or whether

    risks in portfolios (of assets, liabilities or services) may be

    identified as the commercial risks that are being hedged or mitigated

    by the position, and, if so, which components? Also, should additional

    guidance be provided with respect to the form of documentation or the

    elements of the hedging relationship that should be documented, and, if

    so, which elements? Moreover, if a swap or security-based swap that was

    hedging at inception were no longer to serve a hedging purpose over

    time, should it no longer fall within the definition of hedging or

    mitigating commercial risk?

    In addition, should the rule specify the frequency with which an

    entity should assess the effectiveness of the hedge? Also, should we

    provide additional guidance on the acceptable methods of assessing

    effectiveness? Is a qualitative assessment adequate to assess

    effectiveness or should a quantitative assessment also be required?

    Should the rule establish a level of offset between the position and

    the hedged risk, below which the position would not be considered to be

    effective at reducing risk, and, if so, what is the level of offset (or

    range of levels) below which the position should not be considered to

    be effective? Are there methods for assessing effectiveness that should

    not be permitted for these purposes?

    Commenters also are requested to address whether the proposal also

    should encompass certain activities in which an entity hedges an

    affiliate's risks.

    We further request comment on how the definition should apply to

    hedging activities by financial entities. Commenters particularly are

    invited to address whether financial entities should be able to rely on

    this exclusion, or whether financial entities should face special

    limits in the context of this exclusion. Commenters further are

    requested to address how the proposed provisions excluding positions in

    the nature of speculation or trading from the definition would apply to

    activities by banks, including permissible trading activities by banks,

    and, in particular, whether it is appropriate to exclude positions that

    are part of an entity's ``trading book.''

    Commenters also are requested to address the application of the

    proposal to registered investment companies, including whether

    additional guidance would be appropriate with respect to which uses of

    security-based swaps by registered investment companies would fall

    within the exclusion.

    D. ``Substantial Counterparty Exposure''

    The second test of the major participant definitions addresses

    entities whose swaps and security-based swaps ``create substantial

    counterparty exposure that could have serious adverse effects on the

    financial stability of the United States banking system or financial

    markets.'' \137\ Unlike the first test of the major participant

    definitions, this test does not focus on positions in a ``major''

    category of swaps or security-based swaps. Also, unlike the first test,

    this test does not explicitly exclude hedging positions or certain

    ERISA plan positions from the analysis.

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

    \137\ See CEA section 1a(33)(A)(ii); Exchange Act section

    3(a)(67)(A)(ii)(II).

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

    Some commenters suggested that the second major participant

    definition test should be interpreted in a manner similar to the first

    test. Many commenters stated that the analysis should also reflect

    netting agreements and the posting of collateral. Some commenters

    stated that the test should exclude hedging positions, and cleared

    positions.

    We preliminarily believe that the second major participant

    definition test's focus on the counterparty risk associated with an

    entity's swap or security-based swap positions is similar enough to the

    ``substantial position'' risks embedded in the first test that the

    second test appropriately takes into account the same measures of

    current uncollateralized exposure and potential future exposure that

    are used in our proposal for the first test. For the second test,

    however, the thresholds must focus on the entirety of an entity's swap

    positions or security-based swap positions, rather than on positions in

    any specific ``major'' category. In addition, this second test does not

    explicitly account for positions for hedging commercial risk or ERISA

    positions.

    Accordingly, these proposed calculations of substantial

    counterparty exposure would be performed in largely the same way as the

    calculation of substantial position in the first major participant

    definition tests, except that the amounts would be calculated by

    reference to all of the person's swap or security-based swap positions,

    rather than by reference to a specific ``major'' category of such

    positions.\138\

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

    \138\ See proposed CEA rule 1.3(uuu)(2); proposed Exchange Act

    rule 3a67-5(b)(1).

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

    For purposes of the ``major swap participant'' definition, the CFTC

    [[Page 80198]]

    proposes that the second major participant definition test be satisfied

    by a current uncollateralized exposure of $5 billion, or a combined

    current uncollateralized exposure and potential future exposure of $8

    billion, across the entirety of an entity's swap positions.\139\ For

    purposes of the ``major security-based swap participant'' definition,

    the SEC proposes that the second test be satisfied by a current

    uncollateralized exposure of $2 billion, or a combined current

    uncollateralized exposure and potential future exposure of $4 billion,

    across the entirety of an entity's security-based swap positions.\140\

    We look forward to commenters' views as to whether alternative

    thresholds would be more appropriate to achieve the statutory goals.

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

    \139\ See proposed CEA rule 1.3(uuu)(1).

    \140\ See proposed Exchange Act rule 3a67-5(a).

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

    These proposed thresholds in part are based on the same factors

    that underpin the proposed ``substantial position'' thresholds.\141\

    The proposed thresholds, however, also reflect the fact that this test

    must account for an entity's positions across four major swap

    categories or two major security-based swap categories.\142\ These

    proposed thresholds, moreover, have further been raised to reflect the

    fact that this second test (unlike the first major participant test)

    encompasses certain hedging positions that, in general, we would expect

    to pose fewer risks to counterparties and to the markets as a whole

    than positions that are not for purposes of hedging.

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

    \141\ See notes 103 to 106 and 117, supra, and accompanying

    text.

    \142\ Thus, these proposed thresholds in part would account for

    an entity that has large positions in more than one major category

    of swaps or security-based swaps, but that does not meet the

    substantial position threshold for either.

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

    We request comment on this proposal. Commenters particularly are

    requested to address whether the proposed use of current

    uncollateralized exposure and potential future exposure tests

    (including the parts of those tests that account for positions that are

    cleared or subject to mark-to-market margining) are appropriate, and

    whether the proposed thresholds are set at an appropriate level. Should

    the thresholds be higher or lower? If so, what alternative threshold

    amounts would be more appropriate, and why? Commenters also are

    requested to address whether the test should exclude commercial risk

    and ERISA hedging positions, on the grounds that those hedging

    positions may not raise the same degree of risk to counterparties as

    other swap or security-based swap positions. Comments are also

    requested on whether the test of substantial counterparty exposure,

    given its focus on the systemic risks arising from the entirety of a

    person's portfolio, should include a measure to take into account the

    person's combined swap positions and security-based swap positions.

    E. ``Financial Entity'' and ``Highly Leveraged''

    The third test of the major participant definitions addresses any

    ``financial entity,'' other than one subject to capital requirements

    established by an appropriate Federal banking agency,\143\ that is

    ``highly leveraged relative to the amount of capital'' the entity

    holds, and that maintains a substantial position in a ``major''

    category of swaps or security-based swaps. This test does not permit an

    exclusion for positions held for hedging.

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

    \143\ Sections 721 and 761 of the Dodd-Frank Act add a

    definition of the term ``appropriate Federal banking agency'' in

    sections 1a and 3(a) of the CEA and the Exchange Act, respectively,

    7 U.S.C. 1a(2), 15 U.S.C. 78c(a)(72). The Commissions propose to

    refer to those statutory definitions for purposes of the rules.

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

    As discussed below, we are proposing specific definitions of the

    terms ``financial entity'' and ``highly leveraged.'' In addition, we

    request comment on whether we should include additional regulators

    within the proposed interpretation of what is an appropriate Federal

    banking agency.

    1. Meaning of ``financial entity''

    While the third major participant definition test does not

    explicitly define ``financial entity,'' Title VII of the Dodd-Frank Act

    defines ``financial entity'' in the context of the end-user exception

    from mandatory clearing (an exception that generally is not available

    to those entities).\144\ Some commenters have pointed out that using

    that definition here would produce circular results.\145\

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

    \144\ See CEA section 2(h)(7)(C)(i); Exchange Act section

    3C(g)(3)(A).

    \145\ See Cleary letter (also addressing status of broker-

    dealers and futures commission merchants as part of the analysis).

    The circularity would result because, for purposes of the end-

    user clearing exception, ``financial entity'' is defined to include

    swap dealers, security-based swap dealers, major swap participants,

    and major security-based swap participants.

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

    We preliminarily do not believe there is a basis to define

    ``financial entity'' for purposes of the major participant definitions

    in a way that materially differs from the definition used in the end-

    user exception from mandatory clearing. Using the same basic definition

    also would appear to be consistent with the statute's intent to treat

    non-financial end-users differently than financial entities.

    Accordingly, other than technical changes to avoid circularity, we

    propose to use the same definition in the major participant

    definitions.\146\

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

    \146\ See proposed CEA rule 1.3(vvv)(1); proposed Exchange Act

    rule 3a67-6(a). To avoid circularity, the meaning of ``financial

    entity'' for purposes of the ``major swap participant'' definition

    would not encompass any ``swap dealer'' or ``major swap

    participant'' (but would encompass ``security-based swaps dealers''

    and ``major security-based swap participants''). The meaning of

    ``financial entity'' for purposes of the ``major security-based swap

    participant'' definition would not encompass any ``security-based

    swap dealer'' or ``major security-based swap participant (but would

    encompass ``swap dealers'' and ``major swap participants''). For

    both definitions, ``financial entity'' would include any: commodity

    pool (as defined in section 1a(10) of the CEA); private fund (as

    defined in section 202(a) of the Investment Advisers Act of 1940);

    employee benefit plan as defined in paragraphs (3) and (32) of

    section 3 of the Employee Retirement Income Security Act of 1974;

    and person predominantly engaged in activities that are in the

    business of banking or financial in nature (as defined in section

    4(k) of the Bank Holding Company Act of 1956).

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

    Commenters are requested to address our proposed definition of

    ``financial entity.''

    2. Meaning of ``Highly Leveraged''

    Some commenters have stated that the term ``highly leveraged''

    should be interpreted by looking at the leverage associated with other

    firms in an entity's line of business, rather than by applying an

    across-the-board measure of leverage.\147\ One commenter suggested that

    higher leverage may be warranted for entities with a smaller capital

    base, and another commenter suggested that we look at analogous banking

    regulations rather than creating a new regime for measuring leverage.

    Some commenters suggested ways of addressing specific items for

    purposes of determining leverage.\148\

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

    \147\ See letter from Robert Pickel, Executive Vice Chairman,

    International Swaps and Derivatives Association, Inc., dated

    September 20, 2010 (suggesting that ``leverage ratio limits to which

    banks and other regulated entities are subject would be unsuitably

    low for other enterprises''); letter from Steve Martinie, Assistant

    General Counsel and Assistant Secretary, The Northwestern Mutual

    Life Insurance Company, dated September 20, 2010 (``Northwestern

    Mutual letter'') (suggesting that financial firms require less

    cushion than other entities because financial firms are able to

    match their assets and liabilities more closely).

    \148\ See Northwestern Mutual letter (suggesting that the

    Commissions recognize that liabilities such as bank deposits and

    insurance policy reserves are not leverage); Vanguard letter

    (suggesting that leverage should relate to debt financing and should

    not encompass potential leveraging effects posed by derivatives);

    SIFMA AMG letter (suggesting that the Commissions take into account

    the difference between non-recourse and recourse obligations, the

    difference between notional amounts payable and actual payable

    obligations, and the difference between actual financial obligations

    and leverage embedded in a derivative that affects returns but does

    not result in a payment obligation).

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

    The Commissions recognize that traditional balance sheet measures

    of leverage have limitations as tools for

    [[Page 80199]]

    evaluating an entity's ability to meet its obligations. In part this is

    because such measures of leverage do not directly account for the

    potential risks posed by specific instruments on the balance sheet, or

    financial instruments that are held off of an entity's balance sheet

    (as may be the case with an entity's swap and security-based swap

    positions). At the same time, we preliminarily do not believe that it

    is necessary to use more complex measures of risk-adjusted leverage

    here, particularly given that the third test in the major participant

    definitions already addresses those types of risks by considering

    whether an entity has a substantial position in a major category of

    swaps or security-based swaps. We are also mindful of the costs that

    entities would face if forced to undertake a complex risk-adjusted

    leverage calculation, especially for entities that would not already be

    performing this type of analysis.\149\ Additionally, we preliminarily

    do not believe that it is necessary for the leverage standard to

    account for the degree of leverage associated with different types of

    financial entities.

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

    \149\ The Basel Committee on Banking Supervision recently

    proposed one method for calculating risk-adjusted leverage in its

    Consultative Document entitled: ``Strengthening the resilience of

    the banking sector'' (Dec. 2009). This proposal would create a new

    leverage ratio based on a comparison of capital to total exposure.

    Total exposure for these purposes would be measured by, among other

    things, including the notional value of all written credit

    protection, severely limiting the recognition given to netting, and

    calculating the risks associated with off-balance sheet derivatives

    transactions, as measured by the current exposure method for

    calculating future risks outlined in Basel II. The Consultative

    Document drew over 150 comments from the international financial

    community, which included both those in support of, and those that

    questioned the inclusion of a risk-adjusted leverage ratio within

    the Basel framework. The Basel Committee on Banking Supervision

    expects to deliver a full package of reforms by the end of 2010,

    based on the Consultative Document released in December 2009 and

    comments received thereon.

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

    Although the third test of the major participant definitions does

    not define ``highly leveraged,'' we note that Congress addressed the

    issue of leverage in Title I of the Dodd-Frank Act. There, Congress

    provided that the Board of Governors of the Federal Reserve System must

    require a bank holding company with total consolidated assets equal to

    or greater than $50 billion, or a nonbank financial company supervised

    by the Board of Governors, to maintain a debt to equity ratio of no

    more than 15 to 1 if the FSOC determines ``that such company poses a

    grave threat to the financial stability of the United States and that

    the imposition of such requirement is necessary to mitigate the risk

    that such company poses to the financial stability of the United

    States.'' \150\

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

    \150\ See Dodd-Frank Act section 165(j)(1).

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

    This requirement in Title I suggests potential alternative

    approaches to the definition of ``highly leveraged'' for purposes of

    the major participant definitions. On the one hand, the 15 to 1 limit

    may represent an upper limit of acceptable leverage, indicating that

    the limit for the major participant definitions should be lower so as

    to create a buffer between entities at that upper limit and entities

    that are not highly leveraged. On the other hand, the Title 1

    requirement, which applies only when the entity in question poses a

    ``grave threat'' to financial stability, may indicate that the 15 to 1

    leverage ratio is also the appropriate test of whether an entity poses

    the systemic risk concerns implicated by the major participant

    definitions.

    For these reasons, we propose two possible definitions of the point

    at which an entity would be ``highly leveraged''--either an entity

    would be ``highly leveraged'' if the ratio of its total liabilities to

    equity is in excess of 8 to 1, or an entity would be ``highly

    leveraged'' if the ratio of its total liabilities to equity is in

    excess of 15 to 1. In either case, the determination would be measured

    at the close of business on the last business day of the applicable

    fiscal quarter. To promote consistent application of this leverage

    test, entities that file quarterly reports on Form 10-Q and annual

    reports on Form 10-K with the SEC would determine their total

    liabilities and equity based on the financial statements included with

    such filings.\151\ All other entities would calculate the value of

    total liabilities and equity consistent with the proper application of

    U.S. generally accepted accounting principles.

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

    \151\ These entities would include those that submit periodic

    reports on a voluntary basis to the SEC, as well as those that are

    required to file periodic reports with the SEC.

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

    We believe that the 15 to 1 ratio could be consistent with the use

    of that ratio in Title I, which, as noted above, provides that the 15

    to 1 leverage ratio would be applied to a bank holding company or

    nonbank financial company subject to Title I as a maximum only if it is

    determined that the company poses a ``grave threat'' to financial

    stability. Commenters are requested to address whether the proposed 15

    to 1 standard used in Title I suggests that a standard higher than 15

    to 1 should be used here, given that the Title I standard is applicable

    only to large entities that also pose a ``grave threat'' to financial

    stability and thus may suggest that a higher standard is appropriate

    for entities that do not pose the same degree of threat. Alternatively,

    the 8 to 1 ratio could be consistent with the exemption in the third

    test of the major participant definitions for financial institutions

    that are subject to capital requirements set by the Federal banking

    agencies, as it is possible that financial institutions were

    specifically excluded from the third test based on the presumption that

    they generally are highly leveraged, and hence would have been covered

    by the third test if they were not expressly exempted. Based on our

    analysis of financial statements it appears that those institutions

    generally have leverage ratios of approximately 10 to 1, which may

    suggest that the ``highly leveraged'' threshold would have to be lower

    for those institutions to be potentially subject to the third test.

    Such an approach would help to ensure that the third test of the major

    participant definition applies to financial entities that are not

    subject to capital requirements set by the Federal banking agencies,

    but that have leverage ratios similar to institutions that are subject

    to those requirements.

    The Commissions request comment on the proposed alternative

    definitions of ``highly leveraged.'' Commenters particularly are

    requested to specifically address the relative merits of the proposed

    alternative 8 to 1 and 15 to 1 standards, as well as other standards

    that they believe would be appropriate for these purposes.\152\

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

    \152\ In this regard, we recognize that under Exchange Act rule

    15c3-1, a broker-dealer may determine its required minimum net

    capital, among other ways, by applying a financial ratio that

    provides that its aggregate indebtedness shall not exceed 1500% of

    its net capital (i.e., a 15 to 1 aggregate indebtedness to net

    capital ratio). Exchange Act Rule 17a-11 further requires that

    broker-dealers that use such method to establish their required

    minimum net capital must provide notice to regulators if their

    aggregate indebtedness exceeds 1200% of their net capital (i.e., a

    12 to 1 aggregate indebtedness to net capital ratio). We recognize

    that these measures, however, reflect a different ratio of total

    liabilities to equity; for example, the calculation of aggregate

    indebtedness in rule 15c3-1 excludes certain liabilities, and the

    calculation of net capital includes certain subordinated debt--

    meaning that these measures would respectively be equivalent to

    ratios higher than 15:1 or 12:1 when converted to a balance sheet

    ratio of liabilities to equity such as that used under the proposed

    rule.

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

    Commenters further are requested to address whether a risk-adjusted

    leverage ratio should be used, and, if so, how the ratio should be

    calculated (including whether particular items should be included or

    excluded when making this calculation), and whether a risk-adjusted

    leverage ratio could be developed relying on measures already

    [[Page 80200]]

    calculated by entities as a matter of course.\153\ Commenters further

    are requested to address whether the leverage ratio should be revised

    to require that the amount of potential future exposure (as outlined in

    the ``substantial position'' discussion above) be combined with total

    liabilities before such number is compared to equity for purposes of

    calculating the ratio, and, if so, whether the proposed ratios would

    still be appropriate; whether the rule should more specifically address

    issues as to how certain types of positions or liabilities should be

    accounted for when calculating leverage; whether the proposed timing of

    the measurement--the close of business on the last business day of the

    applicable fiscal quarter--would be potentially subject to gaming or

    evasion; and whether the rule text should particularly prescribe how

    separate categories of entities calculate leverage.

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

    \153\ For example, would adjustments akin to those discussed

    above in the context of broker-dealer net capital provide a more

    useful measure of leverage for these purposes?

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

    F. Implementation Standard, Reevaluation Period and Minimum Duration of

    Status

    While the analysis of whether an entity is a major participant is

    backward looking, an entity that meets the criteria for being a major

    participant is required to register with the CFTC and/or the SEC, and

    comply with the requirements applicable to major participants. We

    recognize that these entities will need time to complete their

    applications for registration and to come into compliance with the

    applicable requirements. We thus propose that an unregistered entity

    that meets the major participant criteria as a result of its swap or

    security-based swap activities in a fiscal quarter would not be deemed

    to be a major participant until the earlier of the date on which it

    submits a complete application for registration pursuant to CEA Section

    4s(b) or Exchange Act Section 15F(b), or two months after the end of

    that quarter.\154\ We preliminarily believe that this would provide

    entities with an appropriate amount of time to apply for registration

    and, with the time between the submission of an application and the

    effectiveness of the registration, to comply with the requirements

    applicable to major participants, without permitting undue delay.

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

    \154\ See proposed CEA rule 1.3(qqq)(4)(i); proposed Exchange

    Act rule 3a67-7(a). The Commissions are proposing separate rules

    regarding the registration requirements and processes for major

    participants.

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

    We also propose to provide a reevaluation for entities that meet

    one or more of the applicable major participant thresholds, but only by

    a modest amount.\155\ In particular, an unregistered entity that has

    met these criteria as a result of its swap or security-based swap

    activities in a fiscal quarter, but without exceeding any applicable

    threshold by more than twenty percent, would not immediately be subject

    to the timing requirements discussed above. Instead, that entity would

    become subject to those requirements if the entity exceeded any of the

    applicable daily average thresholds in the next fiscal quarter.\156\ We

    preliminarily believe this type of reevaluation period would avoid

    applying the major participant requirements to entities that meet the

    major participant criteria for only a short time due to unusual

    activity.

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

    \155\ Commenters raised concerns over an entity qualifying as a

    major participant due to an unusual event. See, e.g., letter from

    American Benefits Council and Committee on the Investment of

    Employee Benefit Assets, dated September 20, 2010 (stating that

    quirky volatility may affect the determinations).

    \156\ See proposed CEA rule 1.3(qqq)(4)(ii); proposed Exchange

    Act rules 3a67-7(b).

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

    In addition, we propose that any entity that is deemed to be a

    major participant would retain that status until such time that it does

    not exceed any of the applicable thresholds for four consecutive

    quarters after the entity becomes registered.\157\ Commentators raised

    concerns about the possibility of entities moving in and out of the

    status on a rapid basis,\158\ and we believe that this proposal

    appropriately addresses that concern in a way that would help promote

    the predictable application and enforcement of the requirements

    governing major participants.

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

    \157\ See proposed CEA rule 1.3(qqq)(5); proposed Exchange Act

    rules 3a67-7(c)(1).

    \158\ See Vanguard letter (suggesting that entities should

    remain in the status after qualification for an extended defined

    period such as one calendar year); AIMA letter (noting that

    recategorization of entities could be disruptive for entities'

    business models and could be administratively burdensome for the

    Commissions).

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

    The Commissions request comment on these proposals. Commenters

    particularly are requested to address: Whether two months is an

    adequate amount of time for entities that have met the criteria to

    submit an application for registration; whether there is an adequate

    amount of time to make the necessary internal changes to come into

    compliance with the requirements applicable to major participants

    before being subject to those requirements as a result of a

    registration becoming effective; whether twenty percent is the

    appropriate threshold for applicability of the reevaluation period;

    whether there would be any risks arising from delaying registration as

    a major participant for an entity that exceeds the thresholds, but

    qualifies for the reevaluation period; and whether four consecutive

    quarters of not meeting the criteria for major participant status after

    registration is granted is the appropriate amount of time that a major

    participant should be required to stay in the status.

    In addition, we request comment on the appropriateness of the

    proposed reevaluation period. Commenters particularly are requested to

    address whether it is likely that unusual market conditions could cause

    an entity to exceed the proposed thresholds over the course of a

    quarter (based on a daily average) without generally raising the types

    of risks that the thresholds were intended to identify. Also, should

    the use of the reevaluation period be conditioned on requiring any

    entity relying on the reevaluation period to make a representation, or

    otherwise demonstrate, that it exceeded the threshold due to a one-time

    extraordinary event, and that it will be below the threshold at the

    next time of measurement?

    G. Limited Purpose Designations

    In general, a person that meets the definition of major participant

    will be considered to be a major participant with respect to all

    categories of swaps or security-based swaps, as applicable, and with

    regard to all activities involving those instruments.\159\ As discussed

    above, however, the statutory definitions provide that a person may be

    designated as a major participant for one or more categories of swaps

    or security-based swaps without being classified as a major participant

    for all categories.\160\ Thus, as with the definitions of ``swap

    dealer'' and ``security-based swap dealer,'' we propose to provide that

    major participants who engage in significant activity with respect to

    only certain types, classes or categories of swaps or security-based

    swaps may apply for relief with respect to other types of swaps or

    security-based swaps from certain of the requirements that are

    applicable to major participants. The Commissions anticipate that a

    major participant could seek a limited designation at the same time as,

    or at a later time subsequent to, the person's initial registration as

    a major participant. Because of the variety of situations in which

    major participants

    [[Page 80201]]

    may enter into swaps or security-based swaps, it is difficult to set

    out at this time the conditions, if any, which would allow a person to

    be designated as a major participant with respect to only certain

    types, classes or categories of swaps or security-based swaps.

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

    \159\ See proposed CEA rule 1.3(qqq)(2); proposed Exchange Act

    rule 3a67-1(c).

    \160\ CEA section 1a(33)(C); Exchange Act section 3(a)(67)(C).

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

    The Commissions request comment on the proposed rules regarding

    limited designation as a major participant. Commenters particularly are

    requested to address the circumstances in which such limited purpose

    designations would be appropriate, and to address the factors that the

    Commissions should consider when addressing such requests, and the type

    of information requestors should provide in support of their request.

    Commenters also are asked to address whether such limited purpose

    designations should be conditioned in any way, such as by the provision

    of information of the type that would be required with respect to an

    entity's swaps or security-based swaps involving the particular

    category or activity for which they are not designated as a major

    participant.

    H. Additional Interpretive Issues

    Commenters have raised additional issues related to the major

    participant definitions.

    1. Exclusion for ERISA Plan Positions

    As discussed above, the first test of the major participant

    definitions excludes from the analysis ``positions maintained by any

    employee benefit plan (or any contract held by such a plan) as defined

    in paragraphs (3) and (32) of section 3 of ERISA (29 U.S.C. 1002) for

    the primary purpose of hedging or mitigating any risk directly

    associated with the operation of the plan.'' Some commenters suggested

    that the exclusion should encompass activities such as portfolio

    rebalancing and diversification, and gaining exposure to alternative

    asset classes, and that this type of exclusion also should apply to

    certain other types of entities.\161\

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

    \161\ See Cleary letter (addressing welfare plans or entities

    holding assets of such plans, such as voluntary employee beneficiary

    associations, employer group trusts or bank-maintained collective

    trusts); see also letter from Jane Hamblen, State of Wisconsin

    Investment Board, dated September 20, 2010.

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

    We preliminarily do not believe that it is necessary to propose a

    rule to further define the scope of this exclusion. In this regard, we

    note that this ERISA plan exclusion, unlike the other exclusion in the

    first major participant test, is not limited to ``commercial'' risk,

    which may be construed to mean that hedging by ERISA plans should be

    broadly excluded.

    While the Commissions are not proposing to make this type of

    exclusion available to additional types of entities, we request comment

    on whether we should do so. If so, what type of entities should receive

    this type of exclusion, and why do the concerns that led to the

    enactment of the major participant requirements in the Dodd-Frank Act

    not apply to such entities?

    2. Application of Major Participant Definitions to Managed Accounts

    Some commenters have stated that asset managers and investment

    advisers should not be deemed to be major participants by virtue of the

    swap and security-based swap positions held by the accounts they

    manage. These commenters have emphasized that asset managers and

    investment advisers are separate legal entities from the accounts that

    they administer, the accounts themselves are the counterparties to the

    swaps and security-based swaps, and managers and advisers do not

    maintain capital to support the trades of their clients. One commenter

    also expressed the view that the positions of individual accounts under

    the advisement of a single asset manager should not be aggregated for

    the purpose of the major participant definitions because different

    accounts managed by an asset manager may use the same positions for

    different purposes.\162\

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

    \162\ In addition, a colloquy on the Senate floor addressed the

    status of managed accounts for purposes of the major participant

    definitions, particularly focusing on whether the analysis should

    ``look at the aggregate positions of funds managed by asset managers

    or at the individual fund level?'' In response, it was stated that,

    ``[a]s a general rule, the CFTC and the SEC should look at each

    entity on an individual basis when determining its status as a major

    swap participant.'' See 156 Cong. Rec. S5907 (daily ed. July 15,

    2010) (colloquy between Senators Hagan and Lincoln).

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

    Preliminarily, we do not believe that the major participant

    definitions should be construed to aggregate the accounts managed by

    asset managers or investment advisers to determine if the asset manager

    or investment adviser itself is a major participant. The major

    participant definitions apply to the entities that actually

    ``maintain'' substantial positions in swaps and security-based swaps or

    that have swaps or security-based swaps that create substantial

    counterparty exposure. The Commissions have the authority to adopt

    anti-evasion rules to address the possibility that persons who enter

    into swaps and security-based swaps may attempt to allocate the swaps

    and security-based swaps among different accounts (thereby attempting

    to treat such other accounts as the entity that has entered into the

    swaps or security-based swaps) for the purpose of evading the

    regulations applicable to major participants.\163\ In addition, we note

    that since the major participant definitions focus on the entity that

    enters into swaps or security-based swaps, all of the managed positions

    of which a person is the beneficial owner are to be aggregated (along

    with such beneficial owner's other positions) for purposes of

    determining whether such beneficial owner is a major participant.\164\

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

    \163\ See Dodd-Frank Act sections 721(b)(2), 761(b)(3).

    \164\ This guidance relates only to the application of the major

    participant definitions to managed accounts. It is not intended to

    apply to the treatment of managed accounts with respect to any other

    rules promulgated by the CFTC or SEC to implement Title VII of the

    Dodd-Frank Act or to any other applicable rules or requirements.

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

    The Commissions request comment on the application of the major

    participant definitions to managed accounts. Commenters particularly

    are requested to address: whether additional guidance is necessary to

    address issues relating to the application of the major participant

    definition to managed accounts; whether there are areas of potential

    abuse, and if so, what they may be. Commenters further are requested to

    address whether the Commissions should adopt anti-evasion rules to

    address areas of potential abuse, and if so, how such rules should be

    crafted.

    In addition, commenters are requested to discuss any implementation

    concerns that may arise if the beneficial owner of a managed account

    meets one of the major participant definitions; for example, would the

    beneficial owner face any impediments in terms of identifying whether

    it falls within the major participant definitions? Also, what

    implementation issues would arise with respect to applying the major

    participant definitions to managed accounts and/or their beneficial

    owners if the accounts' advisers or managers are not subject to

    regulation as major participants?

    3. Application of Major Participant Definitions to Positions of

    Affiliated Entities

    The issues discussed above with regard to managed accounts also are

    related to the separate issue of whether the major participant tests

    should, in some circumstances, aggregate the swap and security-based

    swap positions of entities that are affiliated. Absent that type of

    aggregation, an entity could seek to evade major participant status by

    allocating swap or security-based swap

    [[Page 80202]]

    positions among a number of affiliated entities.

    In situations in which a parent is the majority owner of a

    subsidiary entity, we preliminarily believe that the major participant

    tests may appropriately aggregate the subsidiary's swaps or security-

    based swaps at the parent for purposes of the substantial position

    analyses.\165\ Attributing those positions to a parent appears

    consistent with the concepts of ``substantial position'' and

    ``substantial counterparty exposure,'' given that the parent would

    effectively be the beneficiary of the transaction. In those

    circumstances, however, there still may be questions as to whether the

    requirements applicable to major participants--e.g., capital, margin

    and business conduct--should be placed upon the parent or the

    subsidiary. We recognize that it may be appropriate at times to apply

    such requirements upon the subsidiary to the extent that the subsidiary

    is acting on behalf of the parent.\166\

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

    \165\ Arguably, the basis for this type of attribution would be

    even stronger if the parent wholly owns the subsidiary. An

    attribution rule that only addresses 100 percent ownership

    situations, however, may readily be susceptible to gaming if the

    parent were to sell a very small interest in the subsidiary to

    another party.

    \166\ It may also be appropriate to address these issues in

    connection with the rule proposals addressing the substantive

    requirements applicable to major participants.

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

    Commenters particularly are invited to discuss when it would be

    appropriate to apply the major participant definitions to entities that

    are the majority owner of subsidiaries that enter into swaps or

    security-based swaps, or whether attribution of a subsidiary's

    security-based swap positions is generally inappropriate. Also, to the

    extent this type of attribution is appropriate, to what extent should

    the subsidiary retain responsibilities for complying with the capital,

    margin, business conduct and other requirements applicable to major

    participants?

    Commenters further are requested to address whether the swaps or

    security-based swaps of corporate subsidiaries in some circumstances

    should be attributed to an entity that itself is not the majority owner

    of the direct counterparty to a swap or security-based swap. Moreover,

    should this type of attribution apply when one entity controls another

    entity, and, if so, how should the concept of control be defined for

    these purposes? In addition, commenters are requested to address

    whether, as an alternative approach, this type of attribution would be

    appropriate specifically when a parent provides guarantees on behalf of

    its subsidiaries, or third parties provide guarantees on behalf of

    unaffiliated entities.

    Commenters further are requested to address any issues that would

    arise with regard to the effective implementation of the requirements

    applicable to major participants in the context of this type of

    attributions.

    4. Application of Major Participant Definitions to Inter-Affiliate

    Swaps and Security-Based Swaps

    Several commenters have suggested that swaps and security-based

    swaps between affiliated counterparties should not be considered within

    the analysis of whether an entity's swap or security-based swap

    positions cause it to be a major participant. Such inter-affiliate

    swaps and security-based swaps may be used to achieve various

    operational and internal efficiency objectives.

    The Commissions preliminarily believe that when a person analyzes

    its swap or security-based swap positions under the major participant

    definitions, it would be appropriate for the person to consider the

    economic reality of any swaps or security-based swaps it enters into

    with wholly owned affiliates, including whether the swaps and security-

    based swaps simply represent an allocation of risk within a corporate

    group.\167\ Such swaps and security-based swaps among wholly-owned

    affiliates may not pose the exceptional risks to the U.S. financial

    system that are the basis for the major participant definitions. As

    discussed above in the context of managed accounts, however, an entity

    would not be able to evade the requirements applicable to major

    participants by allocating among multiple affiliates swap or security-

    based swap positions of which it is the beneficial owner.

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

    \167\ Such swaps and security-based swaps should be considered

    in this way only for purposes of determining whether a particular

    person is a major participant. The swaps and security-based swaps

    would continue to be subject to all laws and requirements applicable

    to such swaps and security-based swaps.

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

    The Commissions request comment on the treatment of inter-affiliate

    swaps and security-based swaps between wholly-owned affiliates of the

    same corporate parent in connection with the major participant

    definitions. Commenters also are requested to address whether similar

    interpretations should apply to swaps and security-based swaps between

    entities within a consolidated group as determined in accordance with

    U.S. generally accepted accounting principles. Commenters further are

    requested to discuss whether the major participant definition should be

    interpreted to encompass an entity (including an affiliate of the named

    counterparty to the swap or security-based swap) that provides a

    guarantee of the named counterparty's obligations, either in the form

    of a guarantee or through some other form of credit support whereby the

    guarantor agrees to satisfy margin obligations of the named

    counterparty and/or periodic payment obligations of the named

    counterparty.

    5. Legacy Portfolios

    Some commenters have stated that certain entities that maintain

    legacy portfolios of credit default swaps that previously had been

    entered into in connection with the activities of monoline insurers and

    ``credit derivative product companies'' should not be considered major

    participants. The commenters argued that these entities would be unable

    to comply with the capital and margin requirements applicable to major

    participants, and that regulation as major participants is unnecessary

    given that the entities are not writing any additional swaps or

    security-based swaps.

    We request comment on whether the rules further defining major swap

    participant and major security-based swap participant should exclude

    such entities from the major participant definition if their swap and

    security-based swap positions are limited to those types of legacy

    positions. The exclusion from the definition could be conditional, and

    any such excluded entity would be required to provide the Commissions

    with position information of the type that registered major

    participants would be required to provide. We invite comment on any

    other conditions that might be appropriate to an exclusion of such

    legacy portfolios from the major participant definitions.

    6. Potential Exclusions

    Some commenters stated that the major participant definitions

    should not be interpreted to apply to entities such as investment

    companies,\168\ ERISA plans, registered broker-dealers and/or

    registered futures commission

    [[Page 80203]]

    merchants,\169\ and long-term investors such as sovereign wealth

    funds.\170\

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

    \168\ See letter from Karrie McMillan, General Counsel,

    Investment Company Institute, dated September 20, 2010 (registered

    investment companies should be excluded from the major participant

    (and dealer) definitions, or else the terms of the definitions

    should be interpreted to clarify that mutual funds generally will

    not be major participants).

    \169\ See letter from The Swaps & Derivatives Marketing Ass'n,

    dated September 20, 2010 (certain hedged positions of broker-dealers

    and futures commission merchants with customers should not be

    considered as part of the substantial position analysis); Cleary

    letter (registered and well-capitalized broker-dealers and futures

    commission merchants should not fall within the scope of the third

    major participant test).

    \170\ See letter from Lee Ming Chua, General Counsel, Government

    of Singapore Investment Corp., dated September 20, 2010 (stating

    that the major participant definitions were not intended to apply to

    long-term financial investors); see also letter from Richard M.

    Whiting, The Financial Services Roundtable, dated September 20, 2010

    (major participant definitions should exclude firms that solely act

    as investors).

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

    These comments, and the rationale behind the comments, raise the

    issue of whether we should exclude, conditionally or unconditionally,

    certain types of entities from the major participant definitions, on

    the grounds that such entities do not present the risks that underpin

    the major participant definitions and/or to avoid duplication of

    existing regulation. While we are not proposing any such exclusions, we

    request comment as to whether we should exclude certain types of

    entities, including those noted above, as well as to entities subject

    to bank capital rules, State-regulated insurers, private and State

    pension plans, and registered derivatives clearing organizations or

    clearing agencies.

    Commenters particularly are requested to address whether such

    exclusions are necessary and appropriate in light of the proposed rules

    that would be applicable to major participants, whether any conditions

    would be appropriate for such exclusions, and whether modifying those

    proposed rules would more effectively address these issues than

    granting specific exclusions from the major participant definitions for

    specific types of entities. Commenters also are particularly requested

    to discuss whether banks should be excluded from the major participant

    definitions because of the regulation to which they already are

    subject. Commenters also are requested to discuss whether registered

    investment companies should be excluded from the major participant

    definitions because of the regulations to which they already are

    subject, and whether registered investment companies would be able to

    comply with capital and margin requirements applicable to major

    participants.

    Commenters also particularly are requested to address whether

    sovereign wealth funds or other entities linked to foreign governments

    should be excluded from the major participant definitions, particularly

    in light of the provisions of the Dodd-Frank Act governing its

    territorial reach, and whether the answer in part should be determined

    based on whether the entity's obligations are backed by the full faith

    and credit of the foreign government.

    V. Administrative Law Matters--CEA Revisions (Definitions of ``Swap

    Dealer'' and ``Major Swap Participant,'' and Amendments to Definition

    of ``Eligible Contract Participant'')

    A. Regulatory Flexibility Act

    The Regulatory Flexibility Act requires that agencies consider

    whether the rules they propose will have a significant economic impact

    on a substantial number of small entities and, if so, provide a

    regulatory flexibility analysis respecting the impact.\171\ The rules

    proposed by the CFTC provide definitions that will largely be used in

    future rulemakings and which, by themselves, impose no significant new

    regulatory requirements. Accordingly, the Chairman, on behalf of the

    CFTC, hereby certifies pursuant to 5 U.S.C. 605(b) that the proposed

    rules will not have a significant economic impact on a substantial

    number of small entities.

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

    \171\ 5 U.S.C. 601 et seq.

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

    B. Paperwork Reduction Act

    The proposed rule will not impose any new recordkeeping or

    information collection requirements, or other collections of

    information that require approval of the Office of Management and

    Budget under the Paperwork Reduction Act.\172\ The CFTC invites public

    comment on the accuracy of its estimate that no additional

    recordkeeping or information collection requirements or changes to

    existing collection requirements would result from the rules proposed

    herein.

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

    \172\ 44 U.S.C. 3501 et seq.

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

    C. Cost-Benefit Analysis

    Section 15(a) of the CEA \173\ requires the CFTC to consider the

    costs and benefits of its actions before issuing a rulemaking under the

    CEA. By its terms, Section 15(a) does not require the CFTC to quantify

    the costs and benefits of a rule or to determine whether the benefits

    of the rulemaking outweigh its costs; rather, it requires that the CFTC

    ``consider'' the costs and benefits of its actions. Section 15(a)

    further specifies that the costs and benefits shall be evaluated in

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

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

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

    sound risk management practices; and (5) other public interest

    considerations. The CFTC may in its discretion give greater weight to

    any one of the five enumerated areas and could in its discretion

    determine that, notwithstanding its costs, a particular rule is

    necessary or appropriate to protect the public interest or to

    effectuate any of the provisions or accomplish any of the purposes of

    the CEA.

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

    \173\ 7 U.S.C. 19(a).

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

    1. Summary of Proposed Requirements

    The proposed regulations would further define the terms ``swap

    dealer,'' ``eligible contract participant,'' ``major swap

    participant,'' and related terms, including ``substantial position''

    and ``substantial counterparty exposure.'' The proposed regulations

    regarding eligible contract participants are clarifying changes that

    are not expected to have substantive effects on market participants.

    The proposed regulations further defining swap dealer and major swap

    participant are significant because any entity determined to be a swap

    dealer or major swap participant would be subject to registration,

    margin, capital, and business conduct requirements set forth in the

    Dodd-Frank Act, as those requirements are implemented in rules proposed

    or to be proposed by the CFTC. Those requirements will likely lead to

    compliance costs, capital holding costs, and margin posting costs,

    which have been or will be addressed in the CFTC's proposals to

    implement those requirements. On the other hand, those requirements

    will likely lead to benefits in the form of increased market

    transparency, reduced counterparty risk and a lower incidence of

    systemic crises and other market failures. This discussion concerns the

    costs and benefits arising from the proposed definitional tests

    themselves, in terms of the burden on market participants to determine

    how the proposed definitions apply, and the benefits arising from the

    specificity of the proposals.

    2. Proposed Regulations Regarding ``Eligible Contract Participant''

    The proposal regarding ``eligible contract participant'' would

    provide that swap dealers and major swap participants would qualify as

    eligible contract participants. The CFTC believes this proposal is in

    line with the expectations of market participants and would impose

    virtually no costs while providing the benefit of greater certainty.

    The proposal would also

    [[Page 80204]]

    provide that certain commodity pools could not qualify as eligible

    contract participants under certain provisions specified in the

    proposal. The CFTC believes that this proposal clarifies the

    interpretation of this aspect of the eligible contract participant

    definition and would prevent the commodity pools from using a provision

    of the definition that was not intended to apply to the commodity

    pools. Thus, while the proposal would potentially impose some costs on

    the commodity pools that could no longer rely on certain provisions of

    the definition, benefits would arise from preventing the

    misinterpretation of the definition.

    3. Proposed Regulations Regarding ``Swap Dealer''

    The proposal regarding ``swap dealer'' would further define the

    term by providing that any person that engages in specified activities

    is a swap dealer. The proposal describes these activities qualitatively

    and in relatively general terms that apply in the same way to all parts

    of the swap markets. With regard to the de minimis exemption from the

    definition, the proposal sets out bright-line quantitative tests to

    determine if a person's swap dealing activity is de minimis. For the

    exclusion of swaps in connection with originating a loan by an insured

    depository institution, the proposal describes the scope of the

    exclusion qualitatively in terms that depend primarily on the terms of

    the swaps that would be eligible for the exclusion and the identity of

    the parties to the swap. Also, the proposal includes a voluntary

    process by which a swap dealer may request that the CFTC limit the swap

    dealer designation to certain aspects of the person's activity.

    a. Costs

    The costs to a market participant from the proposed regulations

    further defining ``swap dealer'' would arise primarily from its need to

    review its activities and determine, as a qualitative matter, whether

    its activities are of the type described in the proposal. As its

    activities change from time to time, it would be necessary to repeat

    this review, and ongoing compliance costs may arise if the market

    participant determines that it should adapt its activities so as to not

    be encompassed by the definition. Because the proposed regulations are

    qualitative and on relatively general terms, there may be multiple

    interpretations of the general criteria by market participants. A

    market participant whose activities fall within the realm of those

    described in the proposal may have to incur the costs of a more focused

    review to determine whether or not it is encompassed by the definition.

    The proposal regarding the de minimis exemption, on the other hand,

    would impose lower costs because of the precise, quantitative nature of

    the proposed exemption. A market participant would incur only the cost

    of determining the applicable quantities, such as notional value,

    number of swaps, number of counterparties, and so forth set out in the

    proposal. The CFTC believes that relatively few market participants

    would have to determine whether the de minimis exemption applies to

    their activities, and there would be only a low number of instances

    where application of the quantitative tests would be uncertain.

    Similarly, the CFTC believes that insured depository institutions would

    incur relatively low costs to apply the proposed exclusion of swaps in

    connection with originating loans because the proposed criteria relate

    to matters in which the institution is directly involved.

    Last, the costs of the voluntary process for a request for a

    limited designation as a swap dealer are difficult to predict because

    they would depend on the complexity of the person making the request

    and the particular factors that are relevant to the limited

    designation. The CFTC believes that the person making the request would

    have broad discretion in determining how to do so and thereby could

    control the costs of the request to some extent.

    b. Benefits

    The benefits of the proposed regulations further defining ``swap

    dealer'' include that they set out a single set of criteria to be

    applied by all market participants. Thus, the proposed regulations

    create a level playing field that permits all market participants to

    determine, on an equal basis, which activities would potentially lead

    to designation as a swap dealer. The proposed regulations are set out

    in plain language terms that may be understood and applied by all

    market participants without relying on the technical expertise that may

    be required to implement more elaborate tests. The CFTC believes that

    the proposal can be fairly applied by substantially all market

    participants who could potentially be swap dealers.

    Regarding the proposals regarding the de minimis exemption and the

    exclusion of swaps in connection with the origination of loans,

    benefits arise from the relatively specific, quantitative nature of the

    proposals. Since these proposals are expected to be applied by

    relatively few market participants in limited situations, more detailed

    regulations are appropriate. The CFTC believes that these detailed

    criteria will permit market participants to make a relatively quick and

    low-cost determination of whether the exemption or exclusion apply. The

    proposal for requests for a limited swap dealer designation provides

    the benefit of flexibility to allow each market participant making this

    request to determine how to do so.

    4. Proposed Regulations Regarding ``Major Swap Participant''

    The proposal regarding ``major swap participant'' would further

    define the term by setting out quantitative thresholds against which a

    market participant would compare its swap activities to determine

    whether it is encompassed by the definition. The proposal would require

    that potential major swap participants analyze their swaps in detail to

    determine, for example, which of their swaps are subject to netting

    agreements or mark-to-market collateralization and the amount of

    collateral posted with respect to the swaps. The proposal includes a

    general, qualitative definition of the swaps that may be excluded from

    the comparison because they are used to ``hedge or mitigate commercial

    risk.'' Like the swap dealer proposal, there is a voluntary process by

    which a major swap participant may request that the CFTC limit the

    major swap participant designation to certain aspects of the person's

    activity.

    a. Costs

    The costs to a market participant from the proposed regulations

    further defining ``major swap participant'' would arise primarily from

    its need to analyze its swaps and determine whether it has a

    ``substantial position'' or ``substantial counterparty exposure'' as

    defined in the proposal. The proposed rule defines potential future

    exposure by a factor of the dollar notational value of the swap. The

    Commission also considered market-based tests of potential future

    exposure such as margin requirements or other valuations of the

    outstanding position. The Commission decided in favor of a more easily

    implementable test rather than market-based criteria for potential

    future exposure, given that daily variation in market prices is

    captured by the current exposure calculation. The CFTC believes that

    because the proposed quantitative thresholds are high, only very few

    market participants would have to conduct a detailed analysis to

    determine whether they are encompassed by the proposed

    [[Page 80205]]

    definition. The cost of the detailed analysis would vary for each

    market participant, depending on the particular characteristics of its

    swaps. Similarly, the costs to a market participant of determining

    whether it uses swaps to hedge or mitigate commercial risk would depend

    on how the market participant uses swaps. It is possible that for some

    market participants with complex positions in swaps, the costs of the

    analysis could be relatively high.

    As is the case for the similar proposal regarding swap dealers, the

    costs of the voluntary process for a request for a limited designation

    as a major swap participant are difficult to predict because they would

    depend on the complexity of the particular case. The CFTC believes that

    the person making the request would have broad discretion in

    determining how to do so and thereby could control the costs of the

    request to some extent.

    b. Benefits

    The benefits of the proposed regulations further defining ``major

    swap participant'' include that they set out a quantitative, bright-

    line test that can be applied at a relatively low cost. Also, the

    definition of ``hedging or mitigating commercial risk'' is stated in

    general terms that may be flexibly applied by potential major swap

    participants. In preparing this proposal, the CFTC considered other

    methods of defining ``major swap participant,'' including multi-factor

    analyses, stress tests and adversary processes. The CFTC believes that

    these other methods would impose significantly higher costs for both

    the market participants that would have to apply them and for the CFTC

    (and, indirectly, the taxpayer), without providing additional benefits.

    The costs would result primarily from the need to retain qualified

    experts who would devote significant time and other resources to a

    detailed analysis of multiple aspects of the potential major swap

    participant's swap positions. The benefits that could justify more

    costly proposals include reductions in arbitrary differences in results

    and greater consistency and predictability. However, other potential

    methods of further defining ``major swap participant'' do not appear

    likely to provide such benefits to an extent that would justify the

    higher costs.

    5. Request for Comment

    The CFTC invites public comment on its cost-benefit considerations.

    Commenters are also invited to submit any data or other information

    that they may have quantifying or qualifying the costs and benefits of

    the proposed rules with their comments.

    D. Consideration of Impact on the Economy

    For purposes of the Small Business Regulatory Enforcement Fairness

    Act of 1996 (``SBREFA'') \174\ the CFTC must advise the Office of

    Management and Budget as to whether the proposed rules constitute a

    ``major'' rule. Under SBREFA, a rule is considered ``major'' where, if

    adopted, it results or is likely to result in: (1) An annual effect on

    the economy of $100 million or more (either in the form of an increase

    or a decrease); (2) a major increase in costs or prices for consumers

    or individual industries; or (3) significant adverse effect on

    competition, investment or innovation. If a rule is ``major,'' its

    effectiveness will generally be delayed for 60 days pending

    Congressional review. We do not believe that any of the proposed rules,

    in their current form, would constitute a major rule.

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

    \174\ Public Law 104-121, Title II, 110 Stat. 857 (1996)

    (codified in various sections of 5 U.S.C., 15 U.S.C. and as a note

    to 5 U.S.C. 601).

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

    We request comment on the potential impact of the proposed rules on

    the economy on an annual basis, on the costs or prices for consumers or

    individual industries, and on competition, investment or innovation.

    Commenters are requested to provide empirical data and other factual

    support for their views to the extent possible.

    VI. Administrative Law Matters--Exchange Act Rules (Definitions of

    ``Security-Based Swap Dealer'' and ``Major Security-Based Swap

    Participant'')

    A. Paperwork Reduction Act Analysis

    Certain provisions of the proposed rules may impose new

    ``collection of information'' requirements within the meaning of the

    Paperwork Reduction Act of 1995 (``PRA'').\175\ The SEC has submitted

    them to the Office of Management and Budget (``OMB'') for review in

    accordance with 44 U.S.C. 3507 and 5 CFR 1320.11. The title of the new

    collection of information is ``Procedural Requirements Associated with

    the Definition of `Hedging or Mitigating Commercial Risk.''' An agency

    may not conduct or sponsor, and a person is not required to respond to,

    a collection of information unless it displays a currently valid OMB

    control number. OMB has not yet assigned a control number to the new

    collection of information.

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    \175\ 44 U.S.C. 3501 et seq.

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

    1. Summary of Collection of Information

    Proposed Exchange Act rule 3a67-4 would define the term ``hedging

    or mitigating commercial risk.'' \176\ Security-based swap positions

    that meet this proposed definition would be excluded from the

    ``substantial position'' analysis under the first test of the proposed

    definition of major security-based swap participant.

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

    \176\ As noted previously, the concept of ``hedging or

    mitigating commercial risk'' also is found in the statutory

    provisions granting an exception to end-users from the mandatory

    clearing requirement in connection with swaps and security-based

    swaps. See CEA section 2(h)(7)(A); Exchange Act section 3C(g)(1)(B)

    (exception from mandatory clearing requirements when one or more

    counterparties are not ``financial entities'' and are using swaps or

    security-based swaps ``to hedge or mitigate commercial risk''). If

    the proposed rule 3a67-4 definition of ``hedging or mitigating

    commercial risk'' is used any future SEC rulemakings, including

    rulemaking with respect to the end-user exception, any necessary

    discussion of administrative law matters relating to the use of

    proposed rule 3a67-4 will be provided at that time.

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    For a security-based swap position to be held for the purpose of

    hedging or mitigating commercial risk under proposed rule 3a67-4, the

    person holding the position must satisfy several conditions, including

    the following:

    (i) The person must identify and document the risks that are being

    reduced by the security-based swap position;

    (ii) The person must establish and document a method of assessing

    the effectiveness of the security-based swaps as a hedge; and

    (iii) The person must regularly assess the effectiveness of the

    security-based swap as a hedge.

    2. Proposed Use of Information

    The collections of information in proposed rule 3a67-4 are designed

    to help prevent abuse of the exclusion and to help ensure that the

    exclusion is only available to those entities that are engaged in

    legitimate hedging or risk mitigating activities.

    3. Respondents

    The collections of information in proposed rule 3a67-4 would apply

    to those entities seeking to exclude the security-based swap positions

    held for hedging or mitigating commercial risk from the substantial

    position calculation. As discussed below in Section VI.B.4., based on

    the current market, we estimate that approximately 10 entities have

    security-based swap positions of a magnitude that they could

    potentially reach the major security-based swap participant thresholds.

    Accordingly, we estimate that approximately 10 entities would seek to

    avail themselves of the exclusion from

    [[Page 80206]]

    the substantial position calculation for security-based swap positions

    held for hedging or mitigating commercial risk.

    4. Total Annual Reporting and Recordkeeping Burden

    We do not anticipate that the proposed collection of information in

    proposed rule 3a67-4 would cause the estimated 10 entities to incur any

    new costs. We believe that only highly sophisticated market

    participants would potentially meet the proposed thresholds for the

    major security-based swap participant designation and thus have a need

    to take advantage of the exclusion for positions held for hedging or

    mitigating commercial risk (and be required to meet the attendant

    collection requirements). We understand from our staff's discussions

    with industry participants that the entities that have security-based

    swap positions and exposures of this magnitude currently create and

    maintain the documentation proposed to be required in rule 3a67-4, as

    part of their ordinary course business and risk management

    practices.\177\ Thus, we do not believe that any new burdens or costs

    will be imposed on the approximately 10 entities that may seek to use

    the exclusion. We therefore estimate the total annual reporting and

    recordkeeping burden associated with proposed rule 3a67-4 to be

    minimal.

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

    \177\ Some entities follow these types of procedures so that

    their hedging transactions will qualify for hedge accounting

    treatment under generally accepted accounting principles, which

    requires procedures similar to those in proposed rule 3a67-4.

    Hedging relationships involving security-based swaps that qualify

    for the hedging or mitigating commercial risk exception in the

    proposed rule are not limited to those recognized as hedges for

    accounting purposes. We believe that all of the estimated 10

    entities that have security-based swap positions of a magnitude that

    they could potentially be deemed to be major security-based swap

    participants already identify and document their risk management

    activities (including their security-based swap positions used to

    hedge or mitigate commercial risks) and assess the effectiveness of

    those activities as a matter of their ordinary business practice--

    even if they are not seeking hedge accounting treatment.

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

    5. Collection of Information is Mandatory

    The collections of information in proposed rule 3a67-4 would be

    mandatory for those entities seeking to exclude positions they hold for

    hedging or mitigating commercial risk from the substantial position

    calculation.

    6. Confidentiality

    There is no proposed requirement that the collections of

    information in proposed rule 3a67-4 be provided to the SEC or a third

    party on a regular, ordinary course basis. In a situation where the SEC

    has obtained the information, the SEC would consider requests for

    confidential treatment on a case-by-case basis.

    7. Record Retention Period

    Proposed rule 3a67-4 does not contain a specific record retention

    requirement. Nonetheless, we would expect the approximately 10 entities

    that may seek to use the exclusion for positions held for hedging or

    mitigating commercial risk to maintain the records they create in

    connection with the exclusion. Because we understand from our staff's

    discussions with industry participants that the entities that have

    security-based swap positions and exposures of this magnitude currently

    create and maintain the documentation proposed to be required in rule

    3a67-4, as part of their ordinary course business and risk management

    practices, we do not expect any new burdens or costs will be imposed to

    maintain the records.

    8. Request for Comments

    The SEC invites comments on these estimates. Pursuant to 44 U.S.C.

    3506(c)(2)(B), the SEC requests comments in order to: (a) Evaluate

    whether the collection of information is necessary for the proper

    performance of our functions, including whether the information will

    have practical utility; (b) evaluate the accuracy of our estimate of

    the burden of the collection of information; (c) determine whether

    there are ways to enhance the quality, utility, and clarity of the

    information to be collected; and (d) evaluate whether there are ways to

    minimize the burden of the collection of information on those who

    respond, including through the use of automated collection techniques

    or other forms of information technology.

    Persons submitting comments on the collection of information

    requirements should direct them to the Office of Management and Budget,

    Attention: Desk Officer for the Securities and Exchange Commission,

    Office of Information and Regulatory Affairs, Washington, DC 20503, and

    should also send a copy of their comments to Elizabeth M. Murphy,

    Secretary, Securities and Exchange Commission, 100 F Street, NE.,

    Washington, DC 20549-1090, with reference to File No. S7-39-10.

    Requests for materials submitted to OMB by the SEC with regard to this

    collection of information should be in writing, with reference to File

    No. S7-39-10, and be submitted to the Securities and Exchange

    Commission, Records Management, Office of Filings and Information

    Services, 100 F Street, NE., Washington, DC 20549-1090. As OMB is

    required to make a decision concerning the collections of information

    between 30 and 60 days after publication, a comment to OMB is best

    assured of having its full effect if OMB receives it within 30 days of

    publication.

    B. Consideration of Benefits and Costs

    1. Introduction

    The Dodd-Frank Act added definitions of ``security-based swap

    dealer'' and ``major security-based swap participant'' to the Exchange

    Act in conjunction with other provisions that require entities meeting

    either of those definitions to register with the SEC and to be subject

    to capital, margin, business conduct and certain other requirements.

    Consistent with the direction of the Dodd-Frank Act, the SEC is

    proposing rules to further define ``major security-based swap

    participant'' along with additional terms used in that definition. The

    SEC also is proposing rules to further define ``security-based swap

    dealer'' and to set forth factors for determining the availability of

    the de minimis exception from that definition. We believe that these

    proposed rules are consistent with the purposes of the Dodd-Frank Act,

    and, as appropriate, set forth objective standards to facilitate market

    participants' compliance with the amendments that the Dodd-Frank Act

    made to the Exchange Act. Market participants, however, may incur costs

    associated with certain of these proposed rules.

    The SEC believes that there would be two categories of potential

    costs. First, there would be costs associated with the regulatory

    requirements that would apply to a ``security-based swap dealer'' or a

    ``major security-based swap participant'' (e.g., the registration,

    margin, capital, and business conduct requirements that would be

    imposed on security-based swap dealers and major security-based swap

    participants). While the specific costs and benefits associated with

    these regulatory requirements are being addressed in the SEC's

    proposals to implement those requirements, we recognize that the costs

    and benefits of these proposed definitions are directly linked to the

    costs and benefits of the requirements applicable to dealers and major

    participants. We welcome comment on the costs and benefits of these

    proposed definitions in that broader context.

    Second, there may be costs that entities incur in determining

    whether they qualify as a ``security-based swap dealer'' or a ``major

    security-based swap participant'' under the proposed definitional

    rules. These costs, along

    [[Page 80207]]

    with the benefits associated with the proposed rules, are discussed

    below.

    2. Proposed Exchange Act rule 3a67-1--Definition of ``Major Security-

    Based Swap Participant''

    Proposed Exchange Act rule 3a67-1 would largely restate the

    statutory definition of ``major security-based swap participant,'' to

    consolidate the definition and related interpretations for ease of

    reference.

    A person that meets the definition of major security-based swap

    participant generally will be subject to the requirements applicable to

    major security-based swap participants without regard to the purpose

    for which it enters into a security-based swap, and without regard to

    the particular category of security-based swap.\178\ However, the

    statutory definitions provide that a person may be designated as a

    major security-based swap participant for one or more categories of

    security-based swaps or for particular activities without being

    classified as a major security-based swap participant for all

    categories or activities.\179\ Proposed rule 3a67-1 would provide that

    a major security-based swap participant that engages in significant

    activity with respect to only certain types, classes or categories of

    security-based swaps or only in connection with specified activities,

    could obtain relief with respect to other types of security-based swaps

    from certain of the requirements that are applicable to major security-

    based swap participants. The rule would have the benefit of

    implementing the statutory provision and providing that major security-

    based swap participants may obtain relief from the SEC. A person that

    seeks to be considered to be a major security-based swap participant

    only with respect to one category of security-based swaps, or only with

    respect to certain activities, would be expected to incur costs in

    connection with requesting an order from the SEC. However, any such

    costs would be voluntarily incurred by any person seeking to take

    advantage of that limited designation, and thus we preliminarily do

    believe that those costs would be attributable to the statute and not

    to this rule.

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

    \178\ The specific costs associated with these regulatory

    requirements will be addressed in the SEC's proposals to implement

    those requirements.

    \179\ See Exchange Act section 3(a)(67)(C).

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

    3. Proposed Exchange Act Rule 3a67-2--``Major'' Categories of Security-

    Based Swaps

    Proposed Exchange Act rule 3a67-2 would fulfill Congress's mandate

    that the SEC designate ``major'' categories of security-based swaps by

    setting forth two such ``major'' categories--one consisting of credit

    derivatives and the other consisting of equity-swaps and other

    security-based swaps. We believe that these proposed categories would

    have the benefit of being consistent with the different ways in which

    those products are used, as well as market statistics and current

    market infrastructures (particularly the separate trade warehouses for

    credit default swaps and equity swaps). Although, as discussed below,

    this categorization is relevant to the ``substantial position'' tests

    of the ``major security-based swap participant'' definition, we believe

    that the categorization itself would not impose any costs on market

    participants. While the categorization may affect the costs that market

    participants will incur from particular statutory and regulatory

    requirements applicable to major security-based swap participants,\180\

    those costs are being addressed in our proposals to implement those

    requirements.

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

    \180\ For example, distinguishing between categories of

    security-based swaps may cause some entities to incur additional

    costs to calculate their major security-based swap participant

    status with respect to each category. Similarly, categorization may

    affect whether an entity ultimately qualifies as a major security-

    based swap participant.

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

    4. Proposed Exchange Act Rule 3a76-3--Definition of ``Substantial

    Position''

    Proposed Exchange Act rule 3a67-3 would define the term

    ``substantial position,'' which is used in the first and third tests of

    the definition of ``major security-based swap participant.'' The Dodd-

    Frank Act requires the SEC to define this term. We have proposed two

    tests for identifying the presence of a substantial position--one test

    based on a daily average measure of uncollateralized mark-to-market

    exposure, and one based on a daily average measure of combined

    uncollateralized mark-to-market exposure and potential future exposure.

    Both of these daily measures would be calculated and averaged over a

    calendar quarter.

    We believe that this proposed definition would have the benefit of

    providing objective criteria that reasonably would measure the risks

    associated with security-based swap positions, and reflect the

    counterparty risk and risk to the market factors that are embedded

    within the ``major security-based swap participant'' definition. We

    also believe that the proposed use of objective numerical criteria for

    the substantial position thresholds would promote the predictable

    application and enforcement of the requirements governing major

    security-based swap participants by permitting market participants to

    readily evaluate whether their security-based swap positions meet the

    thresholds.

    The first ``substantial position'' test would encompass entities

    that have a daily average uncollateralized mark-to-market exposure of

    $1 billion in a major category of security-based swaps. The second

    ``substantial position'' test would encompass entities that have a

    daily average combined uncollateralized mark-to-market exposure and

    potential future exposure of $2 billion. Potential future exposure

    would be measured, consistent with bank capital rules, largely by

    multiplying notional positions by risk factors. Additional adjustments

    would reflect netting agreements, the presence of central clearing and

    the presence of daily mark-to-market margining practices.

    As previously noted, there will be costs associated with the

    registration, margin, capital, business conduct, and other requirements

    that will be imposed on major security-based swap participants. Those

    costs are being addressed in the SEC's rule proposals to implement

    those requirements. We also believe that there will be costs incurred

    by entities in determining whether they meet the definition of major

    security-based swap participant. These costs are discussed below.

    Based on the current over-the-counter derivatives market, we

    estimate that no more than 10 entities that are not otherwise security-

    based swap dealers would have either uncollateralized mark-to-market

    positions \181\ or

    [[Page 80208]]

    combined uncollateralized current exposure and potential future

    exposure of a magnitude \182\ that may rise close enough to the levels

    of our proposed thresholds to necessitate monitoring to determine

    whether they meet those thresholds. Additionally, we preliminarily

    believe that all of these approximately 10 entities currently maintain

    highly sophisticated financial operations in order to achieve the large

    security-based swap positions necessitating their use of the tests.

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

    \181\ We believe that an estimate of an entity's mark-to-market

    exposure associated with its security-based swap positions can be

    derived from the level of an entity's notional positions. We

    recognize that the ratio of exposure to notional amount will vary by

    market participant and by position. We understand that mark-to-

    market exposures associated with credit derivative positions on

    average are equal to approximately three percent of an entity's

    level of notional positions in credit derivatives. This estimate is

    based on second quarter 2010 U.S. bank market statistics involving

    credit derivatives, given that banks have credit derivative

    positions with gross positive fair value (which would equate to

    negative fair value for the banks' counterparties) of $403 billion,

    compared to total notional credit derivative positions of $13.9

    trillion. See Office of the Comptroller of the Currency, ``OCC's

    Quarterly Report on Bank Trading and Derivatives Activities''

    (Second Quarter 2010) at 4 & Table 12. This data suggests that, on

    average, an entity would need to have notional credit derivative

    positions of roughly $33 billion to meet our proposed threshold for

    the first substantial position test, $1 billion in mark-to-market

    exposure.

    We understand, based on our staff's discussions with industry,

    that approximately 39 entities have credit default swap notional

    positions of roughly $33 billion or above. We understand that the

    large majority of those entities are banks or hedge funds (which we

    would expect to fully collateralize their positions with dealers as

    a matter of course). We further understand that banks, securities

    firms, and hedge funds typically collateralize most or all of their

    mark-to-market exposure to U.S. banks as a matter of practice. See

    OCC's Quarterly Report on Bank Trading and Derivatives Activities

    (second quarter 2010) at 6. Therefore, it is not clear if any

    entities would have uncollateralized credit default swap positions

    near the proposed first substantial position threshold of $1 billion

    uncollateralized outward exposure.

    \182\ The proposed risk multiplier of 0.1 for credit derivatives

    would require an entity to have a notional position of $20 billion

    in credit derivatives to reach the proposed $2 billion potential

    future exposure threshold (even before accounting for netting

    adjustments). The proposed additional multiplier of 0.2 for

    security-based swaps cleared by a registered clearing agency or

    subject to daily mark-to-market margining would mean that an entity

    with credit derivative positions that are cleared or subject to

    daily mark-to-market margining would need a notional position in

    credit derivatives of at least $100 billion to potentially reach the

    proposed $2 billion potential future exposure threshold. In this

    example, we are assuming an uncollateralized outward exposure of

    zero.

    We understand, based on our staff's discussions with industry,

    that there are approximately 10 non-dealer entities that have a

    notional position in credit derivatives of over $50 billion.

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

    We expect the costs associated with the proposed substantial

    position tests to be modest for these entities. We understand that the

    entities that have this magnitude of security-based swap positions

    already monitor and collect all of the data necessary for the proposed

    substantial position tests. Preliminarily, we understand that these

    entities already use automated systems to gauge their positions and

    exposures and assist in their risk management. Accordingly, we estimate

    that each of the entities would incur a one-time programming cost,\183\

    as well as ongoing costs associated with the continuing use and

    monitoring of the testing.\184\ We estimate that the one-time

    programming cost would be approximately $13,444 per entity, and

    $134,440 for all entities.\185\ We estimate that the annual ongoing

    costs would be approximately $7,260 per entity, and $72,600 for all

    entities.\186\

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

    \183\ For each of the entities, we estimate that the initial

    programming would require the following levels of work from a

    Compliance Attorney, Compliance Manager, Programmer Analyst, Senior

    Internal Auditor, and Chief Financial Officer. The estimated

    contributions are as follows: approximately 2 hours of work from a

    Compliance Attorney to advise the entity's compliance department on

    the legal requirements associated with the proposed tests;

    approximately 8 hours of work from a Compliance Manager to assist a

    Programmer Analyst in making the necessary changes to the entity's

    existing automated system and to oversee and manage the entire

    programming process; approximately 40 hours of work from a

    Programmer Analyst to make the necessary programming changes to the

    existing automated system and to test the system; approximately 8

    hours of work from a Senior Internal Auditor to perform quality

    assurance to ensure that the automated system is properly performing

    the proposed tests; and approximately 3 hours of work from the

    entity's Chief Financial Officer to monitor the process. We estimate

    that the hourly wage of a Compliance Attorney, Compliance Manager,

    Programmer Analyst, Senior Internal Auditor, and Chief Financial

    Officer would be approximately $291, $294, $190, $195, and $450,

    respectively. The $291/hour figure for a Compliance Attorney, the

    $294/hour figure for a Compliance Manager, the $190/hour figure for

    a Programmer Analyst, and the $195/hour figure for a Senior Internal

    Auditor are from SIFMA's Management & Professional Earnings in the

    Securities Industry 2009, modified by SEC staff to account for an

    1800-hour work-year and multiplied by 5.35 to account for bonuses,

    firm size, employee benefits, and overhead. The $450/hour figure for

    a Chief Financial Officer is from http://www.payscale.com, modified

    by SEC staff to account for an 1800-hour work-year and multiplied by

    5.35 to account for bonuses, firm size, employee benefits, and

    overhead. See http://www.payscale.com (last visited Nov. 1, 2010).

    \184\ We anticipate that each entity would incur ongoing

    monitoring costs to evaluate their test results and to ensure that

    the tests are properly run. We estimate that each entity would have

    a Senior Internal Auditor spend approximately 4 hours each quarter

    (or a total of 16 hours annually) to perform this quality assurance.

    We also estimate that each entity would need a Compliance Attorney,

    a Compliance Manager, and its Chief Financial Officer to each spend

    approximately 1 hour each quarter (or a total of 4 hours annually)

    to monitor the entity's test results and the entity's status under

    the proposed rule.

    \185\ The estimated one-time programming cost of approximately

    $13,444 per entity and $134,440 for all entities was calculated as

    follows: (Compliance Attorney at $291 per hour for 2 hours) +

    (Compliance Manager at $294 per hour for 8 hours) + (Programmer

    Analyst at $190 per hour for 40 hours) + (Senior Internal Auditor at

    $195 per hour for 8 hours) + (Chief Financial Officer at $450 per

    hour for 3 hours) x (10 entities) = $134,440.

    \186\ The estimated ongoing monitoring cost of approximately

    $7,260 per year per entity and $72,600 per year for all entities was

    calculated as follows: (Senior Internal Auditor at $195 per hour for

    16 hours) (Compliance Attorney at $291 per hour for 4 hours) +

    (Compliance Manager at $294 per hour for 4 hours) + (Chief Financial

    Officer at $450 per hour for 4 hours) x (10 entities) = $72,600.

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

    5. Proposed Exchange Act Rule 3a67-4--Definition of ``Hedging or

    Mitigating Commercial Risk''

    Proposed Exchange Act rule 3a67-4 would define the term ``hedging

    or mitigating commercial risk.'' Security-based swap positions that

    meet that definition are excluded from the ``substantial position''

    analysis under the first test of the major participant definition. The

    proposed rule is intended to be objective and promote the predictable

    application and enforcement of the requirements governing major

    security-based swap participants.

    For a security-based swap position to be held for the purpose of

    hedging or mitigating commercial risk under proposed Exchange Act rule

    3a67-4, the person holding the position must satisfy certain

    conditions:

    (i) The person must identify and document the risks that are being

    reduced by the security-based swap position;

    (ii) The person must establish and document a method of assessing

    the effectiveness of the security-based swap as a hedge; and

    (iii) The person must regularly assess the effectiveness of the

    security-based swap as a hedge.

    Proposed rule 3a67-4 would affect whether an entity will meet the

    definition of major security-based swap participant. The specific costs

    associated with these regulatory requirements are being addressed in

    the SEC's proposals to implement those requirements.

    While we expect that there could be some potential costs associated

    with the procedural requirements of proposed rule 3a67-4, as described

    in Section VI.B.4., supra, we expect only highly sophisticated entities

    to hold security-based swap positions of a magnitude that would require

    use of the proposed tests. Thus, we do not anticipate that these

    proposed procedural requirements would cause market participants to

    incur costs that they do not incur already as a matter of their

    ordinary business and risk management practices. Accordingly, we do not

    expect that the proposed definition of ``hedging or mitigating

    commercial risk'' would impose any costs on the potentially affected

    entities beyond those already regularly incurred by these entities as a

    matter of course.

    6. Proposed Exchange Act Rule 3a67-5--Definition of ``Substantial

    Counterparty Exposure That Could Have Serious Adverse Effects on The

    Financial Stability of The United States Banking System or Financial

    Markets''

    Proposed Exchange Act rule 3a67-5 would define ``substantial

    counterparty exposure that could have serious adverse effects on the

    financial stability of the United States banking system or financial

    markets,'' a term that comprises part of the second test of the ``major

    security-based swap participant'' definition. This proposed rule would

    [[Page 80209]]

    parallel the ``substantial position'' analysis discussed above, but

    would examine an entity's security-based swap positions as a whole

    (rather than focusing on a particular ``major'' category), and would

    not exclude certain hedging positions. Consistent with this broader

    scope, and the proposal that there be two ``major'' categories of

    security-based swaps, the thresholds used in this test would be two

    times the comparable ``substantial position'' thresholds. We believe

    that this approach reasonably would measure the counterparty exposure

    associated with the entirety of an entity's security-based swap

    positions, consistent with the risk factors in the ``major security-

    based swap participant'' definition. Additionally, we believe that the

    proposed definition would provide objective criteria and promote the

    predictable application and enforcement of the requirements governing

    major security-based swap participants by permitting market

    participants to readily evaluate whether their security-based swap

    positions meet the proposed thresholds.

    We believe that the same approximately 10 entities would calculate

    their substantial counterparty exposure under this rule as would

    undertake the substantial position calculation under proposed rule

    3a67-3. Given that the threshold for this proposed rule is derived from

    the calculations of substantial position that would be mandated by

    proposed rule 3a67-3, we do not anticipate that it would create any

    costs outside of those already covered in the discussion of the

    estimated costs associated with the proposed definition of substantial

    position.

    7. Proposed Exchange Act Rule 3a67-6--Definitions of ``Financial

    Entity'' and ``Highly Leveraged''

    Proposed Exchange Act rule 3a67-6 would define the terms

    ``financial entity'' and ``highly leveraged,'' both of which are used

    in the third test of the ``major security-based swap participant''

    definition. The proposed definition of ``financial entity'' would be

    consistent with the use of that term in the Title VII exception from

    mandatory clearing for end-users of security-based swaps (subject to

    limited technical changes). One of the two alternative proposed

    definitions of ``highly leveraged'' would be consistent with a standard

    used in Title I of the Dodd-Frank Act, while the other alternative is

    based on an understanding of typical leverage ratios for certain

    financial entities. We believe that these proposed alternative

    standards would apply reasonable objective criteria to implement and

    further define the third test. Additionally, we believe that the

    proposed use of these objective definitions and numerical criteria

    would promote the predictable application and enforcement of the

    requirements governing major security-based swap participants by

    permitting market participants to readily evaluate whether they meet

    the threshold for major security-based swap participant status.

    We do not believe that the proposed definition of ``financial

    entity'' would impose any significant costs on market entities, given

    the objective nature of the definition. We also do not believe that the

    proposed definition of ``highly leveraged''--a balance sheet test that

    would be based on the ratio of an entity's liabilities and equity, and

    that, in the case of entities subject to public reporting requirements,

    could be derived from financial statements filed with the SEC--would

    impose any significant costs on entities that have security-based swap

    positions large enough to potentially meet the ``substantial position''

    requirement that is part of the third test.

    8. Proposed Exchange Act Rule 3a67-7--Timing Requirements, Reevaluation

    Period and Termination of Status

    Proposed Exchange Act rule 3a67-7 would set forth methods for

    specifying when an entity that satisfies the tests specified within the

    definition of ``major security-based swap participant'' would be deemed

    to meet that definition. The proposed rule also would address the

    termination of an entity's status as a major security-based swap

    participant. We believe that the proposed rule would set forth

    pragmatic standards for permitting entities that have security-based

    swap positions that require registration to go through the registration

    process, and to terminate their status when appropriate. We believe

    that this proposed rule would impose no direct costs on market

    entities.\187\

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

    \187\ As noted above, we recognize that major security-based

    swap participants will incur costs associated with the registration

    and termination of registration processes. These costs will be

    addressed in the SEC rule's proposals to implement those

    requirements.

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

    9. Proposed Exchange Act Rule 3a71-1--Definition of ``Security-Based

    Swap Dealer''

    Proposed Exchange Act rule 3a71-1 largely would restate the

    statutory definition of ``security-based swap dealer,'' to consolidate

    the definition and related interpretations for market participants'

    ease of reference. We are not proposing to further define the four

    specific tests set forth in the ``security-based swap dealer''

    definition. However, our release contains interpretive language that

    would have the benefit of providing additional legal certainty to

    market participants. While market participants would incur certain

    costs to analyze whether their security-based swap activities cause

    them to be on the ``dealer'' side of the dealer-trader distinction

    (which would require them to register with the SEC and comply with the

    other requirements applicable to security-based swap dealers unless

    they can take advantage of the de minimis exception), these costs would

    be incurred because of the statutory change, rather than due to

    proposed rule 3a71-1. The Dodd-Frank Act determined that persons that

    engage in dealing activities involving security-based swaps should be

    subject to comprehensive regulation, and any such analytic costs arise

    from Congress's determination to amend the Exchange Act.\188\

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

    \188\ Based on our staff's discussions with industry, we

    estimate that approximately 50 entities may be required to register

    as security-based swap dealers following implementation of these

    proposed rules. The specific costs associated with these regulatory

    requirements will be addressed in the SEC's proposals to implement

    those requirements.

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

    10. Proposed Exchange Act Rule 3a71-2--de Minimis Exception

    Proposed Exchange Act rule 3a71-2 would set forth factors for

    determining whether a person that otherwise would be a security-based

    swap dealer can take advantage of the de minimis exception. The Dodd-

    Frank Act directed the SEC to promulgate these factors.\189\ The

    proposed factors would account for an entity's annual notional

    security-based swap positions in a dealing capacity, its total notional

    security-based swap positions in a dealing capacity when the

    counterparty is a ``special entity,'' \190\ and its total number of

    counterparties and security-based swaps as a dealer. We believe that

    these factors appropriately would focus on dealing activities that do

    not warrant an entity's regulation as a security-based swap dealer. We

    also believe that these objective numerical criteria for the de minimis

    exception would promote the predictable application and enforcement of

    the de minimis exception from security-based swap dealer status.

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

    \189\ See Section 761(a)(6) of the Dodd-Frank Act.

    \190\ See Section 15F(h)(2)(C) of the Exchange Act.

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

    In general, we would expect a person that enters into security-

    based swaps in a dealing capacity would, as a matter of course, be

    aware of the notional amount

    [[Page 80210]]

    of those positions, whether a particular counterparty is a ``special

    entity,'' and the total number of counterparties and security-based

    swaps it has in a dealer capacity. As a result, we believe that there

    would be no new costs incurred by entities in assessing the

    availability of the de minimis exception. Moreover, any costs

    associated with ensuring that a person can take advantage of the de

    minimis exception would be voluntarily incurred by entities that engage

    in dealing activities that seek to take advantage of the exception.

    11. Request for Comments

    The SEC requests comment on these estimated benefits and costs.

    Commenters particularly are requested to address: the accuracy of our

    estimate that there would be approximately 10 entities in the market

    (that would not otherwise be security-based swap dealers) that would

    have security-based swap positions of a magnitude that may rise close

    enough to the levels of our proposed thresholds to necessitate

    monitoring to determine whether they meet those thresholds; the

    accuracy of our estimate that there would be approximately 50 entities

    in the market that may be required to register as security-based swap

    dealers following implementation of the proposed rules; the accuracy of

    our estimates of the costs associated with entities performing the

    proposed substantial position tests; whether the entities that have

    security-based swap positions that are significant enough to

    potentially meet one or more of the tests in the ``major security-based

    swap participant'' definition would, as a matter of course, already

    have the data necessary to perform the two proposed substantial

    position tests, and if not, what additional data would they need and

    how much time and expense would gathering that data require; whether

    these same entities would, as a matter of course, already comply with

    the proposed procedural requirements associated with the exclusion for

    positions that are for the purpose of ``hedging or mitigating

    commercial risk;'' and whether entities would change their behavior to

    avoid meeting the proposed definitions of ``security-based swap

    dealer'' or ``major security-based swap participant,'' and if so, what,

    if any, economic costs would be associated with such behavioral

    changes.

    In addition, and more generally, we request comment on the costs

    and benefits of these proposed definitions in the broader context of

    the substantive rules, including capital, margin and business conduct

    rules, applicable to dealers and major participants. Commenters

    particularly are requested to address whether the proposed scope of the

    dealer and major participant definitions are appropriate in light of

    the costs and benefits associated with those substantive rules.

    C. Consideration of Burden on Competition, and Promotion of Efficiency,

    Competition, and Capital Formation

    Section 3(f) of the Exchange Act requires the SEC, whenever it

    engages in rulemaking and is required to consider or determine whether

    an action is necessary or appropriate in the public interest, to

    consider whether the action would promote efficiency, competition, and

    capital formation.\191\ In addition, Section 23(a)(2) of the Exchange

    Act \192\ requires the SEC, when adopting rules under the Exchange Act,

    to consider the impact such rules would have on competition. Section

    23(a)(2) of the Exchange Act also prohibits the SEC from adopting any

    rule that would impose a burden on competition not necessary or

    appropriate in furtherance of the purposes of the Exchange Act.

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

    \191\ 15 U.S.C. 78c(f).

    \192\ 15 U.S.C. 78w(a)(2).

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

    We preliminarily do not believe that the proposed rules would

    result in any burden on competition that is not necessary or

    appropriate in furtherance of the purposes of the Exchange Act. We are

    proposing rules to further define ``major security-based swap

    participant,'' along with several terms used in that definition. We are

    also proposing rules to further define ``security-based swap dealer''

    and to set forth factors for determining the availability of the de

    minimis exception from that definition. We believe that the proposed

    rules are consistent with the purposes of Title VII of the Dodd-Frank

    Act, and, as appropriate, set forth objective standards to facilitate

    market participants' compliance with the amendments that Title VII of

    the Dodd-Frank Act made to the Exchange Act. These amendments mandate

    that the SEC regulate major security-based swap participants and

    security-based swap dealers, which include some, but not all, entities

    that enter into security-based swaps. Although regulation of certain

    security-based swap market participants may result in competitive

    burdens to these entities when compared to unregulated security-based

    swap market participants, these burdens stem directly from Congress's

    decision to impose regulation on a specified set of security-based swap

    market participants through the Dodd-Frank Act.

    While our decisions on how to further define the terms may have

    some effect on competition (e.g., our determinations regarding the

    proposed definition of substantial position will affect whether

    entities qualify as major security-based swap participants), we

    preliminarily do not believe that our decisions would impose additional

    competitive burdens on entities outside of those that Congress

    previously imposed through its decision in Title VII of the Dodd-Frank

    Act to regulate and differentiate security-based swap market

    participants. Moreover, we believe that defining substantial position

    will help provide market participants with legal certainty regarding

    their need to register as major security-based swap participants and is

    necessary and appropriate to implement the purposes of regulating

    security-based swap dealers and major security-based swap participants.

    We also preliminarily believe that the proposed rules would promote

    efficiency. We believe that the proposed rules would set forth clear

    objective standards to facilitate market participants' compliance with

    the amendments that the Dodd-Frank Act made to the Exchange Act.

    Moreover, we believe that the proposed rules would promote the

    predictable application and enforcement of the Exchange Act. We also

    have considered what effect, if any, our proposed rules would have on

    capital formation. We preliminarily do not believe that our proposed

    rules would have a negative effect on capital formation.

    The SEC requests comment on the effect of the proposed rules on

    efficiency, competition, and capital formation. Commenters are

    particularly requested to address whether entities would change their

    behavior to avoid meeting the proposed definitions of ``security-based

    swap dealer'' or ``major security-based swap participant,'' and if so,

    how. Commenters are also requested to address the effect, if any, that

    the proposed definitions of ``substantial position,'' ``hedging or

    mitigating commercial risk,'' ``substantial counterparty exposure,''

    ``financial entity,'' or ``highly leveraged,'' or the proposed

    categories of security-based swaps would have on business decisions,

    trading behavior, transaction costs, or capital allocation. We also

    request comment on the effect, if any that the proposed de minimis

    exception to the definition of security-based swap dealer would have on

    business decisions, trading behavior, transaction costs, or capital

    allocation, and if so, how. Commenters are particularly

    [[Page 80211]]

    encouraged to provide quantitative information to support their views.

    D. Consideration of Impact on the Economy

    For purposes of SBREFA, the SEC must advise the Office of

    Management and Budget as to whether the proposed rules constitute a

    ``major'' rule. Under SBREFA, a rule is considered ``major'' where, if

    adopted, it results or is likely to result in: (1) An annual effect on

    the economy of $100 million or more (either in the form of an increase

    or a decrease); (2) a major increase in costs or prices for consumers

    or individual industries; or (3) significant adverse effect on

    competition, investment or innovation. If a rule is ``major,'' its

    effectiveness will generally be delayed for 60 days pending

    Congressional review. We do not believe that any of the proposed rules,

    in their current form, would constitute a major rule.

    We request comment on the potential impact of the proposed rules on

    the economy on an annual basis, on the costs or prices for consumers or

    individual industries, and on competition, investment or innovation.

    Commenters are requested to provide empirical data and other factual

    support for their views to the extent possible.

    E. Regulatory Flexibility Act Certification

    The Regulatory Flexibility Act (``RFA'') \193\ requires Federal

    agencies, in promulgating rules, to consider the impact of those rules

    on small entities. Section 603(a) \194\ of the Administrative Procedure

    Act,\195\ as amended by the RFA, generally requires the SEC to

    undertake a regulatory flexibility analysis of all proposed rules, or

    proposed rule amendments, to determine the impact of such rulemaking on

    ``small entities.'' \196\ Section 605(b) of the RFA provides that this

    requirement shall not apply to any proposed rule or proposed rule

    amendment, which if adopted, would not have a significant economic

    impact on a substantial number of small entities.\197\

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

    \193\ 5 U.S.C. 601 et seq.

    \194\ 5 U.S.C. 603(a).

    \195\ 5 U.S.C. 551 et seq.

    \196\ Although Section 601(b) of the RFA defines the term

    ``small entity,'' the statute permits the Commissions to formulate

    their own definitions. The SEC has adopted definitions for the term

    small entity for the purposes of SEC rulemaking in accordance with

    the RFA. Those definitions, as relevant to this proposed rulemaking,

    are set forth in Rule 0-10, 17 CFR 240.0-10. See Securities Exchange

    Act Release No. 18451 (Jan. 28, 1982), 47 FR 5215 (Feb. 4, 1982)

    (File No. AS-305).

    \197\ See 5 U.S.C. 605(b).

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

    For purposes of SEC rulemaking in connection with the RFA, a small

    entity includes: (i) When used with reference to an ``issuer'' or a

    ``person,'' other than an investment company, an ``issuer'' or

    ``person'' that, on the last day of its most recent fiscal year, had

    total assets of $5 million or less,\198\ or (ii) a broker-dealer with

    total capital (net worth plus subordinated liabilities) of less than

    $500,000 on the date in the prior fiscal year as of which its audited

    financial statements were prepared pursuant to Rule 17a-5(d) under the

    Exchange Act,\199\ or, if not required to file such statements, a

    broker-dealer with total capital (net worth plus subordinated

    liabilities) of less than $500,000 on the last day of the preceding

    fiscal year (or in the time that it has been in business, if shorter);

    and is not affiliated with any person (other than a natural person)

    that is not a small business or small organization.\200\ Under the

    standards adopted by the Small Business Administration, small entities

    in the finance and insurance industry include the following: (i) For

    entities engaged in credit intermediation and related activities,

    entities with $175 million or less in assets; \201\ (ii) for entities

    engaged in non-depository credit intermediation and certain other

    activities, entities with $7 million or less in annual receipts; \202\

    (iii) for entities engaged in financial investments and related

    activities, entities with $7 million or less in annual receipts; \203\

    (iv) for insurance carriers and entities engaged in related activities,

    entities with $7 million or less in annual receipts; \204\ and (v) for

    funds, trusts, and other financial vehicles, entities with $7 million

    or less in annual receipts.\205\

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

    \198\ See 17 CFR 240.0-10(a).

    \199\ See 17 CFR 240.17a-5(d).

    \200\ See 17 CFR 240.0-10(c).

    \201\ See 13 CFR 121.201 (Subsector 522).

    \202\ See id. at Subsector 522.

    \203\ See id. at Subsector 523.

    \204\ See id. at Subsector 524.

    \205\ See id. at Subsector 525.

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

    Based on feedback from industry participants about the security-

    based swap markets, the SEC preliminarily believes that entities that

    would qualify as security-based swap dealers and major security-based

    swap market participants, whether registered broker-dealers or not,

    exceed the thresholds defining ``small entities'' set out above. Thus,

    the SEC believes it is unlikely that the proposed rules would have a

    significant economic impact any small entity.

    For the foregoing reasons, the SEC certifies that the proposed

    rules would not have a significant economic impact on a substantial

    number of small entities for purposes of the RFA.

    The SEC encourages written comments regarding this certification.

    The SEC requests that commenters describe the nature of any impact on

    small entities and provide empirical data to illustrate the extent of

    the impact.

    VII. Statutory Basis and Rule Text

    List of Subjects

    17 CFR Part 1

    Definitions.

    17 CFR Part 240

    Reporting and recordkeeping requirements, Securities.

    Commodity Futures Trading Commission

    Text of Proposed Rules

    For the reasons stated in this release, the CFTC is proposing to

    amend 17 CFR part 1 as follows:

    PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT

    1. The authority citation for part 1 is revised to read as follows:

    Authority: 7 U.S.C. 1a, 2, 5, 6, 6a, 6b, 6c, 6d, 6e, 6f, 6g, 6h,

    6i, 6j, 6k, 6l, 6m, 6n, 6o, 6p, 7, 7a, 7b, 8, 9, 12, 12a, 12c, 13a,

    13a-1, 16, 16a, 19, 21, 23, and 24, as amended by Title VII of the

    Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L.

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

    2. Amend Sec. 1.3 by:

    a. Adding paragraph (m); and

    b. As proposed to be amended at 75 FR 63762, October 18, 2010, and

    75 FR 77576, December 13, 2010, adding (ppp) through (vvv) to read as

    follows:

    Sec. 1.3 Definitions

    * * * * *

    (m) Eligible contract participant. This term has the meaning set

    forth in Section 1a(18) of the Commodity Exchange Act, except that:

    (1) A major swap participant, as defined in Section 1a(33) of the

    Commodity Exchange Act and Sec. 1.3(qqq), is an eligible contract

    participant;

    (2) A swap dealer, as defined in Section 1a(49) of the Commodity

    Exchange Act and Sec. 1.3(ppp), is an eligible contract participant;

    (3) A major security-based swap participant, as defined in Section

    3(a)(67) of the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(67))

    and Sec. 240.3a67-1 of this title, is an eligible contract

    participant;

    (4) A security-based swap dealer, as defined in Section 3(a)(71) of

    the

    [[Page 80212]]

    Securities and Exchange Act of 1934 (15 U.S.C. 78c(a)(71)) and Sec.

    240.3a71-1 of this title, is an eligible contract participant;

    (5) A commodity pool with one or more direct or indirect

    participants that is not an eligible contract participant is not an

    eligible contract participant for purposes of Sections 2(c)(2)(B)(vi)

    and 2(c)(2)(C)(vii) of the Commodity Exchange Act; and

    (6) A commodity pool that does not have total assets exceeding

    $5,000,000 or that is not operated by a person described in clause

    (A)(iv)(II) of Section 1a(18) of the Commodity Exchange Act is not an

    eligible contract participant pursuant to clause (A)(v) of such

    Section.

    * * * * *

    (ppp) Swap Dealer. (1) In general. The term ``swap dealer'' means

    any person who:

    (i) Holds itself out as a dealer in swaps;

    (ii) Makes a market in swaps;

    (iii) Regularly enters into swaps with counterparties as an

    ordinary course of business for its own account; or

    (iv) Engages in any activity causing it to be commonly known in the

    trade as a dealer or market maker in swaps.

    (2) Exception. The term ``swap dealer'' does not include a person

    that enters into swaps for such person's own account, either

    individually or in a fiduciary capacity, but not as a part of regular

    business.

    (3) Scope. A person who is a swap dealer shall be deemed to be a

    swap dealer with respect to each swap it enters into, regardless of the

    category of the swap or the person's activities in connection with the

    swap. However, if a person makes an application to limit its

    designation as a swap dealer to specified categories of swaps or

    specified activities of the person in connection with swaps, the

    Commission shall determine whether the person's designation as a swap

    dealer shall be so limited. A person may make such application to limit

    its designation at the same time as, or at a later time subsequent to,

    the person's initial registration as a swap dealer.

    (4) De minimis exception. A person shall not be deemed to be a swap

    dealer as a result of swap dealing activity involving counterparties

    that meets each of the following conditions:

    (i) The swap positions connected with those activities into which

    the person enters over the course of the immediately preceding 12

    months have an aggregate gross notional amount of no more than $100

    million, and have an aggregate gross notional amount of no more than

    $25 million with regard to swaps in which the counterparty is a

    ``special entity'' (as that term is defined in Section 4s(h)(2)(C) of

    the Commodity Exchange Act). For purposes of this paragraph, if the

    stated notional amount of a swap is leveraged or enhanced by the

    structure of the swap, the calculation shall be based on the effective

    notional amount of the swap rather than on the stated notional amount.

    (ii) The person has not entered into swaps in connection with those

    activities with more than 15 counterparties, other than swap dealers,

    over the course of the immediately preceding 12 months. In determining

    the number of counterparties, all counterparties that are members of a

    single group of persons under common control shall be considered to be

    a single counterparty.

    (iii) The person has not entered into more than 20 swaps in

    connection with those activities over the course of the immediately

    preceding 12 months. For purposes of this paragraph, each transaction

    entered into under a master agreement for swaps shall constitute a

    distinct swap, but entering into an amendment of an existing swap in

    which the counterparty to such swap remains the same and the item

    underlying such swap remains substantially the same shall not

    constitute entering into a swap.

    (5) Insured depository institution swaps in connection with

    originating loans to customers. Swaps entered into by an insured

    depository institution with a customer in connection with originating a

    loan with that customer shall not be considered in determining whether

    such person is a swap dealer.

    (i) A swap shall be considered to have been entered into in

    connection with originating a loan only if the rate, asset, liability

    or other notional item underlying such swap is, or is directly related

    to, a financial term of such loan. The financial terms of a loan

    include, without limitation, the loan's duration, rate of interest, the

    currency or currencies in which it is made and its principal amount.

    (ii) An insured depository institution shall be considered to have

    originated a loan with a customer if the insured depository

    institution:

    (A) Directly transfers the loan amount to the customer;

    (B) Is a part of a syndicate of lenders that is the source of the

    loan amount that is transferred to the customer;

    (C) Purchases or receives a participation in the loan; or

    (D) Otherwise is the source of funds that are transferred to the

    customer pursuant to the loan or any refinancing of the loan.

    (iii) The term loan shall not include:

    (A) Any transaction that is a sham, whether or not intended to

    qualify for the exclusion from the definition of the term swap dealer

    in this rule; or

    (B) Any synthetic loan, including without limitation a loan credit

    default swap or loan total return swap.

    (qqq) Major Swap Participant. (1) In general. The term major swap

    participant means any person:

    (i) That is not a swap dealer; and

    (ii)(A) That maintains a substantial position in swaps for any of

    the major swap categories, excluding both positions held for hedging or

    mitigating commercial risk, and positions maintained by any employee

    benefit plan (or any contract held by such a plan) as defined in

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

    Security Act of 1974 (29 U.S.C. 1002) for the primary purpose of

    hedging or mitigating any risk directly associated with the operation

    of the plan;

    (B) Whose outstanding swaps create substantial counterparty

    exposure that could have serious adverse effects on the financial

    stability of the United States banking system or financial markets; or

    (C) That is a financial entity that:

    (1) Is highly leveraged relative to the amount of capital such

    entity holds and that is not subject to capital requirements

    established by an appropriate Federal banking agency (as defined in

    Section 1a(2) of the Commodity Exchange Act); and

    (2) Maintains a substantial position in outstanding swaps in any

    major swap category.

    (2) Scope of designation. A person that is a major swap participant

    shall be deemed to be a major swap participant with respect to each

    swap it enters into, regardless of the category of the swap or the

    person's activities in connection with the swap. However, if a person

    makes an application to limit its designation as a major swap

    participant to specified categories of swaps or specified activities of

    the person in connection with swaps, the Commission shall determine

    whether the person's designation as a major swap participant shall be

    so limited. A person may make such application to limit its designation

    at the same time as, or at a later time subsequent to, the person's

    initial registration as a major swap participant.

    (3) Timing requirements. A person that is not registered as a major

    swap participant, but that meets the criteria in this rule to be a

    major swap participant as a result of its swap activities in a

    [[Page 80213]]

    fiscal quarter, will not be deemed to be a major swap participant until

    the earlier of the date on which it submits a complete application for

    registration as a major swap participant or two months after the end of

    that quarter.

    (4) Reevaluation period. Notwithstanding paragraph (qqq)(3) of this

    section, if a person that is not registered as a major swap participant

    meets the criteria in this rule to be a major swap participant in a

    fiscal quarter, but does not exceed any applicable threshold by more

    than twenty percent in that quarter:

    (i) That person will not immediately be subject to the timing

    requirements specified in paragraph (qqq)(3) of this section; but

    (ii) That person will become subject to the timing requirements

    specified in paragraph (3) at the end of the next fiscal quarter if the

    person exceeds any of the applicable daily average thresholds in that

    next fiscal quarter.

    (5) Termination of status. A person that is deemed to be a major

    swap participant shall continue to be deemed a major swap participant

    until such time that its swap activities do not exceed any of the daily

    average thresholds set forth within this rule for four consecutive

    fiscal quarters after the date on which the person becomes registered

    as a major swap participant.

    (rrr) Category of swaps; major swap category. For purposes of

    Sections 1a(33) and 1a(49) of the Commodity Exchange Act and Sec. Sec.

    1.3(ppp) and 1.3(qqq), the terms major swap category, category of swaps

    and any similar terms mean any of the categories of swaps listed below.

    For the avoidance of doubt, the term swap as it is used in this Sec.

    1.3(rrr) has the meaning set forth in Section 1a(47) of the Commodity

    Exchange Act and the rules thereunder.

    (1) Rate swaps. Any swap which is primarily based on one or more

    reference rates, including but not limited to any swap of payments

    determined by fixed and floating interest rates, currency exchange

    rates, inflation rates or other monetary rates, any foreign exchange

    swap, as defined in Section 1a(25) of the Commodity Exchange Act, and

    any foreign exchange option.

    (2) Credit swaps. Any swap that is primarily based on instruments

    of indebtedness, including but not limited to any swap primarily based

    on one or more broad-based indices related to debt instruments, and any

    swap that is an index credit default swap or total return swap on one

    or more indices of debt instruments.

    (3) Equity swaps. Any swap that is primarily based on equity

    securities, including but not limited to any swap based on one or more

    broad-based indices of equity securities and any total return swap on

    one or more equity indices.

    (4) Other commodity swaps. Any swap that is not included in the

    rate swap, credit swap or equity swap categories.

    (sss) Substantial position. (1) In general. For purposes of Section

    1a(33) of the Commodity Exchange Act and Sec. 1.3(qqq), the term

    substantial position means swap positions, other than positions that

    are excluded from consideration, that equal or exceed any of the

    following thresholds in the specified major category of swaps:

    (i) For rate swaps:

    (A) $3 billion in daily average aggregate uncollateralized outward

    exposure; or

    (B) $6 billion in:

    (1) Daily average aggregate uncollateralized outward exposure plus

    (2) Daily average aggregate potential outward exposure.

    (ii) For credit swaps:

    (A) $1 billion in daily average aggregate uncollateralized outward

    exposure; or

    (B) $2 billion in:

    (1) Daily average aggregate uncollateralized outward exposure plus

    (2) Daily average aggregate potential outward exposure.

    (iii) For equity swaps:

    (A) $1 billion in daily average aggregate uncollateralized outward

    exposure; or

    (B) $2 billion in:

    (1) Daily average aggregate uncollateralized outward exposure plus

    (2) Daily average aggregate potential outward exposure.

    (iv) For other commodity swaps:

    (A) $1 billion in daily average aggregate uncollateralized outward

    exposure; or

    (B) $2 billion in:

    (1) Daily average aggregate uncollateralized outward exposure plus

    (2) Daily average aggregate potential outward exposure.

    (2) Aggregate uncollateralized outward exposure. (i) In general.

    Aggregate uncollateralized outward exposure in general means the sum of

    the current exposure, obtained by marking-to-market using industry

    standard practices, of each of the person's swap positions with

    negative value in a major swap category, less the value of the

    collateral the person has posted in connection with those positions.

    (ii) Calculation of aggregate uncollateralized outward exposure. In

    calculating this amount the person shall, with respect to each of its

    swap counterparties in a given major swap category:

    (A) Determine the dollar value of the aggregate current exposure

    arising from each of its swap positions with negative value (subject to

    the netting provisions described below) in that major category by

    marking-to-market using industry standard practices; and

    (B) Deduct from that dollar amount the aggregate value of the

    collateral the person has posted with respect to the swap positions.

    The aggregate uncollateralized outward exposure shall be the sum of

    those uncollateralized amounts across all of the person's swap

    counterparties in the applicable major category.

    (iii) Relevance of netting agreements. (A) If the person has a

    master netting agreement in effect with a particular counterparty, the

    person may measure the current exposure arising from its swaps in any

    major category on a net basis, applying the terms of the agreement.

    Calculation of net exposure may take into account offsetting positions

    entered into with that particular counterparty involving swaps (in any

    swap category) as well as security-based swaps and securities financing

    transactions (consisting of securities lending and borrowing,

    securities margin lending and repurchase and reverse repurchase

    agreements), to the extent these are consistent with the offsets

    permitted by the master netting agreement.

    (B) Such adjustments may not take into account any offset

    associated with positions that the person has with separate

    counterparties.

    (3) Aggregate potential outward exposure. (i) In general. Aggregate

    potential outward exposure in any major swap category means the sum of:

    (A) The aggregate potential outward exposure for each of the

    person's swap positions in a major swap category that are not subject

    to daily mark-to-market margining and are not cleared by a registered

    clearing agency or derivatives clearing organization, as calculated in

    accordance with paragraph (sss)(3)(ii); and

    (B) The aggregate potential outward exposure for each of the

    person's swap positions in such major swap category that are subject to

    daily mark-to-market margining or are cleared by a registered clearing

    agency or derivatives clearing organization, as calculated in

    accordance with paragraph (sss)(3)(iii) of this section.

    (ii) Calculation of potential outward exposure for swaps that are

    not subject to daily mark-to-market margining and are not cleared by a

    registered clearing

    [[Page 80214]]

    agency or derivatives clearing organization. (A) In general. (1) For

    positions in swaps that are not subject to daily mark-to-market

    margining and are not cleared by a registered clearing agency or a

    derivatives clearing organization, potential outward exposure equals

    the total notional principal amount of those positions, adjusted by the

    following multipliers on a position-by-position basis reflecting the

    type of swap. For any swap that does not appropriately fall within any

    of the specified categories, the ``other commodities'' conversion

    factors are to be used. If a swap is structured such that on specified

    dates any outstanding exposure is settled and the terms are reset so

    that the market value of the swap is zero, the remaining maturity

    equals the time until the next reset date.

    Table to Sec. 1.3 (sss)--Conversion Factor Matrix for Swaps

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

    Foreign exchange Precious metals

    Residual maturity Interest rate rate and gold (except gold) Other commodities

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

    One year or less............ 0.00 0.01 0.07 0.10

    Over one to five years...... 0.005 0.05 0.07 0.12

    Over five years............. 0.015 0.075 0.08 0.15

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

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

    Residual maturity Credit Equity

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

    One year or less.............. 0.10 0.06

    Over one to five years........ 0.10 0.08

    Over five years............... 0.10 0.10

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

    (2) Use of effective notional amounts. If the stated notional

    amount on a position is leveraged or enhanced by the structure of the

    position, the calculation in paragraph (sss)(3)(ii)(A)(1) of this

    section shall be based on the effective notional amount of the position

    rather than on the stated notional amount.

    (3) Exclusion of certain positions. The calculation in paragraph

    (sss)(3)(ii)(A)(1) of this section shall exclude:

    (i) Positions that constitute the purchase of an option, such that

    the person has no additional payment obligations under the position;

    and

    (ii) Other positions for which the person has prepaid or otherwise

    satisfied all of its payment obligations.

    (4) Adjustment for certain positions. Notwithstanding paragraph

    (sss)(3)(ii)(A)(1) of this section, the potential outward exposure

    associated with a position by which a person buys credit protection

    using a credit default swap or index credit default swap is capped at

    the net present value of the unpaid premiums.

    (B) Adjustment for netting agreements. Notwithstanding paragraph

    (sss)(3)(ii)(A) of this section, for positions subject to master

    netting agreements the potential outward exposure associated with the

    person's swaps with each counterparty equals a weighted average of the

    potential outward exposure for the person's swaps with that

    counterparty as calculated under paragraph (sss)(3)(ii)(A), and that

    amount reduced by the ratio of net current exposure to gross current

    exposure, consistent with the following equation as calculated on a

    counterparty-by-counterparty basis:

    PNet = 0.4 * PGross + 0.6 * NGR * PGross

    Note to paragraph (sss)(3)(ii)(B): PNet is the potential outward

    exposure, adjusted for bilateral netting, of the person's swaps with

    a particular counterparty; PGross is that potential outward exposure

    without adjustment for bilateral netting; and NGR is the ratio of

    net current exposure to gross current exposure.

    (iii) Calculation of potential outward exposure for swaps that are

    subject to daily mark-to-market margining or are cleared by a

    registered clearing agency or derivatives clearing organization. For

    positions in swaps that are subject to daily mark-to-market margining

    or cleared by a registered clearing agency or derivatives clearing

    organization:

    (A) Potential outward exposure equals the potential exposure that

    would be attributed to such positions using the procedures in paragraph

    (sss)(3)(ii) of this section multiplied by 0.2.

    (B) For purposes of this calculation, a swap shall be considered to

    be subject to daily mark-to-market margining if, and for so long as,

    the counterparties follow the daily practice of exchanging collateral

    to reflect changes in the current exposure arising from the swap (after

    taking into account any other financial positions addressed by a

    netting agreement between the counterparties. If the person is

    permitted by agreement to maintain a threshold for which it is not

    required to post collateral, the total amount of that threshold

    (regardless of the actual exposure at any time) shall be added to the

    person's aggregate uncollateralized outward exposure for purposes of

    paragraph (sss)(1)(i)(B), (ii)(B), (iii)(B) or (iv)(B) of this section,

    as applicable. If the minimum transfer amount under the agreement is in

    excess of $1 million, the entirety of the minimum transfer amount shall

    be added to the person's aggregate uncollateralized outward exposure

    for purposes of paragraph (sss)(1)(i)(B), (ii)(B), (iii)(B) or (iv)(B),

    as applicable.

    (4) Calculation of daily average. Measures of daily average

    aggregate uncollateralized outward exposure and daily average aggregate

    potential outward exposure shall equal the arithmetic mean of the

    applicable measure of exposure at the close of each business day,

    beginning the first business day of each calendar quarter and

    continuing through the last business day of that quarter.

    (ttt) Hedging or mitigating commercial risk. For purposes of

    Section 1a(33) of the Commodity Exchange Act and Sec. 1.3(qqq), a swap

    position shall be deemed to be held for the purpose of hedging or

    mitigating commercial risk when:

    (1) Such position:

    (i) Is economically appropriate to the reduction of risks in the

    conduct and management of a commercial enterprise, where the risks

    arise from:

    (A) The potential change in the value of assets that a person owns,

    produces, manufactures, processes, or merchandises or reasonably

    anticipates owning, producing, manufacturing, processing, or

    merchandising in the ordinary course of business of the enterprise;

    (B) The potential change in the value of liabilities that a person

    has incurred or reasonably anticipates incurring in the ordinary course

    of business of the enterprise; or

    (C) The potential change in the value of services that a person

    provides, purchases, or reasonably anticipates

    [[Page 80215]]

    providing or purchasing in the ordinary course of business of the

    enterprise;

    (D) The potential change in the value of assets, services, inputs,

    products, or commodities that a person owns, produces, manufactures,

    processes, merchandises, leases, or sells, or reasonably anticipates

    owning, producing, manufacturing, processing, merchandising, leasing,

    or selling in the ordinary course of business of the enterprise;

    (E) Any potential change in value related to any of the foregoing

    arising from foreign exchange rate movements associated with such

    assets, liabilities, services, inputs, products, or commodities; or

    (F) Any fluctuation in interest, currency, or foreign exchange rate

    exposures arising from a person's current or anticipated assets or

    liabilities; or

    (ii) Qualifies as bona fide hedging for purposes of an exemption

    from position limits under the Commodity Exchange Act; or

    (iii) Qualifies for hedging treatment under Financial Accounting

    Standards Board Accounting Standards Codification Topic 815,

    Derivatives and Hedging (formerly known as Statement No. 133); and

    (2) Such position is:

    (i) Not held for a purpose that is in the nature of speculation,

    investing or trading;

    (ii) Not held to hedge or mitigate the risk of another swap or

    securities-based swap position, unless that other position itself is

    held for the purpose of hedging or mitigating commercial risk as

    defined by this rule or Sec. 240.3a67-4 of this title.

    (uuu) Substantial counterparty exposure. (1) In general. For

    purposes of Section 1a(33) of the Act and Sec. 1.3(qqq), the phrase

    substantial counterparty exposure that could have serious adverse

    effects on the financial stability of the United States banking system

    or financial markets means a swap position that satisfies either of the

    following thresholds:

    (i) $5 billion in daily average aggregate uncollateralized outward

    exposure; or

    (ii) $8 billion in:

    (A) Daily average aggregate uncollateralized outward exposure plus

    (B) Daily average aggregate potential outward exposure.

    (2) Calculation methodology. For these purposes, the terms ``daily

    average aggregate uncollateralized outward exposure'' and ``daily

    average aggregate potential outward exposure'' have the same meaning as

    in Sec. 1.3(sss), except that these amounts shall be calculated by

    reference to all of the person's swap positions, rather than by

    reference to a specific major swap category.

    (vvv) Financial entity; highly leveraged. (1) For purposes of

    Section 1a(33) of the Commodity Exchange Act and Sec. 1.3(qqq), the

    term ``financial entity'' means:

    (i) A security-based swap dealer;

    (ii) A major security-based swap participant;

    (iii) A commodity pool as defined in Section 1a(10) of the

    Commodity Exchange Act;

    (iv) A private fund as defined in Section 202(a) of the Investment

    Advisers Act of 1940 (15 U.S.C. 80b-2(a));

    (v) An employee benefit plan as defined in paragraphs (3) and (32)

    of Section 3 of the Employee Retirement Income Security Act of 1974 (29

    U.S.C. 1002); and

    (vi) A person predominantly engaged in activities that are in the

    business of banking or financial in nature, as defined in Section 4(k)

    of the Bank Holding Company Act of 1956.

    (2) For purposes of Section 1a(33) of the Commodity Exchange Act

    and Sec. 1.3(qqq), the term ``highly leveraged'' means the existence

    of a ratio of an entity's total liabilities to equity in excess of [8

    to 1 or 15 to 1] as measured at the close of business on the last

    business day of the applicable fiscal quarter. For this purpose,

    liabilities and equity should each be determined in accordance with

    U.S. generally accepted accounting principles.

    Securities and Exchange Commission

    Pursuant to the Exchange Act, 15 U.S.C. 78a et seq., and

    particularly, Sections 3 and 23 thereof, and Sections 712 and 761(b) of

    the Dodd-Frank Act, the SEC is proposing to adopt Rules 3a67-1, 3a67-2,

    3a67-3, 3a67-4, 3a67-5, 3a67-6, 3a67-7, 3a71-1, and 3a71-2 under the

    Exchange Act.

    Text of Proposed Rules

    For the reasons stated in the preamble, the SEC is proposing to

    amend Title 17, Chapter II of the Code of the Federal Regulations as

    follows:

    PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF

    1934

    1. The authority citation for part 240 is amended by adding the

    following citation in numerical order:

    Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3,

    77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78d, 78e, 78f, 78g, 78i,

    78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78o, 78o-4, 78p, 78q, 78s,

    78u-5, 78w, 78x, 78ll, 78mm, 80a-20, 80a-23, 80a-29, 80a-37, 80b-3,

    80b-4, 80b-11, and 7201 et seq., 18 U.S.C. 1350; and 12 U.S.C.

    5221(e)(3), unless otherwise noted.

    * * * * *

    Sections 3a67-1 through 3a67-7 and sections 3a71-1 and 3a71-2

    are also issued under Pub. L. 111-203, Sec. Sec. 712, 761(b), 124

    Stat. 1841 (2010).

    * * * * *

    2. Add Sec. Sec. 240.3a67-1 through 240.3a67-7 and Sec. Sec.

    240.3a71-1, 240.3a71-2 to read as follows:

    * * * * *

    Sec.

    240.3a67 1--Definition of ``Major Security-based Swap Participant.''

    240.3a67 2--Categories of Security-based Swaps.

    240.3a67 3--Definition of ``Substantial Position.''

    240.3a67 4--Definition of ``Hedging or Mitigating Commercial Risk.''

    240.3a67 5--Definition of ``Substantial Counterparty Exposure.''

    240.3a67 6--Definitions of ``Financial Entity'' and ``Highly

    Leveraged.''

    240.3a67 7--Timing Requirements, Reevaluation Period, and

    Termination of Status.

    240.3a71 1--Definition of ``Security-based Swap Dealer.

    240.3a71 2--De minimis Exception.

    * * * * *

    Sec. 240.3a67-1 Definition of ``Major Security-based Swap

    Participant.''

    (a) General. Major security-based swap participant means any

    person:

    (1) That is not a security-based swap dealer; and

    (2)(i) That maintains a substantial position in security-based

    swaps for any of the major security-based swap categories, excluding

    both positions held for hedging or mitigating commercial risk, and

    positions maintained by any employee benefit plan (or any contract held

    by such a plan) as defined in paragraphs (3) and (32) of section 3 of

    the Employee Retirement Income Security Act of 1974 (29 U.S.C. 1002)

    for the primary purpose of hedging or mitigating any risk directly

    associated with the operation of the plan;

    (ii) Whose outstanding security-based swaps create substantial

    counterparty exposure that could have serious adverse effects on the

    financial stability of the United States banking system or financial

    markets; or

    (iii) That is a financial entity that:

    (A) Is highly leveraged relative to the amount of capital such

    entity holds and that is not subject to capital requirements

    established by an appropriate Federal banking agency (as defined in 15

    U.S.C. 78c(a)(72)); and

    (B) Maintains a substantial position in outstanding security-based

    swaps in any major security-based swap category.

    [[Page 80216]]

    (b) Scope of designation. A person that is a major security-based

    swap participant in general shall be deemed to be a major security-

    based swap participant with respect to each security-based swap it

    enters into, regardless of the category of the security-based swap or

    the person's activities in connection with the security-based swap,

    unless the Commission limits the person's designation as a major

    security-based swap participant to specified categories of security-

    based swaps or specified activities of the person in connection with

    security-based swaps.

    Sec. 240.3a67-2 Categories of Security-based Swaps.

    For purposes of sections 3(a)(67) and 3(a)(71) of the Act, 15

    U.S.C. 78c(a)(67) and 78c(a)(71), and the rules thereunder, the terms

    major security-based swap category, category of security-based swaps

    and any similar terms mean either of the following categories of

    security-based swaps:

    (a) Security-based credit derivatives. Any security-based swap that

    is based, in whole or in part, on one or more instruments of

    indebtedness (including loans), or on a credit event relating to one or

    more issuers or securities, including but not limited to any security-

    based swap that is a credit default swap, total return swap on one or

    more debt instruments, debt swap, debt index swap, or credit spread.

    (b) Other security-based swaps. Any security-based swap not

    described in paragraph (a) of this section.

    Sec. 240.3a67-3 Definition of ``Substantial Position.''

    (a) General. For purposes of section 3(a)(67) of the Act, 15 U.S.C.

    78c(a)(67), and Sec. 240.3a67-1 of this chapter, the term substantial

    position means security-based swap positions, other than positions that

    are excluded from consideration, that equal or exceed either of the

    following thresholds in any major category of security-based swaps:

    (1) $1 billion in daily average aggregate uncollateralized outward

    exposure; or

    (2) $2 billion in:

    (i) Daily average aggregate uncollateralized outward exposure; plus

    (ii) Daily average aggregate potential outward exposure.

    (b) Aggregate uncollateralized outward exposure. (1) General.

    Aggregate uncollateralized outward exposure in general means the sum of

    the current exposure, obtained by marking-to-market using industry

    standard practices, of each of the person's security-based swap

    positions with negative value in a major security-based swap category,

    less the value of the collateral the person has posted in connection

    with those positions.

    (2) Calculation of aggregate uncollateralized outward exposure. In

    calculating this amount the person shall, with respect to each of its

    security-based swap counterparties in a given major security-based swap

    category:

    (i) Determine the dollar value of the aggregate current exposure

    arising from each of its security-based swap positions with negative

    value (subject to the netting provisions described below) in that major

    category by marking-to-market using industry standard practices; and

    (ii) Deduct from that dollar amount the aggregate value of the

    collateral the person has posted with respect to the security-based

    swap positions. The aggregate uncollateralized outward exposure shall

    be the sum of those uncollateralized amounts across all of the person's

    security-based swap counterparties in the applicable major category.

    (3) Relevance of netting agreements. (i) If a person has a master

    netting agreement with a counterparty, the person may measure the

    current exposure arising from its security-based swaps in any major

    category on a net basis, applying the terms of the agreement.

    Calculation of net exposure may take into account offsetting positions

    entered into with that particular counterparty involving security-based

    swaps (in any swap category) as well as swaps and securities financing

    transactions (consisting of securities lending and borrowing,

    securities margin lending and repurchase and reverse repurchase

    agreements), to the extent these are consistent with the offsets

    permitted by the master netting agreement.

    (ii) Such adjustments may not take into account any offset

    associated with positions that the person has with separate

    counterparties.

    (c) Aggregate potential outward exposure. (1) General. Aggregate

    potential outward exposure means the sum of:

    (i) The aggregate potential outward exposure for each of the

    person's security-based swap positions in a major security-based swap

    category that are not cleared by a registered clearing agency or

    subject to daily mark-to-market margining, as calculated in accordance

    with paragraph (c)(2) of this section; and

    (ii) The aggregate potential outward exposure for each of the

    person's security-based swap positions in a major security-based swap

    category that are cleared by a registered clearing agency or subject to

    daily mark-to-market margining, as calculated in accordance with

    paragraph (c)(3) of this section.

    (2) Calculation of potential outward exposure for security-based

    swaps that are not cleared by a registered clearing agency or subject

    to daily mark-to-market margining.

    (i) General. (A)(1) For positions in security-based swaps that are

    not cleared by a registered clearing agency or subject to daily mark-

    to-market margining, potential outward exposure equals the total

    notional principal amount of those positions, multiplied by the

    following factors on a position-by-position basis reflecting the type

    of security-based swap. For any security-based swap that is not of the

    ``credit'' or ``equity'' type, the ``other'' conversion factors are to

    be used:

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

    Residual maturity Credit Equity Other

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

    One year or less................................. 0.10 0.06 0.10

    Over one to five years........................... 0.10 0.08 0.12

    Over five years.................................. 0.10 0.10 0.15

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

    (2) If a security-based swap is structured such that on specified

    dates any outstanding exposure is settled and the terms are reset so

    that the market value of the security-based swap is zero, the remaining

    maturity equals the time until the next reset date.

    (B) Use of effective notional amounts. If the stated notional

    amount on a position is leveraged or enhanced by the structure of the

    position, the calculation in paragraph (c)(2)(i)(A) of this section

    shall be based on the effective notional amount of the position rather

    than on the stated notional amount.

    [[Page 80217]]

    (C) Exclusion of certain positions. The calculation in paragraph

    (c)(2)(i)(A) of this section shall exclude:

    (1) Positions that constitute the purchase of an option, such that

    the person has no additional payment obligations under the position;

    and

    (2) Other positions for which the person has prepaid or otherwise

    satisfied all of its payment obligations.

    (D) Adjustment for certain positions. Notwithstanding paragraph

    (c)(2)(i)(A) of this section, the potential outward exposure associated

    with a position by which a person buys credit protection using a credit

    default swap is capped at the net present value of the unpaid premiums.

    (ii) Adjustment for netting agreements. Notwithstanding paragraph

    (c)(2)(i) of this section, for positions subject to master netting

    agreements the potential outward exposure associated with the person's

    security-based swaps with each counterparty equals a weighted average

    of the potential outward exposure for the person's security-based swaps

    with that counterparty as calculated under paragraph (c)(2)(i) of this

    section, and that amount reduced by the ratio of net current exposure

    to gross current exposure, consistent with the following equation as

    calculated on a counterparty-by-counterparty basis:

    PNet = 0.4 x PGross + 0.6 x NGR x PGross

    Note to paragraph (c)(2)(ii). Where: PNet is the potential

    outward exposure, adjusted for bilateral netting, of the person's

    security-based swaps with a particular counterparty; PGross is that

    potential outward exposure without adjustment for bilateral netting;

    and NGR is the ratio of net current exposure to gross current

    exposure.

    (3) Calculation of potential outward exposure for security-based

    swaps that are cleared by a registered clearing agency or subject to

    daily mark-to-market margining. For positions in security-based swaps

    that are cleared by a registered clearing agency or subject to daily

    mark-to-market margining:

    (i) Potential outward exposure equals the potential outward

    exposure that would be attributed to such positions using the

    procedures in paragraph (c)(2) of this section, multiplied by 0.2.

    (ii) For purposes of this calculation, a security-based swap shall

    be considered to be subject to daily mark-to-market margining if, and

    for as long as, the counterparties follow the daily practice of

    exchanging collateral to reflect changes in the current exposure

    arising from the security-based swap (after taking into account any

    other financial positions addressed by a netting agreement between the

    counterparties). If the person is permitted by agreement to maintain a

    threshold for which it is not required to post collateral, the total

    amount of that threshold (regardless of the actual exposure at any

    time) shall be added to the person's aggregate uncollateralized outward

    exposure for purposes of paragraph (a)(2) of this section. If the

    minimum transfer amount under the agreement is in excess of $1 million,

    the entirety of the minimum transfer amount shall be added to the

    person's aggregate uncollateralized outward exposure for purposes of

    paragraph (a)(2) of this section.

    (d) Calculation of daily average. Measures of daily average

    aggregate uncollateralized outward exposure and daily average aggregate

    potential outward exposure shall equal the arithmetic mean of the

    applicable measure of exposure at the close of each business day,

    beginning the first business day of each calendar quarter and

    continuing through the last business day of that quarter.

    Sec. 240.3a67-4 Definition of ``Hedging or Mitigating Commercial

    Risk.''

    For purposes of section 3(a)(67) of the Act, 15 U.S.C. 78c(a)(67),

    and Sec. 240.3a67-1 of this chapter, a security-based swap position

    shall be deemed to be held for the purpose of hedging or mitigating

    commercial risk when:

    (a) Such position is economically appropriate to the reduction of

    risks that are associated with the present conduct and management of a

    commercial enterprise, or are reasonably expected to arise in the

    future conduct and management of the commercial enterprise, where such

    risks arise from:

    (1) The potential change in the value of assets that a person owns,

    produces, manufactures, processes, or merchandises or reasonably

    anticipates owning, producing, manufacturing, processing, or

    merchandising in the ordinary course of business of the enterprise;

    (2) The potential change in the value of liabilities that a person

    has incurred or reasonably anticipates incurring in the ordinary course

    of business of the enterprise; or

    (3) The potential change in the value of services that a person

    provides, purchases, or reasonably anticipates providing or purchasing

    in the ordinary course of business of the enterprise;

    (b) Such position is:

    (1) Not held for a purpose that is in the nature of speculation or

    trading; and

    (2) Not held to hedge or mitigate the risk of another security-

    based swap position or swap position, unless that other position itself

    is held for the purpose of hedging or mitigating commercial risk as

    defined by this section or 17 CFR 1.3(ttt); and

    (c) The person holding the position satisfies the following

    additional conditions:

    (1) The person identifies and documents the risks that are being

    reduced by the security-based swap position;

    (2) The person establishes and documents a method of assessing the

    effectiveness of the security-based swap as a hedge; and

    (3) The person regularly assesses the effectiveness of the

    security-based swap as a hedge.

    Sec. 240.3a67-5 Definition of ``Substantial Counterparty Exposure.''

    (a) General. For purposes of section 3(a)(67) of the Act, 15 U.S.C.

    78c(a)(67), and Sec. 240.3a67-1 of this chapter, the term substantial

    counterparty exposure that could have serious adverse effects on the

    financial stability of the United States banking system or financial

    markets means a security-based swap position that satisfies either of

    the following thresholds:

    (1) $2 billion in daily average aggregate uncollateralized outward

    exposure; or

    (2) $4 billion in:

    (i) Daily average aggregate uncollateralized outward exposure; plus

    (ii) Daily average aggregate potential outward exposure.

    (b) Calculation. For these purposes, daily average aggregate

    uncollateralized outward exposure and daily average aggregate potential

    outward exposure shall be calculated the same way as is prescribed in

    Sec. 240.3a67-3 of this chapter, except that these amounts shall be

    calculated by reference to all of the person's security-based swap

    positions, rather than by reference to a specific major security-based

    swap category.

    Sec. 240.3a67-6 Definitions of ``Financial Entity'' and ``Highly

    Leveraged.''

    (a) For purposes of section 3(a)(67) of the Act, 15 U.S.C.

    78c(a)(67), and Sec. 240.3a67-1 of this chapter, the term financial

    entity means:

    (1) A swap dealer;

    (2) A major swap participant;

    (3) A commodity pool as defined in section 1a(10) of the Commodity

    Exchange Act (7 U.S.C. 1a(10));

    (4) A private fund as defined in section 202(a) of the Investment

    Advisers Act of 1940 (15 U.S.C. 80b-2(a));

    (5) An employee benefit plan as defined in paragraphs (3) and (32)

    of section 3 of the Employee Retirement Income Security Act of 1974 (29

    U.S.C. 1002); and

    [[Page 80218]]

    (6) A person predominantly engaged in activities that are in the

    business of banking or financial in nature, as defined in section 4(k)

    of the Bank Holding Company Act of 1956 (12 U.S.C. 1843k).

    (b) For purposes of section 3(a)(67) of the Act, 15 U.S.C.

    78c(a)(67), and Sec. 240.3a67-1 of this chapter, the term highly

    leveraged means the existence of a ratio of an entity's total

    liabilities to equity in excess of [8 to 1 or 15 to 1] as measured at

    the close of business on the last business day of the applicable fiscal

    quarter. For this purpose, liabilities and equity should each be

    determined in accordance with U.S. generally accepted accounting

    principles.

    Sec. 240.3a67-7 Timing Requirements, Reevaluation Period, and

    Termination of Status.

    (a) Timing requirements. A person that is not registered as a major

    security-based swap participant, but that meets the criteria in Sec.

    240.3a67-1 of this chapter to be a major security-based swap

    participant as a result of its security-based swap activities in a

    fiscal quarter, will not be deemed to be a major security-based swap

    participant until the earlier of the date on which it submits a

    complete application for registration pursuant to 15 U.S.C. 78o-8 or

    two months after the end of that quarter.

    (b) Reevaluation period. Notwithstanding paragraph (a) of this

    section, if a person that is not registered as a major security-based

    swap participant meets the criteria in Sec. 240.3a67-1 of this chapter

    to be a major security-based swap participant in a fiscal quarter, but

    does not exceed any applicable threshold by more than twenty percent in

    that quarter:

    (1) That person will not immediately be subject to the timing

    requirements specified in paragraph (a) of this section; but

    (2) That person will become subject to the timing requirements

    specified in paragraph (a) of this section at the end of the next

    fiscal quarter if the person exceeds any of the applicable daily

    average thresholds in that next fiscal quarter.

    (c) Termination of status. A person that is deemed to be a major

    security-based swap participant shall continue to be deemed a major

    security-based swap participant until such time that its security-based

    swap activities do not exceed any of the daily average thresholds set

    forth within Sec. 240.3a67-1 of this chapter for four consecutive

    fiscal quarters after the date on which the person becomes registered

    as a major security-based swap participant.

    Sec. 240.3a71-1 Definition of ``Security-based Swap Dealer.''

    (a) General. The term security-based swap dealer in general means

    any person who:

    (1) Holds itself out as a dealer in security-based swaps;

    (2) Makes a market in security-based swaps;

    (3) Regularly enters into security-based swaps with counterparties

    as an ordinary course of business for its own account; or

    (4) Engages in any activity causing it to be commonly known in the

    trade as a dealer or market maker in security-based swaps.

    (b) Exception. The term security-based swap dealer does not include

    a person that enters into security-based swaps for such person's own

    account, either individually or in a fiduciary capacity, but not as a

    part of regular business.

    (c) Scope of designation. A person that is a security-based swap

    dealer in general shall be deemed to be a security-based swap dealer

    with respect to each security-based swap it enters into, regardless of

    the category of the security-based swap or the person's activities in

    connection with the security-based swap, unless the Commission limits

    the person's designation as a major security-based swap participant to

    specified categories of security-based swaps or specified activities of

    the person in connection with security-based swaps.

    Sec. 240.3a71-2 De minimis Exception.

    For purposes of section 3(a)(71) of the Act, 15 U.S.C. 78c(a)(71),

    and Sec. 240.3a71-1 of this chapter, a person shall not be deemed to

    be a security-based swap dealer as a result of security-based swap

    dealing activity involving counterparties that meets each of the

    following conditions:

    (a) Notional amount of outstanding security-based swap positions.

    The security-based swap positions connected with those activities into

    which the person enters over the course of the immediately preceding 12

    months have an aggregate gross notional amount of no more than $100

    million and have an aggregate gross notional amount of no more than $25

    million with regard to security-based swaps in which the counterparty

    is a ``special entity'' (as that term is defined in 15 U.S.C. 78o-8).

    For purposes of this paragraph (a), if the stated notional amount of a

    security-based swap is leveraged or enhanced by the structure of the

    security-based swap, the calculation shall be based on the effective

    notional amount of the security-based swap rather than on the stated

    notional amount.

    (b) No more than 15 counterparties. The person does not enter into

    security-based swaps in connection with those activities with more than

    15 counterparties, other than security-based swap dealers, over the

    course of the immediately preceding 12 months. In determining the

    number of counterparties, all counterparties that are members of a

    single affiliated group shall be considered to be a single

    counterparty.

    (c) No more than 20 security-based swaps. The person has not

    entered into more than 20 security-based swaps in connection with those

    activities over the course of the immediately preceding 12 months. For

    purposes of this paragraph, each transaction entered into under a

    master agreement for security-based swaps shall constitute a distinct

    security-based swap, but entering into an amendment of an existing

    security-based swap in which the counterparty to such swap remains the

    same and the notional item underlying such security-based swap remains

    substantially the same shall not constitute entering into a security-

    based swap.

    Dated: December 1, 2010.

    By the Commodity Futures Trading Commission.

    David A. Stawick,

    Secretary.

    Dated: December 7, 2010.

    By the Securities and Exchange Commission.

    Elizabeth M. Murphy,

    Secretary.

    Additional Statement by the Commodity Futures Trading Commission

    Regarding the Joint Proposed Rule Entitled ``Further Definition of

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

    `Major Security-Based Swap Participant,' and `Eligible Contract

    Participant.'''

    On this matter, Chairman Gensler and Commissioners Dunn and Chilton

    voted in the affirmative; Commissioners Sommers and O'Malia voted in

    the negative.

    [FR Doc. 2010-31130 Filed 12-20-10; 8:45 am]

    BILLING CODE 6351-01-P; 8011-01-P

    Last Updated: May 3, 2011