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2010-31578

  • FR Doc 2010-31578[Federal Register: December 23, 2010 (Volume 75, Number 246)]

    [Proposed Rules]

    [Page 80747-80758]

    From the Federal Register Online via GPO Access [wais.access.gpo.gov]

    [DOCID:fr23de10-23]

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    COMMODITY FUTURES TRADING COMMISSION

    17 CFR Part 39

    RIN 3038-AD10

    End-User Exception to Mandatory Clearing of Swaps

    AGENCY: Commodity Futures Trading Commission.

    ACTION: Proposed rule.

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

    ``Commission'') is proposing new requirements governing the elective

    exception to mandatory clearing of swaps available for swap

    counterparties meeting certain conditions under Section 2(h)(7) of the

    Commodity Exchange Act, as amended by the Dodd-Frank Wall Street Reform

    and Consumer Protection Act. The Commission is requesting comments on

    the proposed rule and related matters.

    DATES: Comments must be received on or before February 22, 2011.

    ADDRESSES: You may submit comments, identified by RIN number 3038-AD10,

    by any of the following methods:

    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 of the Commission,

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

    Street, NW., Washington, DC 20581.

    Hand Delivery/Courier: Same as mail above.

    Federal eRulemaking Portal: http://www.regulations.gov.

    Follow instructions for submitting comments.

    Please submit your comments using only one method. All comments

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

    translation. Comments will be posted as received to http://

    www.cftc.gov. You should submit only information that you wish to make

    [[Page 80748]]

    available publicly. If you wish the Commission to consider information

    that is exempt from disclosure under the Freedom of Information Act, a

    petition or confidential treatment of the exempt information may be

    submitted according to the established procedures in Sec. 145.9 of the

    Commission's regulations.\1\ The Commission reserves the right, but

    shall have no obligation, to review, pre-screen, filter, redact,

    refuse, or remove any or all of your submission from http://

    www.cftc.gov that it may deem to be inappropriate for publication, such

    as obscene language. All submissions that have been redacted or removed

    that contain comments on the merits of the rulemaking will be retained

    in the public comment file and will be considered as required under the

    Administrative Procedure Act and other applicable laws, and may be

    accessible under the Freedom of Information Act.

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    \1\ 17 CFR 145.9.

    FOR FURTHER INFORMATION CONTACT: Lee Ann Duffy, Assistant General

    Counsel, (202) 418-6763, lduffy@cftc.gov, or Mark Fajfar, Assistant

    General Counsel, (202) 418-6636, mfajfar@cftc.gov, Office of General

    Counsel, Commodity Futures Trading Commission, Three Lafayette Centre,

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

    SUPPLEMENTARY INFORMATION: The Commission is proposing Sec. 39.6 to

    govern the elective exception to mandatory clearing of swaps available

    to swap counterparties meeting certain conditions. The Commission is

    requesting comments on all aspects of the proposed rules and related

    matters. The Commission will carefully consider any comments received

    and will respond as necessary or appropriate.

    I. Introduction

    The Commodity Exchange Act (``CEA'' or ``Act''),\2\ as amended by

    Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection

    Act (``Dodd-Frank Act'' or ``DFA''),\3\ establishes a comprehensive new

    regulatory framework for swaps, security-based swaps, and related

    instruments. The Dodd-Frank Act was enacted to reduce risk, increase

    transparency, and promote market integrity within the financial system

    by, among other things: (1) Providing for the registration and

    comprehensive regulation of swap dealers and major swap participants;

    (2) imposing clearing and trade execution requirements on standardized

    derivative products; (3) creating rigorous recordkeeping and real-time

    reporting regimes; and (4) enhancing the Commission's rulemaking and

    enforcement authorities over all registered entities and intermediaries

    subject to the Commission's oversight.

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    \2\ 7 U.S.C. 1 et seq.

    \3\ See Dodd-Frank Wall Street Reform and Consumer Protection

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

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    The Dodd-Frank Act amended the CEA to require that: (1) Swaps be

    cleared through a derivatives clearing organization (``DCO'') if they

    are of a type that the Commission determines must be cleared, unless an

    exception from mandatory clearing applies; (2) swaps be reported to a

    registered swap data repository (``SDR'') or the Commission; and (3) if

    a swap is subject to a clearing requirement, it be executed on a

    registered trading platform, i.e., a swap execution facility or a

    designated contract market (``DCM''), unless no facility or market is

    available for execution of such swap.\4\

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    \4\ The Dodd-Frank Act amends the Securities Exchange Act of

    1934 (``Exchange Act'') to provide for a similar regulatory

    framework for transactions in security-based swaps regulated by the

    Securities and Exchange Commission (``SEC'').

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    CEA Section 2(h)(1) provides that it shall be unlawful for any

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

    clearing to a DCO if the swap is required to be cleared.\5\ However,

    Section 2(h)(7) of the CEA also provides that a swap otherwise subject

    to mandatory clearing is subject to an elective exception from clearing

    if one party to the swap is not a financial entity, is using swaps to

    hedge or mitigate commercial risk, and notifies the Commission, in a

    manner set forth by the Commission, how it generally meets its

    financial obligations associated with entering into non-cleared swaps

    (the ``end-user clearing exception'').\6\

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    \5\ See Process for Review of Swaps for Mandatory Clearing, 75

    FR 67277 (Nov. 2, 2010).

    \6\ When entering into a swap with a swap dealer or a major swap

    participant, non-financial counterparties are granted a right to

    forgo the exception and require clearing for a swap subject to a

    clearing mandate from the Commission. Non-financial counterparties

    are granted a similar elective right regarding clearing where a swap

    has been listed for clearing, but is not the subject of a Commission

    clearing mandate. See CEA Section 2(h)(7)(E). The choice to require

    or forgo clearing is solely at the nonfinancial counterparty's

    discretion. See CEA Section 2(h)(7)(B).

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    The Dodd-Frank Act provides the Commission with authority to adopt

    rules governing the end-user clearing exception and to prescribe rules,

    issue interpretations, or request information from persons claiming the

    end-user clearing exception necessary to prevent abuse of the

    exception. The Commission is also required to consider whether to

    except small banks, savings associations, farm credit system

    institutions, and credit unions from the definition of ``financial

    entity'' contained in CEA Section 2(h)(7)(C)(ii).

    The Commission is proposing Sec. 39.6 to specify requirements for

    electing to use, and facilitating compliance with, the exception to

    mandatory clearing of swaps established by CEA Section 2(h)(7). The

    Commission is also requesting comments regarding the requirements that

    should apply to small banks, savings associations, farm credit system

    institutions, and credit unions that may wish to elect to use this

    clearing exception.

    II. Description of Proposed Rule

    A. Notification to the Commission

    A non-financial entity \7\ that enters into a swap to hedge or

    mitigate commercial risk must notify the Commission how it generally

    meets its financial obligations associated with non-cleared swaps in

    order to use the end-user clearing exception. The CEA authorizes the

    Commission to establish the manner of notification and to prescribe

    such rules as may be necessary to prevent abuse of the end-user

    clearing exception. The Commission is proposing in Sec. 39.6(b) to

    require non-financial entities to notify the Commission each time the

    end-user clearing exception is elected by delivering specified

    information to an SDR in the manner required by proposed rules for

    swaps data recordkeeping and reporting.\8\ The specified information

    would be

    [[Page 80749]]

    delivered to the SDR by the reporting counterparty defined in the swap

    data recordkeeping and reporting rules together with other information

    regarding the swap that is subject to the end-user clearing exception

    to form the central record of the swap held by the SDR.

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    \7\ CEA Section 2(h)(7)(A)(i) limits availability of the end-

    user clearing exception to counterparties to the swap that are not a

    financial entity. The term financial entity is defined in CEA

    Section 2(h)(7)(C)(i), and includes the following eight entities:

    (i) A swap dealer; (ii) a security-based swap dealer; (iii) a major

    swap participant; (iv) a major security-based swap participant; (v)

    a commodity pool as defined in CEA Section 1a(10); (vi) a private

    fund as defined in section 202(a) of the Investment Advisers Act of

    1940 (15 U.S.C. 80b-2(a)); (vii) 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); or (viii) 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. 1843(k)). Four of these

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

    swap dealer'' and ``major security-based swap participant'' are

    themselves the subject of current proposed joint rulemaking by the

    Commission and the SEC. See Further Definition of Swap Dealer,

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

    Based Swap Participant and Eligible Contract Participant, approved

    by the Commission on December 1, 2010, to be published in the

    Federal Register on December 21, 2010.

    \8\ See Swap Data Recordkeeping and Reporting Requirements, 75

    FR 76573, December 8, 2010. The recordkeeping and reporting rules

    contemplate that this information may be delivered to the Commission

    directly in limited circumstances when an SDR is not available. When

    permitted, such delivery would also meet the end-user clearing

    exception notice requirement.

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    Under the approach set forth in proposed Sec. 39.6(b), whenever

    the end-user clearing exception is elected, ten additional items of

    information would be required to be provided to the SDR. If the

    counterparty electing to use the end-user clearing exception is an

    issuer of securities under Exchange Act Section 12 or required to file

    periodic reports with the SEC under Exchange Act Section 15(d), two

    further items of information would be required: the electing

    counterparty's SEC Central Index Key number, and whether the

    appropriate governing body of that counterparty has reviewed and

    approved the decision not to clear the swap.

    1. Meeting Financial Obligations

    A non-financial entity electing to use the end-user clearing

    exception must notify the Commission of ``how it generally meets its

    financial obligations associated with non-cleared swaps'' (``Financial

    Obligation Notice''). See CEA Section 2(h)(7)(A)(iii). A principal

    feature distinguishing cleared swaps from non-cleared swaps is that

    non-cleared swaps do not have a uniform method of mitigating

    counterparty credit risk.\9\ Proposed Sec. 39.6(b)(5) would require a

    person relying on the end-user clearing exception to provide additional

    information regarding the methods used to mitigate credit risk in

    connection with non-cleared swaps. If more than one method is used by

    the person electing to use the end-user clearing exception, information

    must be provided for each of the methods being used.

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    \9\ See ``ISDA Collateral Steering Committee, Market Review of

    OTC Derivative Bilateral Collateralization Practices (2.0)''

    (available at http://www.idsa.org/c_and_a/pdf/Collateral-Market-

    Review.pdf) (``ISDA Collateralization Practices'')(describing

    methods of risk mitigation used in connection with swaps and key

    legal foundations supporting collateralization).

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    a. Credit Support

    Proposed Sec. 39.6(b)(5)(i) requires an indication of whether a

    written credit support agreement is being used with respect to the non-

    financial entity or entities in connection with the non-cleared swap.

    For these purposes, the term credit support agreement may refer to any

    agreement, or annex, amendment or supplement to another agreement,

    which contemplates the periodic transfer of specified collateral to or

    from another party to support payment obligations associated with the

    swap or a related portfolio, basket or other combination of securities,

    swaps and other instruments. Agreements of this kind are frequently

    used to mitigate the counterparty credit risk of swaps and other

    instruments that are not centrally cleared, but the use of such

    arrangements may be more or less common among certain types of

    counterparties and for certain types of swaps.\10\ The proposed

    notification would provide the Commission with information regarding

    the extent to which credit support agreements are used by non-financial

    entities to support their meeting financial obligations associated with

    non-cleared swaps.

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    \10\ See ISDA Collateralization Practices. See also ``ISDA

    Margin Survey 2010'' (available at http://www.isda.org/c_and_a/

    pdf/ISDA-Margin-Survey-2010.pdf) (``ISDA Margin Survey 2010'')

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    b. Pledged or Segregated Assets

    Proposed Rule 39.6(b)(5)(ii) requires an indication of whether

    payment of all or any portion of the financial obligations associated

    with the non-cleared swap are secured by collateral that has been

    pledged pursuant to a documented security arrangement not requiring the

    transfer of possession of collateral to the swap counterparty. Examples

    of this type of arrangement include, but are not limited to, agreements

    granting security interests over property of the non-financial entity,

    whether or not such security interests are perfected by the filing of a

    mortgage, financing statement or similar document, agreements to

    transfer assets to collateral agents or escrow agents acting pursuant

    to instructions agreed by both parties to a swap, or the posting or

    receiving of margin. While such arrangements may be somewhat less

    commonly used to mitigate credit risk associated with non-cleared

    swaps, the Commission preliminarily believes this method may have

    particular importance for certain categories of non-financial entities,

    such as enterprises with high levels of fixed assets relative to cash

    flows.\11\ Accordingly, the Commission considers it appropriate to

    separately categorize this information in the data being collected.

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    \11\ See e.g. ISDA Margin Survey 2010 at 9 (noting types of non-

    ISDA collateral agreements used and frequency of use).

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    c. Guarantee

    Proposed Sec. 39.6(b)(5)(iii) requires an indication of whether

    all or any portion of the financial obligations associated with the

    non-cleared swap are guaranteed in writing by a person or entity other

    than the non-financial entity or entities that are party to the swap.

    The proposed notification would provide the Commission with information

    regarding the role that guarantees by third parties (such as parent

    companies, affiliated parties or others) play in meeting financial

    obligations associated with non-cleared swaps.\12\

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    \12\ See ISDA Collateralization Practices at 20 (identifying

    master cross-netting and cross-guarantee structures as common credit

    risk mitigation practices).

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    d. Sole Reliance on Available Financial Resources

    Proposed Rule 39.6(b)(5)(iv) requires an indication of whether the

    non-financial entity or entities that are party to the swap intend(s)

    to meet the obligations associated with the swap solely by utilizing

    available financial resources.\13\ Financial resources available to

    meet obligations associated with non-cleared swaps may include various

    liquidity sources, including existing assets, investments and cash

    balances, cash flow from operations, short-term and long-term lines of

    credit, and capital market sources of funding.

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    \13\ For a variety of reasons one or both of the counterparties

    to some non-cleared swaps may choose not to mitigate credit risk and

    instead rely on the general creditworthiness of their opposite

    counterparty, given the circumstances and financial terms of the

    transaction. See, e.g. Office of the Comptroller of Currency ``Risk

    Management of Financial Derivatives'' Comptroller's Handbook

    (Jan.1997) at 50 (available at http://www.occ.gov/static/

    publications/handbook/deriv.pdf) (contemplating that evaluations of

    individual counterparty credit limits should aggregate limits for

    derivatives with credit limits established for other activities,

    including commercial lending).

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    e. Other Means

    Proposed Sec. 39.6(b)(5)(v) requires an indication of whether the

    non-financial entity or entities that are party to the swap intend(s)

    to employ means other than those described in proposed Sec.

    39.6(b)(5)(i) through (iv) to meet the financial obligations associated

    with a swap. This item is intended to separately categorize all other

    methods that may be used in the markets today or that may develop in

    the future. The Commission anticipates many entities would meet their

    financial obligations through one of the specific methods listed in

    Sec. 39.6(b)(5)(i) through (iv). The information collected pursuant to

    proposed Sec. 39.6(b)(5)(v), however, together with other information

    collected, may allow the Commission to gain greater insight regarding

    whether additional data concerning methods used to mitigate credit risk

    should be collected in the future.

    [[Page 80750]]

    2. Preventing Abuse of the End-User Clearing Exception

    The remaining items of information required by proposed Sec. 39.6

    are designed to confirm compliance with particular requirements of CEA

    Section 2(h)(7) or otherwise produce information necessary or useful to

    aid the Commission in its efforts to prevent abuse of the end-user

    clearing exception as contemplated by CEA Section 2(h)(7)(F).

    a. Person Electing to Use the End-User Clearing Exception

    Proposed Sec. 39.6(b)(1) requires identification of which of the

    parties to the swap is electing to use the end-user clearing exception.

    b. Financial Entity Status

    Proposed Sec. 39.6(b)(2) requires an indication of whether a

    person electing to use the end-user clearing exception is a financial

    entity as defined in CEA Section 2(h)(7)(C)(i). The exception to

    mandatory clearing of swaps under CEA Section 2(h)(7) is only available

    to persons that are not financial entities, or are affiliates of non-

    financial entities satisfying the requirements of CEA Sections

    2(h)(7)(C)(iii) or 2(h)(7)(D).

    c. Finance Affiliate Status

    Proposed Sec. 39.6(b)(3) requires an indication of whether a

    person electing to use the end-user clearing exception is an affiliate

    of another person qualifying for the exception under CEA Section

    2(h)(7), and satisfies the additional requirements of CEA Sections

    2(h)(7)(C)(iii) or 2(h)(7)(D). These sections of the CEA contain

    provisions specially designed for captive finance affiliates of persons

    qualifying for the end-user clearing exception.\14\ Given the nature of

    these provisions, the Commission preliminarily believes it is

    appropriate to separately categorize swaps transacted by such finance

    affiliates in particular.

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    \14\ CEA Section 2(h)(7)(D)(i) provides that affiliates of

    persons qualifying for the end-user clearing exception will also

    qualify for the end-user clearing exception if the affiliate (1)

    acts on behalf of the person and as agent, (2) uses the swap to

    hedge or mitigate commercial risk of that person or another

    affiliate of that person that is not a financial entity as defined

    in CEA Section 2(h)(7)(C)(i), and (3) is not itself one of seven

    entities defined in CEA Section 2(h)(7)(D)(ii). The seven entities

    are: (i) A swap dealer; (ii) a security-based swap dealer; (iii) a

    major swap participant; (iv) a major security-based swap

    participant; (v) an issuer that would be an investment company, as

    defined in section 3 of the Investment Company Act of 1940 (15

    U.S.C. 80a-3), but for paragraph (1) or (7) of subsection c of that

    Act (15 U.S.C. 80a-3(c)); (vi) a commodity pool; or (vii) a bank

    holding company with over $50,000,000,000 in consolidated assets.

    See CEA Section 2(h)(7)(D)(ii). In addition, an affiliate,

    subsidiary, or wholly owned entity of a person that qualifies for an

    exception under CEA Section 2(h)(7)(A) and which is predominantly

    engaged in providing financing for the purchase or lease of

    merchandise or manufactured goods of the person shall be excepted

    from both the margin requirements described in CEA Section 4s(e) and

    the clearing requirement in CEA Section 2(h)(1), provided that the

    swaps in question are entered into to mitigate the risk of the

    financing activities. See CEA Section 2(h)(7)(D)(iii). Finally,

    excluded from the definition of financial entity are those entities

    (1) whose primary business is providing financing, and (2) who are

    using derivatives to hedge underlying commercial risks related to

    interest rate and foreign currency exposures, if 90% or more of

    those risks arise from the finance or lease of products, and if 90%

    or more of those products are manufactured by the parent company or

    another subsidiary of the parent. See CEA Section 2(h)(7)(C)(iii).

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    d. Hedging or Mitigating Commercial Risk

    Proposed Sec. 39.6(b)(4) requires an indication of whether a

    person electing to use the end-user clearing exception is using the

    swap being reported to hedge or mitigate commercial risk. The exception

    to mandatory clearing of swaps under Section 2(h)(7) of the CEA is only

    available to persons that use such swaps to hedge or mitigate

    commercial risk. The definition of ``hedging or mitigating commercial

    risk'' is discussed below in Section B.

    e. End-User Board Approval

    Proposed Sec. 39.6(b)(6) requires all persons electing the end-

    user clearing exception to indicate whether they are an issuer of

    securities registered under Exchange Act Section 12 or required to file

    reports under Exchange Act Section 15(d) (``SEC Filer'').\15\ Under CEA

    Section 2(j), the exception to mandatory clearing of swaps under CEA

    Section 2(h)(7) is available to SEC Filers only if an appropriate

    committee of the issuer's board or governing body has reviewed and

    approved the issuer's decision to enter into swaps that are subject to

    the exception.\16\ When the person electing to use the end-user

    clearing exception is an SEC Filer, two additional items of information

    must be provided:

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    \15\ For these purposes, a counterparty electing to use the end-

    user clearing exception is considered to be an issuer of securities

    registered under Exchange Act Section 12 or required to file reports

    pursuant to Exchange Act Section 15(d) if it is controlled by a

    person that is an issuer of securities registered under Exchange Act

    Section 12 or required to file reports pursuant to Exchange Act

    Section 15(d). See Rule 1-02(x) of SEC Regulation S-X, 17 CFR Sec.

    210.1-02(x) (defining subsidiary for purposes of the financial

    statements required to be filed as part of registration statements

    under Exchange Act Section 12, and annual and other reports under

    Exchange Act Sections 13 and 15(d)).

    \16\ See CEA Section 2(j). For these purposes, the Commission

    considers a committee to be appropriate if it is specifically

    authorized to review and approve the issuer's decisions to enter

    into swaps.

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    Proposed Sec. 39.6(b)(6)(i) requires an SEC Filer

    electing to use the end-user clearing exception to specify its SEC

    Central Index Key number. Collection of this information will allow the

    CFTC to cross reference materials filed with the relevant SDR with

    information in periodic reports and other materials filed by the SEC

    Filer with the SEC.\17\

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    \17\ See Item 305 of SEC Regulation S-K, 17 CFR 229.305.

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    Proposed Sec. 39.6(b)(6)(ii) requires confirmation that

    an appropriately authorized committee of the board of directors or

    equivalent governing body of the SEC Filer has reviewed and approved

    the decision of the electing person not to clear the swap being

    reported, as required by CEA Section 2(j).\18\

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    \18\ For example, a board resolution or an amendment to a board

    committee's charter could expressly authorize such committee to

    review and approve decisions of the electing person not to clear the

    swap being reported. In turn, such board committee could adopt

    policies and procedures to review and approve decisions not to clear

    swaps, on a periodic basis or subject to other conditions determined

    to be satisfactory to the board committee.

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    Given the requirements of CEA Section 2(j) and its relationship to

    the end-user clearing exception, the Commission preliminarily believes

    collection of this information is appropriate to promote compliance

    with the requirements of the end-user clearing exception.

    Request for Comment:

    The Commission generally requests comments on all aspects of the

    proposed rules. Additionally, the Commission requests comments on the

    following specific issues:

    Is it sufficiently clear what information the Commission

    is requiring to be reported under proposed Sec. 39.6? If not, why not?

    Is it sufficiently clear how information would be reported under

    proposed Sec. 39.6 if a swap is between two non-financial entities

    both seeking to elect to use the end-user clearing exception? If not,

    why not? Are there clarifications or instructions the Commission could

    adopt that are useful for parties seeking to elect to use the end-user

    clearing exception? If so, what are they and what would be the benefits

    of adopting them?

    Would it be difficult or prohibitively expensive for

    persons to report the information required under the proposed Sec.

    39.6? If so, why?

    Is the information the Commission proposes to collect in

    connection with the Financial Obligation Notice sufficient? Is other

    information needed to achieve the purposes of the Dodd-Frank Act? For

    example, is it necessary or appropriate for the Commission to collect:

    Additional general information on the credit support agreement and the

    [[Page 80751]]

    collateral practices under the agreement, such as the level of margin

    collateral outstanding (e.g., less than or equal to a specified dollar

    amount, or greater than a series of progressively higher dollar

    amounts); the types of collateral provided (e.g., cash, government

    securities, other securities, other collateral), or the frequency of

    portfolio reconciliation? Additional general information on specific

    terms of the credit support agreement, such as whether the collateral

    requirements are unilateral or bilateral provisions and whether there

    are contractual terms triggered by changes in the credit rating or

    other financial circumstances of one or both of the counterparties?

    Additional general information about the guarantor, such as whether or

    not the guarantor is a parent or affiliate of the person electing to

    use the end-user clearing exception? Additional general information

    regarding the assets pledged, such as the type of security interest or

    the type of property being used as collateral? Additional general

    information regarding the segregation arrangements, such as the

    identity of the collateral agent or other third party involved in the

    arrangement, and information regarding whether the arrangement involves

    a custodian, tri-party or different type of relationship? Additional

    general information regarding the adequacy of other means being used,

    or the adequacy of the financial resources available, to meet the

    financial obligations associated with the non-cleared swap?

    Should the Commission provide additional clarity to the

    terms used in CEA Sections 2(h)(7)(C)(iii) and 2(h)(7)(D) in proposed

    Sec. 39.6 for affiliates electing to use the end-user clearing

    exception? Should the Commission adopt more specific requirements to

    implement the provisions of CEA Sections 2(h)(7)(C)(iii) and

    2(h)(7)(D)? Is there need for the Commission to address the factors to

    be taken into account or the manner of calculating the percentage

    standards established in CEA Section 2(h)(7)(C)(iii)? Should the

    Commission provide further guidance on other terms used in these

    sections, such as the meaning of the term ``predominantly engaged'' in

    CEA Section 2(h)(7)(D)? If so, what specific rules or guidance should

    the Commission consider and what would be the benefits of adopting

    them?

    Should the Commission provide additional clarity to the

    requirements of CEA Section 2(j) to facilitate compliance with proposed

    Sec. 39.6 by parties electing to use the end-user clearing exception?

    Should the Commission adopt more specific requirements to implement the

    provisions of CEA Section 2(j)? If so, what specific rules should the

    Commission consider and what would be the benefits of adopting them?

    Should the Commission provide additional guidance as to

    the meaning of the term ``issuer of securities'' as used in CEA Section

    2(j)?

    Should the Commission consider requiring parties electing

    to use the end-user clearing exception to report additional types of

    information, either in order to limit abuse of the exception or for

    other reasons? If so, what other information should be reported and

    what would be the benefit of requiring such information to be reported?

    What categories of information, if any, should not be required to be

    reported and why?

    What does it mean to abuse the clearing exception under

    CEA Section 2(h)(7)(F)? Will some types of swaps be more susceptible to

    such abuse than others? For example: Are large or small companies or

    other identifiable sub-categories of swap users more or less likely to

    abuse the end-user clearing exception than other persons? Are there

    certain swap products or counterparties that the Commission should

    monitor for abuse more closely than others?

    Are there different considerations for small companies or

    other identifiable categories of persons who may wish to elect to use

    the end-user clearing exception? If so, what are they and how should

    the Commission take these considerations into account?

    3. Form of Notice to the Commission

    Proposed Rule 39.6 provides that a person electing to use the end-

    user clearing exception for a swap shall satisfy the notice

    requirements of CEA Section 2(h)(7)(A)(iii) upon providing the

    information specified in proposed Sec. 39.6 to a registered SDR or, if

    no registered SDR is available, the Commission, in the form and manner

    generally required for delivery of information specified under proposed

    swap data recordkeeping and reporting rules.\19\ Under this approach,

    rather than collecting information through a separate process

    established by the Commission for these purposes, the information

    delivered in compliance with the requirements of proposed Sec. 39.6

    and the proposed swap data recordkeeping and reporting rules would

    serve as the official notice of a swap covered by the end-user clearing

    exception.

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

    \19\ Proposed Sec. Sec. 45.2 and 45.3 establish the

    recordkeeping and reporting requirements for swaps. See Swap Data

    Recordkeeping and Reporting Requirements, 75 FR 76573 (Dec. 8,

    2010). The information required under proposed Rule 39.6 would be in

    addition to these requirements but would be delivered to the SDR by

    the reporting counterparty in the same manner as required by the

    proposed swap data recordkeeping and reporting rules.

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

    The CEA, as amended by the Dodd-Frank Act, requires all swaps

    (whether cleared or non-cleared) to be reported to a registered SDR or,

    if no registered SDR is available, the Commission. See CEA Sections

    2(a)(13)(G) (reporting of swaps to SDRs) and 4r (reporting alternatives

    for non-cleared swaps). As centralized recordkeeping facilities of

    swaps, SDRs are intended to play a critical role in enhancing

    transparency in the swap markets. SDRs will enhance transparency by

    having complete records of swaps, maintaining the integrity of those

    records, and providing effective access to those records to relevant

    authorities and the public in line with their respective information

    needs.\20\ The Commission recently proposed a series of new rules

    relating to the SDR registration process, duties, and core principles

    to ensure that SDRs operate in the manner contemplated by the Dodd-

    Frank Act amendments to the CEA.\21\

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

    \20\ In the case of non-cleared swaps, CEA Section 21(c)(2)

    requires each SDR to confirm with both parties to the swap the

    accuracy of the data submitted to the SDR. CEA Section 4r(c)

    requires each party to a non-cleared swap to maintain records of the

    swaps held by such party in the form required by the Commission, and

    CEA Section 4r(d) provides that these records shall be in a form not

    less comprehensive than required to be collected by SDRs. These

    records are available for inspection by the Commission and other

    specified authorities under CEA Section 4r(c)(2).

    \21\ See Swap Data Repositories, approved by the Commission on

    Novovember 19, 2010, to be published in a forthcoming issue of the

    Federal Register.

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

    The Commission is proposing to collect notice information for the

    end-user clearing exception through SDRs. This will permit detailed

    information on the use of the end-user clearing exception to be

    collected in conjunction with other swap information in a format well

    suited to analysis by the Commission and consistent with the

    development of straight-through processing for swaps. Using SDRs should

    also help to reduce the administrative burdens of the notice

    requirement because the information would be incorporated into a

    transaction record already required by the Dodd-Frank Act in connection

    with each swap and subject to standards designed to assure the accuracy

    of the information collected. The Commission anticipates that empirical

    data collected in this manner will aid its ability to evaluate how the

    end-user clearing exception is being used and encourage appropriate

    deliberation by counterparties prior to its use. The

    [[Page 80752]]

    Commission also preliminarily believes receiving notification and other

    information in connection with CEA Sections 2(h)(7)(A)(iii) and

    2(h)(7)(F) through SDRs should allow monitoring for potentially abusive

    practices, and timely action to address abusive practices if they were

    to develop.\22\

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

    \22\ The proposed notification method is supported by the

    recordkeeping requirements under CEA Section 4r, which will permit

    the Commission to review transaction information and take such

    action as may be necessary to prevent abuses of the end-user

    clearing exception. Such Commission action would be taken in a

    manner consistent with our review practices for other transaction

    information submitted to SDRs, rather than through a separate

    process developed for these purposes, thereby helping to maintain

    consistency of regulatory action in comparable areas.

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

    Request for Comment:

    The Commission generally requests comments on all aspects of the

    proposed rules. Additionally, the Commission requests comments on the

    following specific issues:

    Is it appropriate for the Commission to require

    notification regarding use of the end-user clearing exception to be

    made through SDRs? What are the advantages or disadvantages of the

    Commission's proposal?

    Does collecting Financial Obligation Notice information

    through SDRs provide sufficient assurance that the end-user clearing

    exception will be available to non-financial entities wishing to use

    the exception? Are SDRs reliable enough to be used for these purposes?

    Is Financial Obligation Notice information different from

    other information collected by SDRs in any respect that makes use of

    SDRs for these purposes inappropriate? If so, how is the notice

    information different and why is it inappropriate to use SDRs to

    collect the information?

    Is there a more feasible and cost effective way for the

    Commission to receive notification regarding the use of the end-user

    clearing exception? If so, what is the better alternative and in what

    ways is it better?

    Do the CEA and the associated rules and proposed rules

    regulating SDRs and parties to swaps create sufficient assurance that

    notice information collected through SDRs will be accurate? Are there

    additional protections the Commission should establish to create

    greater assurance that the notice information collected will be

    accurate? If so, what are they and how will they improve the

    information collection process?

    Would the person reporting information to the SDR be in a

    position to have or be able to obtain, in all cases, the information

    the Commission is requiring to be reported under proposed Rule 39.6. If

    not, why not? Are there special considerations in this regard when a

    swap is between two non-financial entities that are each seeking to

    elect to use this exception? Are representations and warranties and

    similar established market practices associated with documenting swaps

    adequate to ensure the person reporting information to the SDR can

    obtain such information when necessary?

    How long would it be expected to take for the person

    reporting information to the SDR to gather the information required

    under proposed Sec. 39.6? Will the time needed to gather the required

    information disrupt the transaction process for swaps to any material

    extent?

    Should the Commission require persons electing to use the

    end-user clearing exception to follow additional compliance practices

    in some circumstances? For example, should the Commission require

    electing persons to create a record of the means being used to mitigate

    the credit risk of the swap? Would such a requirement be redundant or

    duplicative of other proposed recordkeeping requirements?

    Will collecting notice information together with other

    transaction information have the advantages expected by the Commission?

    For example, will it be useful to analyze information regarding use of

    the end-user clearing exception by product type and other transaction

    characteristics? Are there other advantages or disadvantages related to

    collecting notice information through SDRs that the Commission should

    consider? If so, what are they?

    Is there reason to believe that collecting information

    through SDRs will make it more or less difficult for the Commission to

    take action to prevent abuse of the clearing exception? If so, what

    Commission actions might be more or less difficult and what

    alternatives should the Commission consider?

    Does collecting notice information regarding use of the

    end-user clearing exception through SDRs create significantly greater

    burdens for some parties to swaps compared to others? For example, will

    parties who frequently enter into swaps face higher or lower burdens

    compared to parties that enter swaps less frequently? Will small

    companies face different burdens than large companies? Will non-

    financial entities that enter into swaps with other non-financial

    entities face different burdens? If so, what steps should the

    Commission consider taking to account for these differences?

    Are there international or cross-border issues related to

    the end-user exception that the Commission should address?

    B. Hedging or Mitigating Commercial Risk

    To qualify to use the end-user clearing exception with respect to a

    particular swap, CEA Section 2(h)(7)(A)(ii) requires that a non-

    financial entity must be using the swap to hedge or mitigate commercial

    risk. The Commission's proposal deems that the use of a swap is for

    hedging purposes in three circumstances. While the proposed definition

    in Proposed Sec. 39.6(c) 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 clearing exception are not limited to those two circumstances. See

    Proposed Sec. 39.6(c)(1)(ii) and (iii). The proposal also covers swaps

    used to hedge or mitigate any of a person's business risks, as defined

    by six categories in the proposal, regardless of their status under

    accounting guidelines or the bona fide hedging exemption. See Proposed

    Sec. 39.6(c)(1)(i). Proposed Sec. 39.6(c)(2) further provides,

    however, that a swap is disqualified from the clearing exception if it

    is held for a speculative, investing, or trading purpose,\23\ or if it

    hedges another swap unless that swap itself is held for hedging

    purposes.

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

    \23\ The Commission preliminarily believes 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.

    The Commission preliminarily believes 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 phrase ``hedging or mitigating commercial risk'' is the subject

    of current joint rulemaking by the Commission and the SEC.\24\ Through

    this joint rulemaking exercise, the Commission is proposing a

    definition of ``hedging or mitigating commercial risk''

    [[Page 80753]]

    that would govern for purposes of the major swap participant definition

    under CEA Section 1a(33). The Commission has determined to propose

    nearly identical regulatory language in Proposed Sec. 39.6(c) to

    define the meaning of the phrase ``hedge or mitigate commercial risk''

    as found in CEA Section 2(a)(7)(A)(ii) for purposes of the elective

    end-user clearing exception. This parallel approach should allow

    consistency of interpretation across the CEA as a whole and help

    provide for fair and equivalent treatment for similarly situated

    parties.\25\

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

    \24\ See Further Definition of Swap Dealer, Security-Based Swap

    Dealer, Major Swap Participant, Major Security-Based Swap

    Participant and Eligible Contract Participant, approved by the

    Commission on December 1, 2010, to be published in the Federal

    Register on December 21, 2010.

    \25\ The Commission notes that the major swap participant

    definitional rule does not contemplate applying the definition of

    hedging or mitigating commercial risk to affiliates. CEA Sections

    2(h)(7)(C)(iii) and 2(h)(7)(D) create certain additional

    requirements for affiliates of non-financial entities seeking to

    elect the end-user clearing exception, and these requirements must

    also be satisfied for the end-user clearing exception to be

    available.

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

    The Commission proposes an inclusive, multi-pronged definition that

    allows end users to qualify their hedging transactions in a manner that

    best fits their businesses. The Commission preliminarily believes that

    such an approach is appropriate, given the elective nature of this

    exception. While the line between speculation and hedging can at times

    be difficult to discern, the Dodd-Frank Act nonetheless requires such

    determinations to be made, and the Commission believes its rules

    proposal provides guidance and a measure of certainty in this regard.

    Proposed Sec. 39.6(c)(1)(i) takes a narrative approach similar to

    that used in Sec. 1.3(z) of the Commission's regulations, which

    defines what activities qualify as hedging when used in futures

    markets, by enumerating specific risk shifting practices that are

    deemed to qualify for purposes of the clearing exception. Proposed

    Sec. 39.6(c)(1)(ii) and (iii) assure counterparties that if their swap

    qualifies for the bona fide hedge exemptions from positions limits, or

    if their swap qualifies for hedge accounting treatment under the FASB

    hedge accounting standards, the swap also qualifies for the clearing

    exception.

    As a general matter, the Commission preliminarily believes that

    whether a position is used to hedge or mitigate 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. The Commission 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 for purposes of the clearing exception. In

    this regard, the Commission preliminarily believes the question whether

    an activity is commercial should not be determined solely by an

    entity's organizational status as a for-profit company, a non-profit

    organization, or a governmental entity. Instead, the determinative

    factor should be whether the underlying activity to which the swap

    relates is commercial in nature.

    Request for Comment:

    The Commission generally requests comments on all aspects of the

    proposed rules. Additionally, the Commission requests comments on the

    following specific issues:

    Should swaps qualifying as hedging or risk mitigating be

    limited to swaps where the underlying hedged item is a non-financial

    commodity? Commenters may also address whether swaps qualifying as

    hedging or risk mitigating 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 Commission 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. The

    Commission is interested in whether special considerations are

    warranted with respect to the use of non-cleared swaps by agricultural

    cooperatives as well as by non-profit, governmental, or municipal

    entities engaged in electric power or energy activities. Commenters are

    requested to discuss both the policy and legal bases underlying such

    comments.

    Should the Commission consider adopting a definition of

    ``hedge or mitigate commercial risk'' in proposed Sec. 39.6(c) that is

    different from definition of ``hedging or mitigating commercial risk''

    in the major swap participant definitions rule and is specifically

    designed to address the circumstances of the end-user clearing

    exception? If so, what are the specific considerations associated with

    the end-user clearing exception that make a separate definition

    desirable? What features would such a definition need in order to be

    effective and what would be the benefits of adopting them?

    Should the Commission consider adopting a definition of

    ``hedge or mitigate commercial risk'' in proposed Sec. 39.6(c) that is

    different from definition of ``hedging or mitigating commercial risk''

    in the major swap participant definitions rule and is specifically

    designed to address the circumstances of the end-user clearing

    exception? If so, what are the specific considerations associated with

    the end-user clearing exception that make a separate definition

    desirable? What features would such a definition need in order to be

    effective and what would be the benefits of adopting them?

    III. Consideration of a Clearing Exception for Small Banks, Savings

    Associations, Farm Credit System Institutions, and Credit Unions

    Pursuant to CEA Section 2(h)(7)(C)(ii), the Commission is

    considering whether to except small banks, savings associations, farm

    credit systems institutions, and credit unions from the Act's

    definition of financial entity, including specifically those with total

    assets of $10,000,000,000 or less (``Small Financial Institutions'').

    This type of exception would permit Small Financial Institutions to use

    the end-user exception from the mandatory clearing requirement, which

    is otherwise unavailable to financial entities.

    To inform its consideration of whether it would be appropriate for

    the Commission to grant any exception for Small Financial Institutions,

    the Commission requests comments on the following specific issues:

    Would such an exception be appropriate? If so, what terms

    and conditions should apply? Would it be better for the Commission to

    simply require Small Financial Institutions to follow the same

    practices as other financial institutions in the future? Would such an

    exception pose any risks to the swap markets or the financial system?

    Why or why not?

    How should the Commission take into account the

    supervisory regimes to which Small Financial Institutions are currently

    subject, and whether those regulatory regimes adequately mitigate any

    risks associated with an exception?

    Should the Commission consider treating different types of

    swaps differently when considering whether any exception should be

    available for Small Financial Institutions? If so, what specific

    distinctions should be considered by the Commission and what would be

    the benefits of adopting them?

    Should the Commission consider limiting the availability

    of any end-user clearing exception to only some Small Financial

    Institutions? Are there differences between Small Financial

    [[Page 80754]]

    Institutions that should lead to differences in the availability of the

    exception? If so, what specific distinctions should be considered by

    the Commission and what would be the benefits of adopting them? Would

    an across-the-board application of an exception to all Small Financial

    Institutions create any advantages or disadvantages for certain Small

    Financial Institutions? Would a differentiated application of an

    exception create any advantages or disadvantages?

    In CEA Section 2(h)(7)(C)(ii), Congress directed the

    Commission to consider whether to exempt small banks, savings

    associations, farm credit institutions, and credit unions, including

    those with total assets of $10 billion or less. The Commission invites

    public comment on the $10 billion total assets level. Are there

    measures other than total assets of $10 billion, such as financial risk

    or capital, which could be used for determining whether an entity

    qualifies for an exception, and if so, what are the advantages or

    disadvantages of utilizing the alternative measures? Would utilizing

    these alternative measures create additional risks, and if so, should

    the Commission consider additional measures to address them?

    IV. General Request for Comments

    The Commission is requesting comments from all members of the

    public. The Commission will carefully consider the comments that it

    receives. The Commission seeks comment generally on all aspects of the

    proposed rules. In addition, the Commission seeks comment on the

    following:

    Should the Commission clarify or modify any of the

    definitions included in the proposed rules? If so, which definitions

    and what specific modifications are appropriate or necessary?

    Are there aspects of the CEA, the Investment Advisers Act

    of 1940 (15 U.S.C. 80), the Employee Retirement Income Security Act of

    1974 (29 U.S.C. 1002), or the Bank Holding Company Act of 1956 (12

    U.S.C. 184) that are incorporated in the definition that may need to be

    taken into consideration by the Commission to ensure the end-user

    clearing exception is available in appropriate circumstances? If so,

    what specific changes should the Commission consider and what would be

    the benefits of adopting them?

    Are the obligations in the proposed rules sufficiently

    clear? Is additional guidance from the Commission necessary?

    What are the technological or administrative burdens of

    complying with the rules proposed by the Commission?

    Should the Commission implement substantive requirements

    in addition to, or in place of, the policies and procedures required in

    the proposed rules?

    If an entity is designated as a swap dealer or a major

    swap participant with respect to only certain of its swaps or

    activities, should it be treated as a financial entity under CEA

    Section 2(h)(7)(C)(i) and thereby be disqualified from electing to use

    the end-user clearing exception with respect to its other swaps or

    activities? If so, why? If not, should the Commission require such an

    entity to separate those swaps or activities for which it is designated

    as a swap dealer or major swap participant from its other swaps or

    activities? If so, how? If not, why not?

    In addition, the Commission seeks commenters' views regarding any

    potential impact of the proposals on non-financial entities expecting

    to elect to use the end-user clearing exception, SDRs, other market

    participants, and the public generally. The Commission seeks comments

    on the proposals as a whole, including their interaction with the other

    provisions of the Dodd-Frank Act. The Commission seeks comments on

    whether the proposals would help achieve the broader goals of

    increasing transparency and accountability in the swap market.

    The Commission requests comment generally on whether its proposed

    actions today to govern the elective exception to mandatory clearing of

    swaps available under CEA Section 2(h)(7) are necessary or appropriate

    for those purposes. If commenters do not believe one or all such

    actions are necessary and appropriate, why not? What would be the

    preferred action?

    Title VII requires that the Commission consult and coordinate to

    the extent possible with the SEC for the purposes of assuring

    regulatory consistency and comparability, to the extent possible, and

    states that in adopting rules, the Commission and SEC shall treat

    functionally or economically similar products or entities in a similar

    manner. Specifically, do the regulatory approaches under the

    Commission's proposed rulemaking under DFA Section 723(a) and the SEC's

    proposed rulemaking under DFA Section 763(a) result in duplicative or

    inconsistent efforts on the part of market participants subject to both

    regulatory regimes or result in gaps between those regimes? If so, in

    what ways do commenters believe that such duplication, inconsistencies,

    or gaps should be minimized? Do commenters believe the approaches

    proposed by the Commission and the SEC to govern the elective exception

    to mandatory clearing of swaps and security-based swaps are comparable?

    If not, why? Do commenters believe there are approaches that would make

    the elective exception to mandatory clearing of swaps and security-

    based swaps more comparable? If so, what are they and what would be the

    benefits of adopting such approaches? Do commenters believe that it

    would be appropriate for us to adopt an approach proposed by the SEC

    that differs from our proposal? If so, which one? Are there further

    distinctions or clarifications that should be made by the Commission

    for purposes of the end-user clearing exception that are different from

    those being made in connection with the proposed joint rulemaking by

    the Commission and the SEC? If so, what are they and what would be the

    benefits of adopting them?

    Commenters should, whenever possible, provide the Commission with

    empirical data to support their views. Commenters suggesting

    alternative approaches should provide comprehensive proposals,

    including any conditions or limitations that they believe should apply,

    the reasons for their suggested approaches, and their analysis

    regarding why their suggested approaches would satisfy the statutory

    mandate contained in DFA Section 723(a) governing the exception to

    mandatory clearing of swaps.

    V. Related Matters

    A. Cost-Benefit Analysis

    Section 15(a) of the Act requires that the Commission, before

    promulgating a regulation or issuing an order, consider the costs and

    benefits of its action. By its terms, CEA Section 15(a) does not

    require the Commission to quantify the costs and benefits of a new

    regulation or determine whether the benefits of the regulation outweigh

    its costs. Rather, CEA Section 15(a) simply requires the Commission to

    ``consider the costs and benefits'' of its action.

    CEA Section 15(a) specifies that costs and benefits shall be

    evaluated in light of the following considerations: (1) Protection of

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

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

    sound risk management practices; and (5) other public interest

    considerations. Accordingly, the Commission could, in its discretion,

    give greater weight to any of the five considerations and could, in its

    [[Page 80755]]

    discretion, determine that, notwithstanding its costs, a particular

    regulation was necessary or appropriate to protect the public interest

    or to effectuate any of the provisions or to accomplish any of the

    purposes of the Act.

    Costs

    Proposed Sec. 39.6 specifies requirements for using the elective

    end-user exception to the mandatory clearing of swaps established by

    CEA Section 2(h)(7). The proposal calls for a user-friendly, check-the-

    box approach to the Dodd-Frank Act's notification requirement. Proposed

    Rule 39.6 would simply require an indication of each method used to

    mitigate the credit risk associated with non-cleared swaps. Additional

    boxes would indicate whether finance affiliate or a SEC Filer is

    involved. The reporting counterparty would further be required to check

    a box in order to indicate whether the swap was being used to hedge or

    mitigate commercial risk, as defined by proposed Sec. 39.6(c). These

    data elements would be provided as part of the overall package of swap-

    related information that must generally be submitted by reporting

    counterparties to SDRs under the Dodd-Frank Act.

    With respect to costs, the Commission has determined that the

    notification requirement imposed by the rule proposal will present an

    increased cost. Currently, there is no requirement to notify the

    Commission of how a swap counterparty generally meets its financial

    obligations associated with its non-cleared swaps; therefore, the new

    notification requirement necessarily introduces a new cost to the

    system. While the Commission must be notified each time an election to

    forgo clearing is made, the cost incurred should be minimal since only

    general information must be included in the notification. In most

    cases, this check-the-box notification process will be performed by the

    swap dealer or major swap participant for whom such notification will

    represent only a small added cost to the overall cost of complying with

    its general reporting and recordkeeping obligations for swaps under the

    DFA. End users will provide the notification only for those swaps that

    do not involve a swap dealer or a major swap participant.

    Benefits

    With respect to benefits, the Commission has determined that the

    rule proposal should enhance the level of transparency associated with

    the OTC swap activity of non-financial entities, grant the Commission

    new insights into the practices of non-financial entities, and help the

    Commission and other regulators in their efforts to reduce risk in the

    financial system.

    Proposed Sec. 39.6's collateralization reporting requirements

    should allow the Commission to identify the collateral activities of

    non-financial entities. The role of OTC swaps in the financial system

    came into focus in the aftermath of the financial crisis of 2007;

    instituting the proposed rule would strengthen the regulatory regime

    that governs OTC swaps, and provide a greater degree of transparency

    with regard to non-financial entities in general.

    When non-financial entities report that they use alternative

    methods to meet their financial obligations related to OTC swaps, they

    would provide the Commission with a valuable insight into the practices

    of non-financial entities of various types. Although the Commission

    expects that most transactions rely on one of the specific methods

    listed in Sec. 39.6(b)(5)(i), (ii), (iii), or (iv), the reporting of

    the use of alternative methods should help the Commission determine

    whether additional data collection could be needed in the future.

    Finally, the rule proposal represents a more rigorous reporting

    regime, a stated goal of the Dodd-Frank Act. While the reporting

    requirements contained in the rule proposal might present increased

    costs to non-financial entities seeking to engage in OTC swaps, they

    provide the benefits of a greater body of information for the

    Commission to analyze.

    Summary

    In summary, the Commission, after considering the CEA Section 15(a)

    factors, finds that the incremental cost imposed by the proposed rules

    is outweighed by their expected benefit. Accordingly, the Commission

    has determined to propose the rules. The Commission invites public

    comment on its cost-benefit considerations. Commenters also are invited

    to submit any data or other information that they may have quantifying

    or qualifying the costs and benefits of the proposed rules.

    B. Regulatory Flexibility Act

    The Regulatory Flexibility Act (``RFA'') requires federal agencies,

    in proposing regulations, to consider the impact of those regulations

    on ``small entities.'' \26\ The proposed rules detailed in this release

    would affect organizations including eligible contract participants

    (``ECPs'') \27\ and SDRs. The Commission has previously determined that

    ECPs are not ``small entities'' for purposes of the RFA.\28\ Since SDRs

    are new entities to be regulated by the Commission pursuant to the

    Dodd-Frank Act, the Commission has not previously determined whether

    they are small entities for the purpose of the RFA. The Commission

    therefore has determined that SDRs are not small entities for purposes

    of the RFA. Specifically, the Commission has determined that SDRs

    should not be considered small entities based on the central role they

    will play in the national regulatory scheme overseeing the trading of

    swaps, similarly to DCMs and DCOs, which the Commission has previously

    determined not to be small entities on the same grounds.\29\ Moreover,

    because they will be required to accept swaps across asset classes,

    SDRs will require significant operational resources.

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    \26\ 5 U.S.C. 601 et seq.

    \27\ Under CEA Section 2(e), only ECPs are permitted to

    participate in a swap subject to the end-user clearing exception.

    \28\ See Opting Out of Segregation, 66 FR 20740 at 20743 (April

    25, 2001).

    \29\ See A New Regulatory Framework for Clearing Organizations,

    66 FR 45604 at 45609 (Aug. 29, 2001)(DCOs); Policy Statement and

    Establishment of Definitions of ``Small Entities'' for Purposes of

    the Regulatory Flexibility Act, 47 FR 18618 at 18618-18619 (April

    30, 1982)(DCMs).

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    Accordingly, the Commission does not expect the proposed rules to

    have a significant impact on a substantial number of small entities.

    Therefore, the Chairman, on behalf of the Commission, hereby certifies,

    pursuant to 5 U.S.C. 605(b), that the proposed regulation would not

    have a significant economic impact on a substantial number of small

    entities. The Commission invites the public to comment on whether the

    entities covered by these proposed regulations should be considered

    small entities for purposes of the RFA.

    C. Paperwork Reduction Act

    1. Overview

    The Paperwork Reduction Act (``PRA'') \30\ imposes certain

    requirements on Federal agencies in connection with their conducting or

    sponsoring any collection of information as defined by the PRA. This

    proposed rulemaking would result in new collection of information

    requirements within the meaning of the PRA. The Commission therefore is

    submitting this proposal to the Office of Management and Budget

    (``OMB'') for review in accordance with 44 U.S.C. 3507(d) and 5 CFR

    1320.11. The title for this collection of information is ``Rule 39.6

    End-User Non-Cleared Swap Notification'' (OMB control number [3038-

    NEW]). If

    [[Page 80756]]

    adopted, responses to this collection of information would be

    mandatory.

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    \30\ 44 U.S.C. 3501 et seq.

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    An agency may not conduct or sponsor, and a person is not required

    to respond to, a collection of information unless it displays a

    currently valid control number. OMB has not yet assigned a control

    number to the new collection for proposed rule 39.6. The requirements

    of new rule 39.6 are not currently covered by any existing OMB control

    number.

    Proposed Rule 39.6 would require non-financial entities to notify

    the Commission each time the end-user clearing exception is elected by

    delivering specified information to a registered SDR or, if no

    registered SDR is available, the Commission in the manner required by

    the proposed part 49 rules for swaps data recordkeeping and reporting.

    The notification will occur only once at the beginning of the swap life

    cycle. If one of the counterparties to the swap transaction is a swap

    dealer or a major swap participant, notification would be provided

    through that counterparty. The non-financial counterparty would provide

    notice only in the event its counterparty is not a swap dealer or a

    major swap participant.

    The Commission estimates that there are approximately 30,000 end

    users who are counterparties to a swap in a given year. Of these end

    users, the Commission estimates that the majority will not be required

    to report under proposed Sec. 39.6 because their counterparty is a

    swap dealer or major swap participant. In that case, as described

    above, the swap dealer or major swap participant is required to make

    the report on behalf of the end user. Also, end users who are

    counterparties to a swap entered into in a previous year will

    presumably have already made the notification under proposed Sec. 39.6

    and therefore will not be required to make further notifications under

    the rule in subsequent years. Reducing the number of annual end users

    by these factors, the Commission estimates that there are approximately

    1,000 end users who must report in a given year.\31\ The Commission

    estimates that the report will require between approximately 10 minutes

    and one hour of burden, per end user per year.\32\ The number of burden

    hours per end user may vary depending on various factors, such as the

    number of swaps entered into by that end user in the given year.

    Therefore, the number of estimated aggregate annual burden hours is

    between approximately 167 and 1,000 hours.

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    \31\ The Commission requests public comment on this estimate.

    \32\ The Commission requests public comment on this estimate.

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    2. Confidentiality

    The Commission protects proprietary information pursuant to the

    Freedom of Information Act and 17 CFR part 145, ``Commission Records

    and Information.'' In addition, Section 8(a)(1) of the CEA prohibits

    the Commission, unless specifically authorized by the Act, from making

    public ``data and information that would separately disclose the

    business transactions or market positions of any person and trade

    secrets or names of customers.'' \33\ The Commission also is required

    to protect certain information contained in a government system of

    records pursuant to the Privacy Act of 1974, 5 U.S.C. 552a.

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    \33\ 7 U.S.C. 12(a)(1).

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    3. Information Collection Comments

    The Commission invites the public and other federal agencies to

    comment on any aspect of the reporting burden discussed above. Pursuant

    to 44 U.S.C. 3506(c)(2)(B), the Commission solicits comments in order

    to: (i) Evaluate whether the proposed collection of information is

    necessary for the proper performance of the functions of the

    Commission, including whether the information would have practical

    utility; (ii) evaluate the accuracy of the Commission's estimate of the

    burden of the proposed collection of information; (iii) determine

    whether there are ways to enhance the quality, utility, and clarity of

    the information to be collected; and (iv) minimize the burden of the

    collection of information on those who are to respond, including

    through the use of automated collection techniques or other forms of

    information technology.

    Comments may be submitted directly to the Office of Information and

    Regulatory Affairs (``OIRA'') in OMB, by fax at (202) 395-6566 or by e-

    mail at OIRAsubmissions@omb.eop.gov. Please provide the Commission with

    a copy of submitted comments so that all comments can be summarized and

    addressed in the final rule preamble. Refer to the Addresses section of

    this notice of proposed rulemaking for comment submission instructions

    to the Commission. A copy of the supporting statements for the

    collections of information discussed above may be obtained by visiting

    RegInfo.gov.

    D. Antitrust Considerations

    Section 15(b) of the CEA requires the Commission, before adopting a

    rule or issuing an order, to take into consideration the public

    interest protected by the antitrust laws and endeavor to take the least

    anticompetitive means of achieving the objectives of the Act, as well

    as the purposes and policies of the CEA.\34\ The Commission did not

    identify any means by which the proposed end-user exception could be

    implemented to achieve the objectives, purposes and policies of the CEA

    in a less anticompetitive manner. The Commission invites comments on

    all aspects of its rules proposal in this regard.

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    \34\ See also Section 6 of the Dodd-Frank Act.

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    E. Consideration of Impact on the Economy

    Under the Small Business Enforcement Fairness Act of 1996

    (``SBREFA''), federal agencies are called upon to advise the

    Administrator of the OIRA in the OMB whether their proposed rules

    constitute ``major'' rules.\35\ 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 the costs or prices

    for consumers, individual industries, federal, state, or local

    government agencies, or geographic regions; or (3) significant adverse

    effects on competition, employment, investment, productivity,

    innovation, or on the ability of United States-based enterprises to

    compete with foreign-based enterprises in domestic and export

    markets.\36\ If a rule is ``major,'' its effectiveness will generally

    be delayed for 60 days pending Congressional review.

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    \35\ See Public Law 104-121 (March 29, 1996), as amended by

    Public Law 110-28 (May 25, 2007). The provisions governing

    congressional review of agency rulemaking are set forth in SBREFA

    Subtitle E, which is codified at 5 U.S.C. 801-808.

    \36\ See 5 U.S.C. 804(2).

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    The Commission requests comment on whether its proposed rule would,

    if adopted, constitute a major rule under SBREFA. Commenters are

    requested to provide empirical data and other factual support for their

    view to the extent possible.

    VI. Statutory Authority

    Pursuant to the CEA, and particularly Section 2(h)(7) thereof, the

    Commission proposes new Rule 39.6, as set forth below, governing the

    exception to mandatory clearing of swaps established by CEA Section

    2(h)(7).

    [[Page 80757]]

    List of Subjects in 17 CFR Part 39

    Business and industry, Reporting requirements, Swaps.

    For the reasons stated in the preamble, the Commission proposes to

    amend 17 CFR part 39 as follows:

    PART 39--DERIVATIVES CLEARING ORGANIZATIONS

    1. The authority citation for part 39 is revised to read as

    follows:

    Authority: 7 U.S.C. 2, 5, 6, 6d, 7a-1, 7a-2, and 7b, as amended

    by the Dodd-Frank Wall Street Reform and Consumer Protection Act,

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

    2. Section 39.6 is revised to read as follows:

    Sec. 39.6 Electing to use the end-user exception to mandatory swap

    clearing.

    (a) A counterparty to a swap (an ``electing counterparty'') may

    elect to use the exception to mandatory clearing under section

    2(h)(7)(A)(iii) of the Act if the electing counterparty is not a

    ``financial entity'' as defined in section 2(h)(7)(C)(i) of the Act, is

    using the swap to hedge or mitigate commercial risk as defined in Sec.

    39.6(c), and provides or causes to be provided to a registered swap

    data repository or, if no registered swap data repository is available,

    the Commission, the information specified in Sec. 39.6(b). More than

    one counterparty to a swap may be an electing counterparty. If there is

    more than one electing counterparty to a swap, the information

    specified in Sec. 39.6(b) shall be provided with respect to each of

    the electing counterparties.

    (b) When an electing counterparty to a swap elects to use the

    exception to mandatory clearing under section 2(h)(7)(A)(iii) of the

    Act, one of the counterparties to the swap (the ``reporting

    counterparty'') shall provide or cause to be provided the following

    information to a registered swap data repository or, if no registered

    swap data repository is available, the Commission, in the form and

    manner required for delivery of information specified under the

    Commission's rules:

    (1) The identity of the electing counterparty to the swap;

    (2) Whether the electing counterparty is a ``financial entity'' as

    defined in section 2(h)(7)(C)(i) of the Act;

    (3) Whether the electing counterparty is a finance affiliate

    meeting the requirements described in sections 2(h)(7)(C)(iii) or

    2(h)(7)(D) of the Act;

    (4) Whether the swap is used by the electing counterparty to hedge

    or mitigate commercial risk as defined in Sec. 39.6(c) under the Act;

    (5) Whether the electing counterparty generally expects to meet its

    financial obligations associated with its non-cleared swap by using:

    (i) A written credit support agreement;

    (ii) Pledged or segregated assets (including posting or receiving

    margin);

    (iii) A written third-party guarantee;

    (iv) Solely the electing counterparty's available financial

    resources; or

    (v) Means other than those described in Sec. 39.6(b)(5)(i), (ii),

    (iii) or (iv); and

    (6) Whether the electing counterparty is an entity that is an

    issuer of securities registered under section 12 of, or is required to

    file reports under 15(d) of, the Securities Exchange Act of 1934, and

    if so:

    (i) The relevant SEC Central Index Key number for that

    counterparty; and

    (ii) Whether an appropriate committee of the board of directors (or

    equivalent body) has reviewed and approved the decision not to clear

    the swap.

    (c) For purposes of section 2(a)(7)(A)(ii) of the CEA and Sec.

    39.6(b)(4), a swap shall be deemed to be used to hedge or mitigate

    commercial risk when:

    (1) Such swap:

    (i) Is economically appropriate to the reduction of risks in the

    conduct and management of a commercial enterprise, where the risks

    arise from:

    (A) The potential change in the value of assets that a person owns,

    produces, manufactures, processes, or merchandises or reasonably

    anticipates owning, producing, manufacturing, processing, or

    merchandising in the ordinary course of business of the enterprise;

    (B) The potential change in the value of liabilities that a person

    has incurred or reasonably anticipates incurring in the ordinary course

    of business of the enterprise; or

    (C) The potential change in the value of services that a person

    provides, purchases, or reasonably anticipates providing or purchasing

    in the ordinary course of business of the enterprise;

    (D) The potential change in the value of assets, services, inputs,

    products, or commodities that a person owns, produces, manufactures,

    processes, merchandises, leases, or sells, or reasonably anticipates

    owning, producing, manufacturing, processing, merchandising, leasing,

    or selling in the ordinary course of business of the enterprise;

    (E) Any potential change in value related to any of the foregoing

    arising from foreign exchange rate movements associated with such

    assets, liabilities, services, inputs, products, or commodities; or

    (F) Any fluctuation in interest, currency, or foreign exchange rate

    exposures arising from a person's current or anticipated assets or

    liabilities; or

    (ii) Qualifies as bona fide hedging for purposes of an exemption

    from position limits under the Act; or

    (iii) Qualifies for hedging treatment under Financial Accounting

    Standards Board Accounting Standards Codification Topic 815,

    Derivatives and Hedging (formerly known as Statement No. 133); and

    (2) Such swap is:

    (i) Not used for a purpose that is in the nature of speculation,

    investing, or trading; or

    (ii) Not used to hedge or mitigate the risk of another swap or

    securities-based swap, unless that other swap itself is used to hedge

    or mitigate commercial risk as defined by this rule or the equivalent

    definitional rule governing security-based swaps promulgated by the

    Securities and Exchange Commission under the Securities Exchange Act of

    1934.

    Issued in Washington, DC, on December 9, 2010, by the

    Commission.

    David A. Stawick,

    Secretary of the Commission.

    Appendices to End-User Exception to Mandatory Clearing of Swaps--

    Commission Voting Summary and Statements of Commissioners

    Note: The following appendices will not appear in the Code of

    Federal Regulations.

    Appendix 1--Commission Voting Summary

    On this matter, Chairman Gensler and Commissioners Dunn and

    Chilton voted in the affirmative; Commissioners Sommers and O'Malia

    voted in the negative.

    Appendix 2--Statement of Chairman Gary Gensler

    I support the proposed rule on the end-user exception. Congress

    decided that non-financial entities hedging or mitigating commercial

    risk will have a choice of whether to submit their transactions to

    clearinghouse.

    In essence, the proposal says that, if a company is using a swap

    to hedge an asset, liability, input or service that it currently has

    or uses or anticipates having or using, it would qualify for the

    end-user exception. In addition, the proposal says that if the swap

    meets generally accepted accounting principles as a hedge or if it

    used for bona fide hedging, the transaction would qualify for the

    end-user exception. These non-financial entities would be able to

    hedge interest rate risk, currency risk, physical commodity risk or

    other types of risk.

    The proposed rule does, however, say that if an entity is taking

    a position to speculate,

    [[Page 80758]]

    the transaction would not qualify for the end-user exception.

    I also support the series of questions included in the proposal

    regarding small financial institutions. In the Dodd-Frank Act,

    Congress directed the commission to consider possible exemptions for

    small financial institutions. I look forward to hearing from the

    public on their views on this and what conditions would be

    appropriate for such exemptions.

    [FR Doc. 2010-31578 Filed 12-22-10; 8:45 am]

    BILLING CODE P

    Last Updated: December 23, 2010