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2011-11008

  • Federal Register, Volume 76 Issue 99 (Monday, May 23, 2011)[Federal Register Volume 76, Number 99 (Monday, May 23, 2011)]

    [Proposed Rules]

    [Pages 29818-29900]

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

    [FR Doc No: 2011-11008]

    [[Page 29817]]

    Vol. 76

    Monday,

    No. 99

    May 23, 2011

    Part II

    Commodity Futures Trading Commission

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    17 CFR Part 1

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    Securities and Exchange Commission

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    17 CFR Part 240

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

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

    Agreement Recordkeeping; Proposed Rule

    Federal Register / Vol. 76 , No. 99 / Monday, May 23, 2011 / Proposed

    Rules

    [[Page 29818]]

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    COMMODITY FUTURES TRADING COMMISSION

    17 CFR Part 1

    RIN 3038-AD46

    SECURITIES AND EXCHANGE COMMISSION

    17 CFR Part 240

    [Release No. 33-9204; 34-64372; File No. S7-16-11]

    RIN 3235-AL14

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

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

    Agreement Recordkeeping

    AGENCIES: Commodity Futures Trading Commission; Securities and Exchange

    Commission.

    ACTION: Joint proposed rules; proposed interpretations.

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    SUMMARY: In accordance with section 712(a)(8), section 712(d)(1),

    sections 712(d)(2)(B) and (C), sections 721(b) and (c), and section

    761(b) of the Dodd-Frank Wall Street Reform and Consumer Protection Act

    (``Dodd-Frank Act''), the Commodity Futures Trading Commission

    (``CFTC'') and the Securities and Exchange Commission (``SEC'')

    (collectively, ``Commissions''), in consultation with the Board of

    Governors of the Federal Reserve System (``Board''), are jointly

    issuing proposed rules and proposed interpretive guidance under the

    Commodity Exchange Act (``CEA'') and the Securities Exchange Act of

    1934 (``Exchange Act'') to further define the terms ``swap,''

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

    (collectively, ``Product Definitions''), regarding ``mixed swaps,'' and

    governing books and records with respect to ``security-based swap

    agreements.''

    DATES: Comments should be received on or before July 22, 2011.

    ADDRESSES: Comments may be submitted, identified by File No. S7-16-11,

    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: http://www.regulations.gov.

    Follow the instructions for submitting comments.

    Please submit your comments using only one method. ``Product

    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. Comments will be posted as received to http://www.cftc.gov. You should submit only information that you wish to make

    available publicly. If you wish the CFTC to consider information that

    you believe is exempt from disclosure under the Freedom of Information

    Act, a petition for confidential treatment of the exempt information

    may be submitted according to the procedures established in section

    145.9 of the CFTC's regulations.\1\

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    \1\ 17 CFR 145.9.

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    The CFTC reserves the right, but shall have no obligation, to

    review, pre-screen, filter, redact, refuse or remove any or all of your

    submission from www.cftc.gov that it may deem to be inappropriate for

    publication, including 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.

    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 S7-16-11 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

    S7-16-11. 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 SEC will post all comments

    on the SEC's Internet Web site (http://www.sec.gov/rules/proposed.shtml). Comments are also available for Web site viewing and

    printing in the SEC'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;

    the SEC does not edit personal identifying information from

    submissions. You should submit only information that you wish to make

    available publicly.

    FOR FURTHER INFORMATION CONTACT: CFTC: Julian E. Hammar, Assistant

    General Counsel, at 202-418-5118, jhammar@cftc.gov, Mark Fajfar,

    Assistant General Counsel, at 202-418-6636, mfajfar@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: Matthew A. Daigler,

    Senior Special Counsel, at 202-551-5578, Cristie L. March, Attorney-

    Adviser, at 202-551-5574, or Leah M. Drennan, Attorney-Adviser, at 202-

    551-5507, Division of Trading and Markets, or Michael J. Reedich,

    Special Counsel, or Tamara Brightwell, Senior Special Counsel to the

    Director, at 202-551-3500, Division of Corporation Finance, Securities

    and Exchange Commission, 100 F Street, NE., Washington, DC 20549-7010.

    SUPPLEMENTARY INFORMATION: The Commissions jointly are proposing new

    rules and interpretive guidance under the CEA and the Exchange Act

    relating to the Product Definitions, mixed swaps, and security-based

    swap agreements.

    Table of Contents

    I. Background

    II. Scope of Definitions of Swap and Security-Based Swap

    A. Introduction

    B. Proposed Rules and Interpretive Guidance Regarding Certain

    Transactions Outside the Scope of the Definitions of the Terms

    ``Swap'' and ``Security-Based Swap''

    1. Insurance Products

    (a) Types of Insurance Products

    (b) Providers of Insurance Products

    2. The Forward Contract Exclusion

    (a) Forward Contracts in Nonfinancial Commodities

    (b) Commodity Options and Commodity Options Embedded in Forward

    Contracts

    (c) Security Forwards

    3. Consumer and Commercial Agreements, Contracts, and

    Transactions

    4. Loan Participations

    C. Proposed Rules and Interpretive Guidance Regarding Certain

    Transactions Within the Scope of the Definitions of the Terms

    ``Swap'' and ``Security-Based Swap''

    1. In General

    [[Page 29819]]

    2. Foreign Exchange Products

    (a) Foreign Exchange Products Subject to the Secretary's Swap

    Determination: Foreign Exchange Forwards and Foreign Exchange Swaps

    (b) Foreign Exchange Products Not Subject to the Secretary's

    Swap Determination

    (i) Foreign Currency Options

    (ii) Non-Deliverable Forward Contracts Involving Foreign

    Exchange

    (iii) Currency Swaps and Cross-Currency Swaps

    3. Forward Rate Agreements

    4. Combinations and Permutations of, or Options on, Swaps and

    Security-Based Swaps

    5. Contracts for Differences

    D. Certain Interpretive Issues

    1. Agreements, Contracts, or Transactions That May Be Called, or

    Documented Using Form Contracts Typically Used for, Swaps or

    Security-Based Swaps

    2. Transactions in Regional Transmission Organizations and

    Independent System Operators

    III. The Relationship Between the Swap Definition and the Security-

    Based Swap Definition

    A. Introduction

    B. Title VII Instruments Based on Interest Rates, Other Monetary

    Rates, and Yields

    1. Title VII Instruments Based on Interest Rates or Other

    Monetary Rates That Are Swaps

    2. Title VII Instruments Based on Yields

    3. Title VII Instruments Based on Government Debt Obligations

    C. Total Return Swaps

    D. Security-Based Swaps Based on a Single Security or Loan and

    Single-Name Credit Default Swaps

    E. Title VII Instruments Based on Futures Contracts

    F. Use of Certain Terms and Conditions in Title VII Instruments

    G. The Term ``Narrow-Based Security Index'' in the Security-

    Based Swap Definition

    1. Introduction

    2. Applicability of the Statutory Narrow-Based Security Index

    Definition and Past Guidance of the Commissions to Title VII

    Instruments

    3. Narrow-Based Security Index Criteria for Index Credit Default

    Swaps

    (a) In General

    (b) Proposed Rules Regarding the Definitions of ``Issuers of

    Securities in a Narrow-Based Security Index'' and ``Narrow-Based

    Security Index'' for Index Credit Default Swaps

    (i) Number and Concentration Percentages of Reference Entities

    or Securities

    (ii) Public Information Availability Regarding Reference

    Entities and Securities

    (iii) Treatment of Indexes Including Reference Entities That Are

    Issuers of Exempted Securities or Including Exempted Securities

    4. Security Indexes

    5. Evaluation of Title VII Instruments on Security Indexes That

    Move From Broad-Based to Narrow-Based or Narrow-Based to Broad-Based

    (a) In General

    (b) Title VII Instruments on Security Indexes Traded on

    Designated Contract Markets, Swap Execution Facilities, Foreign

    Boards of Trade, Security-Based Swap Execution Facilities, and

    National Securities Exchanges

    H. Method of Settlement of Index CDS

    I. Security-Based Swaps as Securities Under the Exchange Act and

    Securities Act

    IV. Mixed Swaps

    A. Scope of the Category of Mixed Swap

    B. Regulation of Mixed Swaps

    1. Introduction

    2. Bilateral Uncleared Mixed Swaps Entered Into by Dually-

    Registered Dealers or Major Participants

    3. Regulatory Treatment for Other Mixed Swaps

    V. Security-Based Swap Agreements

    A. Introduction

    B. Swaps That Are Security-Based Swap Agreements

    C. Books and Records Requirements for Security-Based Swap

    Agreements

    VI. Process for Requesting Interpretations of the Characterization

    of a Title VII Instrument

    VII. Anti-Evasion

    A. CFTC Proposed Anti-Evasion Rules

    B. SEC Request for Comment Regarding Anti-Evasion

    VIII. Administrative Law Matters--CEA Revisions

    IX. Administrative Law Matters--Exchange Act Revisions

    X. Statutory Basis and Rule Text

    I. Background

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

    law.\2\ Title VII of the Dodd-Frank Act \3\ (``Title VII'') 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: (i) Providing for the registration and

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

    major swap participants, and major security-based swap participants;

    (ii) imposing clearing and trade execution requirements on swaps and

    security-based swaps, subject to certain exceptions; (iii) creating

    rigorous recordkeeping and real-time reporting regimes; and (iv)

    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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    \2\ 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 is available at http://www.cftc.gov/LawRegulation/OTCDERIVATIVES/index.htm.

    \3\ 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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    Section 712(d)(1) of the Dodd-Frank Act provides that the

    Commissions, in consultation with the Board, shall jointly further

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

    based swap agreement'' (``SBSA'').\4\ Section 712(a)(8) of the Dodd-

    Frank Act provides further that the Commissions shall jointly prescribe

    such regulations regarding ``mixed swaps'' as may be necessary to carry

    out the purposes of Title VII. In addition, sections 721(b) and 761(b)

    of the Dodd-Frank Act provide that the Commissions may adopt rules to

    further define terms included in subtitles A and B, respectively, of

    Title VII, and sections 721(c) and 761(b) of the Dodd-Frank Act provide

    the Commissions with authority to define the terms ``swap'' and

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

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

    security-based swap participant,'' to include transactions and entities

    that have been structured to evade the requirements of subtitles A and

    B, respectively, of Title VII.

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    \4\ In addition, section 719(d)(1)(A) of the Dodd-Frank Act

    requires the Commissions to conduct a joint study, within 15 months

    of enactment, to determine whether stable value contracts, as

    defined in section 719(d)(2) of the Dodd-Frank Act, are encompassed

    by the swap definition. If the Commissions determine that stable

    value contracts are encompassed by the swap definition, section

    719(d)(1)(B) of the Dodd-Frank Act requires the Commissions jointly

    to determine whether an exemption for those contracts from the swap

    definition is appropriate and in the public interest. Section

    719(d)(1)(B) also requires the Commissions to issue regulations

    implementing the determinations made under the required study. Until

    the effective date of such regulations, the requirements under Title

    VII do not apply to stable value contracts, and stable value

    contracts in effect prior to the effective date of such regulations

    are not considered swaps. See section 719(d) of the Dodd-Frank Act.

    The Commissions currently are conducting the required joint study

    and will consider whether to propose any implementing regulations

    (including, if appropriate, regulations determining that stable

    value contracts: (i) are not encompassed within the swap definition;

    or (ii) are encompassed within the definition but are exempt from

    the swap definition) at the conclusion of that study.

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    Section 712(d)(2)(B) of the Dodd-Frank Act requires the

    Commissions, in consultation with the Board, to jointly adopt rules

    governing books and records requirements for SBSAs by persons

    registered as swap data repositories (``SDRs'') under the CEA,\5\

    including uniform rules that specify the data elements that shall be

    collected and maintained by each SDR.\6\ Similarly,

    [[Page 29820]]

    section 712(d)(2)(C) of the Dodd-Frank Act requires the Commissions, in

    consultation with the Board, to jointly adopt rules governing books and

    records for SBSAs, including daily trading records, for swap dealers,

    major swap participants, security-based swap dealers, and security-

    based swap participants.\7\

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

    \6\ The CFTC has issued proposed rules regarding SDRs and,

    separately, swap data recordkeeping and reporting. See Regulations

    Establishing and Governing the Duties of Swap Dealers and Major Swap

    Participants, 75 FR 71397, Nov. 23, 2010; Swap Data Recordkeeping

    and Reporting Requirements, 75 FR 76573, Dec. 8, 2010. The SEC has

    also issued proposed rules regarding security-based swap data

    repositories (``SBSDRs''), including rules specifying data

    collection and maintenance standards for SBSDRs, as well as rules

    regarding security-based swap data recordkeeping and reporting. See

    Security-Based Swap Data Repository Registration, Duties, and Core

    Principles, 75 FR 77306, Dec. 10, 2010; Regulation SBSR--Reporting

    and Dissemination of Security-Based Swap Information, 75 FR 75208,

    Dec. 2, 2010.

    \7\ The CFTC has issued proposed rules regarding recordkeeping

    requirements for swap dealers and major swap participants. See

    Reporting, Recordkeeping, and Daily Trading Records Requirements for

    Swap Dealers and Major Swap Participants, 75 FR 76666, Dec. 9, 2010.

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    Under the comprehensive framework for regulating swaps and

    security-based swaps established in Title VII, the CFTC is given

    regulatory authority over swaps,\8\ the SEC is given regulatory

    authority over security-based swaps,\9\ and the Commissions shall

    jointly prescribe such regulations regarding mixed swaps as may be

    necessary to carry out the purposes of Title VII.\10\ In addition, the

    SEC is given antifraud authority over, and access to information from,

    certain CFTC-regulated entities regarding SBSAs, which are a type of

    swap related to securities over which the CFTC is given regulatory

    authority.\11\

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    \8\ Section 721(a) of the Dodd-Frank Act defines the term

    ``swap'' by adding section 1a(47) to the CEA, 7 U.S.C. 1a(47). This

    new swap definition also is cross-referenced in new section 3(a)(69)

    of the Exchange Act, 15 U.S.C. 78c(a)(69). Citations to provisions

    of the CEA and the Exchange Act, 15 U.S.C. 78a et seq., in this

    release refer to the numbering of those provisions after the

    effective date of Title VII, except as indicated.

    \9\ Section 761(a) of the Dodd-Frank Act defines the term

    ``security-based swap'' by adding new section 3(a)(68) to the

    Exchange Act, 15 U.S.C. 78c(a)(68). This new security-based swap

    definition also is cross-referenced in new CEA section 1a(42), 7

    U.S.C. 1a(42). The Dodd-Frank Act also explicitly includes security-

    based swaps in the definition of security under the Exchange Act and

    the Securities Act of 1933 (``Securities Act''), 15 U.S.C. 77a et

    seq.

    \10\ Section 721(a) of the Dodd-Frank Act describes the category

    of ``mixed swap'' by adding new section 1a(47)(D) to the CEA, 7

    U.S.C. 1a(47)(D). Section 761(a) of the Dodd-Frank Act also includes

    the category of ``mixed swap'' by adding new section 3(a)(68)(D) to

    the Exchange Act, 15 U.S.C. 78c(68)(D). A mixed swap is defined as a

    subset of security-based swaps that also are based on the value of 1

    or more interest or other rates, currencies, commodities,

    instruments of indebtedness, indices, quantitative measures, other

    financial or economic interest or property of any kind (other than a

    single security or a narrow-based security index), or the

    occurrence, non-occurrence, or the extent of the occurrence of an

    event or contingency associated with a potential financial,

    economic, or commercial consequence (other than the occurrence, non-

    occurrence, or extent of the occurrence of an event relating to a

    single issuer of a security or the issuers of securities in a

    narrow-based security index, provided that such event directly

    affects the financial statements, financial condition, or financial

    obligations of the issuer).

    \11\ Section 761(a) of the Dodd-Frank Act defines the term

    ``security-based swap agreement'' by adding new section 3(a)(78) to

    the Exchange Act, 15 U.S.C. 78c(a)(78). The CEA includes the

    definition of ``security-based swap agreement'' in subparagraph

    (A)(v) of the swap definition in CEA section 1a(47), 7 U.S.C.

    1a(47). The only difference between these definitions is that the

    definition of SBSA in the Exchange Act specifically excludes

    security-based swaps (see section 3(a)(78)(B) of the Exchange Act,

    15 U.S.C. 78c(a)(78)(B)), whereas the definition of SBSA in the CEA

    does not contain a similar exclusion. Instead, under the CEA, the

    exclusion for security-based swaps is placed in the general

    exclusions from the swap definition (see CEA section 1a(47)(B)(x), 7

    U.S.C. 1a(47)(B)(x)). Although the statutes are slightly different

    structurally, the Commissions interpret them to have consistent

    meaning that the category of security-based swap agreements excludes

    security-based swaps.

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    To assist the Commissions in further defining the Product

    Definitions (as well as certain other definitions) and in prescribing

    regulations regarding mixed swaps as may be necessary to carry out the

    purposes of Title VII, the Commissions published an advance notice of

    proposed rulemaking (``ANPR'') in the Federal Register on August 20,

    2010.\12\ The comment period for the ANPR closed on September 20,

    2010.\13\ The Commissions received comments addressing the Product

    Definitions and/or mixed swaps in response to the ANPR, as well as

    comments in response to the Commissions' informal solicitations,\14\

    from a wide range of commenters.

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    \12\ See Definitions Contained in Title VII of Dodd-Frank Wall

    Street Reform and Consumer Protection Act, 75 FR 51429, Aug. 20,

    2010. The ANPR also solicited comment regarding the definitions of

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

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

    ``eligible contract participant.'' These definitions are the subject

    of a separate joint proposed rulemaking by the Commissions. See

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

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

    Participant'' and ``Eligible Contract Participant,'' 75 FR 80174,

    Dec. 21, 2010 (``Entity Definitions''). The Commissions also

    provided the public with the ability to present their views more

    generally on implementation of the Dodd-Frank Act through their Web

    sites, dedicated electronic mailboxes, and meetings with interested

    parties. See Public Comments on SEC Regulatory Initiatives Under the

    Dodd-Frank Act/Meetings with SEC Officials located at http://www.sec.gov/spotlight/regreformcomments.shtml; Public Submissions,

    located at http://comments.cftc.gov/PublicComments/ReleasesWithComments.aspx; External Meetings, located at http://www.cftc.gov/LawRegulation/DoddFrankAct/ExternalMeetings/index.htm.

    \13\ Copies of all comments received by the SEC on the ANPR are

    available on the SEC's Internet Web site, located at http://www.sec.gov/comments/s7-16-10/s71610.shtml. Comments are also

    available for Web site viewing and printing in the SEC'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. Copies of all

    comments received by the CFTC on the ANPR are available on the

    CFTC's Internet Web site, located at http://www.cftc.gov/LawRegulation/DoddFrankAct/OTC_2_Definitions.html.

    \14\ See supra note 12.

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    The Commissions have reviewed the comments received, and the staffs

    of the Commissions have met with many market participants and other

    interested parties to discuss the definitions.\15\ Moreover, the

    Commissions' staffs have consulted extensively with each other as

    required by sections 712(a)(1) and (2) of the Dodd-Frank Act and have

    consulted with staff of the Board as required by section 712(d) of the

    Dodd-Frank Act.

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    \15\ Information about meetings that CFTC staff have had with

    outside organizations regarding the implementation of the Dodd-Frank

    Act is available at http://www.cftc.gov/LawRegulation/DoddFrankAct/ExternalMeetings/index.htm. Information about meetings that SEC

    staff have had with outside organizations regarding the product

    definitions is available at http://www.sec.gov/comments/s7-16-10/s71610.shtml#meetings. The views expressed in the comments in

    response to the ANPR, in response to the Commissions' informal

    solicitations, and at such meetings are collectively referred to as

    the views of ``commenters.''

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    Based on this review and consultation, the Commissions are

    proposing interpretive guidance, and in some instances also proposing

    rules, regarding, among other things: (i) The regulatory treatment of

    insurance products; (ii) the exclusion of forward contracts from the

    swap and security-based swap definitions; (iii) the regulatory

    treatment of certain consumer and commercial contracts; (iv) the

    regulatory treatment of certain foreign-exchange related and other

    instruments; (v) swaps and security-based swaps involving interest

    rates (or other rates) and yields; (vi) total return swaps (``TRS'');

    (vii) the application of the definition of ``narrow-based security

    index'' in distinguishing between certain swaps and security-based

    swaps, including credit default swaps (``CDS'') and index CDS; and

    viii) the specification of certain swaps and security-based swaps that

    are, and are not, mixed swaps. In addition, the Commissions are

    proposing rules: (i) establishing books and records requirements

    applicable to SBSAs; (ii) providing a mechanism for requesting the

    Commissions to interpret whether a particular type of agreement,

    contract, or transaction (or class of agreements, contracts, or

    transactions) is a swap, security-based swap, or both (i.e., a mixed

    swap); and (iii) providing a mechanism for evaluating the applicability

    of certain regulatory requirements to particular mixed swaps. Finally,

    the CFTC is proposing rules to

    [[Page 29821]]

    implement the anti-evasion authority provided in the Dodd-Frank Act.

    The Commissions believe that the proposed rules and interpretive

    guidance will further the purposes of Title VII. While the Commissions

    believe that these proposals, if adopted, would appropriately effect

    the intent of the Dodd-Frank Act, the Commissions are very interested

    in commenters' views as to whether those purposes have been achieved,

    and, if not, how to improve these proposals.

    II. Scope of Definitions of Swap and Security-Based Swap

    A. Introduction

    Title VII of the Dodd-Frank Act applies to a wide variety of

    agreements, contracts, and transactions classified as swaps or

    security-based swaps. The statute lists these agreements, contracts,

    and transactions in the definition of the term ``swap.'' \16\ The

    statutory definition of the term ``swap'' also has various

    exclusions,\17\ rules of construction, and other provisions for the

    interpretation of the definition.\18\ One of the exclusions to the

    definition of the term ``swap'' is for security-based swaps.\19\ The

    term ``security-based swap,'' in turn, is defined as an agreement,

    contract, or transaction that is a ``swap'' (without regard to the

    exclusion from that definition for security-based swaps) and that also

    has certain characteristics specified in the statute.\20\ Thus, the

    statutory definition of the term ``swap'' also determines the scope of

    agreements, contracts, and transactions that could be security-based

    swaps.

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    \16\ See CEA section 1a(47)(A), 7 U.S.C. 1a(47)(A). This swap

    definition is also cross-referenced in new section 3(a)(69) of the

    Exchange Act, 15 U.S.C. 78c(a)(69).

    \17\ See CEA section 1a(47)(B), 7 U.S.C. 1a(47)(B), clauses (i)-

    (x).

    \18\ See CEA sections 1a(47)(C)-(F), 7 U.S.C. 1a(47)(C)-(F).

    \19\ See CEA section 1a(47)(B)(x), 7 U.S.C. 1a(47)(B)(x).

    \20\ See section 3(a)(68) of the Exchange Act, 15 U.S.C.

    78c(a)(68).

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    The statutory definitions of ``swap'' and ``security-based swap''

    are detailed and comprehensive, and the Commissions believe that

    extensive ``further definition'' of the terms by rule is not necessary.

    Nevertheless, several commenters have stated,\21\ and the Commissions

    agree, that the definitions could be read to include certain types of

    agreements, contracts, and transactions that previously have not been

    considered swaps or security-based swaps and that nothing in the

    legislative history of the Dodd-Frank Act appears to suggest that

    Congress intended such agreements, contracts, and transactions to be

    regulated as swaps or security-based swaps under Title VII. The

    Commissions thus believe that it is important to clarify the treatment

    under the definitions of certain types of agreements, contracts, and

    transactions, such as insurance products and certain consumer and

    commercial contracts.

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    \21\ See, e.g., Letter from Edward J. Rosen, Cleary Gottlieb

    Steen & Hamilton LLP, Sept. 21, 2010 (``Cleary Letter''); Letter

    from Robert Pickel, Executive Vice President, International Swaps

    and Derivatives Association, Inc., Sept. 20, 2010 (``ISDA Letter'').

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

    In addition, commenters also raised questions regarding, and the

    Commissions believe that it is important to clarify: (i) The exclusion

    for forward contracts from the definitions of the terms ``swap'' and

    ``security-based swap;'' and (ii) the status of certain commodity-

    related products (including various foreign exchange products and

    forward rate agreements (``FRAs'')) under the definitions of the terms

    ``swap'' and ``security-based swap.'' Finally, the Commissions are

    providing guidance regarding certain interpretive issues related to the

    definitions.\22\

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

    \22\ Some commenters raised concerns regarding the treatment of

    inter-affiliate swaps and security-based swaps. See, e.g., Cleary

    Letter; Letter from Coalition for Derivatives End Users, Sept. 20,

    2010 (``CDEU Letter''); ISDA Letter; Letter from Richard A. Miller,

    Vice President and Corporate Counsel, Prudential Financial Inc.,

    Sept. 17, 2010; Letter from Richard M. Whiting, The Financial

    Services Roundtable, Sept. 20, 2010. A few commenters suggested that

    the Commissions should further define the term ``swap'' or

    ``security-based swap'' to exclude inter-affiliate transactions. See

    Cleary Letter; CDEU Letter. The Commissions are considering whether

    inter-affiliate swaps or security-based swaps should be treated

    differently from other swaps or security-based swaps in the context

    of the Commissions' other Title VII rulemakings.

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

    B. Proposed Rules and Interpretive Guidance Regarding Certain

    Transactions Outside the Scope of the Definitions of the Terms ``Swap''

    and ``Security-Based Swap''

    1. Insurance Products

    A number of commenters expressed concern that the definitions of

    the terms ``swap'' and ``security-based swap'' potentially could

    include certain types of insurance products \23\ because the statutory

    definition of the term ``swap'' includes, in part, any agreement,

    contract, or transaction ``that provides for any purchase, sale,

    payment, or delivery (other than a dividend on an equity security) that

    is dependent on the occurrence, nonoccurrence, or the extent of the

    occurrence of an event or contingency associated with a potential

    financial, economic, or commercial consequence.'' \24\ The Commissions

    do not interpret this clause to mean that products historically treated

    as insurance products should be included within the swap or security-

    based swap definition.\25\

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

    \23\ See, e.g., Letter from Ernest C. Goodrich, Jr., Managing

    Director--Legal Department, and Marcelo Riffaud, Managing Director--

    Legal Department, Deutsche Bank AG, Sept. 20, 2010 (``Deutsche Bank

    Letter''); Letter from Sean W. McCarthy, Chairman, Association of

    Financial Guaranty Insurers, Sept. 20, 2010 (``AFGI Letter'');

    Letter from Robert J. Duke, The Surety & Fidelity Association of

    America, Sept. 20, 2010 (``SFAA Letter''); Letter from J. Stephen

    Zielezienski, Senior Vice President & General Counsel, American

    Insurance Association, Sept. 20, 2010; Letter from Franklin W.

    Nutter, President, Reinsurance Association of America, Sept. 20,

    2010 (``RAA Letter''); Letter from James M. Olsen, Senior Director

    Accounting and Investment Policy, Property Casualty Insurers

    Association of America, Sept. 17, 2010; Letter from Jane L. Cline,

    President, and Therese M. Vaughan, Chief Executive Officer, National

    Association of Insurance Commissioners, Sept. 20, 2010; Letter from

    Joseph W. Brown, Chief Executive Officer, MBIA Inc., Sept. 20, 2010

    (``MBIA Letter''); Cleary Letter; Letter from White & Case LLP

    (``White & Case Letter''), Sept. 20, 2010; Letter from Carl B.

    Wilkerson, Vice President and Chief Counsel, Securities &

    Litigation, American Council of Life Insurers, Nov. 12, 2010 (``ACLI

    Letter''); Letter from Stephen E. Roth, James M. Cain, and W. Thomas

    Conner, Sutherland Asbill & Brennan LLP, for the Committee of

    Annuity Insurers, Dec. 3, 2010.

    \24\ CEA section 1a(47)(A)(ii), 7 U.S.C. 1a(47)(A)(ii).

    \25\ The Commissions also believe it was not the intent of

    Congress through the swap and security-based swap definitions to

    preclude the provision of insurance to individual homeowners and

    small businesses that purchase property and casualty insurance. See

    CEA section 2(e), 7 U.S.C. 2(e) and section 6(l) of the Exchange

    Act, 15 U.S.C. 78f(l) (prohibiting individuals and small businesses

    that do not meet specified financial thresholds or other conditions

    from entering into swaps or security-based swaps other than on or

    subject to the rules of regulated futures and securities exchanges).

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

    The Commissions are aware of nothing in Title VII to suggest that

    Congress intended for insurance products to be regulated as swaps or

    security-based swaps. Moreover, that swaps and insurance products are

    subject to different regulatory regimes is reflected in section 722(b)

    of the Dodd-Frank Act which, in new section 12(h) of the CEA, provides

    that a swap ``shall not be considered to be insurance'' and ``may not

    be regulated as an insurance contract under the law of any State.''

    \26\

    [[Page 29822]]

    Accordingly, the Commissions believe that state or Federally regulated

    insurance products that are provided by state or Federally regulated

    insurance companies \27\ that otherwise could fall within the

    definitions should not be considered swaps or security-based swaps so

    long as they satisfy the proposed rules or comport with the related

    proposed interpretive guidance.\28\ At the same time, however, the

    Commissions are concerned that agreements, contracts, or transactions

    that are swaps or security-based swaps might be characterized as

    insurance products to evade the regulatory regime under Title VII of

    the Dodd-Frank Act. Accordingly, the Commissions are proposing rules

    and interpretive guidance that would clarify that agreements,

    contracts, or transactions meeting certain requirements would be

    considered insurance and not swaps or security-based swaps.

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

    \26\ 7 U.S.C. 16(h). Moreover, other provisions of the Dodd-

    Frank Act address the status of insurance more directly, and more

    extensively, than Title VII. For example, Title V of the Dodd-Frank

    Act requires the newly established Federal Insurance Office to

    conduct a study and submit a report to Congress, within 18 months of

    enactment of the Dodd-Frank Act, on the regulation of insurance,

    including the consideration of Federal insurance regulation.

    Notably, the Federal Insurance Office's authority under Title V

    extends primarily to monitoring and information gathering; its

    ability to promulgate Federal insurance regulation that preempts

    state insurance regulation is significantly restricted. See section

    502 of the Dodd-Frank Act (codified in various sections of 31

    U.S.C.). Title X of the Dodd-Frank Act also specifically excludes

    the business of insurance from regulation by the Bureau of Consumer

    Financial Protection. See section 1027(m) of the Dodd-Frank Act, 12

    U.S.C. 5517(m) (``The [Bureau of Consumer Financial Protection] may

    not define as a financial product or service, by regulation or

    otherwise, engaging in the business of insurance.''); section

    1027(f) of the Dodd-Frank Act, 12 U.S.C. 5517(f) (excluding persons

    regulated by a state insurance regulator, except to the extent they

    are engaged in the offering or provision of consumer financial

    products or services or otherwise subject to certain consumer laws

    as set forth in Title X of the Dodd-Frank Act).

    \27\ As discussed above, the establishment of the Federal

    Insurance Office under Title V of the Dodd-Frank Act suggests that

    Federal insurance law could be established in the future. The

    Commissions believe that the proposed rules should, therefore,

    include a specific reference to Federal insurance law.

    \28\ To the extent an insurance product does not fall within the

    language of the swap definition by its terms, it would not need to

    satisfy the requirements under the proposed rules in order to avoid

    being considered a swap or security-based swap.

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

    The proposed rules contain two subparts; the first subpart

    addresses the agreement, contract, or transaction and the second

    subpart addresses the entity providing that agreement, contract, or

    transaction. More specifically, with respect to the former, paragraph

    (i) of proposed rule 1.3(xxx)(4) under the CEA and paragraph (a) of

    proposed rule 3a69-1 under the Exchange Act would clarify, as discussed

    in more detail below, that the terms ``swap'' and ``security-based

    swap'' would not include an agreement, contract, or transaction that,

    by its terms or by law, as a condition of performance:

    Requires the beneficiary of the agreement, contract, or

    transaction to have an insurable interest that is the subject of the

    agreement, contract, or transaction and thereby carry the risk of loss

    with respect to that interest continuously throughout the duration of

    the agreement, contract, or transaction;

    Requires that loss to occur and to be proved, and that any

    payment or indemnification therefor be limited to the value of the

    insurable interest;

    Is not traded, separately from the insured interest, on an

    organized market or over-the-counter; and

    With respect to financial guaranty insurance only, in the

    event of payment default or insolvency of the obligor, any acceleration

    of payments under the policy is at the sole discretion of the insurer.

    In addition, the second subpart of the proposed rules, in paragraph

    (ii) of proposed rule 1.3(xxx)(4) under the CEA and paragraph (b) of

    proposed rule 3a69-1 under the Exchange Act, would require that, in

    order to be excluded from the swap and security-based swap definitions

    as an insurance product, the agreement, contract, or transaction must

    be provided:

    By a company that is organized as an insurance company

    whose primary and predominant business activity is the writing of

    insurance or the reinsuring of risks underwritten by insurance

    companies and that is subject to supervision by the insurance

    commissioner (or similar official or agency) of any state \29\ or by

    the United States or an agency or instrumentality thereof, and such

    agreement, contract, or transaction is regulated as insurance under the

    laws of such state or the United States;

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

    \29\ The term ``State'' is defined in section 3(a)(16) of the

    Exchange Act to mean ``any State of the United States, the District

    of Columbia, Puerto Rico, the Virgin Islands, or any other

    possession of the United States.'' 15 U.S.C. 78c(a)(16). The CFTC is

    proposing to incorporate this definition into proposed rule

    1.3(xxx)(4) for purposes of ensuring consistency between the CFTC

    and SEC rules further defining the term ``swap.''

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

    By the United States or any of its agencies or

    instrumentalities, or pursuant to a statutorily authorized program

    thereof; or

    In the case of reinsurance only, by a person located

    outside the United States to an insurance company that is eligible

    under the proposed rules, provided that: (i) such person is not

    prohibited by any law of any state or of the United States from

    offering such agreement, contract, or transaction to such an insurance

    company; (ii) the product to be reinsured meets the requirements under

    the proposed rules to be an insurance product; and (iii) the total

    amount reimbursable by all reinsurers for such insurance product cannot

    exceed the claims or losses paid by the cedant.\30\

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

    \30\ The ``cedant'' is the insurer writing the risk being ceded

    or transferred to such person located outside the United States.

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

    In order for an agreement, contract, or transaction to qualify as

    an insurance product that would not be a swap or security-based swap:

    (i) The agreement, contract, or transaction would have to meet the

    criteria in the first subpart of the proposed rules and (ii) the person

    or entity providing the agreement, contract, or transaction would have

    to meet the criteria in the second subpart of the proposed rules.\31\

    The fact that an agreement, contract, or transaction qualifies as an

    insurance product does not exclude it from the swap or security-based

    swap definitions if it is not provided by a qualifying person or

    entity, nor does the fact that a product is regulated by an insurance

    regulator exclude it from the swap or security-based swap definitions

    if the agreement, contract, or transaction does not satisfy the

    criteria for insurance set forth in the proposed rules.\32\

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

    \31\ The Commissions note that certain variable life insurance

    and annuity products are securities and would not be swaps or

    security-based swaps regardless of whether they met the requirements

    under the proposed rules. See CEA section 1a(47)(B)(v), 7 U.S.C.

    1a(47)(B)(v) (excluding from the definition of ``swap'' any

    ``agreement, contract, or transaction providing for the purchase or

    sale of 1 or more securities on a fixed basis that is subject to--

    (I) the [Securities Act]; and (II) the [Exchange Act]''). See also

    SEC v. United Benefit Life Ins. Co., 387 U.S. 202 (1967) (holding

    that a ``flexible fund'' annuity contract was not entitled to

    exemption under section 3(a)(8) of the Securities Act, 15 U.S.C.

    77c(a)(8), for insurance and annuities); SEC v. Variable Annuity

    Life Ins. Co., 359 U.S. 65 (1959) (holding that a variable annuity

    was not entitled to exemption under section 3(a)(8) of the

    Securities Act, 15 U.S.C. 77c(a)(8), for insurance and annuities).

    \32\ The Commissions note that Title VII provides flexibility to

    address the facts and circumstances of new products that may be

    marketed or sold as insurance, for the purpose of determining

    whether they satisfy the requirements of the proposed rules, through

    joint interpretations pursuant to section 712(d)(4) of the Dodd-

    Frank Act.

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

    In addition, the Commissions are proposing interpretive guidance to

    clarify that, independent of paragraph (i) of proposed rule 1.3(xxx)(4)

    under the CEA and paragraph (a) of proposed rule 3a69-1 under the

    Exchange Act, certain insurance products do not fall within the swap or

    security-based swap definitions so long as they are provided in

    accordance with paragraph (ii) of proposed rule 1.3(xxx)(4) under the

    CEA and paragraph (b) of proposed rule 3a69-1 under the Exchange Act.

    (a) Types of Insurance Products \33\

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

    \33\ See supra note 23, regarding comments received addressing

    this criterion.

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

    Paragraph (i) of proposed rule 1.3(xxx)(4) under the CEA and

    paragraph (a) of proposed rule 3a69-1 under the Exchange Act would set

    forth four criteria for an agreement, contract, or transaction to be

    considered insurance. First, the proposed rules would require that the

    beneficiary have an ``insurable interest'' underlying the

    [[Page 29823]]

    agreement, contract, or transaction at every point in time during the

    term of the agreement, contract, or transaction for that agreement,

    contract, or transaction to qualify as insurance. The requirement that

    the beneficiary be at risk of loss (which could be an adverse

    financial, economic, or commercial consequence) with respect to the

    interest that is the subject of the agreement, contract, or transaction

    at all times throughout the term of the agreement, contract, or

    transaction would ensure that an insurance contract beneficiary has a

    stake in the interest on which the agreement, contract, or transaction

    is written.\34\ Similarly, the provision of the proposed rules that

    would require the beneficiary to have the insurable interest

    continuously during the term of the agreement, contract, or transaction

    is designed to ensure that payment on the insurance product is

    inextricably connected to both the beneficiary and the interest on

    which the insurance product is written. In contrast to an insurance

    product, a CDS (which may be a swap or a security-based swap) does not

    require the purchaser of protection to hold any underlying obligation

    issued by the reference entity on which the CDS is written.\35\

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

    \34\ Requiring that a beneficiary of an insurance policy have a

    stake in the interest traditionally has been justified on public

    policy grounds. For example, a beneficiary that does not have a

    property right in a building might have an incentive to profit from

    arson.

    \35\ Standard CDS documentation stipulates that the incurrence

    or demonstration of a loss may not be made a condition to the

    payment on the CDS or the performance of any obligation pursuant to

    the CDS. See, e.g., Int'l Swaps and Derivatives Ass'n, ``2003 ISDA

    Credit Derivatives Definitions,'' art. 9.1(b)(i) (2003) (``2003

    Definitions) (``[T]he parties will be obligated to perform * * *

    irrespective of the existence or amount of the parties' credit

    exposure to a Reference Entity, and Buyer need not suffer any loss

    nor provide evidence of any loss as a result of the occurrence of a

    Credit Event.'').

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

    Second, the requirement that an actual loss occur and be proved

    under the proposed rules similarly would ensure that the beneficiary

    has a stake in the insurable interest that is the subject of the

    agreement, contract, or transaction. If the beneficiary can demonstrate

    actual loss, that loss would ``trigger'' performance by the insurer on

    the agreement, contract, or transaction such that, by making payment,

    the insurer is indemnifying the beneficiary for such loss. In addition,

    limiting any payment or indemnification to the value of the insurable

    interest aids in distinguishing swaps and security-based swaps (where

    there is no such limit) from insurance.\36\

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

    \36\ To the extent an insurance product provides for such items

    as, for example, a rental car for use while the car that is the

    subject of an automobile insurance policy is being repaired, the

    Commissions would consider such items as constituting part of the

    value of the insurable interest.

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

    Third, the proposed rules would require that the insurance product

    not be traded, separately from the insured interest, on an organized

    market or over-the-counter. With limited exceptions,\37\ insurance

    products traditionally have been neither entered into on or subject to

    the rules of an organized exchange nor traded in secondary market

    transactions (i.e., they are not traded on an organized market or over-

    the-counter). Whereas swaps and security-based swaps also generally

    have not been tradable at-will in secondary market transactions (i.e.,

    on an organized market or over-the-counter) without counterparty

    consent, the Commissions understand that swaps and security-based swaps

    are routinely novated or assigned to third parties, usually pursuant to

    industry standard terms and documents.\38\ For the foregoing reasons,

    the Commissions believe that lack of trading separately from the

    insured interest is a feature of insurance that is useful in

    distinguishing insurance from swaps and security-based swaps.

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

    \37\ See, e.g., ``Life Settlements Task Force, Staff Report to

    the United States Securities and Exchange Commission'' (``In an

    effort to help make the bidding process more efficient and to

    facilitate trading of policies after the initial settlement occurs,

    some intermediaries have considered or instituted a trading platform

    for life settlements.''), available at http://www.sec.gov/news/studies/2010/lifesettlements-report.pdf (July 22, 2010).

    \38\ See, e.g., Int'l Swaps and Derivatives Ass'n, ``2005

    Novation Protocol,'' available at http://www.isda.org/2005novationprot/docs/NovationProtocol.pdf (2005); Int'l Swaps and

    Derivatives Ass'n, ``ISDA Novation Protocol II,'' available at

    http://www.isda.org/isdanovationprotII/docs/NPII.pdf (2005); Int'l

    Swaps and Derivatives Ass'n, 2003 Definitions, supra note 35,

    Exhibits E (Novation Agreement) and F (Novation Confirmation).

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

    Fourth, the proposed rules would address financial guarantee

    policies, also known as bond insurance or bond wraps.\39\ Although such

    products can be economically similar to products such as CDS, they have

    certain key characteristics that distinguish them from swaps and

    security-based swaps.\40\ For example, under a financial guarantee

    policy, the insurer typically is required to make timely payment of any

    shortfalls in the payment of scheduled interest to the holders of the

    underlying guaranteed obligation. Also, for particular bonds that are

    covered by a financial guarantee policy, the indenture, related

    documentation, and/or the financial guarantee policy will provide that

    a default in payment of principal or interest on the underlying bond

    will not result in acceleration of the obligation of the insurer to

    make payment of the full amount of principal on the underlying

    guaranteed obligation unless the insurer, in its sole discretion, opts

    to make payment of principal prior to the final scheduled maturity date

    of the underlying guaranteed obligation. Conversely, under a CDS, a

    protection seller frequently is required to make payment of the

    relevant settlement amount to the protection buyer upon demand by the

    protection buyer after any credit event involving the issuer.\41\

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

    \39\ Several commenters expressed concern that the swap and

    security-based swap definitions could encompass financial guarantee

    policies. See, e.g., AFGI Letter; Letter from James M. Michener,

    General Counsel, Assured Guaranty, Dec. 14, 2010 (``Assured Guaranty

    Letter''); MBIA Letter; Letter from the Committee on Futures and

    Derivatives Regulation of the New York City Bar Association, Sept.

    20, 2010. Financial guarantee policies are used by entities such as

    municipalities to provide greater assurances to potential purchasers

    of their bonds and thus reduce their interest costs. See ``Report by

    the United States Securities and Exchange Commission on the

    Financial Guarantee Market: The Use of the Exemption in section

    3(a)(2) of the Securities Act of 1933 for Securities Guaranteed by

    Banks and the Use of Insurance Policies to Guarantee Debt

    Securities'' (Aug. 28, 1987).

    \40\ See, e.g., AFGI Letter (explaining the differences between

    financial guaranty policies and CDS); Letter from James M. Michener,

    General Counsel, Assured Guaranty, Sept. 13, 2010 (noting that the

    Financial Accounting Standards Board has issued separate guidance on

    accounting for financial guaranty insurance and CDS); Deutsche Bank

    Letter (noting that financial guaranty policies require the

    incurrence of loss for payment, whereas CDS do not).

    \41\ While a CDS requires payment in full on the occurrence of a

    credit event, the Commissions recognize that there are other

    financial instruments, such as corporate guarantees of commercial

    loans and letters of credit supporting payments on loans or debt

    securities, that allow for acceleration of payment obligations

    without such guarantees or letters of credit being swaps or

    security-based swaps.

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

    The Commissions do not believe that financial guarantee policies,

    in general, should be regulated as swaps or security-based swaps.

    However, because of the close economic similarity of financial

    guarantee insurance policies guaranteeing payment on debt securities to

    CDS, the Commissions also are proposing that, in addition to the

    criteria noted above with respect to insurance generally, financial

    guarantee policies also would have to satisfy the requirement that they

    not permit the beneficiary of the policy to accelerate the payment of

    any principal due on the debt securities. This requirement would

    further distinguish financial guarantee policies from CDS because, as

    discussed above, the latter generally requires payment of the relevant

    settlement amount on the CDS after demand by the protection buyer.

    [[Page 29824]]

    The Commissions believe that requiring all of the criteria in

    paragraph (i) of proposed rule 1.3(xxx)(4) under the CEA and paragraph

    (a) of proposed rule 3a69-1 under the Exchange Act would help limit the

    application of the proposed rules to products appropriately regulated

    as insurance and provide that products appropriately subject to the

    regulatory regime under Title VII of the Dodd-Frank Act are regulated

    as swaps or security-based swaps. As a result, the Commissions believe

    that these requirements would help prevent the proposed rules from

    being used to circumvent the applicability of the swap and security-

    based swap regulatory regimes under Title VII.

    However, the Commissions are considering an additional criterion as

    well. One ANPR commenter suggested that the proposed rules require

    that, in order to qualify as insurance that is excluded from the swap

    definition, payment on an agreement, contract, or transaction not be

    based on the price, rate, or level of a financial instrument, asset, or

    interest or any commodity.\42\ Such a requirement could help to prevent

    swaps from being executed in the guise of insurance in order to avoid

    the regulatory regime established by Title VII. It may ensure that an

    agreement, contract, or transaction is not treated as insurance if it

    is used for speculative purposes or to influence prices in derivatives

    markets. Yet, another ANPR commenter stated that such a requirement for

    an agreement, contract, or transaction to qualify as insurance rather

    than a swap ``is not consistent with common variable life insurance and

    variable annuity products, which deliver insurance guarantees that do

    vary with the performance of specified assets.'' \43\

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

    \42\ See Cleary Letter.

    \43\ See ACLI Letter.

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

    The Commissions request comment on whether, in order for an

    agreement, contract, or transaction to be considered insurance pursuant

    to paragraph (i) of proposed rule 1.3(xxx)(4) under the CEA and

    paragraph (a) of proposed rule 3a69-1 under the Exchange Act, the

    Commissions should require that payment not be based on the price,

    rate, or level of a financial instrument, asset, or interest or any

    commodity. If so, the Commissions also request comment on whether

    variable annuity contracts (where the income is subject to tax

    treatment under section 72 of the Internal Revenue Code) and variable

    universal life insurance should be excepted from such a

    requirement.\44\

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

    \44\ 26 U.S.C. 72. See also supra note 31.

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

    Although the proposed criteria should appropriately identify

    agreements, contracts, and transactions that should be considered to be

    insurance, the Commissions also are proposing interpretive guidance

    that certain enumerated types of insurance products are outside the

    scope of the statutory definitions of swap and security-based swap

    under the Dodd-Frank Act. These products are surety bonds, life

    insurance, health insurance, long-term care insurance, title insurance,

    property and casualty insurance, and annuity products the income on

    which is subject to tax treatment under section 72 of the Internal

    Revenue Code.\45\ The Commissions believe that these enumerated

    insurance products do not bear the characteristics of the transactions

    that Congress subjected to the regulatory regime for swaps and

    security-based swaps under the Dodd-Frank Act.\46\ As a result,

    excluding these enumerated insurance products should appropriately

    place traditional insurance products outside the scope of the swap and

    security-based swap definitions. Such insurance products, however,

    would need to be provided in accordance with paragraph (ii) of proposed

    rule 1.3(xxx)(4) under the CEA and paragraph (b) of proposed rule 3a69-

    1 under the Exchange Act, as discussed below, and such insurance

    products would need to be regulated as insurance.

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

    \45\ Id.

    \46\ The list of enumerated insurance products is generally

    consistent with the provisions of section 302(c)(2) of the Gramm-

    Leach-Bliley Act (``GLBA''), 15 U.S.C. 6712(c)(2), which addresses

    insurance underwriting in national banks.

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

    (b) Providers of Insurance Products

    The second subpart of the proposed rules, in paragraph (ii) of

    proposed rule 1.3(xxx)(4) under the CEA and paragraph (b) of proposed

    rule 3a69-1 under the Exchange Act, would require that, in addition to

    meeting the product requirements discussed above (or being subject to

    the interpretive guidance regarding enumerated insurance products

    provided above) the agreement, contract, or transaction be provided by

    a person or entity that meets certain criteria. Generally, the product

    would have to be provided by a company that is organized as an

    insurance company whose primary and predominant business activity is

    the writing of insurance or the reinsuring of risks underwritten by

    companies whose insurance business is subject to supervision by the

    insurance commissioner (or similar official or agency) of any state

    \47\ or by the United States or an agency or instrumentality thereof,

    and such agreement, contract, or transaction is regulated as insurance

    under the laws of such state or of the United States.\48\

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

    \47\ See supra note 29, regarding the definition of ``State''

    contained in the proposed rules.

    \48\ This paragraph of the proposed rules is substantially

    similar to the definition of an insurance company under the Federal

    securities laws. See section 2(a)(13) of the Securities Act, 15

    U.S.C. 77b(a)(13); section 2(a)(17) of the Investment Company Act of

    1940, 15 U.S.C. 80a-2(a)(17). These definitions also include

    reinsurance companies. In order to ensure regulatory consistency,

    the Commissions believe that it is appropriate to include

    substantially the same definition of an insurance company as

    currently exists elsewhere in the Federal securities laws, but the

    Commissions are requesting comment regarding the role played by a

    receiver or similar official or any liquidating agent for such

    insurance company, in its capacity as such, rather than proposing

    this provision of the insurance company definition.

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

    The requirement that the agreement, contract, or transaction be

    provided by a state or Federally regulated insurance company would help

    ensure that entities that are not regulated under insurance laws are

    not able to avoid regulation under Title VII of the Dodd-Frank Act as

    well. The Commissions believe that this requirement also should help

    prevent regulatory gaps that otherwise might exist between insurance

    regulation and the regulation of swaps and security-based swaps.

    The proposed rules also would require that the agreement, contract,

    or transaction provided by the insurance company be regulated as

    insurance under the laws of the state in which it is regulated or the

    United States. The purpose of this proposed requirement is that an

    agreement, contract, or transaction that satisfies the other conditions

    of the proposed rules must be subject to regulatory oversight as an

    insurance product. As a result of the requirement that an insurance

    regulator must have determined that the agreement, contract, or

    transaction being sold is insurance (i.e., because state insurance

    regulators are banned from regulating swaps as insurance),\49\ the

    Commissions believe that this condition would help prevent products

    that are swaps or security-based swaps from being characterized as

    insurance products in order to evade the regulatory regime under Title

    VII of the Dodd-Frank Act.

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

    \49\ See section 722(b) of the Dodd-Frank Act.

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

    The Commissions also believe that it is appropriate to exclude

    insurance that is issued by the United States or any of its agencies or

    instrumentalities, or pursuant to a statutorily authorized program

    thereof, from regulation as swaps or security-based swaps. Such

    [[Page 29825]]

    insurance would include, for example, Federal insurance of savings in

    banks, savings associations, and credit unions; catastrophic crop

    insurance; flood insurance; Federal insurance of certain pension

    obligations; and terrorism risk insurance. Accordingly, the proposed

    rules would provide that products meeting the criteria discussed above

    that are required for an agreement, contract, or transaction to qualify

    as insurance are excluded from the swap and security-based swap

    definitions if they are provided by the Federal government or pursuant

    to a statutorily authorized program thereof.

    Finally, the Commissions believe that where an agreement, contract,

    or transaction qualifies as insurance excluded from the swap and

    security-based swap definitions, the lawful reinsurance of that

    agreement, contract, or transaction similarly should be excluded. Such

    reinsurance would be excluded from the definitions even if the

    reinsurer is located abroad and is not state or Federally regulated.

    Accordingly, the proposed rules would provide that an agreement,

    contract, or transaction of reinsurance would be excluded from the swap

    and security-based swap definitions if it is provided by a person

    located outside the United States, if such person is not prohibited by

    any law of any state or the United States from offering such

    reinsurance to a state or Federally regulated insurance company, so

    long as the product to be reinsured meets the requirements under the

    proposed rules to be an insurance product, and the total amount

    reimbursable by all reinsurers for such insurance product cannot exceed

    the claims or losses paid by the cedant.

    The proposed rules would cover only an agreement, contract, or

    transaction by an insurance company and would not affect the

    characterization of the asset that is being insured. For example, if an

    agreement, contract, or transaction insures or guarantees the payment

    on a security, the security would remain subject to all applicable

    securities laws. The guarantee agreement, contract, or transaction,

    however, would not be regulated as a swap or security-based swap if it

    meets all of the requirements of the proposed rules.\50\

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

    \50\ The guarantee agreement, contract, or transaction, however,

    could itself be a security that is subject to the Federal securities

    laws.'' See, e.g., section 2(a)(1) of the Securities Act, 15 U.S.C.

    77b(a)(1) (including in the statutory definition of ``security'' a

    guarantee of a security).

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

    One commenter has stated that monoline insurance companies (also

    called financial guarantors) continue to guarantee payments under

    interest rate swaps related to municipal debt.\51\ The CFTC believes

    that an insurance ``wrap'' of a swap may not be sufficiently different

    from the underlying swap to suggest that Congress intended the former

    to fall outside the definition of the term ``swap'' in Title VII.

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

    \51\ See Letter from Bruce E. Stern, Chairman, Association of

    Financial Guaranty Insurers Government Affairs Committee, Feb. 18,

    2011, at 11-12 (``[F]inancial guarantors have often guaranteed,

    through the issuance of a financial guaranty insurance policy, the

    obligations of unaffiliated parties under swaps with other

    unaffiliated parties. These insurance policies typically cover

    obligations of municipalities under interest rate or basis swaps

    relating to bonds issued by municipalities or in connection with

    asset backed securities.'').

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

    The SEC, however, believes that, where an agreement, contract, or

    transaction is a security-based swap, the insurance of that security-

    based swap should not be regulated pursuant to Title VII, provided that

    the insurance meets the proposed requirements discussed above.\52\

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

    \52\ See supra note 32.

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

    The Commissions request comment on this issue generally, and also

    on the particular questions set forth in the Request for Comment

    section below.

    The Commissions also are considering whether the issuer of such

    insurance (or guarantee) in respect of swaps or security-based swaps

    entered into by an affiliate or third party could be considered to be a

    major swap participant or major security-based swap participant. The

    Commissions have requested comment in the proposing release for the

    definitions of the terms ``major swap participant'' and ``major

    security-based swap participant''.\53\

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

    \53\ See proposed Entity Definitions, supra note 12.

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

    Request for Comment

    1. The Commissions request comment on all aspects of proposed rule

    1.3(xxx)(4) under the CEA and proposed rule 3a69-1 under the Exchange

    Act and the interpretive guidance in this section.

    2. Do the proposed criteria for identifying an agreement, contract,

    or transaction that would not fall within the swap or security-based

    swap definitions appropriately encompass insurance and reinsurance

    products? If not, what types of insurance or reinsurance products are

    not encompassed, and why?

    3. Are there certain products that are commonly known as swaps or

    security-based swaps, or that more appropriately should be considered

    swaps or security-based swaps, that could satisfy the criteria in

    proposed rule 1.3(xxx)(4) under the CEA and proposed rule 3a69-1 under

    the Exchange Act?

    4. Is the proposed requirement that the beneficiary of an

    agreement, contract, or transaction have an insurable interest that is

    the subject of the agreement, contract, or transaction, and thereby

    carry the risk of loss with respect to that interest continuously

    throughout the duration of the agreement, contract, or transaction in

    order for the agreement, contract, or transaction not to fall within

    the swap or security-based swap definition, an effective criterion in

    determining whether a product is insurance? Why or why not?

    5. Is the proposed requirement that loss occur and be proved, and

    that any payment or indemnification therefor be limited to the value of

    the insurable interest, in order for an agreement, contract, or

    transaction not to fall within the swap or security-based swap

    definition, an effective criterion in determining whether a product is

    insurance? Why or why not? Is the requirement that any payment or

    indemnification for proved loss be limited to the value of the

    insurable interest consistent with conventional insurance analysis

    across a broad range of products (including traditional property and

    casualty products)? Are there particular products where such a

    limitation would not be appropriate? If so, please provide a detailed

    description of such products and why such a limitation would not be

    appropriate.

    6. Is the proposed requirement that the agreement, contract, or

    transaction is not traded, separately from the insured interest, on an

    organized market or over-the-counter, an effective criterion in

    determining whether a product is insurance? Why or why not?

    7. Should the Commissions add, as a requirement for an insurance

    agreement, contract, or transaction to not be characterized as a swap,

    that the agreement, contract, or transaction not be based on the price,

    rate, or level of a financial instrument, asset, or interest or any

    commodity? Would such a requirement be an effective criterion in

    distinguishing insurance from swaps and security-based swaps? Why or

    why not? If so, should the Commissions add any carve outs from the

    requirement, such as, for example, variable universal life insurance,

    or annuity contracts where the income is subject to tax treatment under

    section 72 of the Internal Revenue Code? Why or why not? Would such a

    requirement help preclude the use of the proposed rules for products

    that are swaps or security-based swaps? Why or why not? Would such a

    requirement preclude the use of the proposed rules for products that

    currently are insurance? If so, what

    [[Page 29826]]

    insurance products would be precluded by such a requirement, and how?

    How are insurance payments determined today?

    8. Is the proposed requirement that, with respect to financial

    guaranty insurance, in the event of payment default or insolvency of

    the obligor, any acceleration of payments under the policy be at the

    sole discretion of the insurer an effective criterion in determining

    whether a financial guaranty policy is insurance that does not fall

    within the swap or security-based swap definition? Why or why not?

    9. Does the interpretive guidance proposed in this section

    appropriately identify certain enumerated insurance products as

    traditional insurance products that would not fall within the swap or

    security-based swap definition if the provider of the product satisfies

    the requirements of the proposed rules? Why or why not? Is the

    interpretive guidance proposed in this section sufficient? Why or why

    not? Are there additional types of traditional insurance that should be

    similarly enumerated? If so, which ones and why? Could the exclusion of

    any of the enumerated insurance products serve to exclude products that

    should be regulated as swaps or security-based swaps? If so, which ones

    and why? Should the enumerated insurance products be required to be

    provided in accordance with paragraph (ii) of proposed rule 1.3(xxx)(4)

    under the CEA and paragraph (b) of proposed rule 3a69-1 under the

    Exchange Act? Why or why not? If not, please provide a detailed

    explanation of the insurance products that should not be subject to

    these requirements. Are there insurance products currently offered that

    do not meet these criteria? If so, please provide details regarding

    such products and their providers.

    10. The Commissions are proposing guidance that certain enumerated

    types of insurance products, including property and casualty insurance,

    are outside the scope of the statutory definitions of the terms

    ``swap'' and ``security-based swap'' under the Dodd-Frank Act. The

    Commissions request comment generally as to the proposed guidance

    regarding property and casualty insurance. The CFTC also requests

    comment on whether the products specified in section 302(c)(2) of the

    GLBA, which names certain insurance products, including private

    passenger or commercial automobile, homeowners, mortgage, commercial

    multiperil, general liability, professional liability, workers'

    compensation, fire and allied lines, farm owners multiperil, aircraft,

    fidelity, surety, medical malpractice, ocean marine, inland marine, and

    boiler and machinery insurance, should be considered traditional

    property and casualty insurance. Why or why not? If so, please provide

    an explanation of the product and how it differs from transactions that

    should be subject to the swap regulatory regime of the Dodd-Frank Act.

    The SEC also requests comment on whether the products specified in

    section 302(c)(2) of the GLBA should be enumerated in the Commissions'

    proposed guidance regarding property and casualty insurance as outside

    of the scope of the swap and security-based swap definitions? Are there

    other categories of traditional property and casualty insurance that

    should be specifically enumerated? If so, please provide a detailed

    description of such other categories of property and casualty insurance

    that should be specifically identified, and why. If there are certain

    types of property and casualty insurance that fall within the swap

    definition, will that affect the ability of persons, including

    consumers and businesses, to protect their properties against losses?

    If so, please provide a detailed explanation.

    11. Are there situations in which an insurance product may be

    assigned to another party that are not addressed by the criteria in

    proposed rule 1.3(xxx)(4) under the CEA and proposed rule 3a69-1 under

    the Exchange Act? Is additional clarification necessary to address such

    situations? If so, what clarification?

    12. Is the proposed requirement that the agreement, contract, or

    transaction be provided by a company that is organized as an insurance

    company whose primary and predominant business activity is the writing

    of insurance or the reinsuring of risks underwritten by insurance

    companies and that is subject to supervision by the insurance

    commissioner (or similar official or agency) of any state, as defined

    in section 3(a)(16) of the Exchange Act, or by the United States or an

    agency or instrumentality thereof, and that the agreement, contract, or

    transaction be regulated as insurance under the laws of such state or

    of the United States, an effective criterion in determining whether an

    agreement, contract, or transaction falls within the swap or security-

    based swap definition? Does it sufficiently preclude the use of the

    proposed rules by unregulated entities? Why or why not? Does it

    sufficiently prevent evasion of the requirements of Title VII with

    respect to agreements, contracts, or transactions that are swaps or

    security-based swaps? Why or why not?

    13. Are there circumstances under which a receiver or similar

    official or any liquidating agency for a state or Federally regulated

    insurance company, acting in its capacity as such, would be providing

    insurance rather than administering an insurance product that is

    provided by an insurance company? Please provide a detailed explanation

    of any such circumstances. If there are such circumstances, should the

    proposed rules include a provision that an agreement, contract, or

    transaction that satisfies the criteria of insurance but that is

    provided by a receiver or similar official or any liquidating agency

    for a state or Federally regulated insurance company, in its capacity

    as such, qualify as insurance that is excluded from the swap and

    security-based swap definition? Why or why not?

    14. Do the proposed rules appropriately treat an agreement,

    contract, or transaction that satisfies the criteria of insurance but

    that is provided by the United States or any of its agencies or

    instrumentalities, or pursuant to a statutorily authorized program

    thereof, as insurance that is excluded from the swap and security-based

    swap definition? Why or why not? Are there other types of government-

    issued insurance products that are not covered by paragraph (ii) of

    proposed rule 1.3(xxx)(4) under the CEA and paragraph (b) of proposed

    rule 3a69-1 under the Exchange Act? Do states or state agencies or

    instrumentalities provide insurance products? Should the proposed

    requirement also include a provision that the agreement, contract, or

    transaction can be provided by any state or any of its agencies or

    instrumentalities, or pursuant to a statutorily authorized program

    thereof? Why or why not?

    15. Do the proposed rules appropriately treat reinsurance by a

    person located outside the United States of a product meeting the

    requirements for insurance under the proposed rules, so long as the

    total amount reimbursable by all of the reinsurers for such insurance

    product cannot exceed the claims or losses paid by the cedant, as

    insurance excluded from the swap and security-based swap definitions if

    such person is not prohibited by any law of any state or of the United

    States from offering such reinsurance to a state or Federally regulated

    insurance company? Do these provisions of the proposed rules

    sufficiently prevent evasion of the requirements of Title VII with

    respect to agreements, contracts, or transactions that are swaps or

    security-based swaps? Why or why not?

    [[Page 29827]]

    16. Are there additional criteria for identifying contracts,

    agreements, or transactions that are insurance and not swaps or

    security-based swaps that the Commissions should consider? Please

    provide detailed information and empirical data, to the extent

    possible, supporting any suggested criteria.

    17. Should the proposed rules relating to insurance include a

    provision related to whether a product is recognized at fair value on

    an ongoing basis with changes in fair value reflected in earnings under

    U.S. generally accepted accounting principles? If so, what specific

    challenges may be encountered in light of the proposed Accounting

    Standards Update ``Accounting for Financial Instruments and Revisions

    to the Accounting for Derivative Instruments and Hedging Activities,''

    issued by the Financial Accounting Standards Board (``FASB'') on May

    26, 2010? Is recognizing a product at fair value on an ongoing basis

    (with changes in fair value reflected in earnings) inconsistent with

    treating such a product as insurance rather than a swap or security-

    based swap? Why or why not? Please provide examples of specific

    products and their correct accounting treatment under U.S. generally

    accepted accounting principles.

    18. Where an agreement, contract, or transaction falls within the

    swap definition, should insurance of that agreement, contract, or

    transaction also be included in the swap definition? Why or why not? Is

    the insurance wrap of a swap sufficiently different (economically or

    otherwise) from the swap that is insured? Why or why not? Would the

    regulation of such swap ``wraps'' as swaps impose costs on or otherwise

    impact the underlying cash markets (e.g., the ability to issue, and

    cost of issuing, municipal debt)? Please quantify to the extent

    possible. Would treating such ``wraps'' as insurance falling outside

    the swap definition frustrate or undermine Title VII's objectives in

    regulating the swap markets in any way? Why or why not? Please provide

    empirical data and analysis to the extent possible.

    19. Where an agreement, contract, or transaction falls within the

    security-based swap definition, should the insurance of that agreement,

    contract, or transaction also be included in the security-based swap

    definition? Why or why not? Would the regulation of insurance on a

    security-based swap as a security-based swap under Title VII impose

    costs or otherwise impact the underlying cash markets (e.g., the

    ability to issue, and cost of issuing, municipal debt)? Please quantify

    to the extent possible. Would regulating such products as insurance

    rather than as security-based swaps frustrate or undermine Title VII's

    objectives in regulating the security-based swap and swap markets? Why

    or why not? Please provide a detailed explanation and empirical data to

    the extent possible.

    20. Should the proposed rules include a provision similar to

    section 302(c)(1) of the GLBA \54\ that would provide that any product

    regulated as insurance before July 21, 2010 (the date the Dodd-Frank

    Act was signed into law) and provided in accordance with paragraph (ii)

    of proposed rule 1.3(xxx)(4) under the CEA and paragraph (b) of

    proposed rule 3a69-1 would be considered insurance and not fall within

    the swap definition? Why or why not? Should different criteria apply to

    products regulated as insurance before July 21, 2010? Why or why not?

    If so, please provide a detailed description of what different criteria

    should apply.

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

    \54\ 15 U.S.C. 6712(c)(1).

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

    21. The Commissions understand that swap guarantees may be offered

    by non-insurance companies. Should the Commissions provide guidance as

    to whether swap or security-based swap guarantees (that are not

    guarantees or insurance policies offered by insurance companies

    discussed above) should be considered swaps or security-based swaps?

    Why or why not?

    2. The Forward Contract Exclusion

    The definitions of the terms ``swap'' and ``security-based swap''

    do not include forward contracts. They exclude ``any sale of a

    nonfinancial commodity or security for deferred shipment or delivery,

    so long as the transaction is intended to be physically settled''.\55\

    Commenters have requested guidance from the Commissions regarding the

    scope of this exclusion. The Commissions believe it is appropriate to

    provide guidance to market participants regarding the applicability of

    the exclusion from the definitions of swap and security-based swap for

    forward contracts with respect to nonfinancial commodities \56\ and

    securities.

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

    \55\ CEA section 1a(47)(B)(ii), 7 U.S.C. 1a(47)(B)(ii).

    \56\ The discussion in subsections (a) and (b) of this section

    applies solely to the exclusion of nonfinancial commodity forwards

    from the swap definition in the Dodd-Frank Act.

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

    (a) Forward Contracts in Nonfinancial Commodities

    The wording of the forward contract exclusion from the swap

    definition with respect to nonfinancial commodities is similar, but not

    identical, to the forward contract exclusion from the definition of

    ``future delivery'' in the CEA, which excludes ``any sale of any cash

    commodity for deferred shipment or delivery''.\57\ Several ANPR

    commenters expressed the view that, with respect to nonfinancial

    commodities, the forward contract exclusion from the swap definition

    should be interpreted in the same manner as the CFTC has interpreted

    the forward contract exclusion from the term ``future delivery'' and,

    in particular, that the CFTC's ``Brent Interpretation'' \58\ should

    apply to ``book out'' transactions for purposes of the forward

    exclusion from the swap definition.\59\ The CFTC believes that

    clarification of the scope of the forward contract exclusion from the

    swap definition with respect to nonfinancial commodities is

    appropriate.\60\

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

    \57\ CEA section 1a(27), 7 U.S.C. 1a(27). The CEA does not

    define the term ``futures contract.'' Rather, the CEA refers to a

    futures contract as a ``contract of sale of a commodity for future

    delivery.'' See, e.g., CEA section 2(a)(1)(A), 7 U.S.C. 2(a)(1)(A)

    (providing the CFTC with exclusive jurisdiction over ``contracts of

    sale of a commodity for future delivery'' (other than security

    futures) traded or executed on, among other things, a designated

    contract market (``DCM'')); CEA section 4(a), 7 U.S.C. 6(a) (a

    ``contract for the purchase or sale of a commodity for future

    delivery'' other than a contract made on an exchange located outside

    the United States must be conducted on or subject to the rules of,

    among other things, a DCM). Accordingly, by excluding forward

    contracts from the CEA's definition of the term ``future delivery,''

    the CEA provides that a forward contract is not a contract of sale

    of a commodity for future delivery and, hence, not a futures

    contract.

    \58\ Statutory Interpretation Concerning Forward Transactions,

    55 FR 39188, Sept. 25, 1990 (``Brent Interpretation'').

    \59\ See Letter from Joanne T. Medero, Managing Director,

    BlackRock, Sept. 20, 2010 (``BlackRock Letter''), Letter from Matt

    Schatzman, Senior Vice President, Energy Marketing, BG Americas and

    Global LNC, Sept. 20, 2010 (``BG Letter''); Cleary Letter; Letter

    from Edward W. Gallagher, President, Dairy Risk Management Services,

    a division of Dairy Farmers of America, Inc., Sept. 20, 2010 (``DFA

    Letter''); 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

    North America, LLC, Sept. 20, 2010 (``EDF Letter''); Richard F.

    McMahon, Jr., Executive Director, Edison Electric Institute, Sept.

    20, 2010 (``EEI Letter''); Letter from John M. Damgard, President,

    Futures Industry Association, Sept. 20, 2010 (``FIA Letter'');

    Letter from Richard Ostrander, Managing Director and Counsel, Morgan

    Stanley, Sept. 20, 2010 (``Morgan Stanley Letter''); Letter of

    Michael Greenberger, JD, Law School Professor, University of

    Maryland School of Law, Sept. 20, 2010 (``University of Maryland

    Letter''); R. Michael Sweeney, Jr., Mark W. Menezes, and David T.

    McIndoe, Hunton & Williams, LLP, on behalf of the Working Group of

    Commercial Energy Firms, Sept, 20, 2010 (``WGCEF Letter''); Letter

    from Paul H. Stebbins, Chairman and Chief Executive Officer, World

    Fuel Services Corporation, Sept. 17, 2010 (``World Fuel Letter'').

    \60\ As discussed in part II.D.1 below, the terminology and

    documentation used by the parties are not dispositive of whether a

    particular agreement, contract, or transaction is a swap or

    security-based swap under the CEA or Exchange Act. Thus, if an

    agreement, contract, or transaction with respect to a nonfinancial

    commodity qualifies for the forward exclusion from the swap

    definition, it would not be a swap even if the parties refer to it

    as a swap or document it using an industry standard form agreement

    that is typically used for swaps. Conversely, such an agreement,

    contract, or transaction that does not qualify for the forward

    exclusion from the swap definition would not be excluded even if the

    parties refer to it as a forward contract.

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    [[Page 29828]]

    Forward contracts with respect to nonfinancial commodities are

    commercial merchandising transactions. The primary purpose of the

    contract is to transfer ownership of the commodity and not to transfer

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

    solely its price risk. The CFTC has noted:

    The underlying postulate of the [forward] exclusion is that the

    [CEA's] regulatory scheme for futures trading simply should not

    apply to private commercial merchandising transactions which create

    enforceable obligations to deliver but in which delivery is deferred

    for reasons of commercial convenience or necessity.\61\

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

    \61\ Brent Interpretation, supra note 58, at 39190. The CFTC has

    reiterated this view in more recent adjudicative orders. See, e.g.,

    In re Grain Land Coop., [2003-2004 Transfer Binder] Comm. Fut. L.

    Rep. (CCH) ] 29,636 (CFTC Nov. 25, 2003); In re Competitive

    Strategies for Agric., Ltd., [2003-2004 Transfer Binder] Comm. Fut.

    L. Rep. (CCH) ] 29,635 (CFTC Nov. 25, 2003). Courts have expressed

    this view as well. See, e.g., Salomon Forex, Inc. v. Tauber, 8 F.3d

    966, 971 (4th Cir. 1993) (``[C]ash forwards are generally

    individually negotiated sales * * * in which actual delivery of the

    commodity is anticipated, but is deferred for reasons of commercial

    convenience or necessity.''); CFTC v. Int'l Fin. Serv. (N.Y.), 323

    F. Supp. 2d 482, 495 (S.D.N.Y. 2004). See also CFTC v. Co Petro

    Mktg. Grp., Inc., 680 F.2d 573, 579-580 (9th Cir. 1982); CFTC v.

    Noble Metals Int'l, Inc., 67 F.3d 766, 772-773 (9th Cir. 1995; CFTC

    v. Am. Metal Exch. Corp., 693 F. Supp. 168, 192 (D.N.J. 1988); CFTC

    v. Morgan, Harris & Scott, Ltd., 484 F. Supp. 669, 675 (S.D.N.Y.

    1979) (forward contract exclusion does not apply to speculative

    transactions in which delivery obligations can be extinguished under

    the terms of the contract or avoided for reasons other than

    commercial convenience or necessity).

    The CFTC believes that the forward contract exclusion in the Dodd-

    Frank Act with respect to nonfinancial commodities should be read

    consistently with this established, historical understanding that a

    forward contract is a commercial merchandising transaction.

    Many commenters discussed the issue of whether the requirement in

    the Dodd-Frank Act that a transaction be ``intended to be physically

    settled'' in order to qualify for the forward exclusion from the swap

    definition with respect to nonfinancial commodities reflects a change

    in the standard for determining whether a transaction is a forward

    contract.\62\ Because a forward contract is a commercial merchandising

    transaction, intent to deliver historically has been an element of the

    CFTC's analysis of whether a particular contract is a forward

    contract.\63\ In assessing the parties' expectations or intent

    regarding delivery, the CFTC consistently has applied a ``facts and

    circumstances'' test.\64\ Therefore, the CFTC reads the ``intended to

    be physically settled'' language in the swap definition with respect to

    nonfinancial commodities to reflect a directive that intent to deliver

    a physical commodity be a part of the analysis of whether a given

    contract is a forward contract or a swap, just as it is a part of the

    CFTC's analysis of whether a given contract is a forward contract or a

    futures contract.

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

    \62\ See, e.g., BG Letter (forward exclusion for swaps should be

    consistent with the forward exclusion from futures); BlackRock

    Letter (the CFTC should interpret ``intended to be physically

    settled'' consistently with existing CFTC principles, including book

    outs); DFA Letter (forward exclusion for swaps should be interpreted

    consistently with the CFTC's prior forward contract interpretations

    and precedent, including forwards requiring delivery but including

    embedded options); EDF Letter (forward exclusion from the definition

    of swap should be construed in a consistent manner with the forward

    exclusion under the CEA); EEI Letter (forward exclusion from swap

    definition should be interpreted consistently with the forward

    exclusion from futures); FIA Letter (the Commissions should, through

    rulemaking or interpretation, provide that the ``intent'' standard

    in the forward exclusion with respect to swaps will be interpreted

    the same as the existing forward exclusion with respect to futures);

    Morgan Stanley Letter (the forward exclusion from the swap

    definition should be interpreted consistently with the forward

    exclusion from futures); University of Maryland Letter (forward

    exclusion from swap definition intended to be consistent with the

    forward exclusion from futures); WGCEF Letter (physical delivery

    forwards should be distinguished from swaps under standards

    identical to those used in forwards vs. futures); World Fuel Letter

    (forward exclusion for swaps should be interpreted in a manner

    consistent with the forward exclusion from futures).

    \63\ As recently as October 25, 2010, the CFTC observed in In re

    Wright that ``it is well-established that the intent to make or take

    delivery is the critical factor in determining whether a contract

    qualifies as a forward.'' In re Wright, CFTC Docket No. 97-02, 2010

    WL 4388247 at *3 (CFTC Oct. 25, 2010) (citing In re Stovall, et al.,

    [1977-1980 Transfer Binder] Comm. Fut. L. Rep. (CCH) 20,941 (CFTC

    Dec. 6, 1979); Brent Interpretation, supra note 58). In Wright, the

    CFTC noted that ``[i]n distinguishing futures from forwards, the

    [CFTC] and the courts have assessed the transaction as a whole with

    a critical eye toward its underlying purpose. Such an assessment

    entails a review of the overall effect of the transaction as well as

    a determination as to what the parties intended.'' Id. at *3

    (quoting Policy Statement Concerning Swap Transactions, 54 FR 30694,

    July 21, 1989 (``Swap Policy Statement'') (citations and internal

    quotations omitted).

    \64\ In its recent decision in In re Wright, the CFTC applied

    its facts and circumstances test in an administrative enforcement

    action involving hedge-to-arrive contracts for corn, and observed

    that ``[o]ur views of the appropriateness of a multi-factor analysis

    remain unchanged.'' Wright, supra note 63, n.13. The CFTC let stand

    the administrative law judge's conclusion that the hedge-to-arrive

    contracts at issue in the case were forward contracts. Id. at **5-6.

    See also Grain Land, supra note 61; Competitive Strategies for

    Agric., supra note 61.

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

    Commenters also requested clarification of the treatment of one

    type of forward contract--``book-out'' transactions--in the context of

    the forward exclusion from the swap definition with respect to

    nonfinancial commodities. The issue of book-outs first arose in 1990 in

    the Brent Interpretation\65\ because the parties to the crude oil

    contracts in that case could individually negotiate cancellation

    agreements, or ``book-outs,'' with other parties.\66\ In describing

    these transactions, the CFTC stated:

    \65\ See Brent Interpretation, supra note 58. The CFTC issued

    the Brent Interpretation in response to a Federal court decision

    that held that certain 15-day Brent system crude oil contracts were

    illegal off-exchange futures contracts. See Transnor (Bermuda) Ltd.

    v. BP N. Am. Petroleum, 738 F. Supp. 1472 (S.D.N.Y. 1990). The Brent

    Interpretation provided clarification that the 15-day Brent system

    crude oil contracts were forward contracts that were excluded from

    the CEA definition of ``future delivery,'' and thus were not futures

    contracts. See Brent Interpretation, supra note 58.

    \66\ The Brent Interpretation described these ``book-outs'' as

    follows: ``In the course of entering into 15-day contracts for

    delivery of a cargo during a particular month, situations often

    arise in which two counterparties have multiple, offsetting

    positions with each other. These situations arise as a result of the

    effectuation of multiple, independent commercial transactions. In

    such circumstances, rather than requiring the effectuation of

    redundant deliveries and the assumption of the credit, delivery and

    related risks attendant thereto, the parties may, but are not

    obligated to and may elect not to, terminate their contracts and

    forego such deliveries and instead negotiate payment-of-differences

    pursuant to a separate, individually negotiated cancellation

    agreement referred to as a `book-out.' Similarly, situations

    regularly arise when participants find themselves selling and

    purchasing oil more than once in the delivery chain for a particular

    cargo. The participants comprising these `circles' or `loops' will

    frequently attempt to negotiate separate cancellation agreements

    among themselves for the same reasons and with the same effect

    described above.'' Brent Interpretation, supra note 58, at 39190.

    It is noteworthy that while such [book-out] agreements may

    extinguish a party's delivery obligation, they are separate,

    individually negotiated, new agreements, there is no obligation or

    arrangement to enter into such agreements, they are not provided for

    by the terms of the contracts as initially entered into, and any

    party that is in a position in a distribution chain that provides

    for the opportunity to book-out with another party or parties in the

    chain is nevertheless entitled to require delivery of the commodity

    to be made through it, as required under the contracts.\67\

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

    \67\ Id. at 39192.

    Thus, in the scenario at issue in the Brent Interpretation, the

    contracts created a binding obligation to make or take delivery without

    providing any right to offset, cancel, or settle on a payment-of-

    differences basis. The ``parties enter[ed] into such contracts with the

    recognition that they may be required to make or take delivery.'' \68\

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

    \68\ Id. at 39189.

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

    On these facts, the Brent Interpretation concluded that the

    [[Page 29829]]

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

    contracts were forward contracts, not futures contracts:

    Under these circumstances, the [CFTC] is of the view that

    transactions of this type which are entered into between commercial

    participants in connection with their business, which create

    specific delivery obligations that impose substantial economic risks

    of a commercial nature to these participants, but which may involve,

    in certain circumstances, string or chain deliveries of the type

    described * * * are within the scope of the [forward contract]

    exclusion from the [CFTC's] regulatory jurisdiction.\69\

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

    \69\ Id. at 39192.

    Although the CFTC did not expressly discuss intent to deliver, the

    Brent Interpretation concluded that transactions retained their

    character as commercial merchandising transactions, notwithstanding the

    practice of terminating commercial parties' delivery obligations

    through ``book-outs'' as described. At any point in the chain, one of

    the parties could refuse to enter into a new contract to book-out the

    transaction and, instead, insist upon delivery pursuant to the parties'

    obligations under their contract.

    The CFTC believes that the principles underlying the Brent

    Interpretation similarly should apply to the forward exclusion from the

    swap definition with respect to nonfinancial commodities. To summarize,

    then, the CFTC believes that: (i) The forward contract exclusion from

    the swap definition with respect to nonfinancial commodities should be

    interpreted in a manner that is consistent with the CFTC's historical

    interpretation of the forward contract exclusion from the definition of

    the term ``future delivery''; (ii) intent to deliver is an essential

    element of a forward contract excluded from both the swap and future

    delivery definitions, and such intent in both instances should be

    evaluated based on the CFTC's established multi-factor approach; and

    (iii) book-out transactions in nonfinancial commodities that meet the

    requirements specified in the Brent Interpretation, and that are

    effectuated through a subsequent, separately-negotiated agreement,

    should qualify for the forward exclusion from the swap definition.\70\

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

    \70\ This interpretive guidance is consistent with legislative

    history. See 156 Cong. Rec. H5247 (June 30, 2010) (colloquy between

    U.S. House Committee on Agriculture Chairman Collin Peterson and

    Representative Leonard Boswell during the debate on the Conference

    Report for the Dodd-Frank Act, in which Chairman Peterson stated:

    ``Excluding physical forward contracts, including book-outs, is

    consistent with the CFTC's longstanding view that physical forward

    contracts in which the parties later agree to book-out their

    delivery obligations for commercial convenience are excluded from

    its jurisdiction. Nothing in this legislation changes that result

    with respect to commercial forward contracts.''). See also 156 Cong.

    Rec. H5248-49 (June 30, 2010) (introducing into the record a letter

    authored by Senator Blanche Lincoln, Chairman of the U.S. Senate

    Committee on Agriculture, Nutrition and Forestry, and Christopher

    Dodd, Chairman U.S. Senate Committee on Banking, Housing, and Urban

    Affairs, stating that the CFTC is encouraged ``to clarify through

    rulemaking that the exclusion from the definition of swap for `any

    sale of a nonfinancial commodity or security for deferred shipment

    or delivery, so long as the transaction is intended to be physically

    settled' is intended to be consistent with the forward contract

    exclusion that is currently in the [CEA] and the CFTC's established

    policy and orders on this subject, including situations where

    commercial parties agree to `book-out' their physical delivery

    obligations under a forward contract.'').

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

    As noted above, the Brent Interpretation applies to ``commercial

    participants in connection with their business.'' \71\ Market

    participants that regularly make or take delivery of the referenced

    commodity (in the case of the Brent Interpretation, a tanker full of

    Brent oil) in the ordinary course of their business meet that standard.

    Such entities qualify for the forward exclusion from both the future

    delivery and swap definitions for their forward transactions under the

    Brent Interpretation even if they enter a subsequent transaction to

    ``book out'' the forward contract rather than make or take delivery.

    Intent to make or take delivery can be inferred from the binding

    delivery obligation for the referenced commodity in the contract and

    the fact that the parties to the contract do, in fact, regularly make

    or take delivery of the referenced commodity in the contract in the

    ordinary course of their business.

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

    \71\ See Brent Interpretation, supra note 58, at 39192.

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

    Some commenters to the ANPR requested clarification with regard to

    the application of the CFTC's 1993 order exempting certain energy

    contracts from regulation under the CEA (the ``Energy Exemption'') \72\

    after enactment of the Dodd-Frank Act.\73\ The Energy Exemption

    extended the Brent Interpretation regarding the forward contract

    exclusion from the term ``future delivery'' to energy commodities other

    than oil. The CFTC believes that the book-out provisions of the Brent

    Interpretation similarly should apply to the forward contract exclusion

    from the swap definition for nonfinancial commodities besides oil.

    Further, the CFTC also is proposing interpretive guidance herein that

    the Brent Interpretation with respect to the application of the forward

    contract exclusion from the term ``future delivery'' in the context of

    book-out transactions applies not just to oil, but to all nonfinancial

    commodities. The CFTC, therefore, is proposing to withdraw the Energy

    Exemption, while retaining and extending through this interpretive

    guidance the Brent Interpretation regarding book-outs under the forward

    contract exclusion with respect to nonfinancial commodities.\74\

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

    \72\ Exemption for Certain Contracts Involving Energy Products,

    58 FR 21286, Apr. 20, 1993. The Energy Exemption generally applies

    to certain energy contracts: (i) Entered into by persons reasonably

    believed to be within a specified class of commercial and

    governmental entities; (ii) that are bilateral contracts between two

    parties acting as principals; (iii) the material economic terms of

    which are subject to individual negotiation by the parties; and (iv)

    that impose binding obligations on the parties to make and receive

    delivery of the underlying commodity, with no right of either party

    to effect a cash settlement of their obligations without the consent

    of the other party (except pursuant to a bona fide termination right

    such as default). Like the Brent Interpretation, the Energy

    Exemption provides that the parties can enter into a subsequent

    book-out settlement of the obligation in a manner other than by

    physical delivery of the commodity specified in the contract. Id. at

    21294.

    \73\ See, e.g., WGCEF letter. The CFTC issued the Energy

    Exemption shortly after Congress had provided the CFTC with

    exemptive authority pursuant to CEA section 4(c), 7 U.S.C. 6(c), in

    section 502 of the Futures Trading Practices Act of 1992, Public Law

    102-546, 106 Stat. 3590 (1993).

    \74\ To avoid any uncertainty, the CFTC also notes that the

    Dodd-Frank Act supersedes the Swap Policy Statement. The CFTC is

    aware that some commenters have suggested that the Commissions

    should exercise their authority to further define the term

    ``eligible contract participant'' to encompass the ``line of

    business'' provision of the Swap Policy Statement. See Swap Policy

    Statement, supra note 63, at 30696-30697. The Commissions will

    address these comments in their joint final rulemaking with respect

    to the Entity Definitions. See supra note 12.

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

    (b) Commodity Options and Commodity Options Embedded in Forward

    Contracts

    Some commenters responding to the ANPR requested clarification

    regarding the status of commodity options under the swap

    definition.\75\ Questions also were raised regarding options embedded

    in forward contracts, i.e., whether a forward contract with respect to

    a nonfinancial commodity that contains an embedded option can still

    qualify for the forward contract exclusion from the swap

    definition.\76\

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

    \75\ See, e.g., World Fuel Letter (exclusion for commercial

    options set forth in CFTC Regulation 32.4 should also be an

    exclusion from the swap definition).

    \76\ See, e.g., Letter from Patrick Kelly, Policy Advisor, API,

    Sept. 20, 2010 (``API Letter''), EEI Letter; Letter from Daniel S.M.

    Dolan, VP, Policy Research & Communications, Electric Power Supply

    Association, Sept. 20, 2010 (``EPSA Letter'') (physically settled

    options should be included in the forward exclusion from the swap

    definition); DFA Letter; ISDA Letter. One commenter suggested that

    the CFTC should apply to each contract with an enforceable delivery

    obligation a rebuttable presumption of intent to deliver, even if an

    option to cash settle is included in that contract. See WGCEF

    Letter.

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

    The statutory swap definition explicitly provides that commodity

    [[Page 29830]]

    options are swaps.\77\ Accordingly, the CFTC recently proposed

    revisions to its existing options rules in parts 32 and 33 of its

    regulations with respect to the treatment of commodity options under

    the Dodd-Frank Act, and requested public comment on those proposed

    revisions.\78\ The question of the application of the forward exclusion

    from the swap definition with respect to nonfinancial commodities,

    where commodity options are embedded in forward contracts (including

    embedded options to cash settle such contracts), is similar to that

    arising under the CEA's existing forward contract exclusion from the

    definition of the term ``future delivery.'' The CFTC's Office of

    General Counsel addressed forward contracts that contained embedded

    options in a 1985 interpretive statement (``1985 Interpretation''),\79\

    which the CFTC recently adhered to in its adjudicatory Order in the

    Wright case.\80\ While both were issued prior to the effective date of

    the Dodd-Frank Act, the CFTC believes that it would be appropriate to

    apply this guidance to the treatment of forward contracts in

    nonfinancial commodities that contain embedded options under the Dodd-

    Frank Act.

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

    \77\ 7 U.S.C. 1a(47)(A)(i). Options on securities and certain

    options on foreign currency are excluded from the swap definition by

    CEA sections 1a(47)(B)(iii) and (iv), respectively. 7 U.S.C.

    1a(47)(B)(iii) and (iv). These options are not subject to the

    Commissions' proposed guidance in this section.

    \78\ See Commodity Options and Agricultural Swaps, 76 FR 6095,

    Feb. 3, 2011.

    \79\ See Characteristics Distinguishing Cash and Forward

    Contracts and ``Trade'' Options, 50 FR 39656, Sept. 30, 1985.

    \80\ Wright, supra note 63.

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

    In Wright, the CFTC described the 1985 Interpretation and stated

    that the CFTC traditionally has engaged in a two-step analysis of

    ``embedded options'' in which the first step focuses on whether the

    option operates on the price or the delivery term of the forward

    contract and the second step focuses on secondary trading.\81\ The CFTC

    believes that these same principles can be applied with respect to the

    forward contract exclusion from the swap definition for nonfinancial

    commodities in the Dodd-Frank Act, too. That is, a forward contract

    that contains an embedded commodity option or options \82\ would be

    considered an excluded nonfinancial commodity forward contract (and not

    a swap) if the embedded option(s): (i) May be used to adjust the

    forward contract price, but do not undermine the overall nature of the

    contract as a forward contract; (ii) do not target the delivery term,

    so that the predominant feature of the contract is actual delivery; and

    (iii) cannot be severed and marketed separately from the overall

    forward contract in which they are embedded.\83\ Conversely, where the

    embedded commodity option(s) render delivery optional, the predominant

    feature of the contract cannot be actual delivery and, therefore, the

    embedded option(s) to not deliver preclude treatment of the contract as

    a forward contract for a nonfinancial commodity. The CFTC would look to

    the specific facts and circumstances of the transaction as a whole to

    evaluate whether any embedded optionality operates on the price or

    delivery term of the contract, and whether an embedded commodity option

    is marketed or traded separately from the underlying contract, to

    determine whether that transaction qualifies for the forward contract

    exclusion from the swap definition for nonfinancial commodities.\84\

    The CFTC believes that such an approach would help prevent commodity

    options that should fall within the swap definition from qualifying for

    the forward contract exclusion for nonfinancial commodities instead.

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

    \81\ Id. at n.5. In Wright, the CFTC affirmed the Administrative

    Law Judge's holding that an option embedded in a hedge-to-arrive

    contract did not violate CFTC rules regarding the sale of

    agricultural trade options. The CFTC first concluded that the puts

    at issue operated to adjust the forward price and did not render the

    farmer's overall obligation to make delivery optional. Then, turning

    to the next step of the analysis, the CFTC explained that ``the put

    and [hedge-to-arrive contract] operated as a single contract, and in

    most cases were issued simultaneously * * *. We do not find that any

    put was severed from its forward or that either of [the put or the

    hedge-to-arrive contract] was traded separately from the other. We

    hold that in these circumstances, no freestanding option came into

    being. * * *'' Id. at *7.

    \82\ The CFTC believes that ``options'' in the plural would

    include, for example, a situation in which the embedded optionality

    involves option combinations, such as costless collars, that operate

    on the price term of the agreement, contract, or transaction.

    \83\ See Wright, supra note 63, at **6-7.

    \84\ This facts and circumstances approach to determining

    whether a particular embedded option takes a transaction out of the

    forward contract exclusion for nonfinancial commodities is

    consistent with the CFTC's historical approach to determining

    whether a particular embedded option takes a transaction out of the

    forward contract exclusion from the CEA definition of the term

    ``future delivery.'' See Wright, supra note 63, at *5 (``As we have

    held since Stovall, the nature of a contract involves a multi-factor

    analysis . * * *'').

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

    (c) Security Forwards \85\

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

    \85\ The discussion above regarding the exclusion from the swap

    definition for forward contracts on nonfinancial commodities does

    not apply to the exclusion from the swap and security-based swap

    definitions for security forwards or to the distinction between

    security forwards and security futures products.

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

    No commenters sought clarification of the exclusion from the swap

    and security-based swap definitions for the ``sale of a nonfinancial

    commodity or security for deferred shipment or delivery, so long as the

    transaction is intended to be physically settled,'' in the context of

    most sales of securities for deferred shipment or delivery; however,

    some commenters sought clarification of this exclusion in the context

    of mortgage securitizations.\86\ The Commissions believe it is

    appropriate to address how the exclusions from the definitions of swap

    and security-based swap apply to security forwards and other purchases

    and sales of securities.

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

    \86\ Specifically, commenters requested clarification that the

    swap and security-based swap definitions do not include buying and

    selling mortgages and forward trading of agency (i.e., Federal Home

    Loan Mortgage Corporation (``Freddie Mac''), Federal National

    Mortgage Association (``Fannie Mae''), and Government National

    Mortgage Association (``Ginnie Mae'') mortgage-backed securities

    (``MBS'') in the ``To-Be-Announced'' (``TBA'') market in order to

    provide the certainty needed to avoid unnecessary disruption of the

    securitization market. See Letter from Stephen H. McElhennon, Vice

    President & Deputy General Counsel, Fannie Mae, Sept. 20, 2010

    (``Fannie Mae Letter''); Letter from Lisa M. Ledbetter, Freddie Mac,

    Sept. 20, 2010.

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

    The Dodd-Frank Act excludes purchases and sales of securities from

    the definitions of swap and security-based swap in a number of

    different clauses.\87\ Under these exclusions, purchases and sales of

    securities on a fixed or contingent basis \88\ and sales of securities

    for deferred shipment or delivery that are intended to be physically

    delivered \89\ are explicitly excluded from the definitions of swap and

    security-based swap.\90\ The exclusion from the definitions of swap and

    security-based swap of a sale of a security for deferred shipment or

    delivery involves an agreement to purchase securities, or groups or

    indexes of securities, at a future date at a certain price.

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

    \87\ See CEA sections 1a(47)(B)(ii), (v), and (vi), 7 U.S.C.

    1a(47)(B)(ii), (v), and (vi).

    \88\ See CEA section 1a(47)(B)(v), 7 U.S.C. 1a(47)(B)(v)

    (excluding from the swap and security-based swap definitions ``any

    agreement, contract, or transaction providing for the purchase or

    sale of 1 or more securities on a fixed basis that is subject to

    [the Securities Act and Exchange Act]''); CEA section 1a(47)(B)(vi),

    7 U.S.C. 1a(47)(B)(vi) (excluding from the swap and security-based

    swap definitions ``any agreement, contract, or transaction providing

    for the purchase or sale of 1 or more securities on a contingent

    basis that is subject to [the Securities Act and Exchange Act],

    unless the agreement, contract, or transaction predicates the

    purchase or sale on the occurrence of a bona fide contingency that

    might reasonably be expected to affect or be affected by the

    creditworthiness of a party other than a party to the agreement,

    contract, or transaction'').

    \89\ See CEA section 1a(47)(B)(ii), 7 U.S.C. 1a(47)(B)(ii).

    \90\ The Commissions note that calling an agreement, contract,

    or transaction a swap or security-based swap does not determine its

    status. See discussion supra part II.D.1.

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

    [[Page 29831]]

    As with other purchases and sales of securities, security forwards

    are excluded from the definitions of swap and security-based swap. The

    sale of the security in this case occurs at the time the forward

    contract is entered into with the performance of the contract deferred

    or delayed. If such agreement, contract, or transaction is intended to

    be physically settled, the Commissions believe it would be within the

    security forward exclusion and therefore outside the swap and security-

    based swap definitions.\91\ Moreover, as a purchase or sale of a

    security, the Commissions believe it also would be within the

    exclusions for the purchase or sale of one or more securities on a

    fixed basis (or, depending on its terms, a contingent basis) and,

    therefore, outside the swap and security-based swap definitions.\92\

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

    \91\ See CEA section 1a(47)(B)(ii), 7 U.S.C. 1a(47)(B)(ii).

    \92\ See CEA sections 1a(47)(B)(v) and (vi), 7 U.S.C.

    1a(47)(B)(v) and (vi).

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

    As noted above, commenters requested specific guidance in the

    context of forward sales of MBS that are guaranteed or sold by Fannie

    Mae, Freddie Mac, and Ginnie Mae and the mortgages underlying such MBS.

    MBS guaranteed or sold by Fannie Mae, Freddie Mac and Ginnie Mae

    are eligible to be sold in the TBA market, which is essentially a

    forward or delayed delivery market.\93\ The TBA market has been

    described as one that ``allows mortgage lenders essentially to sell the

    loans they intend to fund even before the loans are closed.'' \94\ In

    the TBA market, the lender enters into a forward contract to sell MBS

    and agrees to deliver MBS on the settlement date in the future. The

    specific MBS that will be delivered in the future may not yet be

    created at the time the forward contract is entered into.\95\ The

    Commissions believe that such forward sales of MBS in the TBA market

    would fall within the exclusion for sales of securities on a deferred

    settlement or delivery basis even though the precise MBS are not in

    existence at the time the forward MBS sale is entered into.\96\

    Moreover, as the purchase or sale of a security, the Commissions

    believe such forward sales of MBS in the TBA market would fall within

    the exclusions for the purchase or sale of one or more securities on a

    fixed basis (or, depending on its terms, a contingent basis) and

    therefore outside the swap and security-based swap definitions.\97\

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

    \93\ Task Force on Mortgage-Backed Securities Disclosure,

    ``Staff Report: Enhancing Disclosure in the Mortgage-Backed

    Securities Markets,'' part II.E.2 (Jan. 2003).

    \94\ Id.

    \95\ Id.

    \96\ See CEA section 1a(47)(B)(ii), 7 U.S.C. 1a(47)(B)(ii).

    \97\ See CEA sections 1a(47)(B)(v) and (vi), 7 U.S.C.

    1a(47)(B)(v) and (vi).

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

    Request for Comment

    22. The Commissions request comment on all aspects of the proposed

    interpretive guidance set forth in this section regarding the forward

    contract exclusion from the swap and security-based swap definitions

    with respect to nonfinancial commodities and securities.

    23. Is the proposed interpretive guidance set forth in this section

    sufficient with respect to the application of the forward contract

    exclusion from the swap definition with respect to nonfinancial

    commodities? If not, what changes should be made? Commenters also are

    invited to comment on whether the application of the Brent

    Interpretation generally, and its conclusions regarding book-outs in

    particular, is appropriate to the forward exclusion from the swap

    definition with respect to nonfinancial commodities. Would it permit

    transactions that should be subject to the swap regulatory regime to

    fall outside of the Dodd-Frank Act?

    24. Is it appropriate, in light of the Dodd-Frank Act, for the CFTC

    to withdraw the Energy Exemption while concurrently retaining the Brent

    Interpretation, and extending it to the forward contract exclusion from

    the definition of ``future delivery'' and the swap definition, for

    book-out transactions in all nonfinancial commodities? Why or why not?

    Is the conclusion that the Dodd-Frank Act supersedes the Swap Policy

    Statement appropriate? Why or why not?

    25. Are there any provisions of the Energy Exemption or Swap Policy

    Statement that the Commissions should consider incorporating into the

    definitions rulemakings (other than the request already submitted by

    some commenters in response to the proposed Entity Definitions that the

    ``line of business'' provision of the Swap Policy Statement be

    incorporated into the definition of the term ``eligible contract

    participant'' (``ECP''))? If so, please explain in detail how such

    provisions are consistent with the requirements of the Dodd-Frank Act

    and would not permit transactions that should be subject to the swap

    regulatory regime to fall outside of the Dodd-Frank Act.

    26. How frequently do book-out transactions of the type described

    in the Brent Interpretation occur with respect to nonfinancial

    commodities? Please provide descriptions of any such transactions, and

    data with respect to their frequency. Are there any nonfinancial

    commodities or transactions to which the Brent Interpretation should

    not apply, either with respect to the forward contract exclusion from

    the definition of ``future delivery'' or the forward contract exclusion

    from the swap definition, or both? Why or why not?

    27. Should a minimum contract size for a transaction in a

    nonfinancial commodity (e.g., a tanker full of Brent oil) be required

    in order for the transaction to qualify as a forward contract under the

    Brent Interpretation with respect to the future delivery and swap

    definitions? Why or why not? If so, what standards should apply to

    determine such a minimum contract size? Should the Brent Interpretation

    for nonfinancial commodities with respect to the future delivery and

    swap definitions be limited to market participants that meet certain

    requirements? Why or why not? If so, does the ``eligible commercial

    entity'' definition in CEA section 1a(17) \98\ provide an appropriate

    requirement? Why or why not? What other requirements, if any, should be

    imposed?

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

    \98\ 7 U.S.C. 1a(17).

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

    28. How often, and to what extent, do entities that do not

    regularly make or take delivery of the commodity in the ordinary course

    of their business engage in transactions that should qualify as forward

    contracts? Should such contracts qualify for the safe harbor provided

    by the Brent Interpretation? Why or why not? If so, how can it be

    demonstrated that the primary purpose of such transaction is to acquire

    or sell the physical commodity? Would including these transactions in

    the scope of the Brent Interpretation permit transactions that should

    be subject to the swap regulatory regime to fall outside of the Dodd-

    Frank Act? If so, could this concern be addressed by imposing

    conditions in order to qualify for the forward exclusion? What

    conditions, if any, would be appropriate?

    29. Are ``ring'' or ``daisy chain'' markets for forward contracts,

    such as the 15-day Brent market, primarily used for commercial

    merchandising, or do they serve other purposes such as price discovery

    or risk management? Please explain in detail.

    30. Should contracts in nonfinancial commodities that may qualify

    as forward contracts be permitted to trade on registered trading

    platforms such as DCMs or swap execution facilities (``SEFs'')? If so,

    are additional guidance

    [[Page 29832]]

    or rules necessary to determine whether contracts traded on such

    platforms are excluded from the CEA definition of ``future delivery''

    and/or the swap definition? If so, please describe in detail such

    markets and explain what further guidance or rules would be

    appropriate? Should conditions be imposed with respect to the nature of

    the market participants or the percentage of transactions that must

    result in delivery over a specified measurement period, or both? If so,

    what conditions would be appropriate?

    31. Should the Commissions provide guidance regarding the scope of

    the term ``nonfinancial commodity'' in the forward contract exclusion

    from the swap definition? If so, how and where should the Commissions

    draw the line between financial and nonfinancial commodities?

    32. Should the forward contract exclusion from the swap definition

    apply to environmental commodities such as emissions allowances, carbon

    offsets/credits, or renewable energy certificates? If so, please

    describe these commodities, and explain how transactions can be

    physically settled where the commodity lacks a physical existence (or

    lacks a physical existence other than on paper)? Would application of

    the forward contract exclusion to such environmental commodities permit

    transactions that should be subject to the swap regulatory regime to

    fall outside the Dodd-Frank Act?

    33. Are there other factors that should be considered in

    determining how to characterize forward contracts with embedded options

    with respect to nonfinancial commodities? If so, what factors should be

    considered? Do provisions in forward contracts with respect to

    nonfinancial commodities other than delivery and price contain embedded

    optionality? How do such provisions operate? Please provide a detailed

    analysis regarding how such provisions should be analyzed under the

    Dodd-Frank Act.

    34. Is the analysis of forward contracts with embedded options in

    the 1985 Interpretation and the CFTC's Wright decision appropriately

    applied to transactions entered into after the effective date of the

    Dodd-Frank Act? Why or why not? If not, how should the analysis be

    modified?

    35. How would the proposed interpretive guidance set forth in this

    section affect full requirements contracts, capacity contracts, reserve

    sharing agreements, tolling agreements, energy management agreements,

    and ancillary services? Do these agreements, contracts, or transactions

    have optionality as to delivery? If so, should they--or any other

    agreement, contract, or transaction in a nonfinancial commodity that

    has optionality as to delivery--be excluded from the swap definition?

    If so, please provide a detailed analysis of such agreements,

    contracts, or transactions and how they can be distinguished from

    options that are to be regulated as swaps pursuant to the Dodd-Frank

    Act. To what extent are any such agreements, contracts, or transactions

    in the electric industry regulated by the Federal Energy Regulatory

    Commission (``FERC''), State regulatory authorities, regional

    transmission organizations (``RTOs''), independent system operators

    (``ISOs'') or market monitoring units associated with RTOs or ISOs?

    36. Is there any issue with respect to the treatment of commodity

    options that the Commissions have not addressed and that should be

    addressed as a definitional matter in this rulemaking?

    37. Should the Commissions provide more detailed guidance regarding

    what constitutes a security forward? For instance, should the

    Commissions provide more guidance on what it means for a security

    forward to be ``intended to be physically settled''? If so, what

    further guidance would be appropriate?

    38. Should the Commissions provide more guidance regarding when

    forward sales of MBS in the TBA market would fall within the exclusion

    for sales of securities on a deferred settlement or delivery basis? Is

    there any more guidance the Commissions should provide regarding types

    of transactions that occur in the TBA market?

    3. Consumer and Commercial Agreements, Contracts, and Transactions

    Commenters on the ANPR pointed out a number of areas in which a

    broad reading of the swap and security-based swap definitions could

    cover certain consumer and commercial arrangements that historically

    have not been considered swaps or security-based swaps. Examples of

    such instruments cited by commenters include evidences of indebtedness

    with a variable rate of interest; \99\ commercial contracts containing

    acceleration, escalation, or indexation clauses; \100\ agreements to

    acquire personal property or real property, or to obtain mortgages;

    \101\ employment, lease, and service agreements, including those that

    contain contingent payment arrangements; \102\ and consumer mortgage

    and utility rate caps.\103\

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

    \99\ See Cleary Letter; Letter from Kenneth E. Auer, President

    and CEO, The Farm Credit Council, Sept. 20, 2010 (``Farm Credit

    Council Letter'').

    \100\ See Cleary Letter; White & Case Letter.

    \101\ See White & Case Letter; Fannie Mae Letter.

    \102\ See BlackRock Letter.

    \103\ See White & Case Letter; Deutsche Bank Letter.

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

    Consumers enter into various types of agreements, contracts, and

    transactions as part of their household and personal lives that may

    have attributes that could be viewed as falling within the swap or

    security-based swap definition. Similarly, businesses and other

    entities, whether or not for profit, also enter into agreements,

    contracts, and transactions as part of their operations relating to,

    among other things, acquisitions or sales of property (tangible and

    intangible), provisions of services, employment of individuals, and

    other matters that could be viewed as falling within the definitions.

    The Commissions do not believe that Congress intended to include

    these types of customary consumer and commercial agreements, contracts,

    or transactions in the swap or security-based swap definition, to limit

    the types of persons that can enter into or engage in them, or to

    otherwise to subject these agreements, contracts, or transactions to

    the regulatory scheme for swaps and security-based swaps. The

    Commissions, therefore, are proposing the following interpretive

    guidance to assist consumers and businesses in understanding whether

    certain agreements, contracts, or transactions that they enter into

    would be regulated as swaps or security-based swaps.

    With respect to consumers, the Commissions believe that the types

    of agreements, contracts, or transactions that should not be considered

    swaps or security-based swaps when entered into by consumers (natural

    persons or their agents) as principals primarily for personal, family,

    or household purposes, include:

    Agreements, contracts, or transactions to acquire or lease

    real or personal property, to obtain a mortgage, to provide personal

    services, or to sell or assign rights owned by such consumer (such as

    intellectual property rights);

    Agreements, contracts, or transactions to purchase

    products or services at a fixed price or a capped or collared price, at

    a future date or over a certain time period (such as agreements to

    purchase home heating fuel);\104\

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

    \104\ These agreements, contracts, or transactions involve

    physical delivery which is deferred for convenience or necessity and

    thus can be viewed as being akin to forward purchase agreements

    (sometimes with embedded options, in the case of those with price

    caps), which were discussed above in the context of the exclusion

    from the swap definition for forward contracts in nonfinancial

    commodities. While the CFTC traditionally has viewed forward

    contracts in nonfinancial commodities as limited to commercial

    merchandising transactions, the Commissions view consumer

    agreements, contracts, and transactions involving periodic or future

    purchases of consumer products and services, such as agreements to

    purchase energy commodities to heat or cool consumers' homes, as

    transactions that are not swaps.

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

    [[Page 29833]]

    Agreements, contracts, or transactions that provide for an

    interest rate cap or lock on a consumer loan or mortgage, where the

    benefit of the rate cap or lock is realized only if the loan or

    mortgage is made to the consumer; and

    Consumer loans or mortgages with variable rates of

    interest or embedded interest rate options, including such loans with

    provisions for the rates to change upon certain events related to the

    consumer, such as a higher rate of interest following a default.

    The types of commercial agreements, contracts, or transactions that

    involve customary business arrangements (whether or not involving a

    for-profit entity) and would not be considered swaps or security-based

    swaps under this proposed interpretive guidance include:

    Employment contracts and retirement benefit arrangements;

    Sales, servicing, or distribution arrangements;

    Agreements, contracts, or transactions for the purpose of

    effecting a business combination transaction; \105\

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    \105\ These business combination transactions include, for

    example, a reclassification, merger, consolidation, or transfer of

    assets as defined under the Federal securities laws or any tender

    offer subject to section 13(e) and/or section 14(d) or (e) of the

    Exchange Act, 15 U.S.C. 78m(e) and/or 78n(d) or (e). These business

    combination agreements, contracts, or transactions can be contingent

    on the continued validity of representations and warranties and can

    contain earn-out provisions and contingent value rights.

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

    The purchase, sale, lease, or transfer of real property,

    intellectual property, equipment, or inventory;

    Warehouse lending arrangements in connection with building

    an inventory of assets in anticipation of a securitization of such

    assets (such as in a securitization of mortgages, student loans, or

    receivables); \106\

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

    \106\ The Commissions believe that such lending arrangements

    included in this category are traditional borrower/lender

    arrangements documented using, for example, a loan agreement or

    indenture, as opposed to a synthetic lending arrangement documented

    in the form of, for example, a TRS. The Commissions also note that

    securitization transaction agreements also may contain contingent

    obligations if the representations and warranties about the

    underlying assets are not satisfied.

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

    Mortgage or mortgage purchase commitments, or sales of

    installment loan agreements or contracts or receivables;

    Fixed or variable interest rate commercial loans entered

    into by non-banks \107\; and

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

    \107\ See infra note 115 regarding identified banking products.

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

    Commercial agreements, contracts, and transactions

    (including, but not limited to, leases, service contracts, and

    employment agreements) containing escalation clauses linked to an

    underlying commodity such as an interest rate or consumer price index.

    The Commissions intend this proposed interpretive guidance to allow

    consumers to engage in customary transactions relating to their

    households and personal or family activities without concern that such

    arrangements would be considered swaps or security-based swaps.

    Similarly, applying this guidance to customary commercial arrangements

    should allow commercial and non-profit entities to continue to operate

    their businesses and operations without significant disruption and

    ensure that the swap and security-based swap definitions are not read

    to include commercial and non-profit operations that historically have

    not been considered to involve swaps or security-based swaps.

    The types of agreements, contracts, and transactions discussed

    above are not intended to be exhaustive of the customary consumer or

    commercial arrangements that should not be considered to be swaps or

    security-based swaps. There may be other, similar types of agreements,

    contracts, and transactions that also should not be considered to be

    swaps or security-based swaps. In determining whether similar types of

    agreements, contracts, and transactions entered into by consumers or

    commercial entities are swaps or security-based swaps, the Commissions

    intend to consider the characteristics and factors that are common to

    the consumer and commercial transactions listed above:

    They do not contain payment obligations, whether or not

    contingent, that are severable from the agreement, contract, or

    transaction;

    They are not traded on an organized market or over-the-

    counter; and

    In the case of consumer arrangements, they:

    --Involve an asset of which the consumer is the owner or beneficiary,

    or that the consumer is purchasing, or they involve a service provided,

    or to be provided, by or to the consumer, or

    In the case of commercial arrangements, they are entered

    into:

    --By commercial or non-profit entities as principals (or by their

    agents) to serve an independent commercial, business, or non-profit

    purpose, and

    --Other than for speculative, hedging, or investment purposes.

    Two of the key components reflected in these characteristics that

    distinguish these agreements, contracts, and transactions from swaps

    and security-based swaps are that: (i) The payment provisions of the

    arrangements are not severable; and (ii) the agreement, contract, or

    transaction is not traded on an organized market or over-the-counter--

    so that such arrangements would not involve risk-shifting arrangements

    with financial entities, as would be the case for swaps and security-

    based swaps.\108\

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

    \108\ There also are alternative regulatory regimes that have

    been enacted as part of the Dodd-Frank Act specifically to provide

    enhanced protections to consumers relating to various consumer

    transactions. See, e.g., the Consumer Financial Protection Act of

    2010, Public Law 111-203, title X, 124 Stat. 1376 (July 21, 2010)

    (establishing the Bureau of Consumer Financial Protection to

    regulate a broad category of consumer products and amending certain

    laws under the jurisdiction of the Federal Trade Commission); the

    Mortgage Reform and Anti-Predatory Lending Act, Public Law 111-203,

    title XIV, 124 Stat. 1376 (July 21, 2010) (amending existing laws,

    and adding new provisions, related to certain mortgages). Some of

    these agreements, contracts, or transactions are subject to

    regulation by the Federal Trade Commission and other Federal

    financial regulators and state regulators.

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

    This proposed interpretive guidance is not intended to be the

    exclusive means for consumers and commercial or non-profit entities to

    determine whether their agreements, contracts, or transactions fall

    within the swap or security-based swap definition. If there is a type

    of agreement, contract, or transaction that is not enumerated above, or

    does not have all the characteristics and factors that are listed above

    (including new types of arrangements that may be developed in the

    future), but that a party to the agreement, contract, or transaction

    believes is not a swap or security-based swap, the Commissions invite

    such party to seek an interpretation from the Commissions as to whether

    the agreement, contract, or transaction is a swap or security-based

    swap.

    Request for Comment

    39. Is interpretive guidance of the type proposed in this section

    necessary with respect to the application of the swap and security-

    based swap definitions to certain consumer and commercial agreements,

    contracts, or transactions?

    40. Is the interpretive guidance proposed in this section useful,

    [[Page 29834]]

    appropriate, and sufficient for persons to consider when evaluating

    whether agreements, contracts, or transactions of the types described

    in this section fall within the swap or security-based swap definition?

    41. In particular, are the listed characteristics and factors for

    consumer transactions and for commercial transactions appropriate for

    purposes of evaluating whether agreements, contracts, or transactions

    fall within the swap or security-based swap definition? If not, what

    characteristics or factors should be included or excluded, and why? Are

    any of the characteristics or factors too narrow or too broad? If so,

    how should the listed characteristics and factors be modified, and why?

    42. Is a joint interpretation as provided for in section 712(d)(4)

    of the Dodd-Frank Act, pursuant to the proposed process discussed in

    part VI below, an appropriate means of addressing any further

    interpretive questions?

    43. Does the interpretive guidance proposed in this section

    sufficiently enumerate the types of consumer and commercial agreements,

    contracts, or transactions that should not be considered swaps or

    security-based swaps? If not, please provide details of other types of

    such agreements, contracts, or transactions and an explanation of the

    reasons why the definitions should not apply to them.

    44. Is the treatment of consumer or commercial contracts containing

    payment arrangements sufficiently clear? For example, should the

    interpretive guidance expressly address any other specific types of

    contracts, such as installment sales contracts, financings used in

    normal business operations (such as receivables financings), pensions

    and other post-retirement benefits, contracts relating to the

    performance of a service, standby liquidity agreements, indemnification

    agreements, reimbursement agreements, or affiliate guarantees? Why or

    why not?

    45. Is the treatment of purchases, sales, leases, or transfers of

    equipment and inventory sufficiently flexible to not interfere with

    ordinary business operations? As an alternative, should the guidance

    expressly cover the purchase, sale, lease, or transfer of assets

    (excluding financial assets) that are anticipated to be owned, leased,

    licensed, produced, manufactured, processed, or merchandized by one of

    the parties or an affiliate? Why or why not?

    4. Loan Participations

    Two commenters inquired whether loan participations fall within the

    scope of the swap and security-based swap definitions.\109\ According

    to these commenters, loan participations arise when a lender transfers

    the economic risks and benefits of all or a portion of a loan it has

    entered into with a borrower to another party as an alternative or

    precursor to assigning to such person the loan or an interest in the

    loan.\110\ Two types of loan participations are offered in the market

    today according to these commenters: LSTA-style participations and LMA-

    style participations.\111\ An LSTA-style participation ``specifically

    provides that the participation is intended by the parties to be

    treated as a sale by the grantor and a purchase by the participant''

    and ``is intended to effect a `true sale' of the loan from the grantor

    to the participant and put the participant's beneficial ownership

    interest in the loan beyond the reach of the grantor's bankruptcy

    estate.'' \112\ By contrast, an LMA-style participation, while not

    effecting a sale, ``creates a current debtor-creditor relationship

    between the grantor and the participant under which a future ownership

    interest is conveyed.'' \113\ Neither type of loan participation is a

    ``synthetic'' transaction according to the March LSTA letter because

    ``they are merely transfers of cash loan positions'' and ``[t]he ratio

    of underlying loan to participation is always one-to-one.''

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

    \109\ See Letter from R. Bram Smith, Executive Director, The

    Loan Syndications and Trading Association, Jan. 25, 2011 (``January

    LSTA Letter'') and letter from Elliot Ganz, General Counsel, The

    Loan Syndications and Trading Association, Mar. 1, 2011 (``March

    LSTA Letter, and collectively with the January LSTA Letter, ``LSTA

    Letters''); Letter from Clare Dawson, Managing Director, Loan Market

    Association, Feb. 23, 2011.

    \110\ See Loan Market Association, ``Guide to Syndicated

    Loans,'' section 6.2.5 (``Risk participation may be provided by a

    new lender as an interim measure before it takes full transfer of a

    loan.''), available at http://www.lma.eu.com/uploads/files/Introductory_Guides/Guide_to_Par_Syndicated_Loans.pdf.

    \111\ The LSTA is The Loan Syndications and Trading Association.

    The LMA is the Loan Market Association.

    \112\ See January LSTA Letter (citation omitted).

    \113\ See LSTA Letters. But see Jon Kibbe, Julia Lu and Carl

    Winkworth, Richards Kibbe & Orbe, LLP, ``Dodd-Frank Crosses the

    Pond: Unintended Consequences for LMA-Style Loan Participations?,''

    3 (Nov. 12, 2010) (``The grantor of an LMA-style participation does

    not grant an ownership interest in the loan to the participant.'')

    (``LMA-Style LP Memo''), available at http://www.rkollp.com/assets/attachments/Dodd-Frank%20Crosses%20the%20Pond%20-%20Unintended%20Consequences%20for%20LMA-Style%20Loan%20Participations.pdf.

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

    Depending on the facts and circumstances, a loan participation may

    be a security under the Federal securities laws and, as such, the loan

    participation would be excluded from the definition of swap as the

    purchase and sale of a security on a fixed or contingent basis.\114\ In

    addition, depending on the facts and circumstances, a loan

    participation may be an identified banking product and, as such, would

    be excluded from CFTC jurisdiction and from the ``security-based swap''

    and ``security-based swap agreement'' definitions.\115\

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

    \114\ See CEA sections 1a(47)(B)(v) and (vi), 7 U.S.C.

    1a(47)(b)(v) and (vi), as amended by section 721(a)(21) of the Dodd-

    Frank Act (excluding purchases and sales of a security on a fixed or

    contingent basis, respectively from the swap definition).

    \115\ See section 403(a) of the Legal Certainty for Bank

    Products Act of 2000, 7 U.S.C. 27a(a), as amended by section

    725(g)(2) of the Dodd-Frank Act (providing that, under certain

    circumstances, the CEA shall not apply to, and the CFTC shall not

    exercise regulatory authority over, identified banking products, and

    the definitions of the terms ``security-based swap'' and ``security-

    based swap agreement'' shall not include identified banking

    products).

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

    The Commissions do not interpret the swap and security-based swap

    definitions to include loan participations in which the purchaser is

    acquiring a current or future direct or indirect ownership interest in

    the related loan and the loan participations are ``true

    participations'' (the participant acquires a beneficial ownership

    interest in the underlying loans).\116\

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

    \116\ See generally Richard M. Gray and Suhrud Mehta, Milbank

    Tweed Hadley & McCloy LLP, ``US and UK compared Fundamental

    differences remain between the markets. But is it worth considering

    using a New York participation agreement in an English deal?,''

    International Financial Law Review (Oct. 1, 2009) (discussing

    differences between New York and English participation markets and

    features distinguishing true participations from financings),

    available at http://www.milbank.com/NR/rdonlyres/B95C06AD-C3CA-44C9-8433-B6021C4455C9/0/102009_IFLR_USandUKcompared_RGray_SMehta.pdf; Cleary, Gottlieb, Steen & Hamilton, Memorandum for the

    Financial Accounting Standards Board, Re: Participations (June 14,

    2004) (discussing, among other things, what a ``good'' or ``true''

    participation is under the Uniform Commercial Code, the Bankruptcy

    Code, case law, and other authority), available at http://www.fasb.org/cs/BlobServer?blobcol=urldata&blobtable=MungoBlobs&blobkey=id&blobwhere=1175817895286&blobheader=application%2Fpdf.

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

    Request for Comment

    46. Should any of the enumerated agreements, contracts, or

    transactions be considered swaps or security-based swaps whether in

    general or in certain narrow circumstances? If so, which ones and why?

    In particular, how are loan participations similar to and different

    from loan TRS? Does the proposed guidance adequately distinguish

    between loan participations similar to and different from loan TRS?

    47. Does the Commissions' proposed interpretive guidance regarding

    loan participations exclude from the swap or security-based swap

    definitions agreements, contracts, or transactions

    [[Page 29835]]

    that are swaps or security-based swaps? If so, please describe such

    agreements, contracts, or transactions and suggested adjustments to the

    proposed guidance to capture such agreements, contracts, or

    transactions as swaps or security-based swaps.

    48. Is the Commissions' proposed interpretive guidance regarding

    loan participations as not falling within the swap and security-based

    swap definitions appropriate? Why or why not? Should the Commissions

    provide further guidance on what constitutes an ``ownership interest''

    in the loan underlying a loan participation? If so, what should such

    guidance provide?

    49. Do all loan participations convey a current or future direct or

    indirect ownership interest from the grantor to the participant or sub-

    participant? If so, what indicia of ownership are conveyed and when,

    particularly in LMA-style loan participations? Do loan participations

    use leverage? If so, how?

    50. Are any swaps or security-based swaps partly or fully defeased?

    51. Should the Commissions provide further guidance regarding the

    scope of ``true participation?'' If so, how should the Commissions

    delineate the scope thereof?

    C. Proposed Rules and Interpretive Guidance Regarding Certain

    Transactions Within the Scope of the Definitions of the Terms ``Swap''

    and ``Security-Based Swap''

    1. In General

    In light of provisions in the Dodd-Frank Act that specifically

    address certain foreign exchange products, the Commissions are

    proposing rules to clarify the status of products such as foreign

    exchange forwards, foreign exchange swaps, foreign exchange options,

    non-deliverable forwards involving foreign exchange (``NDFs''), and

    cross-currency swaps. The Commissions also are proposing a rule to

    clarify the status of FRAs and providing interpretive guidance

    regarding: (i) Combinations and permutations of, or options on, swaps

    or security-based swaps; and (ii) contracts for differences (``CFDs'').

    Proposed rule 1.3(xxx)(2) under the CEA and proposed rule 3a69-2

    under the Exchange Act would explicitly define the term ``swap'' to

    include certain foreign exchange-related products and FRAs unless such

    products would be excluded by the list of exclusions in subparagraph

    (B) of the swap definition.\117\ In proposing these rules, the

    Commissions do not mean to suggest that any other agreement, contract,

    or transaction not mentioned in the proposed rules or specifically

    enumerated in the statutory definition would not be covered by the swap

    or security-based swap definitions in the Dodd-Frank Act.

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

    \117\ See CEA section 1a(47)(B), 7 U.S.C. 1a(47)(B).

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

    2. Foreign Exchange Products

    (a) Foreign Exchange Products Subject to the Secretary's Swap

    Determination: Foreign Exchange Forwards and Foreign Exchange Swaps

    The Dodd-Frank Act provides that ``foreign exchange forwards'' and

    ``foreign exchange swaps'' shall be considered swaps under the swap

    definition unless the Secretary of the Treasury (``Secretary'') issues

    a written determination that either foreign exchange swaps, foreign

    exchange forwards, or both: (i) Should not be regulated as swaps; and

    (ii) are not structured to evade the Dodd-Frank Act in violation of any

    rule promulgated by the CFTC pursuant to section 721(c) of the Dodd-

    Frank Act.\118\ A foreign exchange forward is defined as ``a

    transaction that solely involves the exchange of 2 different currencies

    on a specific future date at a fixed rate agreed upon on the inception

    of the contract covering the exchange.'' \119\ A foreign exchange swap,

    in turn, is defined as ``a transaction that solely involves--(A) An

    exchange of 2 different currencies on a specific date at a fixed rate

    that is agreed upon on the inception of the contract covering the

    exchange; and (B) a reverse exchange of the 2 currencies described in

    subparagraph (A) at a later date and at a fixed rate that is agreed

    upon on the inception of the contract covering the exchange.'' \120\

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

    \118\ See CEA section 1a(47)(E)(i), 7 U.S.C. 1a(47)(E)(i). The

    Secretary has issued a request for comment about whether an

    exclusion from the swap definition for foreign exchange swaps,

    foreign exchange forwards, or both, is warranted, and on the

    application of the statutory factors that the Secretary must

    consider in making a determination regarding whether to exclude

    these products. See Determinations of Foreign Exchange Swaps and

    Forwards, 75 FR 66829, Oct. 29, 2010.

    \119\ See CEA section 1a(24), 7 U.S.C. 1a(24).

    \120\ See CEA section 1a(25), 7 U.S.C. 1a(25).

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

    Under the Dodd-Frank Act, if foreign exchange forwards or foreign

    exchange swaps are no longer considered swaps due to a determination by

    the Secretary, nevertheless, certain provisions of the CEA added by the

    Dodd-Frank Act would continue to apply to such transactions.

    Specifically, those transactions still would be subject to certain

    requirements for reporting swaps, and swap dealers and major swap

    participants engaging in such transactions still would be subject to

    certain business conduct standards.\121\

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

    \121\ See, e.g., CEA sections 1a(47)(E)(iii) and (iv), 7 U.S.C.

    1a(47)(E)(iii) and (iv) (reporting and business conduct standards,

    respectively).

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

    The Commissions are proposing to provide greater clarity by

    explicitly defining by rule the term ``swap'' to include foreign

    exchange forwards and foreign exchange swaps (as those terms are

    defined in the CEA).\122\ The proposed rules would incorporate the

    provision of the Dodd-Frank Act that, if the Secretary issues the

    written determination described above, foreign exchange forwards and

    foreign exchange swaps would no longer be considered swaps. The

    proposed rules also would reflect the continuing applicability of

    certain reporting requirements and business conduct standards in the

    event that the Secretary makes such a determination.\123\

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

    \122\ As noted above, the proposed rules provide that foreign

    exchange forwards and forward exchange swaps would not be swaps if

    they fall within one of the exclusions set forth in subparagraph (B)

    of the swap definition.

    \123\ The exclusion of foreign exchange forwards and foreign

    exchange swaps would become effective upon the Secretary's

    submission of the determination to the appropriate Congressional

    Committees. See CEA section 1a(47)(E)(ii), 7 U.S.C. 1a(46)(E)(ii).

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

    (b) Foreign Exchange Products Not Subject to the Secretary's Swap

    Determination

    The Commissions also are proposing rules to provide clarity that a

    determination by the Secretary that foreign exchange forwards or

    foreign exchange swaps, or both, should not be regulated as swaps would

    not affect other products involving foreign currency, such as foreign

    currency options, NDFs, and cross-currency swaps. The Commissions are

    proposing rules to explicitly define the term ``swap'' to include such

    products, irrespective of whether the Secretary makes a determination

    to exempt foreign exchange forwards or foreign exchange swaps.\124\

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

    \124\ As discussed above, however, the proposed rules provide

    that none of the products discussed in this section (b) would be

    swaps if they fall within one of the exclusions set forth in

    subparagraph (B) of the swap definition.

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

    (i) Foreign Currency Options \125\

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

    \125\ This discussion is not intended to address, and has no

    bearing on, the CFTC's jurisdiction over foreign currency options in

    other contexts. See, e.g., CEA sections 2(c)(2)(A)(iii) and

    2(c)(2)(B)-(C), 7 U.S.C. 2(c)(2)(A)(iii) and 2(c)(2)(B)-(C) (off-

    exchange options in foreign currency offered or entered into with

    retail customers).

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

    As discussed above, the statutory swap definition includes options,

    and it expressly enumerates foreign currency options. It encompasses

    any agreement, contract, or transaction: '' (i) that is a

    [[Page 29836]]

    put, call, cap, floor, collar, or similar option of any kind that is

    for the purchase or sale, or based on the value, of 1 or more interest

    or other rates, currencies, commodities, securities, instruments of

    indebtedness, indices, quantitative measures, or other financial or

    economic interests or property of any kind.'' \126\

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

    \126\ See CEA section 1a(47)(A)(i), 7 U.S.C. 1a(47)(A)(i)

    (emphasis added).

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

    Foreign exchange options traded on a national securities exchange

    (``NSE''), however, are securities under the Federal securities laws

    and not swaps or security-based swaps.\127\

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

    \127\ See CEA section 1a(47)(B)(iv), 7 U.S.C. 1a(47)(B)(iv).

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

    Any determination by the Secretary, discussed above, that foreign

    exchange forwards or foreign exchange swaps should not be regulated as

    swaps would not impact foreign currency options because a foreign

    currency option is neither a foreign exchange swap nor a foreign

    exchange forward, as those terms are defined in the CEA. Consequently,

    the Commissions are proposing rules to provide clarity by explicitly

    defining the term ``swap'' to include foreign currency options (other

    than foreign currency options traded on an NSE).\128\ The proposed

    rules also would clarify that foreign currency options are not foreign

    exchange forwards or foreign exchange swaps under the CEA.

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

    \128\ The proposed rules would treat the terms foreign currency

    options, currency options, foreign exchange options, and foreign

    exchange rate options as synonymous. Moreover, for purposes of the

    proposed rules, foreign currency options include options to enter

    into or terminate, or that otherwise operate on, a foreign exchange

    swap or foreign exchange forward or on the terms thereof. As

    discussed above, foreign exchange options traded on an NSE are

    securities and therefore not addressed in the proposed rules.

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

    (ii) Non-Deliverable Forward Contracts Involving Foreign Exchange

    An NDF generally is similar to a forward foreign exchange

    contract,\129\ except that at maturity, the NDF does not require

    physical delivery of currencies and is typically settled in U.S.

    dollars. The other currency, usually an emerging market currency

    subject to capital controls, is therefore said to be

    ``nondeliverable.'' \130\ If the spot market exchange rate on the

    settlement date is greater (in foreign currency per dollar terms) than

    the previously agreed forward exchange rate, the party to the contract

    that is long the emerging market currency must pay its counterparty the

    difference between the contracted forward price and the spot market

    rate, multiplied by the notional amount.\131\

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

    \129\ A deliverable forward foreign exchange contract is an

    obligation to buy or sell a specific currency on a future settlement

    date at a fixed price set on the trade date. See Laura Lipscomb,

    ``Federal Reserve Bank of New York, An Overview of Non-Deliverable

    Foreign Exchange Forward Markets,'' 1 (May 2005) (citation omitted)

    (``Fed NDF Overview'').

    \130\ See id. at 1-2 (citation omitted).

    \131\ See id. at 2. Being long the emerging market currency

    means that the holder of the NDF contract is the ``buyer'' of the

    emerging market currency and the ``seller'' of dollars. Conversely,

    if the emerging market currency appreciates relative to the

    previously agreed forward rate, the holder of the contract that is

    short the emerging market currency must pay its counterparty the

    difference between the spot market rate and the contracted forward

    price, multiplied by the notional amount. See id. at 2, n.4.

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

    NDFs are not expressly enumerated in the swap definition, but they

    satisfy clause (A)(iii) of the definition because they provide for a

    future (executory) payment based on an exchange rate, which is an

    ``interest or other rate[]'' within the meaning of clause (A)(iii) of

    the swap definition.\132\ Each party to an NDF transfers to its

    counterparty the risk of the exchange rate moving against the

    counterparty, thus satisfying the requirement that there be a transfer

    of financial risk associated with a future change in rate. This

    financial risk transfer in the context of an NDF is not accompanied by

    a transfer of an ownership interest in any asset or liability. Thus, an

    NDF is a swap under clause (A)(iii) of the swap definition.\133\

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

    \132\ See CEA section 1a(47)(A)(iii), 7 U.S.C. 1a(47)(A)(iii)

    (providing that a swap is an agreement, contract, or transaction

    ``that provides on an executory basis for the exchange, on a fixed

    or contingent basis, of 1 or more payments based on the value or

    level of 1 or more interest or other rates, currencies, commodities,

    securities, instruments of indebtedness, indices, quantitative

    measures, or other financial or economic interests or property of

    any kind, or any interest therein or based on the value thereof, and

    that transfers, as between the parties to the transaction, in whole

    or in part, the financial risk associated with a future change in

    any such value or level without also conveying a current or future

    direct or indirect ownership interest in an asset (including any

    enterprise or investment pool) or liability that incorporates the

    financial risk so transferred * * *.'').

    \133\ It appears that at least some market participants view

    NDFs as swaps today. See, e.g., Credit Suisse, ``Non-Deliverable

    Forwards,'' at 1 (characterizing NDFs as ``a derivative instrument

    for hedging * * * exchange-rate risk'' in the absence of a forwards

    market), available at https://www.credit-suisse.com/ch/unternehmen/kmugrossunternehmen/doc/nondeliverable_forward_en.pdf; Association

    of Corporate Treasurers, ``Glossary of Terms'' (defining an NDF as

    ``[a] foreign currency financial derivative contract''), available

    at http://www.treasurers.org/glossary/N#Non-deliverableforward.

    Thus, NDFs also may fall within clause (A)(iv) of the swap

    definition as ``an agreement, contract, or transaction that is, or

    in the future becomes, commonly known to the trade as a swap.'' See

    CEA section 1a(47)(A)(iv), 7 U.S.C. 1a(47)(A)(iv). Cf. CFTC rule

    35.1(b)(1)(i), 17 CFR 35.1(b)(1)(i) (providing that the definition

    of ``swap agreement'' includes a ``forward foreign exchange

    agreement,'' without reference to convertibility or delivery).

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

    As discussed above, the Secretary may determine that foreign

    exchange swaps or foreign exchange forwards should not be regulated as

    swaps. The outcome of the Secretary's determination would not impact

    NDFs, however, because NDFs (like foreign currency options) do not meet

    the definitions of the terms foreign exchange forward or foreign

    exchange swap set forth in the CEA. NDFs do not involve an ``exchange''

    of two different currencies (an element of the definition of both a

    foreign exchange forward and a foreign exchange swap); instead, they

    are settled by payment in one currency (usually U.S. dollars).

    Notwithstanding their ``forward'' label, NDFs do not fall within

    the forward contract exclusion of the swap definition. Currency is

    outside the scope of the forward contract exclusion for nonfinancial

    commodities. Nor have NDFs traditionally been considered commercial

    merchandising transactions. Rather, the NDF markets appear to be driven

    in large part by speculation \134\ and hedging,\135\ which features are

    more characteristic of swap markets than forward markets.

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

    \134\ See ``Fed NDF Overview,'' supra note 129, at 5

    (``[E]stimates vary but many major market participants estimate as

    much as 60 to 80 percent of NDF volume is generated by speculative

    interest, noting growing participation from international hedge

    funds.'') and 4 (``[D]ealers note that much of the volume in Chinese

    yuan NDFs is generated by speculative positioning based on

    expectations for an alteration in China's current, basically fixed

    exchange rate.'') (italics in original).

    \135\ See id. at 4 (noting that ``[much of the] Korean won NDF

    volume[,] * * * estimated to be the largest of any currency, * * *

    is estimated to originate with international investment portfolio

    managers hedging the currency risk associated with their onshore

    investments'').

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

    Based on the foregoing considerations, the Commissions are

    proposing to provide greater clarity by explicitly defining the term

    ``swap'' to include NDFs. The proposed rules also would clarify that

    NDFs are not foreign exchange forwards or foreign exchange swaps as

    those terms are defined in the CEA.

    (iii) Currency Swaps and Cross-Currency Swaps

    A currency swap \136\ and a cross-currency swap \137\ each

    generally can be

    [[Page 29837]]

    described as a swap in which the fixed legs or floating legs based on

    various interest rates are exchanged in different currencies. Such

    swaps can be used to reduce borrowing costs, to hedge currency

    exposure, and to create synthetic assets \138\ and are viewed as an

    important tool, given that they can be used to hedge currency and

    interest rate risk in a single transaction.

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

    \136\ A swap that exchanges a fixed rate against a fixed rate is

    known as a currency swap. See Federal Reserve System, ``Trading and

    Capital-Markets Activities Manual,'' section 4335.1 (Jan. 2009).

    \137\ Cross-currency swaps with a fixed leg based on one rate

    and a floating leg based on another rate, where the two rates are

    denominated in different currencies, are generally referred to as

    cross-currency coupon swaps, while those with a floating leg based

    on one rate and another floating leg based on a different rate are

    known as cross-currency basis swaps. Id. Cross-currency swaps also

    include annuity swaps and amortizing swaps. In cross-currency

    annuity swaps, level cash flows in different currencies are

    exchanged with no exchange of principal; annuity swaps are priced

    such that the level payment cash flows in each currency have the

    same net present value at the inception of the transaction. An

    amortizing cross-currency swap is structured with a declining

    principal schedule, usually designed to match that of an amortizing

    asset or liability. Id. See also Derivatives ONE, ``Cross Currency

    Swap Valuation'' (``A cross currency swap is swap of an interest

    rate in one currency for an interest rate payment in another

    currency. * * * This could be considered an interest rate swap with

    a currency component.''), available at http://www.derivativesone.com/cross-currency-swap-valuation/; Financial

    Accounting Standards Board, ``Examples Illustrating Application of

    FASB Statement No. 138,'' Accounting for Certain Derivative

    Instruments and Certain Hedging Activities, section 2, Example 1, at

    3 (``The company designates the cross-currency swap as a fair value

    hedge of the changes in the fair value of the loan due to both

    interest and exchange rates.''), available at http://www.fasb.org/derivatives/examples.pdf.

    \138\ BMO Capital Markets, ``Cross Currency Swaps,'' available

    at http://www.bmocm.com/products/marketrisk/intrderiv/cross/default.aspx.

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

    Currency swaps and cross-currency swaps are not foreign exchange

    swaps as defined in the CEA because, although they may involve an

    exchange of foreign currencies, they also require contingent or

    variable payments in different currencies. Because the CEA defines a

    foreign exchange swap as a swap that ``solely'' involves an initial

    exchange of currencies and a reversal thereof at a later date, subject

    to certain parameters, currency swaps and cross-currency swaps would

    not be foreign exchange swaps. Similarly, currency swaps and cross-

    currency swaps are not foreign exchange forwards because foreign

    exchange forwards ``solely'' involve an initial exchange of currencies,

    subject to certain parameters, while currency swaps and cross-currency

    swaps contain additional elements, as discussed above.

    Currency swaps are expressly enumerated in the statutory definition

    of the term ``swap.'' \139\ Cross-currency swaps, however, are

    not.\140\ Accordingly, based on the foregoing considerations, the

    Commissions are proposing rules to provide greater clarity by

    explicitly defining the term ``swap'' to include cross-currency swaps.

    The proposed rules also would clarify that neither currency swaps nor

    cross-currency swaps are foreign exchange forwards or foreign exchange

    swaps as those terms are defined in the CEA.

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

    \139\ See CEA section 1a(47)(A)(iii)(VII), 7 U.S.C.

    1a(47)(A)(iii)(VII).

    \140\ Clause (A)(iii) of the swap definition expressly refers to

    a cross-currency rate swap. See CEA section 1a(47)(A)(iii)(V), 7

    U.S.C. 1a(47)(A)(iii)(V). Although the swap industry appears to use

    the term ``cross-currency swap,'' rather than ``cross-currency rate

    swap'' (the term used in CEA section 1a(47)(A)(iii)(V)), the

    Commissions interpret these terms as synonymous.

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

    Request for Comment

    52. Should the proposed rules explicitly define the term ``swap''

    to include foreign exchange forwards and foreign exchange swaps, unless

    the Secretary determines to exempt them? Should the proposed rules

    clarify that, if the Secretary determines to exempt foreign exchange

    swaps or foreign exchange forwards, those transactions remain subject

    to certain reporting requirements, and swap dealers and major swap

    participants entering into such transactions remain subject to certain

    business conduct standards, imposed by Title VII and CFTC regulations

    promulgated thereunder? Why or why not?

    53. Should the proposed rules explicitly define the term ``swap''

    to include foreign currency options and clarify that foreign currency

    options are not foreign exchange forwards or foreign exchange swaps?

    Why or why not? Should the terms foreign currency options, currency

    options, foreign exchange options, and foreign exchange rate options be

    interpreted as synonymous? Why or why not?

    54. Should the proposed rules explicitly define the term ``swap''

    to include NDFs and clarify that NDFs are not foreign exchange forwards

    or foreign exchange swaps? Why or why not?

    55. Should the proposed rules explicitly define the term ``swap''

    to include cross-currency swaps as swaps and clarify that currency

    swaps and cross-currency swaps are not foreign exchange forwards or

    foreign exchange swaps? Why or why not? Should the terms cross-currency

    swap and cross-currency rate swap be interpreted as synonymous? Why or

    why not?

    56. Is additional detail needed within the proposed rules regarding

    foreign exchange-related products to provide greater clarity regarding

    the specific products listed in the proposed rules? If so, what

    additional detail would be necessary?

    3. Forward Rate Agreements

    In general, the Commissions understand an FRA to be an over-the-

    counter contract for a single cash payment, due on the settlement date

    of a trade, based on a spot rate (determined pursuant to a method

    agreed upon by the parties) and a prespecified forward rate. The single

    cash payment is equal to the product of the present value (discounted

    from a specified future date to the settlement date of the trade) of

    the difference between the forward rate and the spot rate on the

    settlement date multiplied by the notional amount. The notional amount

    itself is not exchanged.\141\

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

    \141\ See generally ``Trading and Capital-Markets Activities

    Manual,'' supra note 136, section 4315.1 (``For example, in a six-

    against-nine-month (6x9) FRA, the parties agree to a three-month

    rate that is to be netted in six months' time against the prevailing

    three-month reference rate, typically LIBOR. At settlement (after

    six months), the present value of the net interest rate (the

    difference between the spot and the contracted rate) is multiplied

    by the notional principal amount to determine the amount of the cash

    exchanged between the parties * * *. If the spot rate is higher than

    the contracted rate, the seller agrees to pay the buyer the

    differences between the prespecified forward rate and the spot rate

    prevailing at maturity, multiplied by a notional principal amount.

    If the spot rate is lower than the forward rate, the buyer pays the

    seller.'').

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

    An FRA provides for the future (executory) payment based on the

    transfer of interest rate risk between the parties as opposed to

    transferring an ownership interest in any asset or liability.\142\

    Thus, the Commissions believe that an FRA satisfies clause (A)(iii) of

    the swap definition.\143\

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

    \142\ It appears that at least some in the trade view FRAs as

    swaps today. See, e.g., The Globecon Group, Ltd., ``Derivatives

    Engineering: A Guide to Structuring, Pricing and Marketing

    Derivatives,'' 45 (McGraw-Hill 1995) (``An FRA is simply a one-

    period interest-rate swap.''); DerivActiv, Glossary of Financial

    Derivatives Terms (``A swap is * * * a strip of FRAs.''), available

    at http://www.derivactiv.com/

    definitions.aspx?search=forward+rate+agreements. Cf. Don M. Chance,

    et. al, ``Derivatives in Portfolio Management,'' 29 (AIMR 1998)

    (``[An FRA] involves one specific payment and is basically a one-

    date swap (in the sense that a swap is a combination of FRAs[,] with

    some variations).''). Thus, FRAs also may fall within clause (A)(iv)

    of the swap definition, as ``an agreement, contract, or transaction

    that is, or in the future becomes, commonly known to the trade as a

    swap.'' See CEA section 1a(47)(a)(iv), 7 U.S.C. 1a(47)(a)(iv).

    \143\ See CEA section 1a(47)(A)(iii); 7 U.S.C. 1a(47)(A)(iii).

    CFTC regulations have defined FRAs as swap agreements. See CFTC rule

    35.1(b)(1)(i), 17 CFR 35.1(b)(1)(i); Exemption for Certain Swap

    Agreements, 58 FR 5587, Jan. 22, 1993. The CFTC recently has

    proposed to repeal that rule in light of the enactment of Title VII

    of the Dodd-Frank Act. See Commodity Options and Agricultural Swaps,

    supra note 78.

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

    Notwithstanding their ``forward'' label, FRAs do not fall within

    the forward contract exclusion from the swap definition. FRAs do not

    involve nonfinancial commodities and thus are outside the scope of the

    forward contract exclusion. Nor is an FRA a commercial merchandising

    transaction, as there is no physical product to be delivered in an

    FRA.\144\ Accordingly,

    [[Page 29838]]

    the Commissions believe that the forward contract exclusion from the

    swap definition for nonfinancial commodities does not apply to

    FRAs.\145\

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

    \144\ See Regulation of Hybrid and Related Instruments, 52 FR

    47022, 47028, Dec. 11, 1987 (stating ``[FRAs] do not possess all of

    the characteristics of forward contracts heretofore delineated by

    the [CFTC]'').

    \145\ Current European Union law includes FRAs in the definition

    of ``financial instruments.'' See Markets in Financial Instruments

    Directive (MiFID), ``Directive 2004/39/EC of the European Parliament

    and of the Council,'' Annex I(C), 4, 5, 10 (Apr. 21, 2004),

    available at http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=CONSLEG:2004L0039:20070921:EN:PDF. A European

    Commission legislative proposal on derivatives, central clearing,

    and trade repositories applies to FRAs that are traded over-the-

    counter and, thus, would subject such transactions to mandatory

    clearing, reporting and other regulatory requirements. See Proposal

    for a Regulation of the European Parliament and of the Council on

    OTC derivatives, central counterparties and trade repositories,

    title I, art. 1(1), COM(2010) 484/5 (Sept. 15, 2010), available at

    http://ec.europa.eu/internal_market/financial-markets/docs/derivatives/20100915_proposal_en.pdf.

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

    Based on the foregoing considerations, the Commissions are

    proposing rules to provide greater clarity by explicitly defining the

    term ``swap'' to include FRAs. As with the foreign exchange-related

    products discussed above, the proposed rules provide that FRAs would

    not be swaps if they fall within one of the exclusions set forth in

    subparagraph (B) of the swap definition.

    Request for Comment

    57. Is the description of FRAs accurate? If not, please provide a

    detailed description of FRAs. Are there various types of FRAs? If so,

    please provide an explanation of their characteristics and how they

    differ.

    58. What types of market participants use FRAs, and for what

    purposes? What market (spot) and fixed rates are used in FRAs, and how

    are those rates determined, or on what are those rates based?

    59. Should the proposed rules explicitly define the term ``swap''

    to include FRAs? Why or why not?

    60. Should the proposed rules provide a more detailed description

    of what FRAs are? Why or why not? If so, please explain what additional

    language regarding FRAs should be included in the proposed rules.

    4. Combinations and Permutations of, or Options on, Swaps and Security-

    Based Swaps

    Clause (A)(vi) of the swap definition provides that ``any

    combination or permutation of, or option on, any agreement, contract,

    or transaction described in any of clauses (i) through (v)'' of the

    definition is a swap or security-based swap.\146\ As a result, clause

    (A)(vi) means, for example, that an option on a swap or security-based

    swap (commonly known as a ``swaption'') would itself be a swap or

    security-based swap, respectively. The Commissions also interpret

    clause (A)(vi) to mean that a ``forward swap'' would itself be a swap

    or security-based swap, respectively.\147\

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

    \146\ See CEA section 1a(47)(vi), 7 U.S.C. 1a(47)(vi).

    \147\ Forward swaps are also commonly known as forward start

    swaps, or deferred or delayed start swaps. A forward swap can

    involve two offsetting swaps that both start immediately, but one of

    which ends on the deferred start date of the forward swap itself.

    For example, if a counterparty wants to hedge its risk for four

    years, starting one year from today, it could enter into a one-year

    swap and a five-year swap, which would partially offset to create a

    four-year swap, starting one year forward. A forward swap also can

    involve a contract to enter into a swap or security-based swap at a

    future date or with a deferred start date. A forward swap is not a

    nonfinancial commodity forward contract or security forward, both of

    which are excluded from the swap definition and discussed elsewhere

    in this release.

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

    Request for Comment

    61. Is additional guidance regarding swaptions, necessary? Why or

    why not? If so, please provide a detailed explanation of what

    additional guidance would be necessary.

    62. Is the Commissions' description of forward swaps accurate? Why

    or why not? If not, please provide a detailed explanation of why the

    description is inaccurate. Is additional guidance regarding forward

    swaps necessary? Why or why not? If so, please provide a detailed

    explanation of what additional guidance would be necessary.

    63. Is additional guidance regarding other combinations or

    permutations of swaps or security-based swaps necessary? Why or why

    not? If so, please provide a detailed description of any particular

    agreement, contract, or transaction, including the purposes for which

    it is used and the market participants that use it, and what additional

    guidance would be necessary.

    5. Contracts for Differences

    The Commissions have received inquiries over the years regarding

    the treatment of CFDs under the CEA and the Federal securities laws. A

    CFD generally is an agreement to exchange the difference in value of an

    underlying asset between the time at which a CFD position is

    established and the time at which it is terminated.\148\ If the value

    increases, the seller pays the buyer the difference; if the value

    decreases, the buyer pays the seller the difference. CFDs can be traded

    on a number of products, including treasuries, foreign exchange rates,

    commodities, equities, and stock indexes. Equity CFDs closely mimic the

    purchase of actual shares. The buyer of an equity CFD receives cash

    dividends and participates in stock splits.\149\ In the case of a long

    position, a dividend adjustment is credited to the client's account. In

    the case of a short position, a dividend adjustment is debited from the

    client's account. CFDs generally are traded over-the-counter (though

    they also are traded on the Australian Securities Exchange) in a number

    of countries outside the United States.

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

    \148\ See Ontario Securities Commission, Staff Notice 91-702,

    ``Offerings of Contracts for Difference and Foreign Exchange

    Contracts to Investors in Ontario,'' at part IV.1 (defining a CFD as

    ``a derivative product that allows an investor to obtain economic

    exposure (for speculative, investment or hedging purposes) to an

    underlying asset * * * such as a share, index, market sector,

    currency or commodity, without acquiring ownership of the underlying

    asset''), available at http://www.osc.gov.on.ca/documents/en/Securities-Category9/sn_20091030_91-702_cdf.pdf (Oct. 30, 2009);

    Financial Services Authority, Consultation Paper 7/20, ``Disclosure

    of Contracts for Difference--Consultation and draft Handbook text,''

    at part 2.2 (defining a CFD on a share as ``a derivative product

    that gives the holder an economic exposure, which can be long or

    short, to the change in price of a specific share over the life of

    the contract''), available at http://www.fsa.gov.uk/pubs/cp/cp07_20.pdf (Nov. 2007).

    \149\ See, e.g., Int'l Swaps and Derivatives Ass'n, ``2002 ISDA

    Equity Derivatives Definitions,'' art. 10 (Dividends) and 11

    (Adjustments and Modifications Affecting Indices, Shares and

    Transactions).

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

    CFDs, unless otherwise excluded, may fall within the scope of the

    swap and security-based swap definitions.\150\ Whether a CFD is a swap

    or security-based swap will depend on the underlying product of that

    particular CFD transaction. Because CFDs are highly variable and a CFD

    can contain a variety of elements that would affect its

    characterization, the Commissions believe that market participants will

    need to analyze the characteristics of any particular CFD in order to

    determine whether it is a swap or a security-based swap. Therefore, the

    Commissions are not proposing rules or additional interpretive guidance

    at this time regarding CFDs.

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

    \150\ In some cases, depending on the facts and circumstances,

    the SEC may determine that a particular CFD on an equity security,

    for example, should be characterized as constituting a purchase or

    sale of the underlying equity security and, therefore, be subject to

    the requirements of the Federal securities laws applicable to such

    purchases or sales.

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

    Request for Comment

    64. Should the Commissions provide additional guidance regarding

    CFDs? Why or why not? If so, please provide a detailed description of

    any particular CFD and what additional guidance would be necessary.

    [[Page 29839]]

    D. Certain Interpretive Issues

    1. Agreements, Contracts, or Transactions That May Be Called, or

    Documented Using Form Contracts Typically Used for, Swaps or Security-

    Based Swaps

    The Commissions are aware that individuals and companies may

    generally use the term ``swap'' to refer to certain of their

    agreements, contracts, or transactions. For example, the term ``swap''

    may be used to refer to an agreement to exchange real or personal

    property between the parties. Or, two companies that produce fungible

    products may use the term ``swap'' to refer to an agreement to perform

    each other's delivery obligations--for example, if one company must

    deliver the product in California and the other must deliver the same

    product in New York, they may use the term ``swap'' to refer to an

    agreement that each company will perform the other's delivery

    obligation.

    The name or label that the parties use to refer to a particular

    agreement, contract, or transaction is not determinative of whether it

    is a swap or security-based swap.\151\ Also, it may not be relevant

    whether the agreement, contract, or transaction is documented using an

    industry standard form agreement that is typically used for swaps and

    security-based swaps.\152\ Instead, the relevant question is whether

    the agreement, contract, or transaction falls within the definition of

    the terms ``swap'' or ``security-based swap'' (as further interpreted

    pursuant to the guidance proposed herein) based on its terms and other

    characteristics. Even if one effect of an agreement is to reduce the

    risk faced by the parties (e.g., the ``swap'' of physical delivery

    obligations described above may reduce the risk of non-delivery), the

    agreement is not a swap or security-based swap unless it otherwise

    meets one of the statutory definitions, as further defined by the

    Commissions. Similarly, the fact that the parties use another name to

    refer to a swap or security-based swap would not be relevant in

    determining whether the agreement, contract, or transaction is a swap

    or security-based swap as those terms are defined in the CEA and the

    Exchange Act and the rules and regulations thereunder.

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

    \151\ See, e.g., Haekel v. Refco, 2000 WL 1460078, at * 4 (CFTC

    Sept. 29, 2000) (``[T]he labels that parties apply to their

    transactions are not necessarily controlling''); Reves v. Ernst &

    Young, 494 U.S. 56, 61 (1990) (stating that the purpose of the

    securities laws is ``to regulate investments, in whatever form they

    are made and by whatever name they are called'') (emphasis in

    original).

    \152\ The CFTC consistently has found that the form of a

    transaction is not dispositive in determining its nature. See, e.g.,

    Grain Land, supra note 61, at *16 (CFTC Nov. 25, 2003) (holding that

    contract substance is entitled to at least as much weight as form);

    In the Matter of First Nat'l Monetary Corp., [1984-1986 Transfer

    Binder] Comm. Fut. L. Rep. (CCH) ] 22,698 at 30,974 (CFTC Aug. 7,

    1985) (``When instruments have been determined to constitute the

    functional equivalent of futures contracts neither we nor the courts

    have hesitated to look behind whatever self-serving labels the

    instruments might bear.''); Stovall, supra note 63 (holding that the

    CFTC ``will not hesitate to look behind whatever label the parties

    may give to the instrument''). Likewise, the form of a transaction

    is not dispositive in determining whether an agreement, contract, or

    transaction falls within the regulatory regime for securities. See

    SEC v. Merch. Capital, LLC, 483 F.3d 747, 755 (11th Cir. 2007)

    (``The Supreme Court has repeatedly emphasized that economic reality

    is to govern over form and that the definitions of the various types

    of securities should not hinge on exact and literal tests.'')

    (quoting Williamson v. Tucker, 645 F.2d 404, 418 (5th Cir. 1981));

    Robinson v. Glynn, 349 F.3d 166, 170 (4th Cir. 2003) (``What matters

    more than the form of an investment scheme is the `economic reality'

    that it represents * * * .'') (internal citation omitted); Caiola v.

    Citibank, N.A., New York, 295 F.3d 312, 325 (2d Cir. 2002) (quoting

    United Housing Foundation v. Foreman, 421 U.S. 837, 848 (1975) (``In

    searching for the meaning and scope of the word `security' * * * the

    emphasis should be on economic reality'')).

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

    Request for Comment

    65. What agreements, contracts, or transactions that are not swaps

    or security-based swaps are documented using industry standard form

    agreements that are typically used for swaps and security-based swaps?

    Please provide examples of such agreements, contracts, or transactions

    and details regarding their documentation, including why industry

    standard form agreements typically used for swaps and security-based

    swaps are used.

    2. Transactions in Regional Transmission Organizations and Independent

    System Operators

    The Commissions received a comment letter in response to the ANPR

    requesting clarification regarding the status of transactions in RTOs

    and ISOs, including financial transmission rights (``FTRs''), under the

    swap and security-based swap definitions.\153\ Section 722 of the Dodd-

    Frank Act, though, specifically addresses how the CFTC should approach

    products regulated by FERC that also may be subject to CFTC

    jurisdiction. Section 722 of the Dodd-Frank Act amended CEA section

    4(c) \154\ to provide that, if the CFTC determines that an exemption

    for FERC-regulated instruments or other specified electricity

    transactions would be in accordance with the public interest, then it

    shall exempt such instruments or transactions from the requirements of

    the CEA. Given this specific provision regarding these FERC-related

    products, the CFTC believes the treatment of these products should be

    considered under the standards and procedures specified in section 722

    of the Dodd-Frank Act for a public interest waiver, rather than through

    this joint rulemaking to further define the terms ``swap'' and

    ``security-based swap.''

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

    \153\ See WGCEF Letter.

    \154\ 7 U.S.C. 6(c).

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

    Consequently, the Commissions are not addressing FTRs or other

    transactions in RTOs or ISOs within this joint definitional rulemaking.

    Instead, persons with concerns about whether FERC-regulated products

    may be considered swaps (or futures) should request an exemption

    pursuant to section 722 of the Dodd Frank Act.\155\

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

    \155\ This approach, however, should not be taken to suggest any

    findings by the Commissions as to whether or not FTRs or any other

    FERC-regulated products are swaps (or futures contracts).

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

    III. The Relationship Between the Swap Definition and the Security-

    Based Swap Definition

    A. Introduction

    Title VII of the Dodd-Frank Act defines the term ``swap'' under the

    CEA,\156\ and also defines the term ``security-based swap'' under the

    Exchange Act.\157\ Pursuant to the regulatory framework established in

    Title VII, the CFTC has regulatory authority over swaps and the SEC has

    regulatory authority over security-based swaps. The Commissions are

    proposing to further define the terms ``swap'' and ``security-based

    swap'' to clarify whether particular agreements, contracts, or

    transactions are swaps or security-based swaps based on characteristics

    including the specific terms and conditions of the instrument and the

    nature of, among other things, the prices, rates, securities, indexes,

    or commodities upon which the instrument is based.

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

    \156\ See CEA section 1a(47), 7 U.S.C. 1a(47).

    \157\ See section 3(a)(68) of the Exchange Act, 15 U.S.C.

    78c(a)(68).

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

    Because the discussion below is focused on whether particular

    agreements, contracts, or transactions are swaps or security-based

    swaps, the Commissions use the term ``Title VII instrument'' in this

    release to refer to any agreement, contract, or transaction that is

    included in either the definition of the term ``swap'' or the

    definition of the term ``security-based swap.'' Thus, the term ``Title

    VII instrument'' is synonymous with ``swap or security-based swap.''

    \158\

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

    \158\ In some cases, the Title VII instrument may be a mixed

    swap. Mixed swaps are discussed further in part IV below.

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

    The determination of whether a Title VII instrument is a swap or

    security-

    [[Page 29840]]

    based swap should be made based on the facts and circumstances relating

    to the Title VII instrument at the time that the parties enter into it.

    If the Title VII instrument itself is not amended, modified, or

    otherwise adjusted during its term by the parties, its characterization

    as a swap or security-based swap should not change during its duration

    because of any changes that may occur to the factors affecting its

    character as a swap or security-based swap.\159\

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

    \159\ See discussion infra part III.G.3(a) regarding Title VII

    instruments based on indexes.

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

    Classifying a Title VII instrument as a swap or security-based swap

    is straightforward for most instruments. The Commissions, however, are

    proposing guidance to clarify the classification of swaps and security-

    based swaps in certain areas and to provide guidance regarding the use

    of certain terms and conditions in Title VII instruments.

    B. Title VII Instruments Based on Interest Rates, Other Monetary Rates,

    and Yields

    Parties frequently use Title VII instruments to manage risks

    related to, or to speculate on, changes in interest rates, other

    monetary rates or amounts, or the return on various types of assets.

    Broadly speaking, Title VII instruments based on interest or other

    monetary rates would be swaps, whereas Title VII instruments based on

    the yield or value of a single security, loan, or narrow-based security

    index would be security-based swaps. However, market participants and

    financial professionals sometimes use the terms ``rate'' and ``yield''

    in different ways. The Commissions are proposing guidance regarding

    whether Title VII instruments that are based on interest rates, other

    monetary rates, or yields would be swaps or security-based swaps and

    requesting comment as to whether additional clarification in this area

    would be appropriate.\160\

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

    \160\ Commenters did not address these instruments specifically.

    A number of commenters urged clarification that various transactions

    or obligations, such as commercial loans, are not Title VII

    instruments solely because they reference an interest rate. See

    BlackRock Letter; Cleary Letter; Farm Credit Council Letter; White &

    Case Letter. The Commissions have proposed guidance to address such

    customary commercial transactions in part II.B.3 above.

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

    1. Title VII Instruments Based on Interest Rates or Other Monetary

    Rates That Are Swaps

    The Commissions believe that when payments exchanged under a Title

    VII instrument are based solely on the levels of certain interest rates

    or other monetary rates that are not themselves based on one or more

    securities, the instrument would be a swap and not a security-based

    swap.\161\ Often swaps on interest rates or other monetary rates

    require the parties to make payments based on the comparison of a

    specified floating rate (such as the London Interbank Offered Rate

    (``LIBOR'')) to a fixed rate of interest agreed upon by the parties. A

    rate swap also may require payments based on the differences between

    two floating rates, or it may require that the parties make such

    payments when any agreed-upon events with respect to interest rates or

    other monetary rates occur (such as when a specified interest rate

    crosses a threshold, or when the spread between two such rates reaches

    a certain point). The rates referenced for the parties' obligations are

    varied, and examples of such rates include the following:

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

    \161\ See discussion supra part III.F regarding the use of

    certain terms and conditions.

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

    Interbank Offered Rates: An average of rates charged by a

    group of banks for lending money to each other or other banks over

    various periods of time, and other similar interbank rates,\162\

    including, but not limited to, LIBOR (regardless of currency); \163\

    the Euro Interbank Offered Rate (``Euribor''); the Canadian Dealer

    Offered Rate (``CDOR''); and the Tokyo Interbank Offered Rate

    (``TIBOR''); \164\

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

    \162\ Interbank lending rates are measured by surveys of the

    loan rates that banks offer other banks, or by other mechanisms. The

    periods of time for such loans may range from overnight to 12 months

    or longer.

    The interbank offered rates listed here are frequently called

    either a ``reference rate,'' the rate of ``reference banks,'' or by

    a designation that is specific to the service that quotes the rate.

    For some of the interbank offered rates listed here, there is a

    similar rate that is stated as an interbank bid rate, which is the

    average rate at which a group of banks bid to borrow money from

    other banks. For example, the bid rate similar to LIBOR is called

    LIBID.

    \163\ Today, LIBOR is used as a rate of reference for the

    following currencies: Australian Dollar, Canadian Dollar, Danish

    Krone, Euro, Japanese Yen, New Zealand Dollar, Pound Sterling,

    Swedish Krona, Swiss Franc, and U.S. Dollar.

    \164\ Other interbank offered rates include the following (with

    the country or city component of the acronym listed in parentheses):

    AIDIBOR (Abu Dhabi); BAIBOR (Buenos Aires); BKIBOR (Bangkok);

    BRAZIBOR (Brazil); BRIBOR/BRIBID (Bratislava); BUBOR (Budapest);

    CHIBOR (China); CHILIBOR (Chile); CIBOR (Copenhagen); COLIBOR

    (Colombia); HIBOR (Hong Kong); JIBAR (Johannesburg); JIBOR

    (Jakarta); KAIBOR (Kazakhstan); KIBOR (Karachi); KLIBOR (Kuala

    Lumpur); KORIBOR ((South) Korea); MEXIBOR (Mexico); MIBOR (Mumbai);

    MOSIBOR (Moscow); NIBOR (Norway); PHIBOR (Philippines); PRIBOR

    (Prague); REIBOR/REIBID (Reykjavik); RIGIBOR/RIGIBID (Riga); SHIBOR

    (Shanghai); SIBOR (Singapore); SOFIBOR (Sofia); STIBOR (Stockholm);

    TAIBOR (Taiwan); TELBOR (Tel Aviv); TRLIBOR and TURKIBOR (Turkey);

    VILIBOR (Vilnius); VNIBOR (Vietnam); and WIBOR (Warsaw).

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

    Money Market Rates: A rate established or determined based

    on actual lending or money market transactions, including, but not

    limited to, the Federal Funds Effective Rate; the Euro Overnight Index

    Average (``EONIA'' or ``EURONIA'') (which is the weighted average of

    overnight unsecured lending transactions in the Euro-area interbank

    market); the EONIA Swap Index; the Australian dollar RBA 30 Interbank

    Overnight Cash Rate; the Canadian Overnight Repo Rate Average

    (``CORRA''); the Mexican interbank equilibrium interest rate

    (``TIIE''); the NZD Official Cash Rate; the Sterling Overnight

    Interbank Average Rate (``SONIA'') (which is the weighted average of

    unsecured overnight cash transactions brokered in London by the

    Wholesale Markets Brokers' Association); the Swiss Average Rate

    Overnight (``SARON''); and the Tokyo Overnight Average Rate (``TONAR'')

    (which is based on uncollateralized overnight average call rates for

    interbank lending);

    Government Target Rates: A rate established or determined

    based on guidance established by a central bank including, but not

    limited to, the Federal Reserve discount rate, the Bank of England base

    rate and policy rate, the Canada Bank rate, and the Bank of Japan

    policy rate (also known as the Mutan rate);

    General Lending Rates: A general rate used for lending

    money, including, but not limited to, a prime rate, rate in the

    commercial paper market, or any similar rate provided that it is not

    based on any security, loan, or group or index of securities;

    Indexes: A rate derived from an index of any of the

    foregoing or following rates, averages, or indexes, including but not

    limited to a constant maturity rate (U.S. Treasury and certain other

    rates),\165\ the interest rate swap rates published by the Federal

    Reserve in its ``H.15 Selected Interest Rates'' publication, the

    ISDAFIX rates, the ICAP Fixings, a constant maturity swap, or a rate

    generated as an average (geometric, arithmetic, or otherwise) of any of

    the foregoing, such as overnight index swaps (``OIS'')--provided that

    such rates are not based on a specific

    [[Page 29841]]

    security, loan, or narrow-based group or index of securities;

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

    \165\ A Title VII instrument based solely on the level of a

    constant maturity U.S. Treasury rate would be a swap because U.S.

    Treasuries are exempted securities that are excluded from the

    security-based swap definition. Conversely, a Title VII instrument

    based solely on the level of a constant maturity rate on a narrow-

    based index of non-exempted securities under the security-based swap

    definition would be a security-based swap.

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

    Other Monetary Rates: A monetary rate including, but not

    limited to, the Consumer Price Index (``CPI''), the rate of change in

    the money supply, or an economic rate such as a payroll index; and

    Other: The volatility, variance, rate of change of (or the

    spread, correlation or difference between), or index based on any of

    the foregoing rates or averages of such rates, such as forward spread

    agreements, references used to calculate the variable payments in index

    amortizing swaps (whereby the notional principal amount of the

    agreement is amortized according to the movement of an underlying

    rate), or correlation swaps and basis swaps, including but not limited

    to, the ``TED spread'' \166\ and the spread or correlation between

    LIBOR and an OIS.

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

    \166\ The TED spread is the difference between the interest

    rates on interbank loans and short-term U.S. government debt

    (Treasury bills or ``T-bills''). The latter are exempted securities

    that are excluded from the statutory definition of the term

    ``security-based swap.'' Thus, neither any aspect of U.S. Treasuries

    nor interest rates on interbank loans, can form the basis of a

    security-based swap. For this reason, a Title VII instrument on a

    spread between interbank loan rates and T-bill rates also would not

    be a security-based swap.

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

    As discussed above, the Commissions believe that when payments

    under a Title VII instrument are based solely on any of the foregoing,

    such Title VII instrument would be a swap.

    Request for Comment

    66. The Commissions request comment generally on the foregoing

    proposed guidance regarding Title VII instruments where the underlying

    reference is an interest rate or other monetary rate.

    67. Does the proposed guidance in this section accurately describe

    the types of interest rates and other monetary rates that are used as

    an underlying reference of a Title VII instrument, and that should

    cause the instrument to be considered a swap? Are any of the rates

    identified in this list not used in this manner? Are there any

    significant interest or monetary rates that should be added to this

    list in order to provide additional guidance?

    68. As discussed above, a Title VII instrument would be considered

    a security-based swap if the instrument is based on constant maturity

    rates that are derived from the market prices and yields of a non-

    exempted debt security or a narrow-based security index of debt

    securities (depending on the other terms of the Title VII instrument,

    such instrument may be a mixed swap). The Commissions request comment

    on this guidance. Are there certain constant maturity rates that should

    not be considered to be security-based, such that a Title VII

    instrument based on those rates would instead be a swap and not a

    security-based swap or mixed swap? If so, are there objective criteria

    to distinguish between different types of constant maturity rates in

    the determination of whether a Title VII instrument is a swap or

    security-based swap? If so, please describe any such criteria in

    detail.

    2. Title VII Instruments Based on Yields

    The Commissions also propose guidance to clarify the status of

    Title VII instruments in which one of the underlying references of the

    instrument is a ``yield.'' In cases when a ``yield'' is calculated

    based on the price or changes in price of a debt security, loan, or

    narrow-based security index, it is another way of expressing the price

    or value of a debt security, loan, or narrow-based security index. For

    example, debt securities often are quoted and traded on a yield basis

    rather than on a dollar price, where the yield relates to a specific

    date, such as the date of maturity of the debt security (i.e., yield to

    maturity) or the date upon which the debt security may be redeemed or

    called by the issuer (e.g., yield to first whole issue call).\167\

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

    \167\ See, e.g., Securities Confirmations, 47 FR 37920, Aug. 27,

    1982.

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

    Except in the case of certain exempted securities, when one of the

    underlying references of the Title VII instrument is the ``yield'' of a

    debt security, loan, or narrow-based security index in the sense where

    the term ``yield'' is used as a proxy for the price or value of the

    debt security loan, or narrow-based security index, the Title VII

    instrument would be a security-based swap. And, as a result, in cases

    where the underlying reference is a point on a ``yield curve''

    generated from the different ``yields'' on debt securities in a narrow-

    based security index (e.g., a constant maturity yield or rate), the

    Title VII instrument would be a security-based swap. In either case,

    however, where certain exempted securities, such as U.S. Treasury

    securities, are the only underlying reference of a Title VII instrument

    involving securities, the Title VII instrument would be a swap. Title

    VII instruments based on exempted securities are discussed further

    below.

    The above interpretation would not apply in cases where the

    ``yield'' referenced in a Title VII instrument is not based on a debt

    security, loan, or narrow-based security index of debt securities but

    rather is being used to reference an interest rate or monetary rate as

    outlined above in subsection one of this section. In these cases, this

    ``yield'' reference would be considered equivalent to a reference to an

    interest rate or monetary rate and the Title VII instrument would be,

    under the guidance in this section, a swap (or mixed swap depending on

    other references in the instrument).

    Request for Comment

    69. The Commissions request comment generally on the foregoing

    proposed guidance regarding Title VII instruments where the underlying

    reference is a ``yield.'' Please provide a detailed explanation of any

    uncertainty regarding the Commissions' proposed use of the terms

    ``yield'' and ``yield curve'' and what additional guidance would be

    necessary.

    70. Does the proposed guidance in this section appropriately

    describe instruments based on the ``yield'' of a debt security that

    should be considered security-based swaps? Is additional guidance

    necessary regarding when the term ``yield'' is used as a proxy for

    price or value? If so, please provide a detailed explanation of any

    uncertainty regarding how the term ``yield'' is used and what

    additional guidance would be necessary.

    71. Are there instruments where the underlying reference is a

    ``yield'' of a debt security that should be considered a swap as

    opposed to a security-based swap? If so, what are they, and how often

    are they traded? How are such instruments distinguished from

    instruments based on ``yield'' that should be considered security-based

    swaps?

    3. Title VII Instruments Based on Government Debt Obligations

    The Commissions also are providing guidance regarding instances in

    which the underlying reference of the Title VII instrument is a

    government debt obligation. The security-based swap definition

    specifically excludes any agreement, contract, or transaction that

    meets the definition of a security-based swap only because it

    ``references, is based upon, or settles through the transfer, delivery,

    or receipt of an exempted security under [section 3(a)(12) of the

    Exchange Act], as in effect on the date of enactment of the Futures

    Trading Act of 1982 (other than any municipal security as defined in

    [section 3(a)(29) of the Exchange Act] * * *), unless such agreement,

    contract, or transaction is of the character of, or

    [[Page 29842]]

    is commonly known in the trade as, a put, call, or other option.''

    \168\

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

    \168\ Section 3(a)(68)(C) of the Exchange Act, 15 U.S.C.

    76c(a)(68)(C).

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

    As a result of this exclusion in the security-based swap definition

    for ``exempted securities,'' \169\ if the only underlying reference of

    a Title VII instrument involving securities is, for example, the price

    of a U.S. Treasury security and does not have any other underlying

    reference involving securities, then the instrument would be a swap.

    Similarly, if the Title VII instrument is based on the ``yield'' of a

    U.S. Treasury security and does not have any other underlying reference

    involving securities, then the instrument also would be a swap,

    regardless of whether the term ``yield'' is a proxy for the price of

    the security.

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

    \169\ As of January 11, 1983, the date of enactment of the

    Futures Trading Act of 1982, Public Law 97-444, 96 Stat. 2294,

    section 3(a)(12) of the Exchange Act, 15 U.S.C. 78c(a)(12), provided

    that, among other securities, ``exempted securities'' include: (i)

    ``securities which are direct obligations of, or obligations

    guaranteed as to principal or interest by, the United States;'' (ii)

    certain securities issued or guaranteed by corporations in which the

    United States has a direct or indirect interest as designated by the

    Secretary of the Treasury; and (iii) certain other securities as

    designated by the SEC in rules and regulations.

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

    Foreign government securities, by contrast, were not ``exempted

    securities'' as of the date of enactment of the Futures Trading Act of

    1982 \170\ and thus do not explicitly fall within this exclusion from

    the security-based swap definition. Therefore, if the underlying

    reference of the Title VII instrument is the price, value, or ``yield''

    (where ``yield'' is a proxy for price or value) of a foreign government

    security, or a point on a yield curve derived from a narrow-based

    security index composed of foreign government securities, then the

    instrument would be a security-based swap.

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

    \170\ Public Law 97-444, 96 Stat. 2294 (1983).

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

    Request for Comment

    72. The Commissions request comment generally on the foregoing

    proposed guidance regarding the treatment of Title VII instruments in

    which the underlying reference is a government debt obligation.

    General Request for Comment: In addition to the particular requests

    for comment set forth on the issues discussed above, the Commissions

    also request comment generally on the following:

    73. Does the proposed guidance in this part III.B accurately

    describe market practices and terminology? Will the proposed guidance

    be useful in determining whether Title VII instruments are swaps or

    security-based swaps?

    C. Total Return Swaps

    A TRS is a Title VII instrument in which one counterparty, the

    seller of the TRS, makes a payment that is based on the price

    appreciation and income from an underlying security or security

    index.\171\ The other counterparty, the buyer of the TRS, makes a

    financing payment that is often based on a variable interest rate, such

    as LIBOR (or other interbank offered rate or money market rate, as

    described above), as well as a payment based on the price depreciation

    of the underlying reference. The ``total return'' consists of the price

    appreciation or depreciation, plus any interest or income

    payments.\172\ Accordingly, where a TRS is based on a single security

    or loan, or a narrow-based security index, the TRS would be a security-

    based swap.\173\

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

    \171\ Where the underlying security is an equity, a TRS is also

    known as an ``equity swap.''

    \172\ If the total return is negative, the seller receives this

    amount from the buyer. TRS can be used to synthetically reproduce

    the payoffs of a position. For example, two counterparties may enter

    into a 3-year TRS where the buyer of the TRS receives the positive

    total return on XYZ security, if any, and the seller of the TRS

    receives LIBOR plus 30 basis points and the absolute value of the

    negative total return on XYZ security, if any.

    \173\ If the underlying reference of the TRS is a broad-based

    equity security index, however, the Commissions believe that it

    would be a swap (and an SBSA) and not a security-based swap. In

    addition, a TRS on an exempted security, such as a U.S. Treasury,

    under section 3(a)(12) of the Exchange Act, 15 U.S.C. 78c(a)(12), as

    in effect on the date of enactment of the Futures Trading Act of

    1982 (other than any municipal security as defined in section

    3(a)(29) of the Exchange Act, 15 U.S.C. 78c(a)(29), as in effect on

    the date of enactment of the Futures Trading Act of 1982) would be a

    swap (and an SBSA) and not a security-based swap.

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

    Generally, the use of a variable interest rate in the TRS buyer's

    payment obligations to the seller is incidental to the purpose of, and

    the risk that the counterparties assume in, entering into the TRS.

    These payments are a form of financing that reflects the security-based

    swap dealer's cost of financing the position or a related hedge,

    allowing the TRS buyer to receive payments based on the price

    appreciation and income of a security or security index without

    purchasing the security or security index. The Commissions believe that

    when such interest rate payments act merely as a financing component in

    a TRS, or in any other security-based swap, the inclusion of such

    interest rate terms would not cause the security-based swap to be

    characterized as a mixed swap.\174\ Financing terms may also involve

    adding or subtracting a spread to or from the financing rate,\175\ or

    calculating the financing rate in a currency other than that of the

    underlying reference security or security index.\176\ However, the

    Commissions note that where such payments incorporate additional

    elements that create additional interest rate or currency exposures

    that are unrelated to the financing of the security-based swap, or

    otherwise shift or limit risks that are related to the financing of the

    security-based swap, those additional elements may cause the security-

    based swap to be a mixed swap.

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

    \174\ Several commenters noted that such instruments should not

    be characterized as mixed swaps. See Cleary Letter (expressing the

    view that such Title VII instruments should not be characterized as

    mixed swaps because ``the floating rate payment obligation is not

    the principal driver of the security-based swap and, in that sense,

    the security-based swap is not `based on' the level of an interest

    rate within the meaning of [the Dodd-Frank Act]''); Deutsche Bank

    Letter (explaining that such Title VII instruments in which the

    party that is ``synthetically short'' the underlying security makes

    payments based on the value of the underlying security to the party

    that is ``synthetically long,'' and the synthetically long party

    pays the synthetically short party an amount that may be based on

    LIBOR or another interest rate, should not be treated as mixed swaps

    because the payments to the synthetically short party are generally

    intended only for financing costs incurred in establishing or

    maintaining the transaction or its hedge); ISDA Letter (noting that

    variable interest rate-based payments in connection with a typical

    Title VII instrument of this type are ``incidental to what is

    essentially a security-based transaction and should not yield mixed

    swap status''); Morgan Stanley Letter (noting that the interest

    rate-based payments in such Title VII instruments ``reflect

    compensation for the financing costs associated'' with the

    instrument and ``are not at the core of what is being `swapped'

    under the contract''); Letter from Timothy W. Cameron, Esq.,

    Managing Director, Asset Management Group, Securities Industry and

    Financial Markets Association, Sept. 20, 2010 (expressing the view

    that such a financing component is incidental to the Title VII

    instrument and should not cause it to be viewed as a mixed swap).

    \175\ See, e.g., Moorad Chowdry, ``Total Return Swaps: Credit

    Derivatives and Synthetic Funding Instruments,'' at 3-4 (noting that

    the spread to the TRS financing rate is a function of: the credit

    rating of the counterparty paying the financing rate; the amount,

    value, and credit quality of the reference asset; the dealer's

    funding costs; a profit margin; and the capital charge associated

    with the TRS), available at http://www.yieldcurve.com/Mktresearch/LearningCurve/TRS.pdf.

    \176\ For example, a security-based swap on an equity security

    priced in U.S. dollars in which payments are made in Euros based on

    the U.S. dollar/Euro spot rate at the time the payment is made would

    not be a mixed swap. Under these circumstances, the currency is

    merely referenced in connection with the method of payment, and the

    counterparties are not hedging the risk of changes in currency

    exchange rates during the term of the security-based swap.

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

    For example, where the counterparties embed interest-rate

    optionality (e.g., a cap, collar, call, or put) into the terms of a

    security-based swap in a manner designed to shift or limit interest

    rate exposure, the inclusion of these terms would cause

    [[Page 29843]]

    the TRS to be both be a swap and a security-based swap (i.e., a mixed

    swap). Similarly, if a TRS is also based on non-security-based

    components (such as the price of oil, or a currency), the security-

    based swap would also be a swap.\177\

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

    \177\ See Mixed Swaps, infra part IV.

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

    Request for Comment

    74. Is the proposed guidance regarding TRS and other security-based

    swaps for which the use of a variable interest rate in a counterparty's

    payment obligations is incidental to the risk that counterparties

    assume in entering into a TRS or other security-based swap appropriate?

    Why or why not? If not, please provide a detailed explanation of what

    guidance would be appropriate.

    75. How often do market participants use rates, other than

    interbank offered rates or money market rates, in TRS to recoup their

    financing costs? If so, which rates and what portion of the market

    (broken down by product, country, counterparty type, and/or whatever

    data are available to commenters), in percentage and/or dollar terms do

    TRS with such financing rates constitute? What factors influence the

    financing rates that market participants incorporate into their

    security-based swaps?

    76. Do market participants embed optionality, such a cap, collar,

    put, or call, into the payment component of a TRS? If so, how

    frequently and for what purpose?

    77. Do market participants embed nonfinancial commodity components

    into the payment component that directly affect the payments on a TRS

    rather than operating as a mere financing component? If so, how

    frequently and for what purpose?

    78. Do market participants embed foreign currency swaps into a

    foreign currency payment component of a TRS? If so, how frequently and

    for what purpose?

    79. Are there other circumstances under which a TRS should be

    treated as a mixed swap rather than a security-based swap or swap? If

    so, please provide a detailed description of such circumstances and

    explain why.

    D. Security-Based Swaps Based on a Single Security or Loan and Single-

    Name Credit Default Swaps

    The second prong of the security-based swap definition includes a

    swap that is based on ``a single security or loan, including any

    interest therein or on the value thereof.'' \178\ The Commissions

    believe that, under this prong of the definition of security-based

    swap, a single-name CDS that is based on a single reference obligation

    would be a security-based swap because it would be based on a single

    security or loan (or any interest therein or on the value thereof).

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

    \178\ Section 3(a)(68)(A)(ii)(II) of the Exchange Act, 15 U.S.C.

    78c(a)(68)(A)(ii)(II). The first prong of the security-based swap

    definition is discussed below.

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

    In addition, the third prong of the security-based swap definition

    includes a swap that is based on the occurrence of an event relating to

    a ``single issuer of a security,'' provided that such event ``directly

    affects the financial statements, financial condition, or financial

    obligations of the issuer.'' \179\ This provision applies generally to

    event-triggered swap contracts. With respect to a CDS, such events

    could include the bankruptcy of an issuer, a default on one of an

    issuer's debt securities, or the default on a non-security loan of an

    issuer.\180\ Therefore, the Commissions believe that if the payout on a

    CDS on a single issuer of a security is triggered by the occurrence of

    an event relating to that issuer, the CDS would be a security-based

    swap under the third prong.\181\

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    \179\ Section 3(a)(68)(A)(ii)(III) of the Exchange Act, 15

    U.S.C. 78c(a)(68)(A)(ii)(III).

    \180\ The Commissions understand that in the context of credit

    derivatives on asset-backed securities or MBS, the events include

    principal writedowns, failure to pay principal and interest

    shortfalls.

    \181\ The Commissions understand that some single-name CDS now

    trade with fixed coupon payments expressed as a percentage of the

    notional amount of the transaction and payable on a periodic basis

    during the term of the transaction. See Markit, ``The CDS Big Bang:

    Understanding the Changes to the Global CDS Contract and North

    American Conventions,'' 3, available at http://www.markit.com/cds/announcements/resource/cds_big_bang.pdf. The Commissions believe

    the existence of such single-name CDS does not change their

    interpretation.

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

    In this regard, the Commissions note that each transaction under an

    ISDA Master Agreement would need to be analyzed to determine whether it

    is a swap or security-based swap. For example, the Commissions believe

    that a number of single-name CDS that are executed at the same time and

    that are documented under one ISDA Master Agreement, but in which a

    separate confirmation is sent for each CDS, should be treated as an

    aggregation of security-based swaps. As a practical and economic

    matter, the Commissions believe that each such CDS would be a separate

    and independent transaction. Thus, such an aggregation of single-name

    CDS would not constitute a ``group or index'' under the security-based

    swap definition but instead would constitute multiple single-name CDS.

    E. Title VII Instruments Based on Futures Contracts

    A Title VII instrument that is based on a futures contract will

    either be a swap or a security-based swap, or both (i.e., a mixed

    swap), depending on the nature of the futures contract, including the

    underlying reference of the futures contract. The Commissions believe

    that a Title VII instrument where the underlying reference is a

    security future would be a security-based swap.\182\ The Commissions

    believe that, except with respect to certain futures on foreign

    government debt securities discussed below, a Title VII instrument

    where the underlying reference is a futures contract that is not a

    security future would be a swap.\183\

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    \182\ A security future is specifically defined in both the CEA

    and the Exchange Act as a futures contract on a single security or a

    narrow-based security index, including any interest therein or based

    on the value thereof, except an exempted security under section

    3(a)(12) of the Exchange Act, 15 U.S.C. 78c(a)(12), as in effect on

    the date of enactment of the Futures Trading Act of 1982 (other than

    any municipal security as defined in section 3(a)(29) of the

    Exchange Act, 15 U.S.C. 78c(a)(29), as in effect on the date of

    enactment of the Futures Trading Act of 1982).

    The term security future does not include any agreement,

    contract, or transaction excluded from the CEA under CEA sections

    2(c), 2(d), 2(f), or 2(g), 7 U.S.C. 2(c), 2(d), 2(f), or 2(g), (as

    in effect on the date of enactment of the Commodity Futures

    Modernization Act of 2000 (``CFMA'') or Title IV of the CFMA). See

    CEA section 1a(44), 7 U.S.C. 1a(44); section 3(a)(55) of the

    Exchange Act, 15 U.S.C. 78c(a)(55).

    \183\ Depending on the underlying reference of the futures

    contract, though, such swaps could be security-based swap

    agreements. For example, a swap on a future on the S&P 500 index

    would be a security-based swap agreement.

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

    Title VII instruments involving futures contracts on foreign

    government debt securities present a unique circumstance. Rule 3a12-8

    under the Exchange Act exempts certain foreign government debt

    securities, for purposes only of the offer, sale, or confirmation of

    sale of futures contracts on such foreign government debt securities,

    from all provisions of the Exchange Act which by their terms do not

    apply to an ``exempted security,'' subject to certain conditions.\184\

    To date, the SEC has

    [[Page 29844]]

    enumerated within rule 3a12-8 debt securities of 21 identified foreign

    governments solely for purposes of futures trading.\185\

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

    \184\ Specifically, rule 3a12-8 under the Exchange Act requires

    as a condition to the exemption that the foreign government debt

    securities not be registered under the Securities Act (or the

    subject of any American depositary receipt registered under the

    Securities Act) and that futures contracts on such foreign

    government debt securities ``require delivery outside the United

    States, [and] any of its possessions or territories, and are traded

    on or through a board of trade, as defined in [CEA section 2, 7

    U.S.C. 2].'' See rules 3a12-8(b), 3a12-8(a)(2) under the Exchange

    Act, 17 CFR 240.3a12-8(b) and 240.3a12-8(a)(2).These conditions were

    ``designed to minimize the impact of the exemption on securities

    distribution and trading in the United States . . . .'' See

    Exemption for Certain Foreign Government Securities for Purposes of

    Futures Trading, 49 FR 8595, 8596-97, Mar. 8, 1984 (citing Futures

    Trading Act of 1982).

    \185\ See rule 3a12-8(a)(1) under the Exchange Act (designating

    the debt securities of the governments of the United Kingdom,

    Canada, Japan, Australia, France, New Zealand, Austria, Denmark,

    Finland, the Netherlands, Switzerland, Germany, Ireland, Italy,

    Spain, Mexico, Brazil, Argentina, Venezuela, Belgium, and Sweden).

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

    The Commissions are evaluating the appropriate characterization of

    Title VII instruments based on futures on such foreign government debt

    securities that are traded in reliance on rule 3a12-8. The Commissions

    recognize that as a result of the rule 3a12-8 exemption, futures on

    foreign government debt securities of 21 foreign countries trade

    pursuant to the CFTC's exclusive jurisdiction and without the futures

    being considered security futures. Because futures contracts on the 21

    foreign government debt securities designated in rule 3a12-8 are not

    security futures, applying the above interpretive guidance to a Title

    VII instrument on a futures contract on these foreign government debt

    securities would mean that such Title VII instrument would be a

    swap.\186\ The Commissions note, however, that the conditions in the

    rule 3a12-8 exemption were established specifically for trading futures

    contracts on these foreign sovereign debt obligations, not Title VII

    instruments based on futures contracts on foreign government debt

    securities. Furthermore, the Commissions note that the Dodd-Frank Act

    did not exclude debt securities of foreign governments from the

    definition of security-based swap. Therefore, a Title VII instrument

    based on such debt securities would be a security-based swap. Relying

    on rule 3a12-8 for the treatment of Title VII instruments on such

    futures would therefore result in different treatments depending on

    whether the Title VII instrument is based on a foreign government debt

    security or on a future that is in turn based on a foreign government

    debt security.\187\ On the other hand, to do otherwise would create

    different regulators for a future and Title VII instruments based on

    that future.

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

    \186\ The Commissions note, by contrast, that a Title VII

    instrument that is based on the price or value of, or settlement

    into, a futures contract on one of the 21 foreign government debt

    securities designated in rule 3a12-8 and that is also based on the

    price or value of, or had the potential to settle directly into, the

    foreign debt security, would be a security-based swap and, depending

    on other features of the Title VII instrument, possibly a mixed

    swap.

    \187\ This is the case today (i.e., different treatments) with

    respect to, for example, options on broad-based security indexes and

    options on futures on broad-based security indexes.

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

    The SEC believes that the characterization of a Title VII

    instrument involving a foreign government debt security may affect

    Federal securities law provisions relating to the distribution of the

    underlying foreign debt security. Specifically, the Dodd-Frank Act

    included provisions that would not permit issuers, affiliates of

    issuers, or underwriters to use security-based swaps to offer or sell

    the issuers' securities underlying a security-based swap without

    complying with the requirements of the Securities Act.\188\ In

    addition, the Dodd-Frank Act provided that any offer and sale of

    security-based swaps to non-ECPs would have to be registered under the

    Securities Act.\189\ Thus, for example, if a Title VII instrument on a

    future on foreign government debt security is characterized as a swap,

    and not a security-based swap, then the provisions of the Dodd-Frank

    Act enacted to ensure that there could not be offers and sales of

    securities made without compliance with the Securities Act, either by

    issuers, their affiliates, or underwriters or to non-ECPs, would not

    apply to such swap transactions.

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

    \188\ See section 2(a)(3) of the Securities Act as amended by

    the Dodd-Frank Act, 15 U.S.C. 77b(a)(3). This provision applies

    regardless of whether the Title VII instrument allows the parties to

    physically settle any such security-based swap.

    \189\ See section 5 of the Securities Act as amended by the

    Dodd-Frank Act. 15 U.S.C. 77e.

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

    On the other hand, the CFTC believes that characterizing Title VII

    instruments based on a future on a foreign government debt security

    designated in rule 3a12-8 as security-based swaps could undermine the

    regulatory scheme that Congress established in the CEA. As noted above,

    the Commissions generally would treat Title VII instruments based on

    futures that are not security futures as swaps. Many of the futures on

    the 21 foreign government debt securities designated in rule 3a12-8

    trade with substantial volume. Section 753 of the Dodd-Frank Act

    provided the CFTC with additional antifraud and anti-manipulation

    authorities patterned on those provided to the SEC in the Federal

    securities laws. The CFTC believes that treating Title VII instruments

    based on these futures as security-based swaps, while the underlying

    futures come under the CEA, may undermine those authorities.

    In sum, depending on how a Title VII instrument on such a future on

    a foreign government debt security is characterized, there is potential

    for such an instrument: (i) to be used to avoid the application of the

    Federal securities laws, including the Dodd-Frank Act provisions, that

    otherwise would apply if the Title VII instrument was instead based on

    the foreign government debt security directly; or (ii) to be used to

    avoid the application of the CEA, including the Dodd-Frank Act

    provisions, that otherwise would apply if the Title VII instrument was

    instead based on any other futures contract that is not a security

    future. Accordingly, the Commissions also are evaluating whether a

    Title VII instrument on such a futures contract on a foreign government

    debt security should be characterized as a mixed swap.

    Request for Comment

    80. The Commissions request comment generally on the foregoing

    discussion regarding Title VII instruments based on futures contracts

    and security futures.

    81. What types of such products are traded in the market today? How

    often, and where are such products traded?

    82. The Commissions are requesting comment on how to characterize a

    Title VII instrument where the underlying reference is a futures

    contract on one of the 21 foreign government debt securities that have

    been designated as ``exempted securities'' under rule 3a12-8 only for

    the offer, sale, or confirmation of sale of futures contracts on such

    securities and only where the conditions of such exemption are

    satisfied. When should a Title VII instrument on a futures contract on

    a foreign government debt security being traded in reliance on the

    exemption under rule 3a12-8 be treated as a swap, a security-based swap

    or a mixed swap? Is there any economic reason why the treatment of a

    Title VII instrument on a future on a foreign government debt security

    should be different than the treatment of a Title VII instrument on the

    foreign government debt security directly? Is there any economic reason

    why the treatment of a Title VII instrument on a future on a designated

    foreign government debt security should be different than the treatment

    of a Title VII instrument on any other futures contract that is not a

    security future? If the answer to either of the two preceding questions

    is yes, please explain and provide empirical analysis. If the Title VII

    instrument is able to be entered into by the issuer, affiliate of the

    issuer, or an underwriter, or if the Title VII instrument is being

    offered and sold to non-ECPs, should the Title VII instrument be viewed

    as a security-based swap or a mixed swap so that market participants

    cannot chose

    [[Page 29845]]

    whether to comply with the registration requirements of the Securities

    Act with respect to the foreign government debt securities? Should such

    an instrument be viewed as a swap or a mixed swap so that market

    participants cannot choose whether to comply with the requirements of

    the Dodd-Frank Act concerning clearing, trade execution, reporting, and

    standards applicable to dealers and major participants that apply to

    Title VII instruments on futures contracts that are not security

    futures? Are there other suggested approaches to the treatment of Title

    VII instruments on futures on foreign government debt securities that

    would preserve the application of the Securities Act as contemplated by

    the Dodd-Frank Act to Title VII instruments involving foreign

    government debt securities? Are there other suggested approaches to the

    treatment of Title VII instruments on futures on foreign government

    debt securities that would preserve the application of the CEA as

    contemplated by the Dodd-Frank Act to Title VII instruments involving

    futures contracts that are not security futures? If the answer to

    either of the two preceding questions is yes, please provide detail and

    analysis.

    F. Use of Certain Terms and Conditions in Title VII Instruments

    The Commissions are aware that market participants' setting of

    certain fixed terms or conditions of Title VII instruments may be

    informed by the value or level of a security, rate, or other commodity

    at the time of the execution of the instrument. The Commissions believe

    that, in evaluating whether such a Title VII instrument is a swap or

    security-based swap, the nature of the security, rate, or other

    commodity that informed the setting of such fixed term or condition

    should not itself impact the determination of whether the Title VII

    instrument is a swap or a security-based swap, provided that the fixed

    term or condition is set at the time of execution of the Title VII

    instrument and the value or level of that fixed term or condition may

    not vary over the life of the Title VII instrument.

    For example, a Title VII instrument, such as an interest rate swap,

    in which floating payments based on 3-month LIBOR are exchanged for

    fixed rate payments of 5% would be a swap, and not a security-based

    swap, even if the 5% fixed rate was informed by, or quoted based on,

    the yield of a security, provided that the 5% fixed rate was set at the

    time of execution and may not vary over the life of the Title VII

    instrument.\190\ Another example would be where a private sector or

    government borrower that issues a 5-year, amortizing $100 million debt

    security with a semi-annual coupon of LIBOR plus 250 basis points also,

    at the same time, chooses to enter into a 5-year interest rate swap on

    $100 million notional in which this same borrower, using the same

    amortization schedule as the debt security, receives semi-annual

    payments of LIBOR plus 250 basis points in exchange for 5% fixed rate

    payments. The fact that the specific terms of the interest rate swap

    (e.g., 5-year, LIBOR plus 250 basis point, $100 million notional, fixed

    amortization schedule) were set at the time of execution to match

    related terms of a debt security does not cause the interest rate swap

    to become a security-based swap. However, if the interest rate swap

    contained additional terms that were in fact contingent on a

    characteristic of the debt security that may change in the future, such

    as an adjustment to future interest rate swap payments based on the

    future price or yield of the debt security, then this Title VII

    instrument would be a security-based swap that would be a mixed swap.

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

    \190\ However, to the extent the fixed term or condition is set

    at a future date or at a future value or level of a security, rate,

    or other commodity rather than the value or level of such security,

    rate, or other commodity at the time of execution of the Title VII

    instrument, the discussion above would not apply, and the nature of

    the security, rate, or other commodity used in determining the terms

    or conditions would be considered in evaluating whether the Title

    VII instrument is a swap or security-based swap.

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

    Request for Comment

    83. Is the guidance provided by the Commissions regarding the

    relevance of the nature of a security, rate, or other commodity that

    informs the determination of a fixed term or condition of a Title VII

    instrument appropriate? Why or why not? If not, what guidance would be

    appropriate?

    84. The Commissions are aware that quoting conventions are used in

    the context of setting the fixed terms of certain Title VII

    instruments, such as interest rate swaps that exchange LIBOR for a

    fixed rate that is set at the time of execution by reference to U.S.

    Treasury securities.\191\ Are there other Title VII instruments that

    use such quoting conventions? If so, please provide a detailed

    explanation of such Title VII instruments and the references they use.

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

    \191\ The Commissions note that such Title VII instruments would

    be swaps in any event because U.S. Treasury securities are exempted

    securities that are excluded from the security-based swap definition

    in Title VII but understand that such swaps use the reference or

    quoting convention described above in setting the terms or

    conditions of the Title VII instrument at the time of execution.

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

    G. The Term ``Narrow-Based Security Index'' in the Security-Based Swap

    Definition

    1. Introduction\192\

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

    \192\ Four commenters referred to the definition of the term

    ``narrow-based security index,'' each in the context of CDS. See

    infra notes 209 and 211.

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

    As noted above, a Title VII instrument in which the underlying

    reference of the instrument is a ``narrow-based security index'' is

    considered a security-based swap subject to regulation by the SEC,

    whereas a Title VII instrument in which the underlying reference of the

    instrument is a security index that is not a narrow-based security

    index (i.e., the index is broad-based), the instrument is considered a

    swap subject to regulation by the CFTC. In this section, the

    Commissions propose rules and guidance regarding several issues

    regarding the term ``narrow-based security index'' in the security-

    based swap definition, including: (i) The existing criteria for

    determining whether a security index is a narrow-based security index

    and the applicability of past guidance of the Commissions regarding

    those criteria to Title VII instruments; (ii) new criteria for

    determining whether a CDS where the underlying reference is a group or

    index of entities or obligations of entities (typically referred to as

    an ``index CDS'') is based on an index that is a narrow-based security

    index; (iii) the meaning of the term ``index''; (iv) a rule governing

    the tolerance period for Title VII instruments on security indexes

    traded on DCMs, SEFs, foreign boards of trade (``FBOTs''), security-

    based SEFs, or NSEs, where the security index temporarily moves from

    broad-based to narrow-based or from narrow-based to broad-based; and

    (v) a rule governing the grace period for Title VII instruments on

    security indexes traded on DCMs, SEFs, FBOTs, security-based SEFs, or

    NSEs, where the security index moves from broad-based to narrow-based

    or from narrow-based to broad-based and the move is not temporary.

    2. Applicability of the Statutory Narrow-Based Security Index

    Definition and Past Guidance of the Commissions to Title VII

    Instruments

    As defined in the CEA and Exchange Act,\193\ an index is a

    ``narrow-based

    [[Page 29846]]

    security index'' if, among other things, it meets any one of the

    following four criteria:

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

    \193\ Sections 3(a)(55)(B) and (C) of the Exchange Act, 15

    U.S.C. 78c(a)(55)(B) and (C), include a definition of ``narrow-based

    security index'' in the same paragraph as the definition of security

    future. See also CEA sections 1a(35)(A) and (B), 7 U.S.C. 1a(35)(A)

    and (B). A security future is a contract for future delivery on a

    single security or narrow-based security index (including any

    interest therein or based on the value thereof). See section

    3(a)(55) of the Exchange Act, 15 U.S.C. 78c(a)(55), and CEA section

    1a(44), 7 U.S.C. 1a(44).

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

    It has nine or fewer component securities;

    A component security comprises more than 30% of the

    index's weighting;

    The five highest weighted component securities in the

    aggregate comprise more than 60% of the index's weighting; or

    The lowest weighted component securities comprising, in

    aggregate, 25% of the index's weighting have an aggregate dollar value

    of average daily trading volume of less than $50,000,000 (or in the

    case of an index with more than 15 component securities, $30,000,000),

    except that if there are two or more securities with equal weighting

    that could be included in the calculation of the lowest weighted

    component securities comprising, in the aggregate, 25 percent of the

    index's weighting, such securities shall be ranked from lowest to

    highest dollar value of average daily trading volume and shall be

    included in the calculation based on their ranking starting with the

    lowest ranked security.\194\

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    \194\ See section 3(a)(55)(B) of the Exchange Act, 15 U.S.C.

    78c(a)(55)(B). See also CEA sections 1a(35)(A) and (B), 7 U.S.C.

    1a(35)(A) and (B).

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

    The first three criteria apply to the number and concentration of

    the ``component securities'' in the index; the fourth criterion applies

    to the average daily trading volume of an index's ``component

    securities.'' \195\

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

    \195\ The narrow-based security index definition in the CEA and

    Exchange Act also excludes from its scope security indexes that

    satisfy certain specified criteria. See sections 3(a)(55)(C)(i)--

    (vi) of the Exchange Act, 15 U.S.C. 78c(a)(55)(C)(i)--(vi), and CEA

    sections 1a(35)(B)(i)--(vi), 7 U.S.C. 1a(35)(B)(i)--(vi).

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

    This statutory narrow-based security index definition focuses on

    indexes composed of equity securities and certain aspects of the

    definition, in particular the evaluation of average daily trading

    volume, are designed to take into account the trading patterns of

    individual stocks.\196\ However, the Commissions, pursuant to authority

    granted in the CEA and the Exchange Act, previously have extended the

    definition to other categories of indexes but modified the definition

    to take into account the characteristics of those other

    categories.\197\ Specifically, the Commissions have provided guidance

    regarding the application of the narrow-based security index definition

    to futures contracts on volatility indexes \198\ and debt security

    indexes.\199\ Today, then, there exists additional guidance for

    determining what constitutes a narrow-based security index.

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

    \196\ See Joint Order Excluding Indexes Comprised of Certain

    Index Options From the Definition of Narrow-Based Security Index, 69

    FR 16900, Mar. 31, 2004 (``March 2004 Joint Order'').

    \197\ See CEA section 1a(35)(B)(vi), 7 U.S.C. 1a(35)(B)(vi), and

    section 3(a)(55)(C)(vi) of the Exchange Act, 15 U.S.C.

    78c(a)(55)(C)(vi).

    \198\ See March 2004 Joint Order, supra note 196.

    \199\ See Joint Final Rules: Application of the Definition of

    Narrow-Based Security Index to Debt Securities Indexes and Security

    Futures on Debt Securities, 71 FR 39434, July 13, 2006 (``July 2006

    Rules'').

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

    Volatility indexes are indexes composed of index options. The

    Commissions issued a joint order in 2004 to define when a volatility

    index is not a narrow-based security index. Under this joint order, a

    volatility index is not a narrow-based security index if the index

    meets all of the following criteria:

    The index measures the magnitude of changes (as calculated

    in accordance with the order) in the level of an underlying index that

    is not a narrow-based security index pursuant to the statutory criteria

    for equity indexes discussed above;

    The index has more than nine component securities, all of

    which are options on the underlying index;

    No component security of the index comprises more than 30

    percent of the index's weighting;

    The five highest weighted component securities of the

    index in the aggregate do not comprise more than 60 percent of the

    index's weighting;

    The average daily trading volume of the lowest weighted

    component securities in the underlying index (those comprising, in the

    aggregate, 25 percent of the underlying index's weighting) have a

    dollar value of more than $50,000,000 (or $30,000,000 in the case of an

    underlying index with 15 or more component securities), except if there

    are 2 or more securities with equal weighting that could be included in

    the calculation of the lowest weighted component securities comprising,

    in the aggregate, 25 percent of the underlying index's weighting, such

    securities shall be ranked from lowest to highest dollar value of

    average daily trading volume and shall be included in the calculation

    based on their ranking starting with the lowest ranked security;

    Options on the underlying index are listed and traded on

    an NSE registered under section 6(a) of the Exchange Act; \200\ and

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

    \200\ 15 U.S.C. 78f(a).

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

    The aggregate average daily trading volume in options on

    the underlying index is at least 10,000 contracts calculated as of the

    preceding 6 full calendar months.\201\

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

    \201\ See March 2004 Joint Order, supra note 196. In 2009, the

    Commissions issued a joint order that provided that, instead of the

    index options having to be listed on an NSE, the index options must

    be listed on an exchange and pricing information for the index

    options, and the underlying index, must be computed and disseminated

    in real time through major market data vendors. See Joint Order To

    Exclude Indexes Composed of Certain Index Options From the

    Definition of Narrow-Based Security Index, 74 FR 61116, Nov. 23,

    2009 (expanding the criteria necessary for exclusion under the March

    2004 Joint Order to apply to volatility indexes for which pricing

    information for the underlying broad-based security index, and the

    options that compose such index, is current, accurate, and publicly

    available).

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

    With regard to debt security indexes, the Commissions issued joint

    rules in 2006 (``July 2006 Rules'') to define when an index of debt

    securities \202\ is not a narrow-based security index. The first three

    criteria of that definition were similar to the statutory definition

    for equities and the order regarding volatility indexes in that a debt

    security index would not be narrow based if: (i) It had more than 9

    debt securities issued by more than 9 non-affiliated issuers; (ii) the

    securities of any issuer included in the index did not comprise more

    than 30 percent of the index's weighting; and (iii) the securities of

    any five non-affiliated issuers in the index did not comprise more than

    60 percent of the index's weighting.

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

    \202\ Under the rules, debt securities include notes, bonds,

    debentures or evidence of indebtedness. See CFTC rule

    41.15(a)(1)(i), 17 CFR 41.15(a)(1)(i) and rule 3a55-4(a)(1)(i) under

    the Exchange Act, 17 CFR 240.3a55-4(a)(1)(i).

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

    In the July 2006 Rules, instead of the statutory average daily

    trading volume test, however, the Commissions adopted a public

    information availability requirement. Under this requirement, assuming

    the aforementioned number and concentration limits were satisfied, a

    debt security index would not be a narrow-based security index if the

    debt securities or the issuers of debt securities in the index met any

    one of the following criteria:

    The issuer of the debt security is required to file

    reports pursuant to section 13 or section 15(d) of the Securities

    Exchange Act of 1934; \203\

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    \203\ 15 U.S.C. 78m or 78o(d).

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

    The issuer of the debt security has a worldwide market

    value of its outstanding common equity held by non-affiliates of $700

    million or more;

    The issuer of the debt security has outstanding securities

    that are notes, bonds, debentures, or evidence of indebtedness having a

    total remaining principal amount of at least $1 billion;

    [[Page 29847]]

    The security is an exempted security as defined in section

    3(a)(12) of the Securities Exchange Act of 1934 \204\ and the rules

    promulgated thereunder; or

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    \204\ 15 U.S.C. 78c(a)(12).

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

    The issuer of the security is a government of a foreign

    country or a political subdivision of a foreign country.\205\

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    \205\ The July 2006 Rules also provided that debt securities in

    the index must satisfy certain minimum outstanding principal balance

    criteria, established certain exceptions to these criteria and the

    public information availability requirement, and provided for the

    treatment of indexes that include exempted securities (other than

    municipal securities).

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

    The statutory definition of the term ``narrow-based security

    index'' for equities, and the Commissions' subsequent guidance as to

    what constitutes a narrow-based security index with respect to

    volatility and debt indexes, is applicable in the context of

    distinguishing between futures contracts and security futures products.

    In the Dodd-Frank Act, Congress included the term ``narrow-based

    security index'' in the security-based swap definition, and thus the

    statutory definition of the term ``narrow-based security index'' also

    applies in distinguishing swaps (on security indexes that are not

    narrow-based, also known as ``broad-based'') and security-based swaps

    (on narrow-based security indexes). Further, the Commissions believe

    that their prior guidance with respect to what constitutes a narrow-

    based security index in the context of volatility and debt security

    indexes should apply in determining whether a Title VII instrument is a

    swap or a security-based swap.

    To clarify that the Commissions are applying the prior guidance and

    rules to Title VII instruments, the Commissions are proposing rules to

    further define the term ``narrow-based security index'' in the

    security-based swap definition. Under paragraph (1) of proposed rule

    1.3(yyy) under the CEA and paragraph (a) of proposed rule 3a68-3 under

    the Exchange Act, for purposes of the security-based swap definition,

    the term ``narrow-based security index'' would have the same meaning as

    the statutory definition set forth in section 1a(35) of the CEA and

    section 3(a)(55) of the Exchange Act,\206\ and the rules, regulations,

    and orders issued by the Commissions relating to such definition. As a

    result, except as the new rules the Commissions are proposing provide

    for other treatment, market participants generally will be able to use

    the Commissions' past guidance in determining whether certain Title VII

    instruments based on a security index are swaps or security-based

    swaps.

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    \206\ 7 U.S.C. 1a(35) and 15 U.S.C. 78c(a)(55).

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

    However, the Commissions are proposing interpretive guidance and

    additional rules regarding Title VII instruments based on a security

    index. The additional rules and interpretive guidance set forth new

    narrow-based security index criteria with respect to indexes composed

    of securities, loans, or issuers of securities referenced by an index

    CDS. The proposed interpretive guidance and rules also address the

    definition of an ``index'' and the treatment of broad-based security

    indexes that become narrow-based and narrow-based indexes that become

    broad-based, including rule provisions regarding tolerance and grace

    periods for swaps on security indexes that are traded on CFTC-regulated

    trading platforms and security-based swaps on security indexes that are

    traded on SEC-regulated trading platforms. These rules and interpretive

    guidance are discussed in turn below.

    3. Narrow-Based Security Index Criteria for Index Credit Default Swaps

    (a) In General

    A CDS is a Title VII instrument in which the ``protection buyer''

    makes a series of payments to the ``protection seller'' and, in return,

    the ``protection seller'' is obligated to make a payment to the

    ``protection buyer'' if an obligation or obligations (typically bonds,

    but in some cases loans) of an entity or entities referenced in the

    contract, or the entity or entities themselves, experience a ``credit

    event.'' \207\ While the Commissions understand that the underlying

    reference for most cleared CDS is a single entity or an index of

    entities rather than a single security or an index of securities, the

    underlying reference for CDS also could be a single security or an

    index of securities.\208\ A CDS where the underlying reference is a

    single entity (i.e., a single-name CDS), a single obligation of a

    single entity (e.g., a CDS on a specific bond, loan, or asset-backed

    security, or any tranche or series of any bond, loan, or asset-backed

    security), or an index CDS where the underlying reference is a narrow-

    based security index or the issuers of securities in a narrow-based

    security index would be a security-based swap.\209\ An index CDS where

    the underlying reference is not a narrow-based security index or the

    issuers of securities in a narrow-based security index (i.e., a broad-

    based index) would be a swap.\210\

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    \207\ See supra note 180 and accompanying text.

    \208\ See, e.g., Markit, ``Markit CDX'' (describing the Markit

    CDX indexes and the number of ``names'' included in each index),

    available at http://www.markit.com/en/products/data/indices/credit-and-loan-indices/cdx/cdx.page?; Markit, ``Markit iTraxx Indices,''

    (stating that the ``Markit iTraxx indices are comprised of the most

    liquid names in the European and Asian markets'') (emphasis added),

    available at http://www.markit.com/en/products/data/indices/credit-and-loan-indices/itraxx/itraxx.page?]. Examples of indexes based on

    securities include the Markit ABX.HE and CMBX indexes. See Markit,

    ``Markit ABX.HE,'' (describing the Markit ABX.HE index as ``a

    synthetic tradeable index referencing a basket of 20 subprime

    mortgage-backed securities''), available at http://www.markit.com/en/products/data/indices/structured-finance-indices/abx/abx.page;

    Markit, ``Markit CMBX,'' (describing the Markit CMBX index as ``a

    synthetic tradeable index referencing a basket of 25 commercial

    mortgage-backed securities''), available at http://www.markit.com/en/products/data/indices/structured-finance-indices/cmbx/cmbx.page.

    \209\ Two commenters made suggestions relating to the effect of

    the jurisdictional consequences of the definition of the term

    ``narrow-based security index,'' but neither commented on the

    meaning of the term itself. One of the two commenters, recognizing

    that a jurisdictional line would exist for CDS, stressed the need

    for ``substantially identical'' regulations applicable to CDS. See

    Deutsche Bank Letter. The other commenter also noted that a line for

    CDS would exist and urged the Commissions to adopt a regulation

    stating that a derivatives clearing organization (``DCO'') may be a

    clearing agency and a clearing agency may be a DCO, in order to

    facilitate portfolio margining and cross-margining. See White & Case

    Letter. The Commissions are sensitive to the requirement in section

    712(a)(7) of the Dodd-Frank Act to treat functionally or

    economically similar products or entities in a similar manner.

    \210\ Similarly, an option to enter into a single-name CDS or a

    CDS referencing a narrow-based security index as described above

    would be a security-based swap, while an option to enter into a CDS

    on a broad-based security index or the issuers of securities in a

    broad-based security index would be a swap. Index CDS where the

    underlying reference is a broad-based security index would be SBSAs.

    The SEC has enforcement authority with respect to swaps that are

    SBSAs, as discussed further in part V below.

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

    The statutory definition of the term ``narrow-based security

    index,'' as explained above, was designed with the U.S. equity markets

    in mind. Thus, the statutory definition is not appropriate for

    determining whether an index underlying an index CDS is broad or

    narrow-based. Nor is the further guidance that the Commissions have

    previously issued with respect to the narrow-based security index

    definition discussed above necessarily appropriate, because that

    guidance was designed to address and was uniquely tailored to the

    characteristics of volatility indexes and debt security indexes in the

    context of futures. Accordingly, the Commissions are proposing rules

    that would adopt criteria for determining whether an index is a narrow-

    based security index within the context of index CDS.\211\

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

    \211\ Two commenters urged clarification of the definition of

    the term ``narrow-based security index'' in the context of CDS to

    ensure that it reflects ``the letter and the spirit'' of the

    existing definition. See Letter from Thomas W. Jasper, Chief

    Executive Officer, Primus Guaranty Ltd., and Gene Park, Chief

    Executive Officer, Quadrant Structured Investment Advisers, LLC,

    Sept. 20, 2010 (``Primus and Quadrant Letter'').

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    [[Page 29848]]

    The Commissions are further defining the term ``security-based

    swap,'' and the use of the term ``narrow-based security index'' within

    that definition to modify the criteria applied in the context of index

    CDS in assessing whether the index is a narrow-based security index.

    The third prong of the security-based swap definition includes a Title

    VII instrument based on the occurrence of an event relating to the

    ``issuers of securities in a narrow-based security index,'' provided

    that such event directly affects the ``financial statements, financial

    condition, or financial obligations of the issuer.'' \212\ The first

    prong of the security-based swap definition includes a Title VII

    instrument that is based on a ``narrow-based security-index.'' \213\

    Because the third prong of the security-based swap definition relates

    to issuers of securities, while the first prong of such definition

    relates to securities, the Commissions are proposing to further define

    both the term ``narrow-based security index'' and the term ``issuers of

    securities in a narrow-based security index'' in the context of the

    definition of security-based swap as applied to index CDS. The

    Commissions believe it is important to further define both terms in

    order to ensure consistent analysis of index CDS.\214\ While the

    wording of the two proposed definitions differs slightly, the

    Commissions expect that they would yield the same substantive results

    in distinguishing narrow-based and broad-based index CDS.

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    \212\ Section 3(a)(68)(A)(ii)(III) of the Exchange Act, 15

    U.S.C. 78c(a)(68)(A)(ii)(III).

    \213\ Section 3(a)(68)(A)(ii)(I) of the Exchange Act, 15 U.S.C.

    78c(a)(68)(A)(ii)(I).

    \214\ Because it applies only with respect to index CDS, the

    proposed definitions of ``issuers of securities in a narrow-based

    security index'' and ``narrow-based security index'' would not apply

    with respect to other types of event contracts, whether analyzed

    under the first or third prong.

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

    (b) Proposed Rules Regarding the Definitions of ``Issuers of Securities

    in a Narrow-Based Security Index'' and ``Narrow-Based Security Index''

    for Index Credit Default Swaps

    The Commissions are considering how to further define the terms

    ``issuers of securities in a narrow-based security index'' and

    ``narrow-based security index'' in order to provide for appropriate

    criteria for determining whether an index composed of issuers of

    securities referenced by an index CDS and an index composed of

    securities referenced by an index CDS are narrow-based security

    indexes. In formulating these criteria, and consistent with the

    guidance and rules the Commissions have previously issued and adopted

    regarding narrow-based security indexes in the context of security

    futures, the Commissions believe that there should be public

    information available about a predominant percentage of the reference

    entities underlying the index, or, in the case of an index CDS, on an

    index of securities, about the issuers of the securities or the

    securities underlying the index, in order to reduce the likelihood that

    non-narrow-based indexes referenced in index CDS or the component

    securities or issuers of securities in that index would be readily

    susceptible to manipulation, as well as to help prevent the misuse of

    material non-public information through the use of CDS based on such

    indexes.

    To satisfy these objectives, the Commissions intend to use the

    criteria developed for debt indexes discussed above \215\ but tailor

    the criteria specifically to address index CDS.\216\ These criteria

    would be used solely for the purpose of defining the terms ``narrow-

    based security index'' and ``issuers of securities in a narrow-based

    security index'' in the first and third prongs of the security-based

    swap definition with respect to index CDS and would not be interpreted

    to affect any other interpretation or use of the term ``narrow-based

    security index'' or any other provision of the Dodd-Frank Act, CEA, or

    Exchange Act.

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    \215\ See discussion of July 2006 Rules, supra note 199.

    \216\ The Commissions note that the language of the proposed

    rules is intended, in general, to track the criteria developed for

    debt indexes discussed above. Certain changes from the criteria

    developed for debt indexes are necessary to address differences

    between futures on debt indexes and index CDS. Certain other changes

    are necessary because the rules for debt indexes define under what

    conditions an index is not a narrow-based security index, whereas

    the proposed rules define what is a narrow-based security index. For

    example, an index is not a narrow-based security index under the

    rule for debt indexes if it is not a narrow-based security index

    under either subparagraph (a)(1) or paragraph (a)(2) of the rule.

    Under the proposed rules for index CDS, however, an index is a

    narrow-based security index if it meets the requirements of both of

    the counterpart paragraphs in the proposed rules regarding index CDS

    (paragraphs (1)(i) and (1)(ii) of proposed rules 1.3(xxx) and

    1.3(aaaa) under the CEA and paragraphs (a)(1) and paragraph (a)(2)

    of proposed rules 3a68-1a and 3a68-1b under the Exchange Act), even

    though the criteria in the debt index rules and the proposed rules

    for index CDS include generally the same criteria and structure.

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

    (i) Number and Concentration Percentages of Reference Entities or

    Securities

    The Commissions believe that the first three criteria of the debt

    security index test discussed above (i.e., the number and concentration

    weighting requirements) are appropriate to apply to index CDS, whether

    CDS on indexes of securities or indexes of issuers of securities.

    Accordingly, proposed rules 1.3(zzz) under the CEA and proposed

    rule 3a68-1a under the Exchange Act would provide that, for purposes of

    determining whether an index CDS is a security-based swap under section

    3(a)(68)(A)(ii)(III) of the Exchange Act,\217\ the term ``issuers of

    securities in a narrow-based security index'' would include issuers of

    securities identified in an index in which:

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    \217\ 15 U.S.C. 78c(a)(68)(A)(ii)(III).

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

    Number: There are 9 or fewer non-affiliated issuers of

    securities that are reference entities \218\ in the index, provided

    that an issuer of securities shall not be deemed a reference entity in

    the index unless (i) a credit event with respect to such reference

    entity would result in a payment by the credit protection seller to the

    credit protection buyer under the CDS based on the related notional

    amount allocated to such reference entity, or (ii) the fact of such

    credit event or the calculation in accordance with clause (i) above of

    the amount owed with respect to such credit event is taken into account

    in determining whether to make any future payments under the CDS with

    respect to any future credit events;

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    \218\ For purposes of proposed rules 1.3(zzz) and 3a68-1a: (i) A

    reference entity would be affiliated with another entity if it

    controls, is controlled by, or is under common control with, that

    entity; (ii) control would mean ownership of 20 percent or more of

    an entity's equity, or the ability to direct the voting of 20

    percent or more of the entity's voting equity; and (iii) the term

    ``reference entity'' would include an issuer of securities, an

    issuing entity of asset-backed securities, and a single reference

    entity or group of affiliated entities; provided that an issuing

    entity of an asset-backed security shall not be affiliated with any

    other issuing entity or issuer under this proposed definition.

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    Single Component Concentration: The effective notional

    amount allocated to any reference entity included in the index

    comprises more than 30 percent of the index's weighting; or

    Largest Five Component Concentration: The effective

    notional amount allocated to any 5 non-affiliated reference entities

    included in the index comprises more than 60 percent of the index's

    weighting.\219\

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    \219\ These proposed rules refer to the ``effective notional

    amount'' allocated to reference entities or securities in order to

    address potential situations in which the means of calculating

    payout across the reference entities or securities is not uniform.

    Thus, if one or more payouts is leveraged or enhanced by the

    structure of the transaction (i.e., 2x recovery rate), that amount

    would be the ``effective notional amount'' for purposes of the 30%

    and 60% tests in paragraphs (1)(i)(B) and (1)(i)(C) of proposed

    rules 1.3(zzz) and 1.3(aaaa) and paragraphs (a)(1)(ii) and

    (a)(1)(iii) of proposed rules 3a68-1a and 3a68-1b. Similarly, if the

    aggregate notional amount under a CDS is not uniformly allocated to

    each reference entity or security, then the portion of the notional

    amount allocated to each reference entity or security (which may be

    by reference to the product of the aggregate notional amount and an

    applicable percentage) would be the ``effective notional amount.''

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    [[Page 29849]]

    Similarly, proposed rules 1.3(aaaa) under the CEA and proposed rule

    3a68-1b under the Exchange Act would provide that, for purposes of

    determining whether an index CDS is a security-based swap under section

    3(a)(68)(A)(ii)(I) of the Exchange Act,\220\ the term ``narrow-based

    security index'' would include an index in which essentially the same

    criteria apply, substituting securities for issuers. Under these

    proposed criteria, the term ``narrow-based security index'' would mean

    an index in which:

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

    \220\ 15 U.S.C. 78c(a)(68)(A)(ii)(I).

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

    Number: There are 9 or fewer securities, or securities

    that are issued by 9 or fewer non-affiliated issuers,\221\ in the

    index, provided that a security shall not be deemed a component of the

    index unless (i) a credit event with respect to the issuer of such

    security or a credit event with respect to such security would result

    in a payment by the credit protection seller to the credit protection

    buyer under the CDS based on the related notional amount allocated to

    such security, or (ii) the fact of such credit event or the calculation

    in accordance with clause (i) above of the amount owed with respect to

    such credit event is taken into account in determining whether to make

    any future payments under the CDS with respect to any future credit

    events;

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

    \221\ This language is intended to be consistent with the

    language in the rule for debt indexes but the specific language is

    different to deal with the differences in structure between the rule

    for debt indexes and proposed rules 1.3(aaaa) and 3a68-1b. See

    discussion supra note 216.

    For purposes of proposed rules 1.3(aaaa) and 3a68-1b: (i) An

    issuer would be affiliated with another issuer if it controls, is

    controlled by, or is under common control with, that issuer; (ii)

    control would mean ownership of 20 percent or more of an issuer's

    equity, or the ability to direct the voting of 20 percent or more of

    the issuer's voting equity; and (iii) the term ``issuer'' would

    include an issuer of securities, an issuing entity of asset-backed

    securities, and a single issuer or group of affiliated issuers;

    provided that an issuing entity of an asset-backed security shall

    not be deemed affiliated with any other issuing entity or issuer

    under this proposed definition.

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

    Single Component Concentration: The effective notional

    amount allocated to the securities of any issuer included in the index

    comprises more than 30 percent of the index's weighting; or

    Largest Five Component Concentration: The effective

    notional amount allocated to the securities of any 5 non-affiliated

    issuers included in the index comprises more than 60 percent of the

    index's weighting.

    Thus, the applicability of the proposed rules would depend on

    conditions relating to the number of non-affiliated reference entities,

    issuers of securities, or securities, as applicable, included in an

    index and the weighting of notional amounts allocated to the reference

    entities or securities in the index, as applicable. These first three

    criteria of the proposed rules would evaluate the number and

    concentration of the issuers or securities in the index, as applicable,

    and ensure that an index with a small number of issuers or securities

    or concentrated in only a few issuers or securities would be narrow-

    based, and thus where such index is the underlying reference of an

    index CDS, the index CDS would be a security-based swap.

    Specifically, the proposed rules would provide that an index

    meeting any one of certain identified conditions would be a narrow-

    based security index. The first condition in paragraph (1)(i)(A) of

    proposed rule 1.3(zzz) under the CEA and paragraph (a)(1)(i) of

    proposed rule 3a68-1a under the Exchange Act is that there are 9 or

    fewer non-affiliated issuers of securities that are reference entities

    in the index. An issuer of securities would count toward this total

    only if a credit event with respect to such entity would result in a

    payment by the credit protection seller to the credit protection buyer

    under the CDS based on the notional amount allocated to such entity, or

    if the fact of such a credit event or the calculation of the payment

    with respect to such credit event is taken into account when

    determining whether to make any future payments under the CDS with

    respect to any future credit events.

    Similarly, the first condition in paragraph (1)(i)(A) of proposed

    rules 1.3(aaaa) under the CEA and paragraph (a)(1)(i) of proposed rule

    3a68-1b under the Exchange Act would provide that a security would

    count toward the total number of securities in the index only if a

    credit event with respect to such security, or the issuer of such

    security, would result in a payment by the credit protection seller to

    the credit protection buyer under the CDS based on the notional amount

    allocated to such security, or if the fact of such a credit event or

    the calculation of the payment with respect to such credit event is

    taken into account when determining whether to make any future payments

    under the CDS with respect to any future credit events. These

    provisions are intended to ensure that an index concentrated in a few

    reference entities or securities, or a few reference entities that are

    affiliated or a few securities issued by a few issuers that are

    affiliated, are within the ``narrow-based'' definition and that an

    entity is not counted as a reference entity in the index, and a

    security is not counted as a security in the index, unless a credit

    event with respect to the entity, issuer, or security affects payout

    under a CDS on the index.\222\

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    \222\ This requirement is generally consistent with the

    definition of ``narrow-based security index'' in CEA section

    1a(35)(A), 7 U.S.C. 1a(35)(A), and section 3(a)(55)(B) of the

    Exchange Act, 15 U.S.C. 78c(a)(55)(B), and the July 2006 Rules,

    supra note 199.

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

    In addition, the proposed rules would provide that a reference

    entity or issuer of a security in an index and any of that reference

    entity's or issuer's affiliated entities are deemed to be a single

    reference entity or issuer in the index.\223\ For purposes of the

    narrow-based security index definition for index CDS under the third

    prong and first prong, a reference entity or issuer would be affiliated

    with another entity if it controls, is controlled by, or is under

    common control with, that other entity or issuer. The proposed rules

    would define control, solely for purposes of this provision, to mean

    ownership of 20% or more of an entity's or issuer's equity or the

    ability to direct the voting of 20% or more of an entity's or issuer's

    voting equity.\224\ This definition of control is designed to provide a

    clear standard for determining affiliation for purposes of the narrow-

    based security index criteria with respect to index CDS. Determining

    whether a reference entity or issuer is affiliated with another entity

    or issuer is important in assessing whether an index meets the criteria

    in the proposed rules because the notional amounts allocated to all

    affiliated reference entities, or all securities issued by affiliated

    issuers, included in an index must be aggregated in order to prevent a

    concentration of the index in reference entities or securities issued

    by issuers that are affiliated and because a reference entity's and

    issuer's affiliates must be considered when determining whether the

    reference entity or security meets the public information availability

    test discussed below. In addition, in order to ensure application of

    the criteria regarding index CDS to indexes of

    [[Page 29850]]

    reference entities that have issued asset-backed securities as defined

    in section 3(a)(77) of the Exchange Act,\225\ as well as indexes of

    such asset-backed securities, the term reference entity and the term

    issuer under the proposed rules includes issuing entities of asset-

    backed securities. The proposed rules also would provide that each

    issuing entity of an asset-backed security is considered a separate

    reference entity or issuer, as applicable.

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

    \223\ See proposed rule 1.3(zzz)(4) under the CEA and proposed

    rule 3a68-1a(d) under the Exchange Act.

    \224\ The affiliate issue under the Federal securities laws is

    generally a facts and circumstances determination based on the

    definition of the term ``affiliate'' contained in such laws. See,

    e.g., rule 405 under the Securities Act, 17 CFR 230.405; rule 12b-2

    under the Exchange Act, 17 CFR 240.12b-2.

    \225\ 15 U.S.C. 78c(a)(77). The Commissions note that section

    941 of the Dodd-Frank Act added the definition of the term ``asset-

    backed security'' as section 3(a)(77) of the Exchange Act, 15 U.S.C.

    78c(a)(77). However, section 761(a)(6) of the Dodd-Frank Act also

    added the definition of the term ``security-based swap execution

    facility'' as section 3(a)(77) of the Exchange Act, 15 U.S.C.

    78c(a)(77). References to the definition of the term ``asset-backed

    security'' in this release are to the definition added by section

    941 of the Dodd-Frank Act.

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

    The second condition, in paragraphs (1)(i)(B) of proposed rules

    1.3(zzz) and 1.3(aaaa) under the CEA and paragraphs (a)(1)(ii) of

    proposed rules 3a68-1a and 3a68-1b under the Exchange Act, is that the

    effective notional amount allocated to any reference entity or security

    included in the index comprises more than 30 percent of the index's

    weighting.

    The third condition, in paragraphs (1)(i)(C) of proposed rules

    1.3(zzz) and 1.3(aaaa) under the CEA and paragraphs (a)(1)(iii) of

    proposed rules 3a68-1a and 3a68-1b under the Exchange Act, is that the

    effective notional amount allocated to any 5 non-affiliated reference

    entities, or to the securities of any 5 non-affiliated issuers,

    included in the index that are the underlying reference entities or

    securities, respectively, comprises more than 60 percent of the index's

    weighting.

    Given that Congress determined that these concentration percentages

    are appropriate to characterize an index as a narrow-based security

    index, and the Commissions have determined they are appropriate for

    debt security indexes in the security futures context, the Commissions

    believe that these concentration percentages are appropriate to apply

    to the notional amount allocated to reference entities and securities

    in order to apply similar standards to indexes that are the underlying

    references of index CDS. Moreover, with respect to both the numerical

    and concentration percentage criteria, the markets have had experience

    with these criteria with respect to futures on equity indexes,

    volatility indexes, and debt security indexes.

    (ii) Public Information Availability Regarding Reference Entities and

    Securities

    In addition to the numerical and concentration percentage criteria,

    the debt security index test also included, as discussed above, a

    public information availability test. This test was designed to reduce

    the likelihood that broad-based debt security indexes or the component

    securities or issuers of securities in that index would be readily

    susceptible to manipulation. The fourth condition in the proposed rules

    includes a similar public information availability test that is

    intended solely for purposes of determining whether an index underlying

    a CDS is narrow-based. Except as discussed below, under the proposed

    rules, an index CDS would be considered narrow-based if a reference

    entity or security included in the index does not meet any one of the

    following criteria:

    The reference entity or the issuer of the security is

    required to file reports pursuant to the Exchange Act or the

    regulations thereunder;

    The reference entity or the issuer of the security is

    eligible to rely on the exemption provided in rule 12g3-2(b) under the

    Exchange Act; \226\

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

    \226\ 17 CFR 240.12g3-2(b).

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

    The reference entity or the issuer of the security has a

    worldwide market value of its outstanding common equity held by non-

    affiliates of $700 million or more; \227\

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

    \227\ See July 2006 Rules, supra note 199, at 39537 (noting that

    issuers having worldwide equity market capitalization of $700

    million are likely to have public information available about them).

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

    The reference entity or the issuer of the security (other

    than an issuing entity of an asset-backed security as defined in

    section 3(a)(77) of the Exchange Act \228\) has outstanding securities

    that are notes, bonds, debentures, or evidences of indebtedness having

    a total remaining principal amount of at least $1 billion;

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

    \228\ 15 U.S.C. 78c(a)(77).

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

    The reference entity is an issuer of an exempted security,

    or the security is an exempted security, each as defined in section

    3(a)(12) of the Exchange Act \229\ and the rules promulgated thereunder

    (except a municipal security);

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

    \229\ 15 U.S.C. 78c(a)12.

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

    The reference entity or the issuer of the security is a

    government of a foreign country or a political subdivision of a foreign

    country; or

    If the reference entity or the issuer of the security is

    an issuing entity of asset-backed securities as defined in section

    3(a)(77) of the Exchange Act,\230\ such asset-backed securities were

    issued in a transaction registered under the Securities Act and have

    publicly available distribution reports.

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

    \230\ 15 U.S.C. 78c(a)(77).

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

    However, so long as the effective notional amounts allocated to

    reference entities or securities that satisfy the public information

    availability test comprise at least 80 percent of the index's

    weighting, failure by a reference entity or security included in the

    index to satisfy the public information availability test would be

    disregarded if the effective notional amounts allocated to that

    reference entity or security comprise less than 5 percent of the

    index's weighting.

    These issuer eligibility criteria are intended to condition the

    characterization of an index as ``narrow-based'' on the likelihood that

    information about a predominant percentage of the reference entities or

    securities included in the index is publicly available.\231\ For

    example, a reference entity or issuer of securities that is required to

    file reports pursuant to the Exchange Act or the regulations thereunder

    makes regular and public disclosure through those filings. Moreover,

    reference entities and issuers of securities that do not file reports

    with the SEC but that are eligible to rely on the exemption in rule

    12g3-2(b) under the Exchange Act (i.e., foreign private issuers) are

    required to make certain types of financial information publicly

    available in English on their Web sites or through an electronic

    information delivery system generally available to the public in their

    primary trading markets.\232\ The Commissions believe that other

    reference entities or issuers of securities that do not file reports

    with the SEC, but that have worldwide equity market capitalization of

    $700 million, have $1 billion in outstanding debt (other than in the

    case of issuing entities of asset-backed securities), issue exempted

    securities (other than municipal securities), or are foreign

    [[Page 29851]]

    sovereign entities either are required to or are otherwise sufficiently

    likely, solely for purposes of the proposed ``narrow-based security-

    index'' and ``issuers of securities in a narrow-based security index''

    definitions, to have public information available about them.\233\

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

    \231\ See discussion supra part III.G.3(b). Most of the

    thresholds in the public information availability test are similar

    to those the Commissions adopted in their joint rules regarding the

    application of the definition of the term ``narrow-based security

    index'' to debt security indexes and security futures on debt

    securities. See July 2006 Rules, supra note 199. The July 2006 Rules

    also included an additional requirement regarding the minimum

    principal amount outstanding for each security in the index. The

    Commissions have not included this requirement in proposed rule

    1.3(zzz) under the CEA and proposed rule 3a68-1a under the Exchange

    Act. The numerical thresholds also are similar to those the SEC

    adopted in its securities offering reform rules, which were based on

    data analysis conducted by the SEC's Office of Economic Analysis.

    See Securities Offering Reform, 70 FR 44722, Aug. 3, 2005.

    \232\ 17 CFR 240.12g3-2(b).

    \233\ It is important to note that the public information

    availability test is designed solely for purposes of distinguishing

    between index CDS that are swaps and index CDS that are security-

    based swaps. The proposed criteria are not intended to provide any

    assurance that there is any particular level of information actually

    available regarding a particular reference entity or issuer of

    securities. Meeting one or more of the proposed criteria for the

    limited purpose here--defining the terms ``narrow-based security

    index'' and ``issuers of securities in a narrow-based security

    index'' in the first and third prongs of the security-based swap

    definition with respect to index CDS--would not substitute for or

    satisfy any other requirement for public disclosure of information

    or public availability of information for purposes of the Federal

    securities laws.

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

    In the case of indexes including asset-backed securities, or

    reference entities that are issuing entities of asset-backed

    securities, information about the reference entity or issuing entity of

    the asset-backed security would not alone be sufficient and,

    consequently, the proposed rules provide that the public information

    availability test would be satisfied only if certain information also

    is available about the asset-backed securities. An issuing entity

    (whether or not a reference entity) of asset-backed securities may meet

    the public information availability test if such asset-backed

    securities were issued in a transaction registered under the Securities

    Act and distribution reports about such asset-backed securities are

    publicly available. In addition, because of the lack of public

    information regarding many asset-backed securities, despite the size of

    the outstanding amount of securities,\234\ the proposed rules would not

    permit such reference entities and issuers to satisfy the public

    information availability test by having $1 billion in outstanding debt.

    Characterizing an index with reference entities or securities for which

    public information is not likely to be available as ``narrow-based,''

    and thus index CDS where the underlying references or securities are

    such indexes as security-based swaps, should help to ensure the

    transparency of the index components.

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

    \234\ See generally Asset-Backed Securities, 75 FR 23328, May 3,

    2010.

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

    In sum, an index that is not narrow-based under the number and

    weighting requirements would be characterized as broad-based (and thus

    an index CDS, where the underlying reference is that index, would be

    characterized as a swap and not a security-based swap) unless one of

    the reference entities or securities in the index fails to meet one of

    the criteria in the public information availability test set forth in

    the proposed rules. Yet, even if one or more of the reference entities

    or securities included in the index fail the public information

    availability test, the proposed rules would provide that the terms

    ``issuers of securities in a narrow-based security index'' and

    ``narrow-based security index'' would not include such an index, so

    long as the applicable reference entity or security that failed the

    test represents less than 5 percent of the index's weighting, and so

    long as reference entities or securities comprising at least 80 percent

    of the index's weighting do satisfy the public information availability

    test.

    An index that includes a very small proportion of reference

    entities or securities that do not satisfy this public information

    availability test should nevertheless be treated as a broad-based

    security index. This would be achieved where the index satisfies both

    of the requirements at the time the parties enter into the index CDS.

    The 5-percent weighting threshold is designed to provide that reference

    entities or securities not satisfying the public information

    availability test comprise only a very small portion of the index, and

    the 80-percent weighting threshold is designed to provide that a

    predominant percentage of the reference entities or securities in the

    index satisfy the public information availability test. As a result,

    these thresholds would provide market participants with flexibility in

    constructing an index. The Commissions believe that this provision is

    appropriate and that providing such flexibility is not likely to

    increase the likelihood that an index that satisfies these provisions

    would be readily susceptible to manipulation or the likelihood that the

    component securities or issuers of securities in that index also would

    be subject to manipulation or that there would be misuse of material

    non-public information about them through the use of CDS based on such

    indexes.

    The Commissions also are proposing that, for index CDS entered into

    solely between ECPs, the public information availability test may

    instead be satisfied other than in the manner discussed above.

    Accordingly, solely for index CDS entered into between ECPs, an index

    would be considered narrow-based if a reference entity or security

    included in the index does not meet any one of the criteria enumerated

    above or any one of the following criteria:

    The reference entity or the issuer of the security (other

    than issuing entities of asset-backed securities) provides to the

    public or to such eligible contract participant information about such

    reference entity or issuer pursuant to rule 144A(d)(4) under the

    Securities Act; \235\

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

    \235\ 17 CFR 230.144A(d)(4).

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

    Financial information about the reference entity (other

    than an issuing entity of asset-backed securities) is otherwise

    publicly available; or

    In the case of an asset-backed security, or a reference

    entity that is an issuing entity of asset-backed securities,

    information of the type and level included in public distribution

    reports for similar asset-backed securities is publicly available about

    both the reference entity or issuing entity as well as such asset-

    backed securities.

    Reference entities or reference securities that meet alternative

    public information criteria currently may underlie CDS that are entered

    into by ECPs and that are cleared by central counterparties operating

    pursuant to exemptive orders granted by the SEC.\236\ In addition,

    solely with respect to index CDS entered into by ECPs, so long as the

    effective notional amounts allocated to reference entities or

    securities that satisfy this expanded public information availability

    test comprise at least 80 percent of the index's weighting, a reference

    entity or security included in the index that fails to satisfy this

    expanded public information availability test would be disregarded if

    the effective notional amounts allocated to that reference entity or

    security comprise less than 5 percent of the index's weighting.

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

    \236\ See, e.g., Order Granting Temporary Exemptions Under the

    Securities Exchange Act of 1934 in Connection With Request of

    Chicago Mercantile Exchange Inc. and Citadel Investment Group,

    L.L.C. Related to Central Clearing of Credit Default Swaps, and

    Request for Comments, Exchange Act Release No. 34-59578 (Mar. 13,

    2009). This order has been extended a number of times, most recently

    on November 29, 2010. See Order Extending Temporary Conditional

    Exemptions Under the Securities Exchange Act of 1934 in Connection

    With Request of Chicago Mercantile Exchange Inc. Related to Central

    Clearing of Credit Default Swaps and Request for Comment, Exchange

    Act Release No. 34-63388 (Nov. 29, 2010).

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

    The Commissions are also seeking comment as to whether the public

    information availability test should apply to the extent that an index

    is compiled by an index provider that is not a party to an index CDS

    (``third-party index provider'') and makes publicly available general

    information about the construction of the index, index rules, identity

    of components, and predetermined adjustments, and which index is

    referenced by an index CDS that is offered on or subject to the rules

    of a DCM or SEF, or by direct access in

    [[Page 29852]]

    the U.S. from an FBOT that is registered with the CFTC.

    The CFTC believes that the requirement that the index be compiled

    by a third-party index provider may help to ensure that information is

    publicly available because such index providers generally employ a

    variety of selection criteria for inclusion of reference entities or

    securities in the indexes for index CDS, including liquidity

    thresholds. The CFTC believes that requiring that such index providers

    make publicly available general information about the construction of

    the index, index rules, components, and predetermined adjustments may

    help ensure transparency regarding the index and its components. In

    addition, the CFTC believes that the requirement that the index be the

    underlying reference of an index CDS that is offered for trading on or

    subject to the rules of a DCM or SEF, or by direct access in the U.S.

    from a registered FBOT, helps to ensure that information about the

    index is publicly available and that the index is not readily

    susceptible to manipulation. The CEA prohibits DCMs and SEFs from

    offering for trading contracts that are readily susceptible to

    manipulation.\237\ Similarly, under rules recently proposed by the

    CFTC, FBOTs only may offer contracts by direct access from the U.S.

    that are not readily susceptible to manipulation.\238\ The CFTC

    believes that CFTC oversight of DCMs, SEFs and registered FBOTs for

    compliance with these requirements \239\ will help ensure that

    information about an index that is the underlying reference of an index

    CDS traded on these platforms is publicly available and is not readily

    susceptible to manipulation.\240\

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

    \237\ See CEA sections 5(d)(3), 7 U.S.C. 7(d)(3) (a DCM ``shall

    list on the contract market only contracts that are not readily

    susceptible to manipulation.''); 5h(f)(3), 7 U.S.C. 7b-3(f)(3) (same

    requirement for SEFs).

    \238\ See Registration of Foreign Boards of Trade, 75 FR 70973,

    Nov. 19, 2010.

    \239\ CFTC oversight in evaluating compliance with the

    requirement that a swap not be readily susceptible to manipulation

    for cash settled contracts includes consideration of whether cash

    settlement is at a price reflecting the underlying cash market, will

    not be subject to manipulation or distortion, and is based on a cash

    price series that is reliable, acceptable, publicly available, and

    timely. See 17 CFR Part 40, Appendix A--Guideline No. 1.

    \240\ Such indexes also would be SBSAs, providing the SEC with

    antifraud and anti-manipulation authority.

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

    The SEC believes that a third-party index provider that simply

    provides general information about the construction of an index, index

    rules, components, and predetermined adjustments is not a substitute

    for the public availability of information about the issuers of the

    securities or the securities in the index; nor does such a third-party

    index provider indicate a likelihood that such public information is

    available, which the SEC believes, for purposes of index CDS, is

    important to market integrity and to investors in engaging in

    transactions based on such indexes. If a third-party index provider

    does not require, as a condition of inclusion in an index it compiles,

    that information likely is publicly available regarding the component

    issuers or securities in the index, the SEC does not believe investors

    will have adequate information regarding such component issuers or

    securities. In addition, the SEC notes that, absent specified standards

    regarding what persons constitute a third-party index provider for

    purposes of the proposed rules, any person that compiles an index at

    the behest of another person could constitute a ``third-party index

    provider.'' Moreover, the SEC does not believe that requiring an index

    CDS to be offered on or subject to the rules of a DCM or SEF, or by an

    FBOT, addresses whether public information likely is available about

    the issuers of securities or securities in an index compiled by a

    third-party index provider. As a result, the SEC does not believe that

    an index compiled by a third-party index provider that makes publicly

    available general information about the construction of the index,

    index rules, components, and index adjustments, and that is referenced

    by an index CDS that is offered for trading on or subject to the rules

    of a DCM or SEF, or by direct access in the U.S. from a registered

    FBOT, should substitute for the public information availability test

    under the proposed rules for index CDS.

    Accordingly, the Commissions seek comment as to whether the public

    information availability test should apply to indexes compiled by a

    third-party index provider that makes publicly available general

    information about the construction of the index, index rules, identity

    of components, and predetermined adjustments, and which index is

    referenced by an index CDS that is offered on or subject to the rules

    of a DCM or SEF, or by direct access in the U.S. from an FBOT that is

    registered with the CFTC.

    (iii) Treatment of Indexes Including Reference Entities That Are

    Issuers of Exempted Securities or Including Exempted Securities

    In addition, the proposed rules provide for alternative treatment

    of indexes that include exempted securities or reference entities that

    are issuers of exempted securities.\241\ The Commissions believe such

    treatment is consistent with the objective and intent of the definition

    of the term ``security-based swap,'' as well as the approach taken in

    the context of security futures.\242\ Accordingly, paragraph (1)(ii) of

    proposed rules 1.3(zzz) and 1.3(aaaa) under the CEA and paragraph

    (a)(2) of proposed rules 3a68-1a and 3a68-1b under the Exchange Act

    would provide that, in the case of an index that includes exempted

    securities, or reference entities that are issuers of exempted

    securities, in each case as defined as of the date of enactment of the

    Futures Trading Act of 1982 (other than municipal securities), such

    securities or reference entities are excluded from the index when

    determining whether the securities or reference entities in the index

    constitute a ``narrow-based security index'' or ``issuers of securities

    in a narrow-based security index'' under the proposed rules.

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

    \241\ See proposed rules 1.3(zzz)(1)(i) and 1.3(aaaa)(1)(i)

    under the CEA and proposed rules 3a68-1a(a)(2) and 3a68-1b(a)(2)

    under the Exchange Act; July 2006 Rules, supra note 199.

    \242\ See section 3(a)(68)(C) of the Exchange Act, 15 U.S.C.

    78c(a)(68)(C) (providing that ``[t]he term `security-based swap'

    does not include any agreement, contract, or transaction that meets

    the definition of a security-based swap only because such agreement,

    contract, or transaction references, is based upon, or settles

    through the transfer, delivery, or receipt of an exempted security

    under paragraph (12) [of the Exchange Act], as in effect on the date

    of enactment of the Futures Trading Act of 1982 (other than any

    municipal security as defined in paragraph (29) [of the Exchange

    Act] as in effect on the date of enactment of the Futures Trading

    Act of 1982), unless such agreement, contract, or transaction is of

    the character of, or is commonly known in the trade as, a put, call,

    or other option'').

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

    Under paragraph (1)(ii) of proposed rules 1.3(zzz) and 1.3(aaaa)

    under the CEA and paragraph (a)(2) of proposed rules 3a68-1a and 3a68-

    1b under the Exchange Act, an index composed solely of securities that

    are, or reference entities that are issuers of, exempted securities

    (other than municipal securities) would not be a ``narrow-based

    security index'' or an index composed of ``issuers of securities in a

    narrow-based security index.'' In the case of an index where some, but

    not all, of the securities or reference entities are exempted

    securities (other than municipal securities) or issuers of exempted

    securities (other than municipal securities), the index would be a

    ``narrow-based security index'' or an index composed of ``issuers of

    securities in a narrow-based security index'' only if the index is

    narrow-based when the securities that are, or reference entities that

    are issuers of, exempted securities (other than municipal securities)

    are

    [[Page 29853]]

    disregarded. The Commissions believe this approach would result in

    consistent treatment for indexes regardless of whether they include

    securities that are, or issuers of securities that are, exempted

    securities (other than municipal securities) while ensuring that

    exempted securities (other than municipal securities) and issuers of

    exempted securities (other than municipal securities) are not included

    in an index merely to make the index either broad-based or narrow-based

    under the proposed rules.

    Request for Comment

    The Commissions request comment on all aspects of proposed rules

    1.3(zzz) and 1.3(aaaa) under the CEA and proposed rules 3a68-1a and

    3a68-1b under the Exchange Act, as applied to CDS, including the

    following:

    85. Do the proposed criteria for identifying when an index of

    reference entities constitutes ``issuers of securities in a narrow-

    based security index'' and when an index of securities constitutes a

    ``narrow-based security index'' effectively encompass the key elements

    of a narrow-based security index as it pertains to paragraph

    (A)(ii)(III) (i.e., the third prong) and paragraph (A)(ii)(I) (i.e.,

    the first prong) of the security-based swap definition? Why or why not?

    86. Should an index with 9 or fewer non-affiliated issuers of

    securities or 9 or fewer securities be ``narrow-based?'' Why or why

    not?

    87. Should an index in which the effective notional amounts

    allocated to any reference entity or security included in the index

    comprise more than 30 percent of the index's weighting be ``narrow-

    based''? Why or why not?

    88. Should an index in which the effective notional amounts

    allocated to any 5 non-affiliated reference entities or securities

    included in the index comprise more than 60 percent of the index's

    weighting be ``narrow-based''? Why or why not?

    89. Should an index in which publicly available information is not

    available for a predominant percentage of reference entities or

    securities included in the index be ``narrow-based'' for purposes of

    index CDS? Why or why not? The Commissions note that the criteria for

    the public information availability test do not necessarily ensure that

    there is in fact public information available regarding the relevant

    entities or securities, or that the criteria act in any way as a

    substitute for the actual availability of public information; instead,

    the criteria, taken as a whole, are intended to capture, for purposes

    of the definition of the term ``narrow-based security index'' for index

    CDS, those entities or securities, that on average, are likely to have

    public information available, and that the relevant index would

    therefore not be treated as ``narrow-based.'' Do the proposed criteria

    appropriately achieve this objective? Are the criteria for the public

    information availability test under the proposed rules appropriate to

    result in a sufficient likelihood that public information about the

    component securities or issuers of securities in an index CDS would be

    available to properly address the regulatory interests of the Federal

    securities laws? Are the $700 million and $1 billion thresholds

    discussed above appropriate tests for the likelihood of publicly

    available information in this context? These thresholds are similar to

    those in the SEC securities offering reform rules used to determine, in

    part, whether a particular issuer was a ``well-known seasoned issuer,''

    in order to streamline registration requirements under the Securities

    Act.\243\ Are there companies that have less than $700 million in

    worldwide equity capitalization, or less than $1 billion in outstanding

    debt (other than asset-backed securities), and that do not otherwise

    satisfy the public information availability test, that have public

    information available about them for purposes of determining whether an

    index CDS that includes such a company as a reference entity or such a

    security is broad or narrow-based? The Commissions request comment on

    the appropriate thresholds for determining whether there likely is

    public information available for purposes of the proposed definition of

    narrow-based security index and issuers of securities in a narrow-based

    security index for purposes of index CDS, in particular whether these

    thresholds should be modified higher or lower, and request empirical

    data to support the response.

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

    \243\ See supra note 231.

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

    90. Is it appropriate to treat an issuer eligible to rely on rule

    12g3-2(b) under the Exchange Act as meeting the public information

    availability test under the proposed rules? Why or why not? Would such

    a provision include issuers that otherwise would not satisfy the

    information condition in the proposed rules? Why or why not? Please

    provide a detailed explanation and include empirical data to support

    any suggested modification.

    91. With respect to asset-backed securities, is the proposed

    criterion for meeting the public information availability test, that

    the asset-backed securities were issued in a transaction registered

    under the Securities Act and have publicly available distribution

    reports, the correct approach? Why or why not? Should such a provision

    explicitly also apply to include asset-backed securities issued by

    Fannie Mae and Freddie Mac? Why or why not? Please provide a detailed

    explanation of whether and why such a condition is necessary and

    include empirical data to support any suggested modification.

    92. Should the proposed rules exclude a reference entity or

    security in the index from the public information availability test, so

    long as the reference entity or security included in the index

    represents less than five percent of the index's weighting? Why or why

    not?

    93. Should the proposed rules exclude a reference entity or

    security in the index from the public information availability test, so

    long as the reference entities or securities comprising at least 80

    percent of the index's weighting satisfy the provisions of those

    paragraphs? Why or why not?

    94. The Commissions are considering whether the public information

    availability test in proposed rules 1.3(zzz) and 1.3(aaaa) under the

    CEA and proposed rules 3a68-1a and 3a68-1b under the Exchange Act

    should apply to an index of issuers of securities or securities that is

    created and published by a third-party index provider that is not a

    party to an index CDS and makes publicly available general information

    about the construction of the index, index rules, components, and

    predetermined adjustments, and which index is referenced by an index

    CDS that is offered on or subject to the rules of a DCM or SEF, or by

    direct access in the U.S. from an FBOT that is registered with the

    CFTC. How are indexes created by such a third-party index provider and

    what type of compensation do they receive? What role do parties to a

    swap or security-based swap play in determining the constituents or

    index criteria? What type of information does a third-party index

    provider ensure is publicly available on an ongoing basis about each of

    the constituent issuers of securities or securities identified in the

    index and what actions does the third-party index provider take to

    ensure the accuracy of information about the issuers of securities or

    securities in any index compiled by such third-party index provider?

    How would a third-party index provider take steps to ensure that the

    indexes it creates are composed of issuers of securities or securities

    for which there likely is public information available? Please provide

    detailed examples.

    95. If the Commissions determine to use, as an alternative to the

    public

    [[Page 29854]]

    information availability test in the proposed rules relating to index

    CDS, the existence of a third-party index provider that is not a party

    to an index CDS and makes publicly available general information about

    the construction of the index, index rules, components, and

    predetermined adjustments, and which index is referenced by an index

    CDS that is offered on or subject to the rules of a DCM or SEF, or by

    direct access in the U.S. from an FBOT that is registered with the

    CFTC, what requirements, if any, should the Commissions impose on the

    DCM, SEF, or FBOT to ensure that public information likely will be

    available in this context regarding the issuers of securities or

    securities in the index? What specified standards, if any, should the

    Commissions require the DCM, SEF, or FBOT to meet for purposes of the

    proposed rules?

    96. Should index CDS based on an index compiled by a third-party

    index provider as described in this section be considered a ``mixed

    swap'' rather than a swap in order to ensure that the protections of

    the Federal securities laws apply with respect to index constituents

    about which public information about the constituent issuers of

    securities or securities in the index (subject to the de minimis

    provisions of the proposed rules) may not be available?

    97. Are there other criteria that the Commissions should adopt as

    alternative means of satisfying the public information availability

    test in the proposed rules? If so, please explain what they are and

    what requirements the Commissions should impose to ensure the public

    availability of information regarding issuers of securities or

    securities in index CDS.

    98. Should the proposed rules provide, solely with respect to CDS

    that may be entered into only between eligible contract participants,

    that the information availability test could be satisfied if the

    reference entity or the issuer of the security (i) except in the case

    of issuing entities of asset-backed securities, provides information to

    the public or to such eligible contract participant pursuant to rule

    144A(d)(4) of the Securities Act; (ii) except in the case of issuing

    entities of asset-backed securities, financial information is otherwise

    publicly available about the reference entity or the issuer of the

    security; or (iii) in the case of asset-backed securities and issuing

    entities of asset-backed securities, financial information of the type

    and level included in public distribution reports for similar asset-

    backed securities about both the issuing entity and such asset-backed

    securities is publicly available? Why or why not? Please provide a

    detailed explanation and empirical data, to the extent feasible.

    99. Should the proposed rules include additional or other criteria

    to determine whether an index is ``narrow-based'' with respect to index

    CDS? If so, what criteria should be included, and why?

    100. Does the proposed treatment of index CDS whereby a payment is

    contemplated based on the default of a particular entity in the index

    rather than solely on the value of the index adequately address the

    Federal regulatory interests under the Federal securities laws and the

    Commodity Exchange Act?

    101. Does the definition of ``control'' for purposes of identifying

    whether a reference entity or issuer is affiliated with another entity

    (ownership of 20 percent or more of an entity's or issuer's equity, or

    the ability to direct the voting of 20 percent or more of the entity's

    or issuer's voting equity) appropriately identify when affiliates are

    in a control relationship for these purposes? Why or why not? Should

    these thresholds be higher or lower? Please provide supporting data

    and/or analysis. Should issuing entities of asset-backed securities be

    considered separate reference entities or issuers for purposes of the

    proposed criteria? If not, why not? Are there circumstances under which

    issuing entities of asset-backed securities should not be considered

    separate reference entities or issuers for purposes of the proposed

    criteria? Why or why not?

    102. Are there other categories or types of CDS that proposed rules

    1.3(zzz) and (aaaa) and proposed rules 3a68-1a and 3a68-1b do not

    address or that require additional clarification regarding their

    treatment under the Dodd-Frank Act? If so, please provide a detailed

    description of any such categories or types of CDS, as well as any

    analysis, supported by empirical data to the extent feasible, of what

    clarification is necessary.

    103. Are there other categories of event-type contracts relating to

    issuers of securities that require additional clarification regarding

    their treatment under the Dodd-Frank Act? If so, please provide a

    detailed explanation of the types of contracts and why the proposed

    rules should apply to such other event-type contracts.

    4. Security Indexes

    The Dodd-Frank Act defines the term ``index'' as ``an index or

    group of securities, including any interest therein or based on the

    value thereof.'' \244\ The Commissions are proposing guidance as to how

    to determine when a portfolio of securities is a narrow-based or broad-

    based security index and the circumstances in which changes to the

    composition of a security index (including a portfolio of securities)

    \245\ underlying a Title VII instrument would affect the

    characterization of such Title VII instrument.\246\

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    \244\ See section 3(a)(68)(E) of the Exchange Act, 15 U.S.C.

    78c(a)(68)(E).

    \245\ A ``portfolio'' of securities could be a group of

    securities and therefore an ``index'' for purposes of the Dodd-Frank

    Act. To the extent that changes are made to the securities

    underlying the Title VII instrument and each such change is

    individually confirmed, then those substituted securities would not

    be part of a security index as defined in the Dodd-Frank Act, and

    therefore a Title VII instrument on each of those substituted

    securities would be a security-based swap.

    \246\ Solely for purposes of the discussion in this section, the

    terms ``security index'' and ``security portfolio'' are intended to

    include either securities or the issuers of securities.

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

    In most cases, a security index is designed to reflect the

    performance of a market or sector by reference to representative

    securities or interests in securities. There are a number of well-known

    security indexes established and maintained by recognized index

    providers currently in the market.\247\ The Commissions understand,

    however, that instead of using these established indexes, market

    participants may enter into a Title VII instrument where the underlying

    reference of the Title VII instrument is a portfolio of securities

    selected by the counterparties or created by a third-party index

    provider at the behest of one or both counterparties. In some cases,

    the Title VII instrument may give one or both of the counterparties,

    either directly or indirectly (e.g., through an investment adviser or

    through the third-party index provider), discretionary authority to

    change the composition of the security portfolio, including, for

    example, by adding or removing securities in the security portfolio on

    an ``at-will'' basis during the term of the Title VII instrument.\248\

    The Commissions believe that where the counterparties, either directly

    or indirectly (e.g., through an investment adviser or through the

    third-party index provider), have this discretionary authority to

    change the

    [[Page 29855]]

    composition or weighting of securities in a security portfolio, that

    security portfolio should be treated as a narrow-based security index,

    and that therefore a Title VII instrument on that security portfolio

    would be a security-based swap.\249\

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    \247\ For instance, the S&P 500[reg] is an index that gauges the

    large cap U.S. equities market.

    \248\ Alternatively, counterparties may enter into Title VII

    instruments where a third-party investment manager selects an

    initial portfolio of securities and has discretionary authority to

    change the composition of the security portfolio in accordance with

    guidelines agreed upon with the counterparties. Such security

    portfolios would be treated as narrow-based security indexes with

    Title VII instruments on those security portfolios being security-

    based swaps.

    \249\ The Commissions understand that a security portfolio could

    be labeled as such or could just be an aggregate of individual Title

    VII instruments documented, for example, under a master agreement or

    by amending an annex of securities attached to a master trade

    confirmation. If the security portfolio were created by aggregating

    individual Title VII instruments, each Title VII instrument would

    need to be evaluated in accordance with the proposed guidance to

    determine whether it is a swap or a security-based swap. For the

    avoidance of doubt, if the counterparties to a Title VII instrument

    exchanged payments under that Title VII instrument based on a

    security index that was itself created by aggregating individual

    security-based swaps, such Title VII instrument would be a security-

    based swap. See discussion supra part III.D.

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    The Commissions believe, however, that not all changes that occur

    to the composition or weighting of a security index underlying a Title

    VII instrument will always result in that security index being treated

    as a narrow-based security index. Many security indexes are constructed

    and maintained by an index provider pursuant to a published

    methodology.\250\ For instance, the various Standard & Poor's security

    indexes are reconstituted and rebalanced as needed and on a periodic

    basis pursuant to published index criteria.\251\

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    \250\ See, e.g., NASDAQ, ``NASDAQ-100 Index'' (``The NASDAQ-100

    Index is calculated under a modified capitalization-weighted

    methodology. The methodology is expected to retain in general the

    economic attributes of capitalization-weighting while providing

    enhanced diversification. To accomplish this, NASDAQ will review the

    composition of the NASDAQ-100 Index on a quarterly basis and adjust

    the weightings of Index components using a proprietary algorithm, if

    certain pre-established weight distribution requirements are not

    met.''), available at http://dynamic.nasdaq.com/dynamic/nasdaq100_activity.stm

    \251\ Information regarding security indexes and their related

    methodologies may be widely available to the general public or

    restricted to licensees in the case of proprietary or ``private

    label'' security indexes. Both public and private label security

    indexes are frequently subject to intellectual property protection.

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

    In addition, counterparties to a Title VII instrument frequently

    agree to use as the underlying reference of a Title VII instrument a

    security index based on predetermined criteria where the security index

    composition or weighting may change as a result of the occurrence of

    certain events specified in the Title VII instrument at execution, such

    as ``succession events.'' Counterparties to a Title VII instrument also

    may use a predetermined self-executing formula to make other changes to

    the composition or weighting of a security index underlying a Title VII

    instrument. In either of these situations, the composition of a

    security index may change pursuant to predetermined criteria or

    predetermined self-executing formulas without the Title VII instrument

    counterparties, their agents, or third-party index providers having any

    direct or indirect discretionary authority to change the security

    index.

    In general, and by contrast to Title VII instruments in which the

    counterparties, either directly or indirectly (e.g., through an

    investment adviser or through the third-party index provider), have the

    discretion to change the composition or weighting of the referenced

    security index, where there is an underlying security index for which

    there are predetermined criteria or a predetermined self-executing

    formula for adjusting the security index that are not subject to change

    or modification through the life of the Title VII instrument and that

    are set forth in the Title VII instrument at execution (regardless of

    who establishes the criteria or formula), a Title VII instrument on

    such underlying security index would be on a broad-based or narrow-

    based security index, depending on the composition and weighting of the

    underlying security index. Subject to the interpretation discussed

    below regarding security indexes that may shift from being a narrow-

    based security index or broad-based security index during the life of

    an existing Title VII instrument,\252\ the characterization of a Title

    VII instrument based on a security index as either a swap or a

    security-based swap would depend on the characterization of the

    security index using the above interpretation.\253\

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    \252\ As discussed further below, the Commissions are concerned

    about the potential use of security indexes to game the narrow-based

    security index definition.

    \253\ See supra note 249 regarding the aggregation of separate

    trades.

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    Request for Comment

    104. The Commissions request comment on whether there are

    additional or other criteria that would be appropriate in determining

    whether a security index or security portfolio would constitute a

    narrow-based security index for purposes of the definitions of the

    terms ``swap'' and ``security-based swap.'' Please discuss any criteria

    in detail and provide any supporting data where relevant.

    105. What are the ways in which Title VII instruments involving

    security portfolios are structured, including changes in security

    portfolio composition?

    106. Should ``discretionary authority to change'' by the

    counterparties, either directly or indirectly (e.g., through an

    investment adviser or through the third-party index provider), be a

    determinative factor for whether a security portfolio should be treated

    as a narrow-based security index? Why or why not? Are there Title VII

    instruments where the underlying reference is a security portfolio

    where counterparties may directly or indirectly (e.g., through an

    investment manager or the third-party provider) exercise discretionary

    authority to change the composition of the security portfolio that

    should not be considered security-based swaps? Why or why not? Please

    provide a detailed explanation of such Title VII instruments, the means

    by which, and why, the composition of the underlying security portfolio

    are established and subsequently changed, and for what purpose such

    Title VII instruments are used.

    107. Should a security index, where changes to the composition are

    not subject to discretionary authority but instead may be made pursuant

    to predetermined criteria or a predetermined self-executing formula set

    forth in the Title VII instrument at execution, be considered either a

    broad-based security index or a narrow-based security index, depending

    on its constitution? Why or why not? Are changes pursuant to such

    predetermined criteria or formulas common? How frequently do such

    changes occur? What sorts of events trigger such changes? Please

    provide a detailed explanation and empirical data, to the extent

    feasible.

    108. Are the terms ``predetermined criteria'' and ``predetermined

    self-executing formula'' clear? Why or why not? If not, what

    alternative or additional guidance should be provided to clarify under

    what circumstances changes to the composition of a security index

    underlying a Title VII instrument may be made without being considered

    ``at will'' or discretionary changes by the counterparties, either

    directly or indirectly (e.g., through an investment adviser or through

    the third-party index provider), that would result in the security

    index being treated as a narrow-based security index and the Title VII

    instrument being a security-based swap? Are there specific additional

    criteria, restrictions, or parameters that should be considered? If so,

    please provide a detailed explanation regarding such criteria,

    restrictions, or parameters, including the types of changes that should

    or should not be permitted.

    109. Are there specific methodologies or criteria, agreed to at or

    prior to the

    [[Page 29856]]

    execution of a Title VII instrument, for changing the composition of an

    underlying security index, that should be explicitly addressed by the

    Commissions in providing the proposed guidance regarding security

    indexes? If so, please provide a detailed explanation of those

    methodologies or criteria and what additional guidance is necessary.

    110. Would restrictions on the frequency of changes to the

    composition of a security index underlying a Title VII instrument be

    useful in determining whether the underlying security index should be

    treated as a narrow-based security index? If so, please provide a

    detailed explanation of what restrictions should apply and why, as well

    as empirical data to the extent feasible.

    5. Evaluation of Title VII Instruments on Security Indexes That Move

    From Broad-Based to Narrow-Based or Narrow-Based to Broad-Based

    (a) In General

    As discussed above, the determination of whether a Title VII

    instrument is a swap, a security-based swap, or both (i.e., a mixed

    swap), is made at the execution of the Title VII instrument.\254\ If

    the security index underlying a Title VII instrument migrates from

    being broad-based to being narrow-based, or vice versa, during the life

    of a Title VII instrument, the characterization of that Title VII

    instrument would not change from its initial characterization

    regardless of whether the Title VII instrument was entered into

    bilaterally or was executed through a trade on or subject to the rules

    of a DCM, SEF, FBOT, security-based SEF, or NSE. For example, if two

    counterparties enter into a swap based on a broad-based security index,

    and three months into the life of the swap the security index

    underlying that Title VII instrument migrates from being broad-based to

    being narrow-based, the Title VII instrument would remain a swap for

    the duration of its life and would not be recharacterized as a

    security-based swap.

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

    \254\ See discussion supra part III.A.

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

    If the material terms of a Title VII instrument are amended or

    modified during its life, the Commissions would view the amended or

    modified Title VII instrument as a new Title VII instrument.\255\ As a

    result, the characteristics of the underlying security index must be

    reassessed at the time of such an amendment or modification to

    determine whether the security index has migrated from broad-based to

    narrow-based or vice versa. If the security index has migrated, then

    the characterization of the amended or modified Title VII instrument

    would be determined by evaluating the characterization of the

    underlying security index at the time the Title VII instrument is

    amended or modified. Similarly, if a security index has migrated from

    broad-based to narrow-based or vice versa, any new Title VII instrument

    based on that security index would be characterized pursuant to an

    evaluation of the underlying security index at the execution of that

    new Title VII instrument.

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

    \255\ For example, if, on its effective date, a Title VII

    instrument tracks the performance of an index of 12 securities but

    is amended during its term to track the performance of only 8 of

    those 12 securities, the Commissions would view the amended or

    modified Title VII instrument as a new Title VII instrument.

    Conversely, if, on its effective date, a Title VII instrument tracks

    the performance of an index of 12 securities but is amended during

    its term to reflect the replacement of a departing ``key person'' of

    a hedge fund that is a counterparty to the Title VII instrument with

    a new ``key person,'' the Commissions would not view the amended or

    modified Title VII instrument as a new Title VII instrument because

    the amendment or modification is not to a material term of the Title

    VII instrument. Because it would be a new Title VII instrument, any

    regulatory requirements regarding new Title VII instruments would

    apply.

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

    The Commissions are proposing guidance regarding circumstances in

    which the character of a security index on which a Title VII instrument

    is based changes according to predetermined criteria or a predetermined

    self-executing formula set forth in the Title VII instrument (or in a

    related or other agreement entered into by the counterparties or a

    third-party index provider to the Title VII instrument) at execution.

    Where at the time of execution such criteria or such formula would

    cause the underlying broad-based security index to become or assume the

    characteristics of a narrow-based security index or vice versa during

    the duration of the instrument,\256\ then the characterization of the

    Title VII instrument based on such security index would be a mixed swap

    during the entire life of the Title VII instrument.\257\ Although at

    certain points during the life of the Title VII instrument the

    underlying security index would be broad-based and at other points the

    underlying security index would be narrow-based, the Commissions

    believe that regulating such a Title VII instrument as a mixed swap

    from the execution of the Title VII instrument and throughout its life

    reflects the appropriate characterization of a Title VII instrument

    based on a security index that migrates pursuant to predetermined

    criteria or a predetermined self-executing formula.

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

    \256\ Thus, for example, if a predetermined self-executing

    formula agreed to by the counterparties of a Title VII instrument at

    or prior to the execution of the Title VII instrument provided that

    the security index underlying the Title VII instrument would

    decrease from 20 to 5 securities after six months, such that the

    security index would become narrow-based as a result of the reduced

    number of securities, then the Title VII instrument would be a mixed

    swap at its execution. The characterization of the Title VII

    instrument as a mixed swap would not change during the life of the

    Title VII instrument.

    \257\ As discussed above in part III.G.4, to the extent a Title

    VII instrument permits ``at will'' substitution of an underlying

    security index, however, as opposed to the use of predetermined

    criteria or a predetermined self-executing formula, the Title VII

    instrument would be a security-based swap at its execution and

    throughout its life regardless of whether the underlying security

    index was narrow-based at the execution of the Title VII instrument.

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

    The Commissions believe that this guidance regarding the use of

    predetermined criteria or a predetermined self-executing formula would

    prevent potential gaming of the Commissions' guidance regarding

    security indexes and prevent potential regulatory arbitrage based on

    the migration of a security index from broad-based to narrow-based or

    vice versa. In particular, the Commissions note that predetermined

    criteria and predetermined self-executing formulas can be constructed

    in ways that take into account the characteristics of a narrow-based

    security index and prevent a narrow-based security index from becoming

    broad-based and vice versa.

    (b) Title VII Instruments on Security Indexes Traded on Designated

    Contract Markets, Swap Execution Facilities, Foreign Boards of Trade,

    Security-Based Swap Execution Facilities, and National Securities

    Exchanges

    The Commissions recognize that security indexes underlying Title

    VII instruments that are traded on DCMs, SEFs, FBOTs, security-based

    SEFs, or NSEs raise particular issues if an underlying security index

    migrates from broad-based to narrow-based or vice versa. The

    characterization of an exchange-traded Title VII instrument at its

    execution, as explained above, would not change through the life of the

    Title VII instrument, regardless of whether the underlying security

    index migrates from broad-based to narrow-based or vice versa.

    Accordingly, a market participant who enters into a swap on a broad-

    based security index traded on or subject to the rules of a DCM, SEF or

    FBOT that migrates from broad-based to narrow-based may hold that

    position until the swap's expiration without any change in regulatory

    responsibilities, requirements, or obligations, and

    [[Page 29857]]

    similarly a market participant who enters into a security-based swap on

    a narrow-based security index traded on a security-based SEF or NSE may

    hold that position until the security-based swap's expiration without

    any change in regulatory responsibilities, requirements, or

    obligations.

    However, in the absence of any action by the Commissions, if the

    market participant wants to offset the swap or enter into a new swap on

    the DCM, SEF or FBOT where the underlying security index has migrated

    from broad-based to narrow-based, or to offset the security-based swap

    or enter into a new security-based swap on a security-based SEF or NSE

    where the underlying security index has migrated from narrow-based to

    broad-based, the participant would be prohibited from doing so. That is

    because swaps may trade only on DCMs, SEFs, and FBOTs, and security-

    based swaps may trade only on registered NSEs and security-based

    SEFs.\258\ The Commissions believe it is important to address how to

    treat Title VII instruments traded on trading platforms where the

    underlying security index migrates from broad-based to narrow-based or

    narrow-based to broad-based so that market participants will know where

    such Title VII instruments may be traded and can avoid potential

    disruption of their ability to offset or enter into new Title VII

    instruments on trading platforms when such migration occurs. The

    Commissions are proposing rules accordingly.\259\

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

    \258\ If a swap were based on a security index that migrated

    from broad-based to narrow-based, a DCM, SEF, or FBOT could no

    longer offer the Title VII instrument because it would be a

    security-based swap. Similarly, if a security-based swap were based

    on a security index that migrated from narrow-based to broad-based,

    a security-based SEF or NSE could no longer offer the Title VII

    instrument because it would be a swap.

    \259\ The proposed rules apply only to the particular Title VII

    instrument that is traded on or subject to the rules of a DCM, SEF,

    FBOT, security-based SEF, or NSE. To the extent that a particular

    Title VII instrument is not traded on such a trading platform (even

    if another Title VII instrument of the same class or type is traded

    on such a trading platform) the proposed rules would not apply to

    that particular Title VII instrument.

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

    Congress and the Commissions addressed a similar issue in the

    context of security futures, where the security index on which a future

    is based may migrate from broad-based to narrow-based or vice versa.

    Congress provided in the definition of ``narrow-based security index''

    in both the CEA and the Exchange Act \260\ for a tolerance period

    ensuring that, under certain conditions, a futures contract on a broad-

    based security index traded on a DCM may continue to trade, even when

    the index temporarily assumes characteristics that would render it a

    narrow-based security index under the statutory definition.\261\ In

    general, an index is subject to this tolerance period, and therefore is

    not a narrow-based security index, if: (i) a futures contract on the

    index traded on a DCM for at least 30 days as a futures contract on a

    broad-based security index before the index assumed the characteristics

    of a narrow-based security index and (ii) the index does not retain the

    characteristics of a narrow-based security index for more than 45

    business days over 3 consecutive calendar months. Pursuant to these

    statutory provisions, if the index becomes narrow-based for more than

    45 business days over 3 consecutive calendar months, the index is

    excluded from the definition of the term ``narrow-based security

    index'' for the following 3 calendar months as a grace period.

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

    \260\ CEA section 1a(35)(B)(iii), 7 U.S.C. 1a(35)(B)(iii);

    section 3(a)(55)(C)(iii) of the Exchange Act, 15 U.S.C.

    78c(a)(55)(C)(iii).

    \261\ By joint rules, the Commissions have provided that

    ``[w]hen a contract of sale for future delivery on a security index

    is traded on or subject to the rules of a foreign board of trade,

    such index shall not be a narrow-based security index if it would

    not be a narrow-based security index if a futures contract on such

    index were traded on a designated contract market * * * .'' See CFTC

    rule 41.13, 17 CFR 41.13, and rule 3a55-3 under the Exchange Act, 17

    CFR 240.3a55-3. Accordingly, the statutory tolerance period rules

    applicable to futures on security indexes traded on DCMs apply to

    futures traded on FBOTs as well.

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

    The Commissions believe a similar tolerance period should apply to

    swaps traded on DCMs, SEFs, and FBOTs and security-based swaps traded

    on security-based SEFs and NSEs. Accordingly, the Commissions are

    proposing rules providing for tolerance periods for swaps that are

    traded on DCMs, SEFs, or FBOTs and for security-based swaps traded on

    security-based SEFs and NSEs.

    Under paragraph (2)(i)(A) of proposed rule 1.3(yyy) under the CEA

    and paragraph (b)(1)(i) of proposed rule 3a68-3 under the Exchange Act,

    to be subject to the tolerance period, a security index underlying a

    swap executed on or subject to the rules of a DCM, SEF, or FBOT must

    not have been a narrow-based security index \262\ during the first 30

    days of trading.\263\ If the index becomes narrow-based during the

    first 30 days of trading, paragraph (2)(i)(B) of proposed rule 1.3(yyy)

    under the CEA and paragraph (b)(1)(ii) of proposed rule 3a68-3 under

    the Exchange Act provide that the index must not have been a narrow-

    based security index during every trading day of the 6 full calendar

    months preceding a date no earlier than 30 days prior to the

    commencement of trading of a swap on such index.\264\ If either of

    these alternatives are met, paragraph (2)(ii) of proposed rule 1.3(yyy)

    under the CEA and paragraph (b)(2) of proposed rule 3a68-3 under the

    Exchange Act provide that the index will not be a narrow-based security

    index if it has been a narrow-based security index for no more than 45

    business days over 3 consecutive calendar months. Paragraph (2) of

    proposed rule 1.3(yyy) under the CEA and paragraph (b) of proposed rule

    3a68-3 under the Exchange Act apply solely for purposes of swaps traded

    on or subject to the rules of a DCM, SEF, or FBOT.

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    \262\ For purposes of the proposed rules, the term ``narrow-

    based security index'' shall also mean ``issuers of securities in a

    narrow-based security index.'' See supra part III.G.3(b) (discussing

    the proposed rules defining ``issuers of securities in a narrow-

    based security index'').

    \263\ This provision is consistent with the provisions of the

    CEA and the Exchange Act applicable to futures contracts on security

    indexes. CEA section 1a(35)(B)(iii)(I), 7 U.S.C. 1a(35)(B)(iii)(I);

    section 3(a)(55)(C)(iii)(I) of the Exchange Act, 15 U.S.C.

    78c(a)(55)(C)(iii)(I).

    \264\ This alternative test is the same as the alternative test

    applicable to futures contracts in CEA rule 41.12, 17 CFR 41.12 and

    rule 3a55-2 under the Exchange Act, 17 CFR 240.3a55-2.

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

    Similarly, paragraph (3) of proposed rule 1.3(yyy) under the CEA

    and paragraph (c) of proposed rule 3a68-3 under the Exchange Act

    provide a tolerance period for security-based swaps traded on security-

    based SEFs or NSEs. Under paragraph (3)(i)(A) of proposed rule 1.3(yyy)

    under the CEA and paragraph (c)(1)(i) of proposed rule 3a68-3 under the

    Exchange Act, to be subject to the tolerance period, a security index

    underlying a security-based swap executed on a security-based SEF or

    NSE must have been a narrow-based security index during the first 30

    days of trading. If the index becomes broad-based during the first 30

    days of trading, paragraph (3)(i)(B) of proposed rule 1.3(yyy) under

    the CEA and paragraph (c)(1)(ii) of proposed rule 3a68-3 under the

    Exchange Act provide that the index must have been a non-narrow-based

    security index during every trading day of the 6 full calendar months

    preceding a date no earlier than 30 days prior to the commencement of

    trading of a security-based swap on such index. If either of these

    alternatives are met, paragraph (3)(ii) of proposed rule 1.3(yyy) under

    the CEA and paragraph (c)(2) of proposed rule 3a68-3 under the Exchange

    Act provide that the index will be a narrow-based security index if it

    has been a security index that is not narrow-based for no more than 45

    business days over 3 consecutive

    [[Page 29858]]

    calendar months.\265\ Paragraph (3) of proposed rule 1.3(yyy) under the

    CEA and paragraph (c) of proposed rule 3a68-3 under the Exchange Act

    apply solely for purposes of security-based swaps traded on security-

    based SEFs or NSEs.

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

    \265\ These provisions are consistent with the parallel

    provisions in the CEA and the Exchange Act applicable to futures

    contracts on security indexes traded on DCMs. CEA section

    1a(35)(B)(iii)(II), 7 U.S.C. 1a(35)(B)(iii)(II); section

    3(a)(55)(C)(iii)(II) of the Exchange Act, 15 U.S.C.

    78c(a)(55)(C)(iii)(II).

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

    The Commissions are proposing that, once the tolerance period under

    the proposed rules has ended, there would be a grace period during

    which a Title VII instrument based on a security index that has

    migrated from broad-based to narrow-based or vice versa would be able

    to trade on the platform on which Title VII instruments based on such

    security index were trading before the security index migrated and can

    also, during such period, be cleared. Paragraph (4)(i) of proposed rule

    1.3(yyy) under the CEA and paragraph (d)(1) of proposed rule3a68-3

    under the Exchange Act would provide for an additional 3-month grace

    period applicable to a security index that becomes narrow-based for

    more than 45 business days over 3 consecutive calendar months, solely

    with respect to swaps that are traded on or subject to the rules of

    DCMs, SEFs, or FBOTs. During the grace period, such an index would not

    be considered a narrow-based security index. Paragraph (4)(ii) of

    proposed rule 1.3(yyy) under the CEA and paragraph (d)(2) of proposed

    rule3a68-3 under the Exchange Act would apply the same grace period to

    a security-based swap on a security index that becomes broad-based for

    more than 45 business days over 3 consecutive calendar months, solely

    with respect to security-based swaps that are traded on a security-

    based SEF or NSE. During the grace period, such an index would not be

    considered a broad-based security index.\266\ As a result, this

    proposed rule would provide sufficient time for the migrated Title VII

    instrument to satisfy listing and clearing requirements applicable to

    swaps or security-based swaps, as appropriate.

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

    \266\ These provisions are consistent with the parallel

    provisions in the CEA and the Exchange Act applicable to futures

    contracts on security indexes traded on DCMs. See CEA section

    1a(35)(D), 7 U.S.C. 1a(35)(D); section 3(a)(55)(E) of the Exchange

    Act, 15 U.S.C. 78c(a)(55)(E).

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

    There would be no overlap between the tolerance and the grace

    periods under the proposed rules and no ``re-triggering'' of the

    tolerance period. For example, if a security index becomes narrow-based

    for more than 45 business days over 3 consecutive calendar months,

    solely with respect to swaps that are traded on or subject to the rules

    of DCMs, SEFs, or FBOTs, but as a result of the proposed rules is not

    considered a narrow-based security index during the grace period, the

    tolerance period provisions would not apply, even if the security-index

    migrated temporarily during the grace period. After the grace period

    has ended, a security index would need to satisfy anew the requirements

    under the proposed rules regarding the tolerance period in order to

    trigger a new tolerance period.

    The Commissions note that the proposed rules would not result in

    the recharacterization of any outstanding Title VII instruments. In

    addition, the proposed tolerance and grace periods would apply only to

    Title VII instruments that are traded on or subject to the rules of

    DCMs, SEFs, FBOTs, security-based SEFs, and NSEs.

    Request for Comment

    The Commissions request comment on all aspects of proposed rules

    1.3(yyy) under the CEA and proposed rule 3a68-3 under the Exchange Act,

    including the following:

    111. The Commissions request comment regarding whether the term

    ``narrow-based security index'' as defined in the CEA and the Exchange

    Act \267\ requires further definition solely in the context of Title

    VII instruments.

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    \267\ CEA sections 1a(35)(A) and (B), 7 U.S.C. 1a(35)(A) and

    (B); section 3(a)(55)(B) and (C) of the Exchange Act, 15 U.S.C.

    78c(a)(55)(B) and (C).

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

    112. Are there particular types of Title VII instruments that

    require additional guidance as to how the narrow-based security index

    definition applies? If so, which types of Title VII instruments? How

    should the definition apply to them? Please provide a detailed

    explanation of such Title VII instruments and the additional guidance

    that would be appropriate.

    113. Does the proposed guidance effectively address security

    indexes that migrate from broad-based to narrow-based and vice versa?

    Why or why not? If not, what additional or alternative requirements

    would be appropriate, and why?

    114. Will the proposed limitations regarding the use of

    predetermined criteria or predetermined self-executing formulas for

    Title VII instruments effectively prevent gaming of the proposed rules

    and potential regulatory arbitrage based on the migration of a security

    index or security portfolio from broad-based to narrow-based or vice

    versa? Why or why not? If not, please provide a detailed explanation of

    why not, and what additional or alternative limitations would do so.

    115. Should the standard pursuant to which a Title VII instrument

    would be a mixed swap during the entire life of the Title VII

    instrument require instead that the predetermined criteria or

    predetermined self-executing formula be constructed in such a manner

    that a broad-based security index or security portfolio would be

    reasonably likely to become or assume the characteristics of a narrow-

    based security index or security portfolio, or vice versa? Why or why

    not? Are there additional or alternative standards that should be used

    in determining when a Title VII instrument would be a mixed swap during

    the entire life of the Title VII instrument? If so, please provide a

    detailed explanation of such standards and why they would be effective.

    116. Do the proposed tolerance period rules appropriately address

    security indexes that temporarily change from broad-based to narrow-

    based, and from narrow-based to broad-based, in the context of Title

    VII instruments that are executed on or subject to the rules of a DCM,

    SEF, FBOT, security-based SEF, or NSE? Why or why not? If not, how

    should the proposed tolerance period rules be modified?

    117. Should the ``grace period'' applicable to Title VII

    instruments executed on or subject to the rules of a DCM, SEF, FBOT,

    security-based SEF, or NSE regarding a security index that becomes

    narrow-based or broad-based, respectively, for more than 45 business

    days over 3 consecutive calendar months be modified? Why or why not? If

    so, what modifications should be made?

    118. What would be the impact of the proposed rules on market

    participants with open swap or security-based swap positions if the

    security index underlying a swap were to become narrow-based or if the

    security index underlying a security-based swap were to become broad-

    based? Should market participants be allowed to liquidate their swaps

    or security-based swaps prior to expiration but after the grace period?

    If so, how would the listing market restrict trading for liquidation

    only?

    H. Method of Settlement of Index CDS

    The method that the parties have chosen or use to settle an index

    CDS following the occurrence of a credit event under such index CDS

    also can affect whether such index CDS would be a swap, a security-

    based swap, or both (i.e., a mixed swap). The Commissions believe that

    if an index CDS that is not based on a narrow-based

    [[Page 29859]]

    security index under the Commissions' proposed rules includes a

    mandatory physical settlement provision that would require the delivery

    of, and therefore the purchase and sale of, a non-exempted security

    \268\ or a loan in the event of a credit event, such an index CDS would

    be a mixed swap.\269\ Conversely, the Commissions believe that if an

    index CDS that is not based on a narrow-based security index under the

    Commissions' proposed rules includes a mandatory cash settlement \270\

    provision, such index CDS would be a swap, and not a security-based

    swap or a mixed swap, even if the cash settlement were based on the

    value of a non-exempted security or a loan.

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

    \268\ The Commissions note that section 3(a)(68)(C) of the

    Exchange Act, 15 U.S.C. 78c(a)(68)(C), provides that ``[t]he term

    ``security-based swap'' does not include any agreement, contract, or

    transaction that meets the definition of a security-based swap only

    because such agreement, contract, or transaction references, is

    based upon, or settles through the transfer, delivery, or receipt of

    an exempted security under paragraph (12) [of the Exchange Act], as

    in effect on the date of enactment of the Futures Trading Act of

    1982 (other than any municipal security as defined in paragraph (29)

    [of the Exchange Act] as in effect on the date of enactment of the

    Futures Trading Act of 1982), unless such agreement, contract, or

    transaction is of the character of, or is commonly known in the

    trade as, a put, call, or other option.''

    \269\ The Commissions' views as to the legal basis for such a

    conclusion differ. The SEC also notes that there must either be an

    effective registration statement covering the transaction or an

    exemption under the Securities Act would need to be available for

    such physical delivery of securities and compliance issues under the

    Exchange Act would also need to be considered.

    \270\ The Commissions are aware that the 2003 Definitions supra

    note 35, include ``Cash Settlement'' as a defined term and that such

    ``Settlement Method'' (also a defined term in the 2003 Definitions)

    works differently than auction settlement pursuant to the ``Big Bang

    Protocol'' or ``Auction Supplement'' (each as defined below). The

    Commissions' use of the term ``cash settlement'' in this section

    includes ``Cash Settlement,'' as defined in the 2003 Definitions,

    and auction settlement, as described in the ``Big Bang Protocol'' or

    ``Auction Supplement.''

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

    The Commissions believe that an index CDS that is not based on a

    narrow-based security index under the Commissions' proposed rules and

    that provides for cash settlement in accordance with the 2009 ISDA

    Credit Derivatives Determinations Committees and Auction Settlement

    Supplement to the 2003 Definitions (the ``Auction Supplement'') or with

    the 2009 ISDA Credit Derivatives Determinations Committees and Auction

    Settlement CDS Protocol (``Big Bang Protocol'') \271\ would be a swap,

    and would not be considered a security-based swap or a mixed swap

    solely because the determination of the cash price to be paid is

    established through a securities or loan auction.\272\ In 2009, auction

    settlement, rather than physical settlement, became the default method

    of settlement for, among other types of CDS, index CDS on corporate

    issuers of securities.\273\ The amount of the cash settlement is

    determined through an auction triggered by the occurrence of a credit

    event.\274\ The Auction Supplement ``hard wired'' the mechanics of

    credit event auctions into the 2003 Definitions.\275\ The Commissions

    understand that the credit event auction process that is part of the

    ISDA terms works as follows:

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

    \271\ See Int'l Swaps and Derivatives Ass'n, Inc., ``2009 ISDA

    Credit Derivatives Determinations Committees and Auction Settlement

    CDS Protocol,'' available at http://www.isda.org/bigbangprot/docs/Big-Bang-Protocol.pdf.

    \272\ The possibility that such index CDS may, in fact, be

    physically settled if an auction is not held or if the auction fails

    would not affect the characterization of the index CDS.

    \273\ The Commissions understand that the Big Bang Protocol is

    followed for index CDS involving corporate debt obligations but is

    not followed for index CDS based on asset-backed securities, loan-

    only CDS, and certain other types of CDS contracts. To the extent

    that such other index CDS contain auction procedures similar to the

    auction procedures for corporate debt to establish the cash price to

    be paid, the Commissions also would not consider such other index

    CDS that are not based on narrow-based security indexes under the

    Commissions' proposed rules to be mixed swaps.

    \274\ The Commissions understand that other conditions may need

    to be satisfied as well for an auction to be held.

    \275\ See supra note 35.

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

    Following the occurrence of a credit event under a CDS, a

    determinations committee (``DC'') established by ISDA, following a

    request by any party to a credit derivatives transaction that is

    subject to the Big Bang Protocol or Auction Supplement, will determine,

    among other matters: (i) Whether and when a credit event occurred; (ii)

    whether or not to hold an auction to enable market participants to

    settle those of their credit derivatives transactions covered by the

    auction; (iii) the list of deliverable obligations of the relevant

    reference entity; and (iv) the necessary auction specific terms. The

    credit event auction takes place in two parts. In the first part of the

    auction, dealers submit physical settlement requests, which are

    requests to buy or sell any of the deliverable obligations (based on

    the dealer's needs and those of its counterparties), and an initial

    market midpoint price is created based on dealers' initial bids and

    offers. Following the establishment of the initial market midpoint, the

    physical settlement requests are then calculated to determine the

    amount of open interest.

    The aggregate amount of open interest is the basis for the second

    part of the auction. In the second part of the auction, dealers and

    investors can determine whether to submit limit orders and the levels

    of such limit orders. The limit orders, which are irrevocable, have a

    firm price in addition to size and whether it is a buy or sell order.

    The auction is conducted as a ``dutch'' auction, in which the open buy

    interests and open sell interests are matched.\276\ The final price of

    the auction is the last limit order used to match against the open

    interest. The final price in the auction is the cash price used for

    purposes of calculating the settlement payments in respect of the

    orders to buy and sell the deliverable obligations and it is also used

    to determine the cash settlement payment under the CDS.

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

    \276\ The second part of the credit event auction process

    involves offers and sales of securities that must be made in

    compliance with the provisions of the Securities Act and the

    Exchange Act. First, the submission of a physical settlement request

    constitutes an offer by the counterparty to either buy or sell any

    one of the deliverable obligations in the auction. Second, the

    submission of the irrevocable limit orders by dealers or investors

    are sales or purchases by such persons at the time of submission of

    the irrevocable limit order. Through the auction mechanism, where

    the open interest (which represents physical settlement requests) is

    matched with limit orders, buyers and sellers are matched. Finally,

    following the auction and determination of the final price, the

    counterparty who has submitted the physical delivery request decides

    which of the deliverable obligations will be delivered to satisfy

    the limit order in exchange for the final price. The sale of the

    securities in the auction occurs at the time the limit order is

    submitted, even though the identification of the specific

    deliverable obligation does not occur until the auction is

    completed.

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

    I. Security-Based Swaps as Securities Under the Exchange Act and

    Securities Act

    Pursuant to the Dodd-Frank Act, a security-based swap is defined as

    a ``security'' under the Exchange Act \277\ and Securities Act.\278\ As

    a result, security-based swaps are subject to the Exchange Act and the

    Securities Act and the rules and regulations promulgated

    thereunder.\279\ To the

    [[Page 29860]]

    extent that security-based swaps differ from more traditional

    securities products, however, the SEC is soliciting comment on whether

    additional guidance may be necessary regarding the application of

    certain provisions of the Exchange Act and the Securities Act, and the

    rules and regulations promulgated thereunder, to security-based swaps.

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

    \277\ See section 761(a)(2) of the Dodd-Frank Act (inserting the

    term ``security-based swap'' into the definition of ``security'' in

    section 3a(10) of the Exchange Act, 15 U.S.C. 78c(a)(10)).

    \278\ See section 768(a)(1) of the Dodd-Frank Act (inserting the

    term ``security-based swap'' into the definition of ``security'' in

    section 2(a)(1) of the Securities Act, 15 U.S.C. 77b(a)(1)).

    \279\ Sections 761(a)(3) and (4) of the Dodd-Frank Act amend

    sections 3(a)(13) and (14) of the Exchange Act, 15 U.S.C. 78c(a)(13)

    and (14), and section 768(a)(3) of the Dodd-Frank Act adds section

    2(a)(18) to the Securities Act, 15 U.S.C. 77b(a)(18), to provide

    that the terms ``purchase'' and ``sale'' of a security-based swap

    shall mean the ``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, as the context may require.''

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

    Request for Comment

    119. Are there Exchange Act or Securities Act provisions, or rules

    and regulations promulgated thereunder, that contemplate application to

    cash market securities products or other securities products for which

    additional guidance may be necessary when applied to security-based

    swaps? If so, which provisions, and why? Please provide detailed

    analysis and empirical data, to the extent feasible.

    120. What additional guidance or modifications would be necessary

    to any such provisions in order to address the application of these

    provisions to security-based swaps while still achieving the regulatory

    purposes of those provisions?

    IV. Mixed Swaps

    A. Scope of the Category of Mixed Swap

    The category of mixed swap is described, in both the definition of

    the term ``security-based swap'' in the Exchange Act and the definition

    of the term ``swap'' in the CEA, as a security-based swap that is also:

    based on the value of 1 or more interest or other rates, currencies,

    commodities, instruments of indebtedness, indices, quantitative

    measures, other financial or economic interest or property of any kind

    (other than a single security or a narrow-based security index), or the

    occurrence, non-occurrence, or the extent of the occurrence of an event

    or contingency associated with a potential financial, economic, or

    commercial consequence (other than an event described in subparagraph

    (A)(ii)(III) [of section 3(a)(68) of the Exchange Act]).\280\

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

    \280\ Section 3(a)(68)(D) of the Exchange Act, 15 U.S.C.

    78c(a)(68)(D); CEA section 1a(47)(D), 7 U.S.C. 1a(47)(D).

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

    A mixed swap, therefore, is both a security-based swap and a

    swap.\281\

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

    \281\ Id. The exclusion from the definition of the term ``swap''

    for security-based swaps does not include security-based swaps that

    are mixed swaps. See CEA section 1a(47)(B)(x), 7 U.S.C.

    1a(47)(B)(x).

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

    The Commissions believe that the scope of mixed swaps is, and is

    intended to be, narrow. Title VII establishes robust and largely

    parallel regulatory regimes for both swaps and security-based swaps and

    directs the Commissions to jointly prescribe such regulations regarding

    mixed swaps as may be necessary to carry out the purposes of the Dodd-

    Frank Act.\282\ More generally, the Commissions believe the category of

    mixed swap was designed so that there would be no gaps in the

    regulation of swaps and security-based swaps. Therefore, in light of

    the statutory scheme created by the Dodd-Frank Act for swaps and

    security-based swaps, the Commissions believe the category of mixed

    swap covers only a small subset of Title VII instruments.\283\

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

    \282\ See section 712(a)(8) of the Dodd-Frank Act.

    \283\ See Morgan Stanley Letter (expressing the view that ``the

    universe of mixed swaps should be relatively small''); Letter from

    Timothy W. Cameron, Esq., Managing Director, Asset Management Group,

    Securities Industry and Financial Markets Association (``SIFMA

    Letter'') (suggesting that the scope of products included in the

    mixed swap category should be limited to ``avoid unnecessary and

    duplicative regulation'').

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

    For example, a Title VII instrument in which the underlying

    references are the value of an oil corporation stock and the price of

    oil would be a mixed swap. Similarly, a Title VII instrument in which

    the underlying reference is a portfolio of both securities (assuming

    the portfolio is not an index or, if it is an index, that the index is

    narrow-based) and commodities would be a mixed swap. Mixed swaps also

    would include certain Title VII instruments called ``best of'' or ``out

    performance'' swaps that require a payment based on the higher of the

    performance of a security and a commodity (other than a security).\284\

    As discussed elsewhere in this release, the Commissions also believe

    that certain Title VII instruments may be mixed swaps if they meet

    specified conditions.

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

    \284\ See Cleary Letter (providing as examples of mixed swaps,

    ``a swap based on the out-performance of gold, oil or another

    commodity relative to a security or narrow-based security index,''

    ``a security-based swap with knock-out/knock-in events tied to the

    value of gold, oil or another commodity,'' and ``[s]waps on indices

    or baskets that include narrow-based security index and physical

    commodity components''); Deutsche Bank Letter (indicating that

    ``best-of'' swaps should be treated as mixed swaps); Morgan Stanley

    Letter (``An example of a mixed swap might be a contract under which

    one party takes long exposure to the common stock of a U.S.

    corporation while simultaneously taking short exposure to the price

    of gold.'').

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

    The Commissions also believe that the use of certain market

    standard agreements in the documentation of Title VII instruments

    should not in and of itself transform a Title VII instrument into a

    mixed swap. For example, many instruments are documented by

    incorporating by reference market standard agreements. Such agreements

    typically set out the basis of establishing a trading relationship with

    another party but are not, taken separately, a swap or security-based

    swap. These agreements also include termination and default events

    relating to one or both of the counterparties; such counterparties may

    or may not be entities that issue securities.\285\ The Commissions

    believe that the term ``any agreement * * * based on * * * the

    occurrence of an event relating to a single issuer of a security,'' as

    provided in the definition of the term ``security-based swap,'' was not

    intended to include such termination and default events relating to

    counterparties included in standard agreements that are incorporated by

    reference into a Title VII instrument.\286\ Therefore, an instrument

    would not be simultaneously a swap and a security-based swap (and thus

    not a mixed swap) simply by virtue of having incorporated by reference

    a standard agreement, including default and termination events relating

    to counterparties to the Title VII instrument.

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

    \285\ Those standard events include inter alia bankruptcy,

    breach of agreement, cross default to other indebtedness, and

    misrepresentations.

    \286\ See section 3(a)(68)(A)(ii)(III) of the Exchange Act, 15

    U.S.C. 78c(a)(68)(A)(ii)(III).

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

    Request for Comment

    The Commissions request comment on the following:

    121. Are there other examples of Title VII instruments that should,

    or should not, be included within the mixed swap category?

    122. How frequently, and for what purposes, do market participants

    use mixed swaps?

    123. Can, and should, the economic goals of mixed swaps be

    accomplished using a combination of separate Title VII instruments,

    none of which would need to constitute a mixed swap? What problems, if

    any, would arise from the ``disaggregation'' of mixed swaps?

    B. Regulation of Mixed Swaps

    1. Introduction

    Paragraph (a) of proposed rule 1.9 under the CEA and proposed rule

    3a68-4 under the Exchange Act would define a ``mixed swap'' in the same

    manner as the term is defined in both the CEA and the Exchange Act. The

    Commissions are proposing two rules to address the regulation of mixed

    swaps. First, paragraph (b) of proposed rule 1.9 under the CEA and

    proposed rule 3a68-4 under the Exchange Act would provide a regulatory

    framework with which parties to bilateral uncleared mixed swaps (i.e.,

    mixed swaps that are neither executed on or subject to the rules of a

    DCM, NSE, SEF, security-based SEF, or FBOT nor cleared through a DCO or

    clearing agency), as to which at least

    [[Page 29861]]

    one of the parties is dually registered with both Commissions, would

    need to comply. Second, paragraph (c) of the proposed rules would

    establish a process for persons to request that the Commissions issue a

    joint order permitting such persons (and any other person or persons

    that subsequently lists, trades, or clears that class of mixed swap)

    \287\ to comply, as to parallel provisions \288\ only, with specified

    parallel provisions of either the CEA or the Exchange Act, and related

    rules and regulations (collectively ``specified parallel provisions''),

    instead of being required to comply with parallel provisions of both

    the CEA and the Exchange Act.

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

    \287\ All references to Title VII instruments in this part IV

    and in part VI shall include a class of such Title VII instruments

    as well. For example, a ``class'' of Title VII instrument would

    include instruments that are of similar character and provide

    substantially similar rights and privileges.

    \288\ For purposes of paragraph (c) of proposed rule 1.9 under

    the CEA and rule 3a68-4 under the Exchange Act, ``parallel

    provisions'' means comparable provisions of the CEA and the Exchange

    Act that were added or amended by Title VII with respect to

    security-based swaps and swaps, and the rules and regulations

    thereunder.

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

    2. Bilateral Uncleared Mixed Swaps Entered Into by Dually-Registered

    Dealers or Major Participants

    Swap dealers and major swap participants will be comprehensively

    regulated by the CFTC and security-based swap dealers and major

    security-based swap participants will be comprehensively regulated by

    the SEC.\289\ The Commissions recognize that there may be differences

    in the requirements applicable to swap dealers and security-based swap

    dealers, or major swap participants and major security-based swap

    participants, such that dually-registered market participants may be

    subject to potentially conflicting or duplicative regulatory

    requirements when they engage in mixed swap transactions. In order to

    assist market participants in addressing such potentially conflicting

    or duplicative requirements, the Commissions are proposing rules that

    would permit dually-registered swap dealers and security-based swap

    dealers and dually-registered major swap participants and major

    security-based swap participants to comply with an alternative

    regulatory regime when they enter into certain mixed swaps under

    specified circumstances.

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

    \289\ Section 712(a)(7)(A) of the Dodd-Frank Act requires the

    Commissions to treat functionally or economically similar entities

    in a similar manner.

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

    Accordingly, paragraph (b) of proposed rule 1.9 under the CEA and

    rule 3a68-4 under the Exchange Act would provide that a bilateral

    uncleared mixed swap,\290\ where at least one party is dually-

    registered with the CFTC as a swap dealer or major swap participant and

    with the SEC as a security-based swap dealer or major security-based

    swap participant, would be subject to all applicable provisions of the

    Federal securities laws (and SEC rules and regulations promulgated

    thereunder). The proposed rules also would provide that such mixed

    swaps would be subject to only the following provisions of the CEA (and

    CFTC rules and regulations promulgated thereunder):

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

    \290\ For purposes of the proposed rules, a ``bilateral

    uncleared mixed swap'' would be a mixed swap that: (i) Is neither

    executed on nor subject to the rules of a DCM, NSE, SEF, security-

    based SEF, or FBOT; and (ii) will not be submitted to a DCO or

    registered or exempt clearing agency to be cleared. To the extent

    that a mixed swap is subject to the mandatory clearing requirement

    (see CEA section 2(h)(1)(A), 7 U.S.C. 2(h)(1)(A), and section

    3C(a)(1) of the Exchange Act) (and where a counterparty is not

    eligible to rely on the end-user exclusion from mandatory clearing

    requirement (see CEA section 2(h)(7), 7 U.S.C. 2(h)(7), and section

    3C(g) of the Exchange Act)), this alternative regulatory treatment

    would not be available.

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

    Examinations and information sharing: CEA sections 4s(f)

    and 8; \291\

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

    \291\ 7 U.S.C. 6s(f) and 12, respectively.

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

    Enforcement: CEA sections 2(a)(1)(B), 4(b), 4b, 4c, 6(c),

    6(d), 6c, 6d, 9, 13(a), 13(b) and 23; \292\

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

    \292\ 7 U.S.C. 2(a)(1)(B), 6(b), 6b, 6c, 9 and 15, 13b, 13a-1,

    13a-2, 13, 13c(a), 13c(b), and 26, respectively.

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

    Reporting to an SDR: CEA section 4r; \293\

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

    \293\ 7 U.S.C. 6r.

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

    Real-time reporting: CEA section 2(a)(13); \294\

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

    \294\ 7 U.S.C. 2(a)(13).

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

    Capital: CEA section 4s(e); \295\ and

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

    \295\ 7 U.S.C. 6s(e).

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

    Position Limits: CEA section 4a.\296\

    \296\ 7 U.S.C. 6a.

    The Commissions believe that paragraph (b) of the proposed rules would

    address potentially conflicting or duplicative regulatory requirements

    for dually-registered dealers and major participants that are subject

    to regulation by both the CFTC and the SEC, while requiring dual

    registrants to comply with the regulatory requirements the Commissions

    believe are necessary to provide sufficient regulatory oversight for

    mixed swaps transactions entered into by such dual registrants. The

    CFTC also believes that paragraph (b) of the proposed rules would

    provide clarity to dually-registered dealers and major participants,

    who are subject to regulation by both the CFTC and the SEC, as to the

    requirements of each Commission that will apply to their bilateral

    uncleared mixed swaps.

    Request for Comment

    124. The Commissions request comment generally on the foregoing

    proposed rules regarding the regulation of mixed swaps entered into by

    dually-registered swap or security-based swap dealers and major swap or

    security-based swap participants.

    125. Does paragraph (b) of proposed rule 1.9 under the CEA and

    proposed rule 3a68-4 under the Exchange Act provide effective

    regulatory treatment for bilateral uncleared mixed swaps entered into

    by persons that are dually registered both as swap dealers or major

    swap participants with the CFTC and security-based swap dealers or

    major security-based swap participants with the SEC? If not, how should

    the proposed regulatory treatment be modified?

    126. Are the enumerated sections of the CEA (and the regulations

    promulgated thereunder) that are reserved in paragraph (b) appropriate?

    Are there sections that should be withdrawn? Why or why not? Are there

    sections that should be added? Why or why not?

    3. Regulatory Treatment for Other Mixed Swaps

    Because mixed swaps are both security-based swaps and swaps,\297\

    absent a joint rule or order by the Commissions permitting an

    alternative regulatory approach, persons who desire or intend to list,

    trade, or clear a mixed swap (or class thereof) would be required to

    comply with all the statutory provisions in the CEA and the Exchange

    Act (including all the rules and regulations thereunder) that were

    added or amended by Title VII with respect to swaps or security-based

    swaps.\298\ Such dual regulation may not be appropriate in every

    instance and may result in potentially conflicting or duplicative

    regulatory requirements. However, before the Commissions can determine

    the appropriate regulatory treatment for mixed swaps (other than the

    treatment discussed above), the Commissions would need to understand

    better the nature of the mixed swaps that parties want to trade.

    Paragraph (c) of proposed rule 1.9 under the CEA and proposed

    [[Page 29862]]

    rule 3a68-4 under the Exchange Act would establish a process pursuant

    to which any person who desires or intends to list, trade, or clear a

    mixed swap (or class thereof) that is not subject to the provisions of

    paragraph (b) (i.e., bilateral uncleared mixed swaps entered into by at

    least one dual registrant) may request the Commissions to publicly

    issue a joint order permitting such person (and any other person or

    persons that subsequently lists, trades, or clears that class of mixed

    swap) to comply, as to parallel provisions only, with the specified

    parallel provisions, instead of being required to comply with parallel

    provisions of both the CEA and the Exchange Act.\299\

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

    \297\ See supra note 10.

    \298\ Because security-based swaps are also securities,

    compliance with the Federal securities laws and rules and

    regulations thereunder (in addition to the provisions of the Dodd-

    Frank Act and the rules and regulations thereunder) would also be

    required. To the extent one of the Commissions has exemptive

    authority with respect to other provisions of the CEA or the Federal

    securities laws and the rules and regulations thereunder, persons

    may submit separate exemptive requests or rulemaking petitions

    regarding those provisions to the relevant Commission.

    \299\ Other than with respect to the specified parallel

    provisions with which such persons may be permitted to comply

    instead of complying with parallel provisions of both the CEA and

    the Exchange Act, any other provision of either the CEA or the

    Federal securities laws that applies to swaps or security-based

    swaps will continue to apply.

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

    Paragraph (c) of the proposed rules would further provide that a

    person submitting such a request to the Commissions must provide the

    Commissions with:

    (i) All material information regarding the terms of the specified,

    or specified class of, mixed swap;

    (ii) the economic characteristics and purpose of the specified, or

    specified class of, mixed swap;

    (iii) the specified parallel provisions, and the reasons the person

    believes such specified parallel provisions would be appropriate for

    the mixed swap (or class thereof);

    (iv) an analysis of (1) the nature and purposes of the parallel

    provisions that are the subject of the request; (2) the comparability

    of such parallel provisions; and (3) the extent of any conflicts or

    differences between such parallel provisions; and

    (v) such other information as may be requested by either of the

    Commissions.

    This provision is intended to provide the Commissions with

    sufficient information regarding the mixed swap (or class thereof) and

    the proposed regulatory approach to make an informed determination

    regarding the appropriate regulatory treatment of the mixed swap (or

    class thereof).

    Paragraph (c) of the proposed rules also would allow a person to

    withdraw a request regarding the regulation of a mixed swap at any time

    prior to the issuance of a joint order by the Commissions. This

    provision is intended to permit persons to withdraw requests that they

    no longer need. This, in turn, would save the Commissions time and

    staff resources.

    Paragraph (c) would further provide that in response to a request

    pursuant to the proposed rules, the Commissions may jointly issue an

    order, after public notice and opportunity for comment, permitting the

    requesting person (and any other person or persons that subsequently

    lists, trades, or clears that class of mixed swap) to comply, as to

    parallel provisions only, with the specified parallel provisions (or

    another subset of the parallel provisions that are the subject of the

    request, as the Commissions determine is appropriate), instead of being

    required to comply with parallel provisions of both the CEA and the

    Exchange Act. In determining the contents of such a joint order, the

    Commissions could consider, among other things, (i) the nature and

    purposes of the parallel provisions that are the subject of the

    request; (ii) the comparability of such parallel provisions; and (iii)

    the extent of any conflicts or differences between such parallel

    provisions.

    Finally, paragraph (c) of the proposed rules would require the

    Commissions, if they determine to issue a joint order pursuant to these

    rules, to do so within 120 days of receipt of a complete request (with

    such 120-day period being tolled during the pendency of a request for

    public comment on the proposed interpretation). If the Commissions do

    not issue a joint order within the prescribed time period, the proposed

    rules require that each Commission publicly provide the reasons for not

    having done so. Paragraph (c) makes clear that nothing in the proposed

    rules requires either Commission to issue a requested joint order

    regarding the regulation of a particular mixed swap (or class thereof).

    These provisions are intended to provide market participants with a

    prompt review of requests for a joint order regarding the regulation of

    a particular mixed swap (or class thereof). The proposed rules also

    would provide transparency and accountability by requiring that at the

    end of the review period, the Commissions issue the requested order or

    publicly state the reasons for not doing so.

    Request for Comment

    127. Is the proposed procedure set forth in paragraph (c)

    appropriate? Should paragraph (c) of the proposed rules include a more

    detailed process for persons to request that the Commissions issue a

    joint order permitting such persons to comply, as to parallel

    provisions only, with specified parallel provisions, instead of being

    required to comply with parallel provisions of both the CEA and the

    Exchange Act? If so, please provide a detailed explanation of what that

    process should include.

    128. Is the information required by paragraph (c) in support of a

    request for a joint order appropriate? Are there specific economic

    characteristics that should be required? In particular, should

    requesting persons be required to provide the specified parallel

    provisions, and the reasons the person believes it would be appropriate

    to request that regulatory treatment, as well as an analysis of (i) the

    nature and purposes of the parallel provisions that are the subject of

    the request; (ii) the comparability of such parallel provisions; and

    (iii) the extent of any conflicts or differences between such parallel

    provisions? Why or why not? If not, please provide a detailed

    explanation, including what information requesting persons should be

    required to provide.

    129. Is there additional or alternative information that the

    Commissions should require persons to submit in connection with a

    request regarding the regulation of particular mixed swaps (or class

    thereof)? If so, what additional or alternative information should be

    required?

    130. Should persons be able to withdraw a request for a joint order

    regarding the regulation of a particular mixed swap (or class thereof)?

    Why or why not? Should there be additional requirements regarding such

    withdrawals? If so, what should they be?

    131. Is the 120-day timeframe for issuance of a requested joint

    order provided for in paragraph (c) of proposed rule 1.9 under the CEA

    and proposed rule 3a68-4 under the Exchange Act appropriate? Is it too

    short or too long? Are the provisions for tolling this timeframe during

    a public comment period appropriate? Why or why not? Where the

    Commissions do not issue a joint order, is it appropriate that they

    each publicly provide the reasons for not doing so within the

    applicable timeframe? Why or why not?

    V. Security-Based Swap Agreements

    A. Introduction

    SBSAs are swaps over which the CFTC has regulatory and enforcement

    authority but for which the SEC also has antifraud and certain other

    authority.\300\

    [[Page 29863]]

    The term ``security-based swap agreement'' is defined as a ``swap

    agreement'' (as defined in section 206A of the GLBA \301\) of which ``a

    material term is based on the price, yield, value, or volatility of any

    security or any group or index of securities, including any interest

    therein'' but does not include a security-based swap.\302\ The Dodd-

    Frank Act amended the definition of ``swap agreement'' in section 206A

    of the GLBA \303\ to eliminate the requirements that a swap agreement

    be between ECPs, as defined in 1a(12)(C) of the CEA,\304\ and subject

    to individual negotiation.\305\

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

    \300\ See section 3(a)(78) of the Exchange Act, 15 U.S.C.

    78c(a)(78); CEA section 1a(47)(A)(v), 7 U.S.C. 1a(47)(A)(v). The

    Dodd-Frank Act provides that certain CFTC registrants, such as DCOs

    and SEFs, will keep records regarding SBSAs open to inspection and

    examination by the SEC upon request. See, e.g., sections 725(e) and

    733 of the Dodd-Frank Act. The Commissions are committed to working

    cooperatively together regarding their dual enforcement authority

    over SBSAs.

    \301\ 15 U.S.C. 78c note.

    \302\ See section 3(a)(78) of the Exchange Act, 15 U.S.C.

    78c(a)(78). The CFMA amended the Exchange Act and the Securities Act

    to exclude swap agreements from the definitions of security in those

    Acts but subjected ``security-based swap agreements,'' as defined in

    section 206B of the GLBA, 15 U.S.C. 78c note, to the antifraud,

    anti-manipulation, and anti-insider trading provisions of the

    Exchange Act and Securities Act. See CFMA, supra note 182, title

    III.

    The CEA does not contain a stand-alone definition of

    ``security-based swap agreement'' but includes the definition

    instead in subparagraph (A)(v) of the swap definition in CEA section

    1a(47), 7 U.S.C. 1a(47). The only difference between these

    definitions is that the definition of SBSA in the Exchange Act

    specifically excludes security-based swaps (see section 3(a)(78)(B)

    of the Exchange Act, 15 U.S.C. 78c(a)(78)(B)), while the definition

    of SBSA in the CEA does not contain a similar exclusion. Instead,

    the exclusion for security-based swaps is placed in the general

    exclusions from the definition of swap in the CEA (see CEA section

    1a(47)(B)(x), 7 U.S.C. 1a(47)(B)(x)).

    \303\ 15 U.S.C. 78c note.

    \304\ 7 U.S.C. 1a(12)(C).

    \305\ See section 762(b) of the Dodd-Frank Act. Sections 762(c)

    and (d) of the Dodd-Frank Act also made conforming amendments to the

    Exchange Act and the Securities Act to reflect the changes to the

    regulation of ``swap agreements'' that are either ``security-based

    swaps'' or ``security-based swap agreements'' under the Dodd-Frank

    Act.

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

    B. Swaps That Are Security-Based Swap Agreements

    Although the Commissions believe it is not possible to provide a

    bright line test to define an SBSA, the Commissions believe that it is

    possible to clarify that certain types of swaps clearly fall within the

    definition of SBSA. For example, a swap based on an index of securities

    that is not a narrow-based security index (i.e., a broad-based security

    index) would fall within the definition of an SBSA under the Dodd-Frank

    Act.\306\ Similarly, an index CDS that is not based on a narrow-based

    security index or on the ``issuers of securities in a narrow-based

    security index,'' as defined in proposed rule 1.3(zzz) under the CEA

    and proposed rule 3a68-1a under the Exchange Act, would be an SBSA. In

    addition, a swap based on a U.S. Treasury security or on certain other

    exempted securities other than municipal securities would fall within

    the definition of an SBSA under the Dodd-Frank Act.\307\ The

    Commissions have received no comments regarding the definition of SBSA

    in the Dodd-Frank Act in response to the ANPR, and have not been made

    aware of any significant market confusion regarding what constitutes an

    SBSA since the definition of SBSA was enacted as part of the CFMA in

    2000. Accordingly, the Commissions are not proposing to further define

    SBSA at this time beyond providing the examples above.\308\

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

    \306\ Swaps based on indexes that are not narrow-based security

    indexes are not included within the definition of the term security-

    based swap under the Dodd-Frank Act. See section 3(a)(68)(A)(ii)(I)

    of the Exchange Act, 15 U.S.C. 78c(a)(68)(A)(ii)(I), and discussion

    supra part III.G. However, such swaps have a material term that is

    ``based on the price, yield, value, or volatility of any security or

    any group or index of securities, or any interest therein,'' and

    therefore such swaps fall within the SBSA definition.

    \307\ Swaps on U.S. Treasury securities that do not have any

    other underlying references involving securities are expressly

    excluded from the definition of the term ``security-based swap''

    under the Dodd-Frank Act. See section 3(a)(68)(C) of the Exchange

    Act, 15 U.S.C. 78c(a)(68)(C) (providing that an agreement, contract,

    or transaction that would be a security-based swap solely because it

    references, is based on, or settles through the delivery of one or

    more U.S. Treasury securities (or certain other exempted securities)

    is excluded from the security-based swap definition). However, swaps

    on U.S. Treasury securities or on other exempted securities covered

    by subparagraph (C) of the security-based swap definition have a

    material term that is ``based on the price, yield, value, or

    volatility of any security or any group or index of securities, or

    any interest therein,'' and therefore they fall within the SBSA

    definition.

    \308\ The Commissions note that certain transactions that were

    not ``security-based swap agreements'' under the CFMA are

    nevertheless included in the definition of security-based swap under

    the Dodd-Frank Act--including, for example, a CDS on a single loan.

    Accordingly, although such transactions were not subject to insider

    trading restrictions under the CFMA, under the Dodd-Frank Act they

    are subject to the Federal securities laws, including insider

    trading restrictions.

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

    Request for Comment

    132. The Commissions request comment on whether further

    clarification of the definition of SBSA is necessary or appropriate.

    Commenters should provide a detailed analysis regarding what further

    guidance should be provided and how that guidance would affect what

    constitutes an SBSA.

    133. The Commissions also request comment on whether there are

    other examples of swap transactions that the Commissions should clarify

    meet the definition of SBSA.

    C. Books and Records Requirements for Security-Based Swap Agreements

    The Dodd-Frank Act requires the Commissions to adopt rules

    regarding the books and records required to be kept for SBSAs.

    Specifically, section 712(d)(2)(B) of the Dodd-Frank Act requires the

    Commissions, in consultation with the Board, to jointly adopt rules

    governing books and records requirements for SBSAs by persons

    registered as SDRs under the CEA, including uniform rules that specify

    the data elements that shall be collected and maintained by each SDR.

    Similarly, section 712(d)(2)(C) of the Dodd-Frank Act requires the

    Commissions, in consultation with the Board, to jointly adopt rules

    governing books and records for SBSAs, including daily trading records,

    for swap dealers, major swap participants, security-based swap dealers,

    and major security-based swap participants.

    As discussed above, SBSAs are swaps over which the CFTC has primary

    regulatory authority, but for which the SEC has antifraud, anti-

    manipulation, and certain other authority. The CFTC has proposed rules

    governing books and records for swaps, which would apply to swaps that

    also are SBSAs.\309\ The Commissions believe that the proposed rules

    would provide sufficient books and records regarding SBSAs and do not

    believe that additional books and records requirements are necessary

    for SBSAs. The Commissions therefore are proposing rules to clarify

    that there would not be additional books and records requirements

    regarding SBSAs other than those proposed for swaps. Specifically,

    proposed rule 1.7 under the CEA and proposed rule 3a69-3 under the

    Exchange Act would not require persons registered as SDRs under the CEA

    and the rules and regulations thereunder to (i) keep and maintain

    additional books and records regarding SBSAs other than the books and

    records regarding swaps that SDRs would be required to keep and

    maintain pursuant to the CEA and rules and regulations thereunder; and

    (ii) collect and maintain additional data regarding SBSAs other than

    the data regarding swaps that SDRs would be required to collect and

    maintain pursuant to the CEA and rules and regulations thereunder.

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

    \309\ See Swap Data Recordkeeping and Reporting Requirements,

    supra note 6 (proposed rules regarding swap data recordkeeping and

    reporting requirements for SDRs, DCOs, DCMs, SEFs, swap dealers,

    major swap participants, and swap counterparties who are neither

    swap dealers nor major swap participants); Reporting, Recordkeeping,

    and Daily Trading Records Requirements for Swap Dealers and Major

    Swap Participants, supra note 7 (proposed rules regarding reporting

    and recordkeeping requirements and daily trading records

    requirements for swap dealers and major swap participants).

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    [[Page 29864]]

    In addition, the proposed rules would not require persons

    registered as swap dealers or major swap participants under the CEA and

    rules and regulations thereunder, or registered as security-based swap

    dealers or major security-based swap participants under the Exchange

    Act and rules and regulations thereunder, to keep and maintain

    additional books and records, including daily trading records,

    regarding SBSAs other than the books and records regarding swaps those

    persons would be required to keep and maintain pursuant to the CEA and

    the rules and regulations thereunder.\310\

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

    \310\ Proposed rule 1.7 under the CEA and proposed rule 3a69-3

    under the Exchange Act would provide that the term ``security-based

    swap agreement'' has the meaning set forth in CEA section

    1a(47)(A)(v), 7 U.S.C. 1a(47)(A)(v), and section 3(a)(78) of the

    Exchange Act, 15 U.S.C. 78c(a)(78), respectively.

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    Request for Comment

    134. The Commissions request comment on the proposed rules

    regarding books and records requirements for SBSAs. Will requiring the

    same recordkeeping information for SBSAs that will be required for

    swaps under the CFTC's recordkeeping rules be sufficient? Should the

    Commissions impose additional recordkeeping requirements for SBSAs? If

    so, why, and what additional recordkeeping should be required?

    VI. Process for Requesting Interpretations of the Characterization of a

    Title VII Instrument

    As discussed above, there may be Title VII instruments (or classes

    of Title VII instruments) that may be difficult to categorize

    definitively as swaps or security-based swaps. Further, because mixed

    swaps are both swaps and security-based swaps, identifying a mixed swap

    may not always be straightforward.

    Section 712(d)(4) of the Dodd-Frank Act provides that any

    interpretation of, or guidance by, either the CFTC or SEC regarding a

    provision of Title VII shall be effective only if issued jointly by the

    Commissions (after consultation with the Board) on issues where Title

    VII requires the CFTC and SEC to issue joint regulations to implement

    the provision. The Commissions believe that any interpretation or

    guidance regarding whether a Title VII instrument is a swap, a

    security-based swap, or both (i.e., a mixed swap), must be issued

    jointly pursuant to this requirement. Consequently, the Commissions are

    proposing a process for interested persons to request a joint

    interpretation by the Commissions regarding whether a particular Title

    VII instrument (or class of Title VII instruments) is a swap, a

    security-based swap, or both (i.e., a mixed swap).

    Section 718 of the Dodd-Frank Act establishes a process for

    determining the status of ``novel derivative products'' that may have

    elements of both securities and futures contracts. Section 718 of the

    Dodd-Frank Act provides a useful model for a joint Commission review

    process to appropriately categorize Title VII instruments. As a result,

    the Commissions' proposed process rules regarding swaps, security-based

    swaps, and mixed swaps include various attributes of the process

    established in section 718 of the Dodd-Frank Act. In particular, to

    permit an appropriate review period that provides sufficient time to

    ensure Federal regulatory interests are satisfied that also does not

    unduly delay the introduction of new financial products, the proposed

    process, like the process established in section 718, would include a

    deadline for responding to a request for a joint interpretation.\311\

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

    \311\ The Commissions note that section 718 of the Dodd-Frank

    Act is a separate process from the process the Commissions are

    proposing, and that any future interpretation involving the process

    under section 718 would not affect the process being proposed here,

    nor would any future interpretation involving the process proposed

    here affect the process under section 718.

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

    Proposed rule 1.8 under the CEA and proposed rule 3a68-2 under the

    Exchange Act would establish a process for parties to request a joint

    interpretation regarding the characterization of a particular Title VII

    instrument (or class thereof). Specifically, paragraph (a) of the

    proposed rules would provide that any person may submit a request to

    the Commissions to provide a public joint interpretation of whether a

    particular Title VII instrument is a swap, a security-based swap, or

    both (i.e., a mixed swap).

    Paragraph (a) of the proposed rules is intended to afford market

    participants with the opportunity to obtain greater certainty from the

    Commissions regarding the regulatory status of particular Title VII

    instruments under the Dodd-Frank Act. This provision should decrease

    the possibility that market participants inadvertently might violate

    the regulatory requirements applicable to a particular Title VII

    instrument.

    Paragraph (b) of proposed rules 1.8 under the CEA and proposed rule

    3a68-2 under the Exchange Act would provide that a person requesting an

    interpretation as to the characterization of a Title VII instrument as

    a swap, a security-based swap, or both (i.e., a mixed swap), must

    provide the Commissions with the person's determination of the

    characterization of the instrument and supporting analysis, along with

    certain other documentation. Specifically, the person must provide the

    Commissions with the following information:

    All material information regarding the terms of the Title

    VII instrument;

    A statement of the economic characteristics and purpose of

    the Title VII instrument;

    The requesting person's determination as to whether the

    Title VII instrument should be characterized as a swap, a security-

    based swap, or both (i.e., a mixed swap), including the basis for such

    determination; and

    Such other information as may be requested by either

    Commission.

    This provision is intended to provide the Commissions with

    sufficient information regarding the Title VII instrument at issue so

    that the Commissions can appropriately evaluate whether it is a swap, a

    security-based swap, or both (i.e., a mixed swap). By requiring that

    requesting persons furnish a determination regarding whether they

    believe the Title VII instrument is a swap, a security-based swap, or

    both (i.e., a mixed swap), including the basis for such determination,

    this provision also would assist the Commissions in more quickly

    identifying and addressing the relevant issues involved in arriving at

    a joint interpretation of the characterization of the instrument.

    Paragraph (c) of proposed rule 1.8 under the CEA and proposed rule

    3a68-2 under the Exchange Act would provide that a person may withdraw

    a request made pursuant to paragraph (a) at any time prior to the

    issuance of a joint interpretation or joint notice of proposed

    rulemaking by the Commissions. Notwithstanding any such withdrawal, the

    Commissions may provide an interpretation regarding the

    characterization of the Title VII instrument that was the subject of a

    withdrawn request.

    This provision is intended to permit parties to withdraw requests

    for which the party no longer needs an interpretation. This, in turn,

    would save the Commissions time and staff resources. If the Commissions

    believe such an interpretation is necessary regardless of a particular

    request for interpretation, however, the Commissions may provide such a

    joint interpretation of their own accord.

    Paragraph (d) of proposed rule 1.8 under the CEA and proposed rule

    3a68-2 under the Exchange Act would

    [[Page 29865]]

    provide that if either Commission receives a proposal to list, trade,

    or clear an agreement, contract, or transaction (or class thereof) that

    raises questions as to the appropriate characterization of such

    agreement, contract, or transaction (or class thereof) as a swap,

    security-based swap, or both (i.e., a mixed swap), the receiving

    Commission promptly shall notify the other. This provision of the

    proposed rules would further provide that either Commission, or their

    Chairmen jointly, may submit a request for a joint interpretation as to

    the characterization of the Title VII instrument where no external

    request has been received.

    This provision is intended to ensure that Title VII instruments do

    not fall into regulatory gaps and will help the Commissions to fulfill

    their responsibility to oversee the regulatory regime established by

    Title VII of the Dodd-Frank Act by making sure that Title VII

    instruments are appropriately characterized, and thus appropriately

    regulated. An agency, or their Chairmen jointly, submitting a request

    for an interpretation as to the characterization of a Title VII

    instrument under this paragraph would be required to submit the same

    information as, and could withdraw a request in the same manner as, a

    person submitting a request to the Commissions. The bases for these

    provisions are set forth above with respect to paragraphs (b) and (c)

    of these proposed rules.

    Paragraph (e) of proposed rule 1.8 under the CEA and proposed rule

    3a68-2 under the Exchange Act would require the Commissions, if they

    determine to issue a joint interpretation as to the characterization of

    a Title VII instrument, to do so within 120 days of receipt of the

    complete external or agency submission (unless such 120-day period is

    tolled during the pendency of a request for public comment on the

    proposed interpretation).\312\ If the Commissions do not issue a joint

    interpretation within the prescribed time period, the proposed rules

    require that each Commission publicly provide the reasons for not

    having done so. This provision of the proposed rules also incorporates

    the mandate of the Dodd-Frank Act that any joint interpretation by the

    Commissions be issued only after consultation with the Board of

    Governors of the Federal Reserve System.\313\ Finally, paragraph (e)

    makes clear that nothing in the proposed rules requires either

    Commission to issue a requested joint interpretation regarding the

    characterization of a particular instrument.

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

    \312\ This 120-day period is based on the timeframe set forth in

    section 718(a)(3) of the Dodd-Frank Act.

    \313\ See section 712(d)(4) of the Dodd-Frank Act.

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

    These provisions are intended to guarantee market participants a

    prompt review of submissions requesting a joint interpretation of

    whether a Title VII instrument is a swap, a security-based swap, or

    both (i.e., a mixed swap). The proposed rules also would provide

    transparency and accountability by requiring that at the end of the

    review period, the Commissions issue the requested interpretation or

    publicly state the reasons for not doing so.

    Paragraph (f) of proposed rule 1.8 under the CEA and proposed rule

    3a68-2 under the Exchange Act would permit the Commissions, in lieu of

    issuing a requested interpretation, to issue (within the timeframe for

    issuing a joint interpretation) a joint notice of proposed rulemaking

    to further define one or more of the terms ``swap,'' ``security-based

    swap,'' or ``mixed swap.'' Such a rulemaking, as required by Title VII,

    would be required to be done in consultation with the Board of

    Governors of the Federal Reserve System. This paragraph is intended to

    provide the Commissions with needed flexibility to address issues that

    may be of broader applicability than the particular Title VII

    instrument that is the subject of a request for a joint interpretation.

    Request for Comment

    135. The Commissions request comment generally on all aspects of

    proposed rule 1.8 under the CEA and proposed rule 3a68-2 under the

    Exchange Act.

    136. Should proposed rule 1.8(a) under the CEA and proposed rule

    3a68-2(a) under the Exchange Act include a more specific process for

    persons to request a joint interpretation of whether a Title VII

    instrument is a swap, a security-based swap, or both (i.e., a mixed

    swap)? If so, what additional specificity would be appropriate?

    137. Would the information required by paragraph (b) of the

    proposed rules be sufficient for the Commissions to consider a request?

    Should requesting persons have to provide a statement regarding the

    economic characteristics and purpose of the Title VII instrument?

    Should requesting persons have to provide a determination regarding

    whether such instrument should be characterized as a swap, a security-

    based swap, or both (i.e., a mixed swap), along with reasons therefor?

    138. Is there additional or alternative information that the

    Commissions should require persons to submit in connection with a

    request for an interpretation regarding whether a Title VII instrument

    is a swap, a security-based swap, or both (i.e., a mixed swap)? If so,

    what additional or alternative information should be required?

    139. Should persons be able to withdraw a request for an

    interpretation pursuant to paragraph (c) of proposed rule 1.8 under the

    CEA and proposed rule 3a68-2 under the Exchange Act? Why or why not?

    Should there be additional parameters around or requirements regarding

    such withdrawals? If so, what should they be?

    140. Is the 120-day timeframe for issuance of a requested joint

    interpretation provided for in paragraph (e) of proposed rule 1.8 under

    the CEA and proposed rule 3a68-2 under the Exchange Act appropriate? Is

    it too short or too long? Are the provisions for tolling this timeframe

    during a public comment period, and for permitting the Commissions to

    proceed with a joint notice of proposed rulemaking instead of issuing a

    joint interpretation, appropriate? Why or why not? Where the

    Commissions do not issue a joint interpretation, is it helpful that

    they each publicly provide the reasons for not doing so within the

    applicable timeframe? Why or why not?

    141. Title VII requires that certain persons that are registered

    with the CFTC keep books and records relating to SBSAs open to

    inspection and examination by the SEC. As discussed in part V above,

    the Commissions are not proposing additional recordkeeping or other

    regulatory requirements for SBSAs that would require pre-transaction

    identification of a swap as an SBSA by market participants. Under these

    circumstances, is it appropriate to include SBSAs in the interpretation

    process set forth in proposed rule 1.8 under the CEA and proposed rule

    3a68-2 under the Exchange Act? Why or why not?

    142. Would it be appropriate to include SBSAs in the interpretation

    process, if their inclusion required the Commissions to extend the 120-

    day timeframe for issuance of a requested joint interpretation to, for

    example, 180 days for all products in order to address a potential

    increase in requests? Why or why not?

    VII. Anti-Evasion

    A. CFTC Proposed Anti-Evasion Rules

    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,'' in order

    ``[t]o include transactions and entities

    [[Page 29866]]

    that have been structured to evade'' subtitle A of Title VII (or an

    amendment made by subtitle A). Section 761(b)(3) of the Dodd-Frank Act,

    in turn, grants discretionary authority to the SEC to define the terms

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

    based major 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 subtitle B

    of Title VII (or amendments made by subtitle B). The CFTC notes that

    several provisions of Title VII reference the promulgation of anti-

    evasion rules:

    Subparagraph (E) of the definition of ``swap'' provides

    that foreign exchange swaps and foreign exchange forwards shall be

    considered swaps unless the Secretary of the Treasury makes a written

    determination that either foreign exchange swaps or foreign exchange

    forwards, or both, among other things, ``are not structured to evade

    the [Dodd-Frank Act] in violation of any rule promulgated by the [CFTC]

    pursuant to section 721(c) of that Act;'' \314\

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

    \314\ CEA section 1a(47)(E), 7 U.S.C. 1a(47)(E).

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

    Section 722(d) of the Dodd-Frank Act provides that the

    provisions of the CEA relating to swaps shall not apply to activities

    outside the United States unless those activities, among other things,

    ``contravene such rules or regulations as the [CFTC] may prescribe or

    promulgate as are necessary or appropriate to prevent the evasion of

    any provision of [the CEA] that was enacted by the [Title VII];'' \315\

    and

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

    \315\ CEA section 2(i), 7 U.S.C. 2(i). New CEA section 2(i), as

    added by section 722(d) of the Dodd-Frank Act, also provides that

    the provisions of Title VII relating to swaps shall not apply to

    activities outside the United State unless those activities ``have a

    direct and significant connection with activities in, or effect on,

    commerce of the United States.''

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

    Section 725(g) of the Dodd-Frank Act amends the Legal

    Certainty for Bank Products Act of 2000 to provide that, although

    identified banking products generally are excluded from the CEA, that

    exclusion shall not apply to an identified banking product that is a

    product of a bank that is not under the regulatory jurisdiction of an

    appropriate Federal banking agency,\316\ meets the definition of

    ``swap'' or ``security-based swap,'' and ``has been structured as an

    identified banking product for the purpose of evading the provisions of

    the [CEA], the [Securities Act], or the [Exchange Act].'' \317\

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

    \316\ The term ``identified banking product'' is defined in

    section 402 of the Legal Certainty for Bank Products Act of 2000, 7

    U.S.C. 27. The term ``appropriate Federal banking agency'' is

    defined in CEA section 1a(2), 7 U.S.C. 1a(2), and section 3(a)(72)

    of the Exchange Act, 15 U.S.C. 78c(a)(72), which were added by

    sections 721(a) and 761(a) of the Dodd-Frank Act, respectively.

    \317\ Section 741(b) of the Dodd-Frank Act amends section 6(e)

    of the CEA, 7 U.S.C. 9a, to provide that any DCO, swap dealer, or

    major swap participant ``that knowingly or recklessly evades or

    participates in or facilitates an evasion of the requirements of

    section 2(h) [of the CEA] shall be liable for a civil monetary

    penalty in twice the amount otherwise available for a violation of

    section 2(h) [of the CEA].'' This anti-evasion provision is not

    dependent upon the promulgation of a rule under section 721(c) of

    the Dodd-Frank Act, and hence this release does not apply to the

    anti-evasion authority regarding CEA section 2(h), 7 U.S.C. 2(h).

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

    The CFTC has determined to exercise its anti-evasion rulemaking

    authority under the Dodd-Frank Act.\318\

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

    \318\ No comments were received in response to the ANPR that

    specifically addressed anti-evasion authority. One commenter,

    however, noted that evasion is a concern. See Letter from David A.

    Berg, Esq., Vice President & General Counsel, Air Transport

    Association (Sept. 20, 1010).

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

    Structuring transactions and entities to evade the requirements of

    the Dodd-Frank Act could take any number of forms. As with the law of

    manipulation, the ``methods and techniques'' of evasion are ``limited

    only by the ingenuity of man.'' \319\ In light of the myriad methods of

    potential evasion, any attempt to comprehensively determine what

    constitutes evasion, or to provide a bright-line test of evasion by

    rule, would likely not be effective as would-be evaders could simply

    restructure their transactions or entities to fall outside any rigid

    boundary. Accordingly, proposed rule 1.3(xxx)(6) under the CEA

    generally would define as swaps those transactions that are willfully

    structured to evade the provisions of Title VII governing the

    regulation of swaps. Specific provisions would apply in similar fashion

    to currency and interest rate swaps that are willfully structured as

    foreign exchange forwards or foreign exchange swaps, and to

    transactions of a bank that is not under the regulatory jurisdiction of

    an appropriate Federal banking agency where the transactions are

    willfully structured as identified banking products to evade the new

    regulatory regime for swaps that was enacted in Title VII. These

    proposed rules would not apply to any agreement, contract, or

    transaction structured as a security (including a security-based swap)

    under the securities laws (as defined in section 3(a)(47) of the

    Exchange Act).

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

    \319\ Cargill v. Hardin, 452 F.2d 1154, 1163 (8th Cir. 1971).

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

    The Dodd-Frank Act also gives the CFTC general authority to prevent

    evasion of Title VII that occurs outside of the United States.

    Specifically, as noted above, section 722(d) of the Dodd-Frank Act

    states that the provisions of the CEA relating to swaps that were

    enacted by Title VII (including any rule prescribed or regulation

    promulgated thereunder) shall not apply to activities outside the

    United States unless, among other things, those activities ``contravene

    such rules or regulations as the [CFTC] may prescribe or promulgate as

    are necessary or appropriate to prevent the evasion of any provision of

    [the CEA] that was enacted by [Title VII].'' The CFTC is proposing

    rules to address potential evasion of Title VII under this provision of

    the Dodd-Frank Act.

    Proposed rule 1.6 under the CEA would prohibit activities conducted

    outside the United States, including entering into transactions and

    structuring entities, to willfully evade or attempt to evade any

    provision of the CEA as enacted under Title VII or the rules and

    regulations promulgated thereunder. No activity, however, conducted

    outside of the United States with respect to a security (including a

    security-based swap) under the securities laws (as defined in section

    3(a)(47) of the Exchange Act) and that is subject to the jurisdiction

    of the SEC would be prohibited pursuant to proposed rule 1.6.

    The CFTC's proposed rule 1.3(xxx)(6) further defining the term

    ``swap'' would further provide that transactions, other than

    transactions structured as securities, willfully structured to evade

    shall be considered in determining whether a person is a swap dealer or

    major swap participant. Proposed rule 1.6 would further provide that an

    activity conducted outside the United States, other than an activity

    with respect to a security (including a security-based swap), to

    willfully evade or attempt to evade, shall be subject to the swap

    provisions of the CEA enacted under Title VII of the Dodd-Frank Act.

    The CFTC believes that these provisions are necessary to fully prevent

    those who seek to willfully evade the regulatory requirements

    established by Congress in Title VII relating to swaps from enjoying

    any benefits from their efforts to evade.

    Finally, the CFTC's proposed rules would provide that in

    determining whether a transaction has been willfully structured to

    evade, neither the form, label, nor written documentation of the

    transaction shall be dispositive. The CFTC believes that looking beyond

    the form of the transaction to examine its actual substance is

    necessary to prevent evasion through clever draftsmanship. Such an

    approach is consistent with the CFTC's case law in the context of

    determining whether a contract is a futures contract.\320\

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

    \320\ See, e.g., Grain Land, supra note 61, at 55748 (holding

    that contract substance is entitled to at least as much weight as

    form); First Nat'l Monetary Corp., supra note 152, at 30974;

    Stovall, supra note 152, at 23779 (holding that the CFTC ``will not

    hesitate to look behind whatever label the parties may give to the

    instrument'').

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

    [[Page 29867]]

    In order to provide clarity concerning the anti-evasion rules, the

    CFTC also proposes to provide interpretive guidance as to certain types

    of circumstances that may constitute an evasion of the requirements of

    Title VII, while at the same time preserving the CFTC's ability to

    determine, on a case-by-case basis, that particular or other types of

    transactions or actions constitute an evasion of the requirements of

    the statute or the regulations promulgate thereunder. In developing

    this guidance, the CFTC has considered legislative, administrative, and

    judicial precedent with respect to the anti-evasion provisions in other

    Federal statutes. For example, the CFTC has examined the anti-evasion

    provisions in the Truth in Lending Act,\321\ the Bank Secrecy Act,\322\

    and the Internal Revenue Code.\323\ Based on these other statutory

    anti-evasion provisions, as well as the CFTC's authority under the

    Dodd-Frank Act to define terms and promulgate rules and regulations to

    prevent evasion, the CFTC is proposing this interpretive guidance as to

    what may constitute evasion of the requirements of the Dodd-Frank Act

    with respect to swaps. The CFTC emphasizes, however, that it would

    examine each individual case on a case-by-case basis, and additional

    practices or circumstances may warrant a finding that particular

    conduct or transactions constitute an evasion of the requirements of

    the Dodd-Frank Act with respect to swaps.

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

    \321\ 15 U.S.C. 1604(a) provides, in relevant part, that the

    Federal Reserve Board:

    Shall prescribe regulations to carry out the purposes of this

    subchapter * * *. [T]hese regulations may contain such

    classifications, differentiations, or other provisions, and may

    provide for such adjustments and exceptions for any class of

    transactions, as in the judgment of the Board are necessary or

    proper to effectuate the purposes of this subchapter, to prevent

    circumvention or evasion thereof, or to facilitate compliance

    therewith.

    In affirming the Board's promulgation of Regulation Z, the

    Supreme Court noted that anti-evasion provisions such as section

    1604(a) evince Congress's intent to ``stress[] the agency's power to

    counteract attempts to evade the purposes of a statute.'' Mourning

    v. Family Publ'ns Serv., Inc., 411 U.S. 356, 370 (1973) (citing

    Gemsco v. Walling, 324 U.S. 244 (1945) (giving great deference to a

    regulation promulgated under similar prevention-of-evasion

    rulemaking authority in the Fair Labor Standards Act)).

    \322\ 31 U.S.C. 5324 (stating, in pertinent part, that ``[n]o

    person shall, for the purpose of evading the reporting requirements

    of [the Bank Secrecy Act (BSA) or any regulation prescribed

    thereunder].* * * structure or assist in structuring, or attempt to

    structure or assist in structuring, any transaction with one or more

    domestic financial institutions''). The Federal Deposit Insurance

    Corporation regulations implementing the BSA require banks to report

    transactions that ``''the bank knows, suspects, or has reason to

    suspect'' are ``designed to evade any regulations promulgated under

    the Bank Secrecy Act.'' 12 CFR 353.3 (2010).

    \323\ The Internal Revenue Code makes it unlawful for any person

    willfully to attempt ``in any manner to evade or defeat any tax * *

    *.'' 26 U.S.C. 7201. While a considerable body of case law has

    developed under the tax evasion provision, the statute itself does

    not define the term, but generally prohibits willful attempts to

    evade tax.

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

    Business Purpose. The CFTC recognizes that transactions may be

    structured, and entities may be formed, in particular ways for

    legitimate business purposes, without any intention of circumventing

    the requirements of the Dodd-Frank Act with respect to swaps. In

    evaluating whether a person is evading or attempting to evade the

    requirements with respect to a particular instrument, entity, or

    transaction, the CFTC would consider the extent to which a person has a

    legitimate business purpose for structuring the instrument or entity or

    entering into the transaction in that particular manner. Although

    different means of structuring a transaction or entity may have

    differing regulatory implications and attendant requirements, absent

    other indicia of evasion, the CFTC would not consider transactions,

    entities, or instruments structured in a manner solely motivated by a

    legitimate business purpose to constitute evasion. However, to the

    extent a purpose in structuring an entity or instrument or entering

    into a transaction is to evade the requirements of Title VII with

    respect to swaps, the structuring of such instrument, entity, or

    transaction may be found to constitute evasion.\324\

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

    \324\ A similar concept applies with respect to tax evasion. A

    transaction that is structured to avoid the payment of taxes but

    that lacks a valid business purpose may be found to constitute tax

    evasion. See, e.g., Gregory v. Helvering, 293 U.S. 465, 469 (1935)

    (favorable tax treatment disallowed because transaction lacked any

    business or corporate purpose). Under the ``sham-transaction''

    doctrine, ``a transaction is not entitled to tax respect if it lacks

    economic effects or substance other than the generation of tax

    benefits, or if the transaction serves no business purpose.'' Winn-

    Dixie Stores, Inc. v. Comm'r, 254 F.3d 1313, 1316 (11th Cir. 2001)

    (citing Knetsch v. United States, 364 U.S. 361 (1960)). ``The

    doctrine has few bright lines, but `it is clear that transactions

    whose sole function is to produce tax deductions are substantive

    shams.''' Id. (quoting United Parcel Serv. of Am., Inc. v. Comm'r,

    254 F.3d 1014, 1018 (11th Cir 2001)).

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

    Fraud, deceit, or unlawful activity. The CFTC believes that the

    Internal Revenue Service's delineation of what constitutes tax evasion,

    as elaborated upon by the courts, provides a useful guidepost for

    determining which types of activities should be considered to

    constitute an evasion of the Dodd-Frank Act. The Internal Revenue

    Service distinguished between tax evasion and legitimate means for

    citizens to minimize, reduce, avoid or alleviate the tax that they pay

    under the Internal Revenue Code. Whereas permissible means of reducing

    tax (or ``tax avoidance,'' as the Internal Revenue Service refers to

    the practice) is associated with full disclosure and explanation of why

    the tax should be reduced under law, tax evasion consists of the

    willful attempt to evade tax liability, and generally involves

    ``deceit, subterfuge, camouflage, concealment, or some attempt to color

    or obscure events or to make things seem other than they are.'' \325\

    Similarly, persons that craft derivative transactions, structure

    entities, or conduct themselves in a deceptive or other illegitimate

    manner in order to avoid regulatory requirements should not be

    permitted to enjoy the fruits of their deceptive or illegitimate

    conduct. In determining whether particular conduct is an evasion of the

    Dodd-Frank Act, the CFTC will consider the extent to which the conduct

    involves deceit, deception, or other unlawful or illegitimate

    activity.\326\

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

    \325\ The Internal Revenue Service explains:

    Avoidance of taxes is not a criminal offense. Any attempt to

    reduce, avoid, minimize, or alleviate taxes by legitimate means is

    permissible. The distinction between avoidance and evasion is fine,

    yet definite. One who avoids tax does not conceal or misrepresent.

    He/she shapes events to reduce or eliminate tax liability and, upon

    the happening of the events, makes a complete disclosure. Evasion,

    on the other hand, involves deceit, subterfuge, camouflage,

    concealment, some attempt to color or obscure events or to make

    things seem other than they are. For example, the creation of a bona

    fide partnership to reduce the tax liability of a business by

    dividing the income among several individual partners is tax

    avoidance. However, the facts of a particular investigation may show

    that an alleged partnership was not, in fact, established and that

    one or more of the alleged partners secretly returned his/her share

    of the profits to the real owner of the business, who, in turn, did

    not report this income. This would be an instance of attempted

    evasion.

    Internal Revenue Service, Internal Revenue Manual, part

    9.1.3.3.2.1, available at http://www.irs.gov/irm/part9/irm_09-001-003.html#d0e169.

    \326\ Although deceitful, deceptive, or illegitimate conduct may

    be sufficient to find that evasion has occurred, such conduct is not

    a prerequisite for a finding of evasion, particularly when other

    indicia of evasion are present, such as, for example, when the

    transaction lacks any business purpose.

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

    Request for Comment

    The CFTC requests comment on all aspects of the proposed anti-

    evasion rules, including the following:

    143. Are the CFTC's proposed rules and interpretive guidance set

    forth in this section sufficient to address the evasion concerns in

    Title VII? Is further guidance necessary? If so, what further guidance

    would be appropriate?

    [[Page 29868]]

    144. Is further definition of the term ``swap'' necessary to

    address transactions that have been structured to evade subtitle A of

    Title VII? If so, what further definition is appropriate, and why?

    Please provide specific examples or scenarios, and a detailed analysis

    of any such transactions and the guidance that would be appropriate.

    145. In addition to defining the term ``swap'' to address evasion

    generally, and with respect to certain foreign exchange products and

    identified banking products in particular, are CFTC rules prohibiting

    transactions from being willfully structured to evade or attempt to

    evade (similar to the proposed rules regarding activities conducted

    outside the United States) subtitle A of Title VII appropriate?

    B. SEC Request for Comment Regarding Anti-Evasion

    Section 761(b)(3) of the Dodd-Frank Act grants discretionary

    authority to the SEC to define the terms ``security-based swap,''

    ``security-based swap dealer,'' ``security-based major 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 subtitle B of Title VII (or

    amendments made by subtitle B). Section 772(b) of the Dodd-Frank Act

    states that the provisions of the Exchange Act that were added by Title

    VII (including any rule or regulation thereunder) shall not apply to

    any person insofar as that person transacts a business in security-

    based swaps outside the jurisdiction of the United States, unless such

    person transacts such business ``in contravention of such rules and

    regulations as the [SEC] may prescribe as necessary or appropriate to

    prevent evasion of any provision of [the Exchange Act] that was added

    by [Title VII].'' \327\

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

    \327\ See section 30(c) of the Exchange Act, 15 U.S.C. 78dd(c).

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

    The SEC is not proposing specific rules regarding anti-evasion at

    this time. The SEC may consider whether to propose anti-evasion rules

    based on comments received or after having experience with the new

    regulatory regime under subtitle B of Title VII.

    Request for Comment

    146. The SEC requests comment on whether SEC rules or interpretive

    guidance addressing anti-evasion regarding security-based swaps,

    security-based swap dealers, major security-based swap participants, or

    ECPs are necessary. Why or why not? Should the SEC adopt rules and

    interpretive guidance modeled on the CFTC's proposals? If other rules

    or interpretive guidance are necessary, please provide a detailed

    description of what rules or interpretative guidance would be

    necessary.

    147. Are SEC rules or interpretive guidance addressing evasion in

    the context of activities conducted outside the United States

    necessary? Why or why not? Should the SEC adopt rules and interpretive

    guidance modeled on the CFTC's proposals? If other rules or

    interpretive guidance are necessary, please provide a detailed

    description of what rules or interpretative guidance would be

    necessary.

    VIII. Administrative Law Matters--CEA Revisions

    A. Regulatory Flexibility Act

    The Regulatory Flexibility Act (``RFA'') requires that agencies

    consider whether the rules they propose will have a significant

    economic impact on a substantial number of small entities and, if so,

    provide a regulatory flexibility analysis respecting the impact.\328\

    Most of the entities that will be impacted by this proposed rulemaking

    have previously been determined to not be small entities. In addition,

    this proposed rulemaking, which provides interpretive guidance, general

    rules of construction and definitions that will largely be used in

    other rulemakings will, by itself, not impose a significant economic

    impact on market participants or entities.

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

    \328\ 5 U.S.C. 601 et seq.

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

    1. Effect of the Proposed Rulemaking

    The proposed rulemaking in this release further defines, and

    clarifies, the statutory terms ``swap,'' ``security-based swap,''

    ``security-based swap agreement,'' and ``mixed swap.'' It also provides

    a process for requesting joint interpretations from the Commissions as

    to whether agreements, contracts, and transactions are swaps, security-

    based swaps, or mixed swaps, as well as a process for requesting

    alternative regulatory treatment for certain mixed swaps. This proposed

    rulemaking also includes books and records, and data, requirements for

    SDRs, swap dealers, and major swap participants with respect to SBSAs,

    and implements the anti-evasion rulemaking authority granted to the

    CFTC under several provisions of the Dodd-Frank Act.

    Additionally, this release proposes interpretive guidance that the

    forward contract exclusion from the swap definition in the Dodd-Frank

    Act with respect to nonfinancial commodities should be read

    consistently with the forward contract exclusion from the CEA

    definition of the term ``future delivery.'' In that regard, the CFTC is

    proposing to retain the Brent Interpretation and extend it to apply to

    all nonfinancial commodities, and as a result, to withdraw the Energy

    Exemption,\329\ which had extended the Brent Interpretation regarding

    the forward contract exclusion from the term ``future delivery'' to

    energy commodities other than oil. The Energy Exemption listed certain

    ``appropriate persons'' that could rely on the exemption.

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

    \329\ Energy Exemption, supra note 72.

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

    The CFTC anticipates that this proposed rulemaking will affect

    primarily the following entities: DCMs, DCOs, ECPs, swap dealers, major

    swap participants, SEFs, SDRs, FBOTs, and those ``appropriate persons''

    who previously relied on the Energy Exemption.

    2. Specific Entities That Are Not Small Entities

    The vast majority of entities impacted by this proposed rulemaking

    previously have been determined to not be small entities by the CFTC.

    Prior to the enactment of the Dodd-Frank Act, the following entities

    had been determined by the CFTC to not be small entities for purposes

    of the RFA: DCMs, DCOs, and ECPs. Other entities that will be affected

    by this rulemaking, including swap dealers, major swap participants,

    SEFs, SDRs, and FBOTs, have been certified by the CFTC not to be small

    entities in other proposed recent CFTC rulemaking implementing

    requirements of the Dodd-Frank Act. Specifically:

    i. Swap Dealers, Major Swap Participants, SEFs, SDRs, and FBOTs.

    The CFTC previously has certified that swap dealers, major swap

    participants, SEFs, SDRs, and FBOTs are not small entities for purposes

    of the RFA.\330\ Nevertheless, because these are new categories of

    registrants under the Dodd-Frank Act, the CFTC is, again, hereby

    determining that these entities are not small entities.

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

    \330\ See respectively, Registration of Swap Dealers and Major

    Swap Participants, 75 FR 71379, 71385, Nov. 23, 2010 (swap dealers

    and major swap participants); Requirements for Derivatives Clearing

    Organizations, Designated Contract Markets, and Swap Execution

    Facilities Regarding the Mitigation of Conflicts of Interest, 75 FR

    63732, 63745, Oct. 18, 2010 (SEFs); Swap Data Repositories, 75 FR

    80898, 80926, Dec. 23, 2010 (SDRs); Registration of Foreign Boards

    of Trade, 75 FR 70974, 70987, Nov. 19, 2010 (FBOTs).

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

    a. Swap Dealers: As noted above, the CFTC previously has determined

    that FCMs are not small entities for the purpose of the RFA based upon,

    among

    [[Page 29869]]

    other things, the requirements that FCMs must meet, including certain

    minimum financial requirements that enhance the protection of

    customers' segregated funds and protect the financial condition of FCMs

    generally. Swap dealers similarly will be subject to minimum capital

    and margin requirements, and are expected to comprise the largest

    global financial firms. Entities that engage in a de minimis quantity

    of swap dealing in connection with transactions with or on behalf of

    customers will be exempt from designation as a swap dealer. For

    purposes of the RFA, the CFTC is hereby determining that swap dealers

    not be considered to be ``small entities'' for essentially the same

    reasons that FCMs previously have been determined not to be small

    entities.

    b. Major Swap Participants: The CFTC also previously has determined

    that large traders are not small entities for the purpose of the RFA.

    Major swap participants, among other things, maintain substantial

    positions in swaps, creating substantial counterparty exposure that

    could have serious adverse effects on the financial stability of the

    U.S. banking system or financial markets. For purposes of the RFA, the

    CFTC is hereby determining that major swap participants not be

    considered to be ``small entities'' for essentially the same reasons

    that large traders previously have been determined not to be small

    entities.

    c. SEFs: The Dodd-Frank Act defines a SEF to mean a trading system

    or platform in which multiple participants have the ability to accept

    bids and offers made by multiple participants in the facility or

    system, through any means of interstate commerce, including any trading

    facility that facilitates the execution of swaps between persons and is

    not a DCM. The CFTC previously has determined that DCMs are not small

    entities because, among other things, they may be designated only when

    they meet specific criteria, including expenditure of sufficient

    resources to establish and maintain adequate self-regulatory programs.

    Likewise, the CFTC will register an entity as a SEF only after it has

    met specific criteria, including the expenditure of sufficient

    resources to establish and maintain an adequate self-regulatory

    program. For purposes of the RFA, the CFTC is hereby determining that

    SEFs not be considered to be ``small entities'' for essentially the

    same reasons that DCMs previously have been determined to be small

    entities.

    d. SDRs: The CFTC previously has determined that DCMs and DCOs are

    not small entities because, among other things, of ``the central role''

    they play in ``the regulatory scheme concerning futures trading.''

    \331\ Because of the ``importance of futures trading in the national

    economy,'' to be designated as a contract market or registered as a

    DCO, the respective entity must meet stringent requirements set forth

    in the CEA. Similarly, swap positions that are recorded, reported and

    disseminated by SDRs will be an important part of the national economy.

    SDRs will receive data from market participants and will be obligated

    to facilitate swap execution by reporting real-time data. Similar to

    DCMs and DCOs, SDRs will play a central role both in the regulatory

    scheme concerning swap trading. Additionally, the Dodd-Frank Act

    permits DCOs to register as SDRs. For purposes of the RFA, the CFTC is

    hereby determining that SDRs not be considered to be ``small entities''

    for essentially the same reasons that DCMs and DCOs previously have

    been determined not to be small entities.

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

    \331\ Policy Statement and Establishment of Definitions of

    ``Small Entities'' for Purposes of the Regulatory Flexibility Act,

    47 FR 18618, Apr. 30, 1982.

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

    e. FBOTs. The term ``foreign board of trade'' has been used in the

    CEA and in the CFTC's Regulations to refer to a board of trade

    ``located outside the U.S.'' \332\ The term ``board of trade'' is

    defined in the CEA as ``any organized exchange or trading facility.''

    \333\ An ``organized exchange,'' in turn, includes designated or

    registered exchanges, such as DCMs.\334\ The CFTC previously has

    determined that DCMs are not ``small entities.'' As noted above,

    because of DCMs' importance to the economy, they must meet stringent

    requirements set forth in the CEA. Similarly, the CFTC will register an

    FBOT only after it has met criteria similar to those required of a DCM.

    Critically, an FBOT will be registered only after demonstrating, among

    other things, that it possesses the attributes of an organized

    exchange, adheres to appropriate rules prohibiting abusive trading

    practices, and enforces appropriate rules to maintain market and

    financial integrity. Because FBOTs and DCMs are functionally equivalent

    entities, for purposes of the RFA, the CFTC hereby is determining that

    FBOTs not be considered to be small entities for essentially the same

    reasons that DCMs previously have been determined not to be small

    entities.

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

    \332\ See CEA section 4(a), 7 U.S.C. 6(a); CFTC rule 1.33(ss),

    17 C.F.R. 1.33(ss).

    \333\ CEA section 1a(2), 7 U.S.C. 1a(2).

    \334\ CEA section 1a(27), 7 U.S.C. 1a(27).

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

    ii. DCMs, DCOs, and ECPs. The CFTC previously has determined that

    DCMs, DCOs, and ECPs, are not small entities for purposes of the

    Regulatory Flexibility Act.\335\ The Dodd-Frank Act requires that

    counterparties to swaps that are traded on a bilateral basis not on or

    subject to the rules of a DCM be ECPs. Prior to the enactment of the

    Dodd-Frank Act, ECPs trading swaps were generally outside the scope of

    CFTC oversight under the CEA. The CFTC cannot estimate with precision

    the number of non-ECPs that will, as permitted by the Dodd-Frank Act,

    trade swaps on DCMs. Nevertheless, this proposed rulemaking by the CFTC

    provides proposed further definitions of the terms ``swap,''

    ``security-based swap,'' ``mixed swap'' and ``security-based swap

    agreement,'' and proposes rules of construction and interpretive

    guidance (including guidance as to agreements, contracts, and

    transactions that are not included within the scope of the swap

    definition), that will largely be used in other rulemakings and which,

    by themselves, do not impose significant new regulatory requirements on

    market participants.

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

    \335\ See respectively, Policy Statement and Establishment of

    Definitions of ``Small Entities'' for Purposes of the Regulatory

    Flexibility Act, supra note 331, at 18619 (DCMs); A New Regulatory

    Framework for Clearing Organizations, 66 FR 45604, 45609, Aug. 29,

    2001 (DCOs); Opting Out of Segregation. 66 FR 20740, 20743, Apr. 25,

    2001 (ECPs).

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

    iii. ``Appropriate Persons'' who relied on the Energy Exemption.

    The Energy Exemption listed certain ``appropriate persons'' that could

    rely on the exemption and also required that, to be eligible for this

    exemption, an ``appropriate person'' must have a demonstrable capacity

    or ability to make or take delivery. The Energy Exemption stated: ``in

    light of the general nature of the current participants in the market,

    the CFTC believes that smaller commercial firms, which cannot meet

    [certain] financial criteria, should not be included.'' \336\

    Therefore, the CFTC does not believe that the ``appropriate persons''

    eligible for the Energy Exemption, and who may be affected by its

    withdrawal, are ``small entities'' for purposes of RFA.

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

    \336\ Energy Exemption, supra note 72.

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

    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 impact on a substantial number of small entities.

    Nonetheless, the CFTC specifically requests comment on the impact that

    this proposed rulemaking may have on small entities.

    [[Page 29870]]

    B. Paperwork Reduction Act

    1. Introduction

    Proposed CFTC rules 1.8 and 1.9 would result in new ``collection of

    information'' requirements within the meaning of the Paperwork

    Reduction Act of 1995 (``PRA''). An agency may not conduct or sponsor,

    and a person is not required to respond to, a collection of information

    unless it displays a currently valid Office of Management and Budget

    (OMB) control number.

    2. Summary of the Proposed Requirements

    Proposed rule 1.8 of the CEA would allow persons to submit a

    request for a joint interpretation from the Commissions regarding

    whether an agreement, contract or transaction (or a class thereof) is a

    swap, security-based swap, or mixed swap. Proposed rule 1.8 provides

    that a person requesting an interpretation as to the nature of an

    agreement, contract, or transaction as a swap, security-based swap, or

    mixed swap must provide the Commissions with the person's determination

    of the nature of the instrument and supporting analysis, along with

    certain other documentation, including a statement of the economic

    purpose for, and a copy of all material information regarding the terms

    of, each relevant agreement, contract, or transaction (or class

    thereof). The Commissions also may request the submitting person to

    provide additional information. In response to the submission, the

    Commissions may issue a joint interpretation regarding the status of

    that agreement, contract, or transaction (or class of agreements,

    contracts, or transactions) as a swap, security-based swap, or mixed

    swap.

    Proposed rule 1.9 enables persons to submit requests to the

    Commissions for joint orders providing an alternative regulatory

    treatment for particular mixed swaps. Under proposed rule 1.9, a person

    would provide to the Commissions a statement of the economic purpose

    for, and a copy of all material information regarding, the relevant

    mixed swap. In addition, the person would provide the specific

    alternative provisions that the person believes should apply to the

    mixed swap, the reasons the person believes it would be appropriate to

    request an alternative regulatory treatment, and an analysis of: (i)

    The nature and purposes of the specified provisions; (ii) the

    comparability of the specified provisions to other statutory provisions

    of Title VII of the Dodd-Frank Act and the rules and regulations

    thereunder; and (iii) the extent of any conflicting or incompatible

    requirements of the specified provisions and other statutory provisions

    of Title VII and the rules and regulations thereunder. The Commissions

    also may request the submitting person to provide additional

    information.

    3. Information Provided by Reporting Entities

    The burdens imposed by proposed CFTC rules 1.8 and 1.9 are the same

    as the burdens imposed by the SEC's proposed rules 3a68-2 and 3a68-4.

    Therefore, the burdens that would be imposed on market participants

    under CFTC rules 1.8 and 1.9 already have been accounted for within the

    SEC's calculations regarding the impact of this collection of

    information under the PRA and the request for a control number that

    will be submitted by the SEC to OMB.\337\

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

    \337\ 44 U.S.C. 3501-3521. See also 44 U.S.C. 3509 and 3510.

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

    4. Information Collection Comments

    The CFTC invites public comment on any aspect of the reporting and

    recordkeeping burdens discussed above. Pursuant to 44 U.S.C.

    3506(c)(2)(B), the CFTC solicits comments in order to: (i) Evaluate

    whether the proposed collections of information are necessary for the

    proper performance of the functions of the CFTC, including whether the

    information will have practical utility; (ii) evaluate the accuracy of

    the CFTC's estimate of the burden of the proposed collections 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 collections 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 OMB's Office of

    Information and Regulatory Affairs, by fax at (202) 395-6566 or by e-

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

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

    addressed in the preamble to the final rulemaking. Please refer to the

    Addresses section of this notice of proposed rulemaking for comment

    submission instructions to the CFTC. A copy of the supporting

    statements for the collections of information discussed above may be

    obtained by visiting RegInfo.gov. OMB is required to make a decision

    concerning the collections of information between 30 and 60 days after

    publication of this release in the Federal Register. Consequently, a

    comment to OMB is most ensured of being fully effective if received by

    OMB (and the CFTC) within 30 days after publication of this release.

    Nothing in the foregoing affects the deadline enumerated above for

    public comment to the CFTC on the rules and interpretive guidance

    proposed herein.

    C. Cost-Benefit Analysis

    CEA section 15(a) \338\ 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: (i) Protection

    of market participants and the public; (ii) efficiency,

    competitiveness, and financial integrity of futures markets; (iii)

    price discovery; (iv) sound risk management practices; and (v) 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.

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

    \338\ 7 U.S.C. 19(a).

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

    1. Costs and Benefits of the Proposed Definitions

    The proposed rulemaking and interpretive guidance would further

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

    swap agreement,'' and ``mixed swap.'' The scope of the definitions of

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

    agreement,'' and ``mixed swap'' will be an important factor in

    determining the scope of activities and entities that will be subject

    to various requirements set forth in the Dodd-Frank Act, such as

    reporting, registration, business conduct, and capital requirements.

    Those requirements, which will be implemented in rules proposed or to

    be proposed by the CFTC, will likely lead to compliance costs, capital

    holding costs, and other costs, which have been or will be addressed in

    the CFTC's proposals to implement those requirements.

    [[Page 29871]]

    Yet, the CFTC believes that the proposal to further define the

    terms ``swap,'' ``security-based swap,'' ``security-based swap

    agreement,'' and ``mixed swap'' is, for the most part, in line with the

    expectations of market participants and does not depart significantly

    from how market participants would interpret the statutory definitions

    of these terms set forth in Title VII of the Dodd-Frank Act. Thus, the

    CFTC does not believe that the proposed rules and interpretive guidance

    further defining these terms impose any significant incremental costs

    beyond the costs associated with the statutory definitions.

    The CFTC also believes that the proposed rules and guidance

    regarding the definitions will lead to benefits in the form of

    increased market transparency, reduced systemic risk, and a lower

    incidence of market-wide crises and other market failures. Further, the

    proposed rules and guidance can be consistently applied by

    substantially all market participants to determine which agreements,

    contracts, or transactions are, and which are not, swaps, security-

    based swaps, security-based swap agreements, or mixed swaps. Thus, the

    proposed rules and interpretive guidance will help to create a level

    playing field. Market participants will be able to use Title VII

    instruments more efficiently and the swap markets will operate more

    effectively because all market participants will be relying on

    consistent and clear definitions. The clarity provided by the proposed

    rules and interpretive guidance relating to the definitions is in the

    public interest because this clarity will permit the public to better

    evaluate information about Title VII instruments made available under

    the Dodd-Frank Act. In particular, they will allow market participants

    to better understand publicly-available price data. The clarity of the

    definitions also has the potential to ease the negotiation of Title VII

    instruments and reduce other transaction costs. These factors are

    expected to permit the public to make a more extensive use of Title VII

    instruments for risk management and other purposes.

    The CFTC requests comment as to the costs and benefits of the

    proposed rules and interpretive guidance regarding the definitions for

    market participants, markets, and the public. In particular, comment is

    requested as to whether there are any aspects of the proposed rules and

    interpretive guidance regarding the definitions that are both

    burdensome to apply and not helpful to achieving clarity as to the

    scope of the defined terms. In addition, are there less burdensome

    means of providing clarity as to the scope of the defined terms?

    2. Costs and Benefits of Proposed Rules and Interpretive Guidance

    Regarding Insurance

    Proposed CFTC rule 1.3(xxx)(4) under the CEA would clarify that

    insurance products that meet certain requirements, that are provided by

    state or Federally regulated insurance companies, and that are

    regulated as insurance products, would not be swaps. Specifically,

    proposed rule 1.3(xxx)(4) would define the term ``swap'' so that it

    would not include an agreement, contract, or transaction that, by its

    terms or by law, as a condition of performance on the agreement,

    contract, or transaction: (i) Requires the beneficiary to have an

    insurable interest that is the subject of the agreement, contract, or

    transaction and thereby carry the risk of loss with respect to that

    interest continuously throughout the duration of the agreement,

    contract, or transaction; (ii) requires that loss to occur and to be

    proved, and that any payment or indemnification therefore be limited to

    the value of the insurable interest, separately from the insured

    interest; (iii) is not traded, separately from the insured interest, on

    an organized market or over-the-counter; and (iv) with respect to

    financial guarantee insurance only, in the event of payment default or

    insolvency of the obligor, any acceleration of payments under the

    policy is at the sole discretion of the insurer.

    Proposed rule 1.3(xxx)(4) also would require that the agreement,

    contract, or transaction: (i) Be provided by a person or entity that is

    organized as an insurance company whose primary and predominant

    business activity is the writing of insurance or the reinsuring of

    risks underwritten by insurance companies and that is subject to

    supervision by the insurance commissioner, or similar official or

    agency, of a state (as defined under section 3(a)(16) of the Exchange

    Act \339\) or by the United States or an agency or instrumentality

    thereof, and be regulated as insurance under the laws of such state or

    the United States; (ii) be provided by the United States or any of its

    agents or instrumentalities, or pursuant to a statutorily authorized

    program thereof; or (iii) in the case of reinsurance only, be provided

    by a person located outside the United States to an insurance company

    that meets the above requirements, provided that such person is not

    prohibited by the law of any state or the United States from offering

    such agreement, contract, or transaction to such insurance company, the

    product to be reinsured meets the requirements above for insurance

    products, and the total amount reimbursable by all reinsurers for such

    insurance product cannot exceed the claims or losses paid by the

    cedant.

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

    \339\ 15 U.S.C. 78c(a)(16).

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

    An agreement, contract, or transaction would have to meet all of

    these criteria in order to qualify as an insurance product that falls

    outside of the swap and security-based swap definitions pursuant to the

    proposed rules. The Commissions also are proposing interpretative

    guidance to clarify that certain enumerated types of traditional

    insurance products, such as life insurance, health insurance, and

    property and casualty insurance, are outside the scope of the statutory

    swap and security-based swap definitions.

    (a) Costs

    In complying with proposed rule 1.3(xxx)(4), a market participant

    will need to ascertain whether an agreement, contract, or transaction

    is an insurance product according to the criteria set forth in the

    definition. This analysis will have to be performed upon entering into

    the agreement, contract, or transaction to ensure compliance with the

    proposed rule. Absent this analysis, however, the cost associated with

    the uncertainty cited by commenters as to whether an agreement,

    contract, or transaction that the participants consider to be insurance

    could instead be regulated as a swap is expected to be greater than the

    cost of the analysis proposed herein.

    To the extent that the criteria under proposed rule 1.3(xxx)(4)

    inadvertently fail to exclude certain types of insurance products from

    the proposed definitions, these failures could lead to costs for market

    participants entering into agreements, contracts, or transactions that

    might be improperly regulated as swaps and not as insurance products.

    Similarly, to the extent that the criteria under the proposed rule lead

    to the inadvertent treatment of certain types of swaps as insurance,

    costs for market participants entering into agreements, contracts, or

    transactions that are improperly regulated as insurance products and

    not as swaps may increase.

    (b) Benefits

    The proposed rule and interpretative guidance regarding insurance

    will help to assure that traditional insurance products remain subject

    to the current regulatory scheme for insurance and not to the

    regulatory regime established by the Dodd-Frank Act for swaps. Market

    [[Page 29872]]

    participants, therefore, will be able to continue to rely on their

    previous understanding of insurance regulations without any additional

    burden that may have resulted if they had to instead comply with

    regulations under the Dodd-Frank Act.

    Without the proposed rule and interpretative guidance herein,

    market participants may be uncertain about whether an agreement,

    contract, or transaction is an insurance product that is subject to

    regulation as a swap. Proposed rule 1.3(xxx)(4) is intended to

    eliminate the potential uncertainty of what constitutes an insurance

    product by setting forth clear and objective criteria for determining

    that an agreement, contract, or transaction is an insurance product

    that is not subject to regulation as a swap. Providing such an

    objective rule and guidance alleviates additional costs of inquiring

    with the Commissions, or obtaining an opinion of counsel, about whether

    an agreement, contract, or transaction is an insurance product or a

    swap. The added clarity provided by the rule and guidance proposed

    herein will enhance the efficiency of the swaps market and also allow

    market participants to engage in sound risk management practices

    because they will be readily able to consider whether a particular

    agreement, contract, or transaction is insurance or a swap at the

    outset.

    The CFTC requests comment as to the costs and benefits of proposed

    rule 1.3(xxx)(4) and interpretive guidance contained herein to

    distinguish between insurance products and swaps for market

    participants, markets, and the public.

    3. Costs and Benefits of Proposed Rule Regarding Foreign Exchange

    Products and Forward Rate Agreements

    Proposed CFTC rule 1.3(xxx)(2) under the CEA would explicitly

    define the term ``swap'' to include an agreement, contract, or

    transaction that is a cross-currency swap, currency option, foreign

    currency option, foreign exchange option, foreign exchange rate option,

    foreign exchange forward, foreign exchange swap, forward rate

    agreement, and non-deliverable forward involving foreign exchange,

    unless such agreement, contract, or transaction is otherwise excluded

    by section 1a(47)(B) of the CEA. Proposed rule 1.3(xxx)(2) also

    provides that: (i) A foreign exchange forward or a foreign exchange

    swap shall not be considered a swap if the Secretary of the Treasury

    makes the determination described in CEA section 1a(47)(E)(i); and (ii)

    notwithstanding any such determination, certain provisions of the CEA

    will apply to such foreign exchange forward or foreign exchange swap

    (specifically, the reporting requirements in section 4r of the CEA and

    regulations thereunder and, in the case of a swap dealer or major swap

    participant that is a party to a foreign exchange swap or foreign

    exchange forward, the business conduct standards in section 4s of the

    CEA and regulations thereunder). Proposed rule 1.3(xxx)(2) further

    clarifies that a currency swap, cross-currency swap, currency option,

    foreign currency option, foreign exchange option, foreign exchange rate

    option, or non-deliverable forward involving foreign exchange is not a

    foreign exchange forward or foreign exchange swap subject to a

    determination by the Secretary of the Treasury as described above.

    (a) Costs

    In complying with proposed rule 1.3(xxx)(2), a market participant

    will need to ascertain whether an agreement, contract, or transaction

    is a swap under the definition. This analysis will have to be performed

    upon entering into the agreement, contract, or transaction to ensure

    compliance with the proposed rule. However, any costs associated with

    this analysis are expected to be less than the costs of doing the same

    analysis absent the proposed rule, particularly given potential

    confusion in the event of a determination by the Secretary of the

    Treasury that foreign exchange forwards and/or foreign exchange swaps

    not be considered swaps. To the extent that proposed rule 1.3(xxx)(2)

    leads to the improper inclusion of certain types of agreements,

    contracts, and transactions in the swap definition, and therefore the

    imposition of additional requirements and obligations, these

    requirements and obligations could lead to costs for market

    participants entering into such agreements, contracts, or transactions.

    (b) Benefits

    Because the statutory definition of the term ``swap'' includes a

    process by which the Secretary of the Treasury may determine that

    certain agreements, contracts, and transactions that meet the statutory

    definition of a ``foreign exchange forward'' or ``foreign exchange

    swap,'' respectively,\340\ shall not be considered a swap, the CFTC is

    concerned that application of the definition, without further

    clarification, may cause uncertainty about whether, if the Secretary of

    the Treasury makes such a determination, certain agreements, contracts,

    or transactions would be swaps. Proposed rule 1.3(xxx)(2) would clarify

    that a currency swap, cross-currency swap, currency option, foreign

    currency option, foreign exchange option, foreign exchange rate option,

    or non-deliverable forward involving foreign exchange is a swap (unless

    it is otherwise excluded by the statutory definition of the term

    ``swap''). The proposed rule also would clarify that reporting

    requirements, and business conduct requirements for swap dealers and

    major swap participants, are applicable to foreign exchange forwards

    and foreign exchange swaps even if the Secretary of the Treasury

    determines that they should not be considered swaps. The CFTC also is

    concerned that confusion could be generated by the ``forward'' label of

    non-deliverable forwards involving foreign exchange, and forward rate

    agreements. Proposed rule 1.3(xxx)(2) would clarify that these types of

    agreements, contracts, and transactions are swaps.

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

    \340\ CEA section 1a(24), 7 U.S.C. 1a(24)(definition of a

    ``foreign exchange forward''); CEA section 1a(25), 7 U.S.C.

    1a(25)(definition of a ``foreign exchange swap'').

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

    Providing a clarifying rule to market participants to determine

    whether certain types of agreements, contracts, or transactions are

    swaps alleviates additional costs to persons of inquiring with the

    Commissions, or obtaining an opinion of counsel, about whether such

    agreements, contracts, or transactions are swaps. In addition, a

    clarifying rule regarding the requirements that apply to foreign

    exchange forwards and foreign exchange swaps that are subject to a

    determination by the Secretary of the Treasury similarly alleviates

    additional costs to persons of inquiring with the Commissions, or

    obtaining an opinion of counsel, to determine the requirements that are

    applicable to such foreign exchange forwards and foreign exchange

    swaps. As with the other rules related to product definitions, added

    clarity will increase the efficiency of the swaps market and also will

    enable market participants to engage in sound risk management

    practices, which will benefit both market participants and the public.

    The CFTC requests comment as to the costs and benefits of proposed

    rule 1.3(xxx)(2) for market participants, markets, and the public.

    4. Costs and Benefits of Proposed Rules and Interpretive Guidance

    Regarding Title VII Instruments Where the Underlying Reference Is a

    Security Index

    Proposed CFTC rule 1.3(yyy)(1) provides that, for purposes of the

    security-based swap definition, the term ``narrow-based security

    index'' would have the same meaning as the statutory definition set

    forth in CEA section

    [[Page 29873]]

    1a(35), and the rules, regulations, and orders issued by the

    Commissions relating to such definition. As a result, except as the new

    rules the Commissions are proposing provide for other treatment, market

    participants generally will be able to use the Commissions' past

    guidance in determining whether certain Title VII instruments based on

    a security index are swaps or security-based swaps.

    The Commissions also are proposing interpretive guidance and

    additional rules regarding Title VII instruments based on a security

    index. The interpretive guidance and additional rules set forth new

    narrow-based security index criteria with respect to indexes composed

    of securities, loans, or issuers of securities referenced by an index

    CDS. The proposed interpretive guidance and rules also address the

    definition of an ``index'' and the treatment of broad-based security

    indexes that become narrow-based and narrow-based indexes that become

    broad-based, including rule provisions regarding tolerance and grace

    periods for swaps on security indexes that are traded on CFTC-regulated

    trading platforms.

    (a) Costs

    In complying with the proposed rules, a market participant will

    need to ascertain whether an index CDS is a swap or a security-based

    swap according to the criteria set forth in the definitions of the

    terms ``issuers of securities in a narrow-based security index'' and

    ``narrow-based security index'' as used in the security-based swap

    definition. This analysis will have to be performed upon entering into

    an index CDS, and when the material terms of an index CDS are amended

    or modified, to ensure compliance with proposed rules 1.3(zzz) or

    1.3(aaaa). However, any such costs are expected to be less than the

    costs of doing the same analysis absent the proposed rules, which the

    CFTC believes would be more difficult and lead to greater uncertainty.

    Proposed rules 1.3(zzz) and 1.3(aaaa) allow market participants to

    minimize the costs of determining whether an index CDS is a swap or a

    security-based swap by providing a test with objective criteria that is

    similar to a test with which they already are familiar in the security

    futures context, yet tailored to index CDS in particular.

    Additionally, absent proposed rule 1.3(yyy), which applies the

    tolerance period rules, if a security index underlying a Title VII

    instrument traded on a trading platform migrated from being broad-based

    to being narrow-based, market participants may suffer disruption of

    their ability to offset or enter into new Title VII instruments, and

    incur additional costs as a result.

    (b) Benefits

    Proposed rules 1.3(zzz) and 1.3(aaaa) would clarify the treatment

    of an index CDS as either a swap or a security-based swap by setting

    forth objective criteria for meeting the definition of the terms

    ``issuers of securities in a narrow-based security index'' and

    ``narrow-based security index,'' respectively. These objective rules

    will alleviate additional costs to persons trading index CDS of

    inquiring with the Commissions, or obtaining an opinion of counsel, to

    make complex determinations regarding whether an index is broad- or

    narrow-based, and whether an index CDS based on such an underlying

    index is a swap or security-based swap.

    Also, proposed rules 1.3(zzz) and 1.3(aaaa) should reduce the

    potential for market participants to use an index CDS to evade

    regulations, because they set objective requirements relating to the

    concentration of the notional amount allocated to each reference entity

    or security included in the index, as well as the eligibility

    conditions for reference entities and securities. Finally, these

    proposed rules benefit the public by requiring that the providers of

    index CDS make publicly available sufficient information regarding the

    reference entities in an index underlying the index CDS. By requiring

    that such information be made publicly available, proposed rules

    1.3(zzz) and 1.3(aaaa) seek to assure the transparency of the index

    components that will be beneficial to market participants who trade

    such instruments and to the public.

    Separately, proposed rule 1.3(yyy) addresses exchange-traded swaps

    based on security indexes where the underlying index migrates from

    broad-based to narrow-based. The proposed rule includes provisions that

    many market participants are familiar with from security futures

    trading. The CFTC believes that by using a familiar regulatory scheme,

    market participants will be able to more readily understand the

    proposed rule as compared to a wholly new regulatory scheme. Also, the

    proposal of a ``tolerance period'' for swaps on security indexes that

    migrate from broad-based to narrow-based also creates greater clarity

    by establishing a 45-day timeframe (and subsequent grace period) on

    which market participants may rely. This tolerance period results in

    cost savings when compared to the alternative scenario where no

    tolerance period is provided and a migration of an index from broad-

    based to narrow-based would result in potential impediments to the

    ability of market participants to offset their swap positions.

    Finally, the Commissions are proposing interpretive guidance that

    the determination of whether a Title VII instrument is a swap, a

    security-based swap, or both (i.e., a mixed swap), is made at the

    execution of the Title VII instrument. If the security index underlying

    a Title VII instrument migrates from being broad-based to being narrow-

    based, or vice versa, during the life of a Title VII instrument, the

    characterization of that Title VII instrument would not change from its

    initial characterization regardless of whether the Title VII instrument

    was entered into bilaterally or was executed through a trade on or

    subject to the rules of a DCM, SEF, FBOT, security-based SEF, or NSE.

    Absent this guidance, market participants may need to expend additional

    resources to continually monitor their swaps to see if the indexes on

    which they are based have migrated from broad-based to narrow-based.

    Since the proposal provides that the initial determination prevails

    regardless of whether the underlying index migrates from broad-based to

    narrow-based, market participants do not need to expend these

    monitoring costs.

    The CFTC requests comment as to the costs and benefits of proposed

    rules 1.3(yyy), 1.3(zzz), and 1.3(aaaa), and the proposed guidance

    contained herein, regarding Title VII instruments where the underlying

    reference is a security index, and regarding index CDS, for market

    participants, markets, and the public.

    5. Costs and Benefits of Processes To Determine Whether a Title VII

    Instrument Is a Swap, Security-Based Swap, or Mixed Swap, and To

    Determine Regulatory Treatment for Mixed Swaps

    (a) Costs

    Proposed rule 1.8 under the CEA would allow persons to submit a

    request for a joint interpretation from the Commissions regarding

    whether an agreement, contract or transaction (or a class of

    agreements, contracts, or transactions) is a swap, security-based swap,

    or mixed swap. The CFTC estimates the cost of submitting a request for

    a joint interpretation pursuant to rule 1.8 would be approximately 20

    hours of internal company or individual time and a cost of $9,480 for

    the services of outside professionals. Once such a joint interpretation

    is made, however, other market participants that seek to transact in

    the same agreement, contract, or

    [[Page 29874]]

    transaction (or class thereof) would have regulatory clarity about

    whether it is a swap, security-based swap, or mixed swap.

    Separately, proposed CFTC rule 1.9 under the CEA allows persons to

    submit a request for a joint order from the Commissions regarding an

    alternative regulatory treatment for particular mixed swaps. This

    process applies except with respect to bilateral, uncleared mixed swaps

    where one of the parties to the mixed swap is dually registered with

    the CFTC as a swap dealer or major swap participant and with the SEC as

    a security-based swap dealer or major security-based swap participant.

    With respect to bilateral uncleared mixed swaps where one of the

    parties is a dual registrant, the proposed rule provides that such

    mixed swaps would be subject to a regulatory scheme set forth in rule

    1.9 in order to provide clarity as to the regulatory treatment of such

    mixed swaps.

    The CFTC estimates that the cost of submitting a request for a

    joint order seeking an alternative regulatory treatment for a

    particular mixed swap would be approximately 30 hours of internal

    company or individual time and a cost of approximately $15,800 for the

    services of outside professionals. Absent such a process, though,

    market participants that desire or intend to enter into such a mixed

    swap (or class thereof) would be required pursuant to Title VII of the

    Dodd-Frank Act to comply with all regulatory requirements applicable to

    both swaps and security-based swaps. The CFTC believes that the cost of

    such dual regulation would likely be at least as great, if not greater,

    than the costs of the process set forth in proposed rule 1.9 to request

    an alternative regulatory treatment for such the mixed swap. The

    proposed rule regarding bilateral uncleared mixed swaps where at least

    one party is a dual registrant does not entail any additional costs,

    and may reduce costs for dual registrants that enter into such mixed

    swaps by eliminating potentially duplicative or inconsistent

    regulation.

    (b) Benefits

    The CFTC believes that the proposed rules that enable market

    participants to submit requests for joint interpretations regarding the

    nature of various agreements, contracts, or transactions, and requests

    for joint orders regarding the regulatory treatment of mixed swaps,

    will help to create a level playing field (since the joint

    interpretations and joint orders will be available to all market

    participants) regarding which agreements, contracts, or transactions

    constitute swaps, security-based swaps, or mixed swaps, and the

    regulatory treatment applicable to particular mixed swaps. The

    availability of such joint interpretations and joint orders regarding

    the scope of the definitions and the regulatory treatment of mixed

    swaps will reduce transaction costs and thereby promote the use of

    Title VII instruments and the efficient operation of the swap markets.

    This, in turn, is expected to encourage the use of Title VII

    instruments for risk management and other purposes. The separate

    proposed rule for bilateral uncleared mixed swaps where at least one

    party is dually registered should eliminate potentially duplicative and

    inconsistent regulation.

    The CFTC requests comment as to the costs and benefits of the

    processes for seeking joint interpretations and joint orders in

    proposed rules 1.8 and 1.9, respectively, for market participants,

    markets, and the public.

    6. Costs and Benefits of SBSA Books and Records, and Data, Requirements

    Proposed CFTC rule 1.7 under the CEA would clarify that there would

    not be books and records, or data, requirements regarding SBSAs other

    than those that would exist for swaps. The proposed rule alleviates any

    additional books and records or information costs to persons who are

    required to keep and maintain books and records regarding, or collect

    and maintain data regarding, SBSAs because the proposed rule does not

    require such persons to keep or maintain any books and records, or

    collect and maintain any data, regarding, SBSAs that differs from the

    books, records, and data required regarding swaps.

    Specifically, proposed rule 1.7 would require persons registered as

    SDRs to: (i) keep and maintain books and records regarding SBSAs only

    to the extent that SDRs are required to keep and maintain books and

    records regarding swaps; and (ii) collect and maintain data regarding

    SBSAs only to the extent that SDRs are required to collect and maintain

    data regarding swaps. In addition, proposed rule 1.7 would require

    persons registered as swap dealers or major swap participants to keep

    and maintain books and records, including daily trading records,

    regarding SBSAs only to the extent that those persons would be required

    to keep and maintain books and records regarding swaps.

    Because proposed rule 1.7 imposes no requirements with respect to

    SBSAs other than those that exist for swaps, proposed rule 1.7 would

    impose no costs other than those that are required with respect to

    swaps in the absence of proposed rule 1.7. Proposed rule 1.7 provides

    clarity by establishing uniform requirements regarding books and

    records, and data collection, requirements for swaps and for SBSAs.

    The CFTC requests comment as to the costs and benefits of proposed

    rule 1.7 for market participants, markets, and the public.

    7. Costs and Benefits of the Proposed Interpretive Guidance Regarding

    the Forward Contract Exclusion From the Swap Definition

    The CFTC is proposing interpretive guidance that the forward

    contract exclusion from the swap definition for nonfinancial

    commodities should be read consistently with the forward contract

    exclusion from the CEA definition of the term ``future delivery.'' In

    that regard, the CFTC is proposing to retain the Brent Interpretation

    and extend it to apply to all nonfinancial commodities, and to withdraw

    the Energy Exemption which had extended the Brent Interpretation

    regarding the forward contract exclusion from the term ``future

    delivery'' to energy commodities other than oil. The CFTC also is

    proposing that its prior guidance regarding commodity options embedded

    in forward contracts should be applied as well to the treatment of

    forward contracts in nonfinancial commodities that contain embedded

    options under the Dodd-Frank Act.

    The CFTC anticipates that its proposed interpretive guidance

    construing the forward contract exclusion consistently with respect to

    the definitions of the terms ``swap'' and ``future delivery'' in this

    manner will not impose any material costs on market participants. It

    also will establish a uniform interpretation of the forward contract

    exclusion for the definitions of both statutory terms, which will avoid

    the significant costs that some commenters stated would result if the

    forward contract exclusion were construed differently in these two

    contexts.\341\

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    \341\ See EEI Letter (``Without legal certainty as to the

    regulatory treatment of their forward contracts, EEI's members and

    other end users who rely on the forward contract exclusion likely

    will face higher transaction costs due to greater uncertainty. These

    increased transaction costs may include: (i) More volatile or higher

    commodity prices; and (ii) increased credit costs, in each case

    caused by changes in market liquidity as end users change the way

    they transact in the commodity markets. A single regulatory approach

    that uses the same criteria to confirm that a forward contract is

    excluded from the Commission's jurisdiction over swaps and futures

    will reduce this uncertainty and the associated costs to end

    users.'' (footnote omitted)).

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

    The CFTC requests comment as to the costs and benefits of the

    proposed interpretative guidance regarding the

    [[Page 29875]]

    forward contract exclusion from the swap definition, including the

    retention of the Brent Interpretation and its extension to all

    nonfinancial commodities and the withdrawal of the Energy Exemption,

    for market participant, markets, and the public.

    8. Costs and Benefits of the Proposed Anti-Evasion Rules and

    Interpretive Guidance

    The CFTC is proposing to exercise the anti-evasion rulemaking

    authority granted to it by the Dodd-Frank Act. Generally, proposed CFTC

    rule 1.3(xxx)(6) under the CEA would define as a swap any agreement,

    contract, or transaction that is willfully structured to evade (or as

    an attempt to evade) the provisions of Title VII governing the

    regulation of swaps. Further, proposed CFTC rule 1.6 under the CEA

    would prohibit activities conducted outside the United States,

    including entering into agreements, contracts, and transactions and

    structuring entities, to willfully evade any provision of the CEA as

    enacted by Title VII or the rules and regulations promulgated

    thereunder.

    As opposed to providing a bright-line test, proposed rule

    1.3(xxx)(6) would apply to agreements, contracts, and transactions, and

    proposed rule 1.6 would apply to agreements, contracts, transactions

    and entities, that are willfully structured to evade (or as an attempt

    to evade) the provisions of Title VII governing the regulation of

    swaps. Although this test does not provide a bright line, it helps

    ensure that would-be evaders cannot intentionally structure their

    transactions or entities for the sole purpose of evading the

    requirements of Title VII. The CFTC also is proposing interpretive

    guidance as to certain types of circumstances that may constitute an

    evasion of the requirements of Title VII, while at the same time

    preserving the CFTC's ability to determine, on a case-by-case basis,

    that other types of transactions or actions constitute an evasion of

    the requirements of the statute or the regulations promulgated

    thereunder. This will promote the enforcement of the anti-evasion rules

    in a manner that does not inappropriately interfere with activities

    undertaken for legitimate business purposes.

    Absent the proposed anti-evasion rules and interpretive guidance,

    price discovery would be impaired because markets would not be informed

    about those transactions. Additionally, systemic risk could increase in

    a manner that the CFTC would not be able to measure accurately. The

    proposed anti-evasion rules and interpretive guidance will bring the

    appropriate scope of transactions and entities within the regulatory

    framework established by the Dodd-Frank Act, which will better allow

    the CFTC to assure transparency and address systemic risk.

    Request for Comment

    148. After considering the costs and benefits of the proposed rules

    and interpretive guidance as discussed in this section, the CFTC has

    determined to issue the proposal. The CFTC invites public comment on

    all of its cost-benefit considerations. Commenters are requested to

    submit empirical data or other factual information quantifying or

    qualifying the costs and benefits of the proposed rules and

    interpretive guidance with their comments, to the extent possible.

    D. Consideration of Impact on the Economy

    For purposes of the Small Business Regulatory Enforcement Fairness

    Act of 1996 (``SBREFA'') \342\ 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: (i) An annual effect on

    the economy of $100 million or more (either in the form of an increase

    or a decrease); (ii) a major increase in costs or prices for consumers

    or individual industries; or (iii) 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. The CFTC does not believe that any of the

    proposed rules in this release, in their current form, would constitute

    a major rule.

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

    \342\ 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).

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

    The CFTC requests 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.

    IX. Administrative Law Matters--Exchange Act Revisions

    A. Paperwork Reduction Act

    1. Background

    Proposed rules 3a68-2 and 3a68-4(c) would contain new ``collection

    of information'' requirements within the meaning of the Paperwork

    Reduction Act of 1995.\343\ The SEC is submitting them to the Office of

    Management and Budget (``OMB'') for review in accordance with the

    PRA.\344\ 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.

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

    \343\ 44 U.S.C. 3501 et seq.

    \344\ 44 U.S.C. 3507(d) and 5 CFR 1320.11.

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

    These proposed rules contain collections and are being proposed

    pursuant to the Exchange Act. The proposed rules would establish a

    process through which a person could submit a request to the

    Commissions that the Commissions provide a joint interpretation of

    whether an agreement, contract, or transaction (or class thereof) is a

    swap, security-based swap, or both (i.e., a mixed swap). The rules also

    would establish a process with respect to mixed swaps through which a

    person could submit a request to the Commissions that the Commissions

    issue a joint order permitting the requesting person (and any other

    person or persons that subsequently lists, trades, or clears that class

    of mixed swap) to comply, as to parallel provisions only, with the

    specified parallel provisions, instead of being required to comply with

    parallel provisions of both the CEA and the Exchange Act. The hours and

    costs associated with preparing and sending these requests would

    constitute reporting and cost burdens imposed by each collection of

    information.

    2. Summary of Collection of Information Under Proposed Rules 3a68-2 and

    3a68-4(c)

    The SEC is proposing new rules that would allow persons to submit

    requests to the Commissions for joint interpretations regarding whether

    a particular agreement, contract, or transaction (or class thereof) is

    a swap, security-based swap, or both (i.e., a mixed swap), and for

    joint orders permitting alternative regulatory treatment for particular

    mixed swaps.

    First, the SEC is proposing new rule 3a68-2, which would allow

    persons to submit a request for a joint interpretation from the

    Commissions regarding whether an agreement, contract, or transaction

    (or a class thereof) is a swap, security-based swap, or both (i.e., a

    mixed swap). Under proposed rule 3a68-2, a person would provide to the

    Commissions a copy of all material information regarding the terms of,

    and a statement of the economic characteristics and purpose of, each

    relevant agreement, contract, or

    [[Page 29876]]

    transaction (or class thereof), along with that person's determination

    as to whether each such agreement, contract, or transaction (or class

    thereof) should be characterized as a swap, security-based swap, or

    both (i.e., a mixed swap). The Commissions also may request the

    submitting person to provide additional information.

    The Commissions may issue in response a joint interpretation or

    joint notice of proposed rulemaking regarding the status of that

    agreement, contract, or transaction (or class thereof) as a swap,

    security-based swap, or both (i.e., a mixed swap). Any joint

    interpretation, like any joint notice of proposed rulemaking, will be

    public and may discuss the material information regarding the terms of

    the relevant agreement, contract, or transaction (or class thereof), as

    well as any other information the Commissions deem material to the

    interpretation.

    Requesting persons also would be permitted to withdraw a request

    made pursuant to proposed rule 3a68-2 at any time before the

    Commissions have issued a joint interpretation or joint notice of

    proposed rulemaking in response to the request. Regardless of a

    particular request for interpretation, however, the Commissions could

    provide such a joint interpretation or joint notice of proposed

    rulemaking of their own accord.

    Persons would submit requests pursuant to proposed rule 3a68-2 on a

    voluntary basis. However, if a person submits a request, all of the

    information required under the proposed rule, including any additional

    information requested by the Commissions, must be submitted to the

    Commission, except to the extent a person withdraws the request

    pursuant to the proposed rule.

    For purposes of the PRA, the SEC estimates that the total annual

    paperwork burden resulting from proposed rule 3a68-2 would be

    approximately 20 hours of internal company or individual time and a

    cost of approximately $9,480 for the services of outside professionals

    that the SEC believes would consist of services provided by

    attorneys.\345\ As discussed further below, these total costs include

    all collection burdens associated with the proposed rules, including

    burdens related to the initial determination requirements.

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

    \345\ For convenience, the estimated PRA hour burdens have been

    rounded to the nearest whole dollar. Data 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, suggest that that the cost of an attorney is $316 per

    hour.

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

    Second, the SEC is proposing new rule 3a68-4(c), which would allow

    persons to submit requests to the Commissions for joint orders

    regarding the regulation of a particular mixed swap (or class thereof).

    Under proposed rule 3a68-4(c), a person would provide to the

    Commissions a copy of all material information regarding the terms of,

    and the economic characteristics and purpose of, the specified (or

    specified class of) mixed swap. In addition, a person would provide the

    specified parallel provisions, and the reasons the person believes such

    specified parallel provisions would be appropriate for relevant mixed

    swap (or class thereof), and an analysis of: (i) The nature and

    purposes of the parallel provisions that are the subject of the

    request; (ii) the comparability of such parallel provision; and (iii)

    the extent of any conflicts or differences between such parallel

    provisions. The Commissions also may request the submitting person to

    provide additional information.

    The Commissions may issue in response a joint order, after public

    notice and opportunity for comment, providing that the requesting

    person (and any other person or persons that subsequently lists,

    trades, or clears that mixed swap (or class thereof)) is permitted to

    comply, as to parallel provisions only, with the specified parallel

    provisions (or another subset of the parallel provisions that are the

    subject of the request, as the Commissions determine is appropriate),

    instead of being required to comply with parallel provisions of both

    the CEA and the Exchange Act. Any joint order will be public and may

    discuss the material information regarding the terms of the mixed swap

    (or class thereof), as well as any other information the Commissions

    deem material to the order. Requesting persons also would be permitted

    to withdraw a request made pursuant to proposed rule 3a68-4(c) at any

    time before the Commissions have issued a joint order in response to

    the request.

    Persons would submit requests pursuant to proposed rule 3a68-4(c)

    on a voluntary basis. However, if a person submits a request, all of

    the information required under the proposed rule, including any

    additional information requested by the Commissions, must be submitted

    to the Commission, except to the extent a person withdraws the request

    pursuant to the proposed rule.

    For purposes of the PRA, the SEC estimates that the total annual

    incremental paperwork burden resulting from proposed rule 3a68-4(c)

    would be approximately 30 hours of internal company or individual time

    and a cost of approximately $15,800 for the services of outside

    professionals, which the SEC believes would consist of services

    provided by attorneys.\346\ As discussed further below, these total

    costs include all collection burdens associated with the proposed

    rules, including burdens related to the initial determination

    requirements.

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

    \346\ See supra note 345.

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

    3. Proposed Use of Information

    The SEC would use the information collected pursuant to proposed

    rule 3a68-2 to evaluate an agreement, contract, or transaction (or

    class thereof) in order to provide joint interpretations or joint

    notices of proposed rulemaking with the CFTC regarding whether these

    agreements, contracts, or transactions (or classes thereof) are swaps,

    security-based swaps, or both (i.e., mixed swaps) as defined in the

    Dodd-Frank Act. The SEC would use the information collected pursuant to

    proposed rule 3a68-4(c) to evaluate a specified, or a specified class

    of, mixed swaps in order to provide joint orders or joint notices of

    proposed rulemaking with the CFTC regarding the regulation of that

    particular mixed swap or class of mixed swap. The information provided

    to the SEC pursuant to proposed rules 3a68-2 and 3a68-4(c) also would

    allow the SEC to monitor the development of new OTC derivatives

    products in the marketplace and determine whether additional rulemaking

    or interpretive guidance is necessary or appropriate.

    4. Respondents

    It is difficult to calculate the precise number of requests that

    would be submitted to the Commissions under proposed rules 3a68-2 and

    3a68-4(c), given the historical unregulated state of the OTC

    derivatives market. Although any person could submit a request under

    proposed rule 3a68-2, the SEC believes as a practical matter that the

    relevant categories of such persons would be swap dealers and security-

    based swap dealers, major swap participants and major security-based

    swap participants, SEFs, security-based SEFs, DCOs clearing swaps, DCMs

    trading swaps, SDRs, SBSDRs, and clearing agencies clearing security-

    based swaps, and the total number of persons could be 475.\347\

    Similarly, although any

    [[Page 29877]]

    person could submit a request under proposed rule 3a68-4(c), the SEC

    believes as a practical matter that the relevant categories of such

    persons would be SEFs, security-based SEFs, and DCMs trading swaps, and

    the total number of persons could be 72.\348\

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

    \347\ This total number includes an estimated 250 swap dealers,

    50 major swap participants, 50 security-based swap dealers, 10 major

    security-based swap participants, 35 SEFs, 20 security-based SEFs,

    12 DCOs, 17 DCMs, 15 SDRs, 10 SBSDRs, and 6 clearing agencies, as

    set forth by the CFTC and SEC, respectively, in their other Dodd-

    Frank Act rulemaking proposals. See Entity Definitions, supra note

    12 (regarding security-based swap dealers and major security-based

    swap participants); Registration of Swap Dealers and Major Swap

    Participants, supra note 330 (regarding swap dealers and major

    security-based swap participants); Security-Based Swap Data

    Repository Registration, Duties, and Core Principles, supra note 6

    (regarding SBSDRs); Swap Data Repositories, supra note 330

    (regarding SDRs); Core Principles and Other Requirements for Swap

    Execution Facilities, 76 FR 1214, Jan. 7, 2011 (regarding SEFs);

    Registration and Regulation of Security-Based Swap Execution

    Facilities, 76 FR 10948, Feb. 28, 2011 (regarding security-based

    SEFs); Financial Resources Requirements for Derivatives Clearing

    Organizations, 75 FR 63113, Oct. 14, 2010 (regarding DCOs);

    Information Management Requirements for Derivatives Clearing

    Organizations, 75 FR 78185, Dec. 15, 2010 (regarding DCOs); Risk

    Management Requirements for Derivatives Clearing Organizations, 76

    FR 3698, Jan. 20, 2011 (regarding DCOs); Core Principles and Other

    Requirements for Designated Contract Markets, 75 FR 80572, Dec. 22,

    2010 (regarding DCMs); Clearing Agency Standards for Operation and

    Governance, 76 FR 14472, Mar. 16, 2011 (regarding clearing

    agencies).

    \348\ Id.

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

    However, based on the SEC's experience and information received

    from commenters to the ANPR \349\ and during meetings with the public

    to discuss the Product Definitions generally, including the

    interpretation of whether a transaction is a swap, security-based swap,

    or both (i.e., a mixed swap), and taking into consideration the

    certainty provided by the proposed rules and interpretive guidance in

    this release, the SEC believes that the number of requests that would

    be submitted by such persons to the Commissions to provide joint

    interpretations as to whether a given agreement, contract, or

    transaction is a swap, security-based swap, or both (i.e., a mixed

    swap), would be small, and therefore expects that only a small number

    of requests would be submitted pursuant to proposed rule 3a68-2. With

    respect to proposed rule 3a68-4(c), the SEC also estimates the number

    of requests for joint orders would be small.\350\ Pursuant to the

    Commissions' proposed rules and interpretive guidance, a number of

    persons that engage in agreements, contracts, or transactions that are

    swaps, security-based swaps, or both (i.e., a mixed swap) would be

    certain that their transactions are, indeed, swaps, security-based

    swaps, or both, (i.e., a mixed swap) and would not request an

    interpretation pursuant to proposed rule 3a68-2. Also, as the

    Commissions provide joint interpretations regarding whether agreements,

    contracts, or transactions (or classes thereof) are or are not swaps,

    security-based swaps, or both (i.e., mixed swaps), the SEC expects that

    the number of requests for interpretation will decrease over time. The

    SEC believes that the rules and interpretive regarding swaps, security-

    based swaps, and mixed swaps the Commissions are proposing, as well as

    the additional guidance issues pursuant to joint interpretations and

    orders under proposed rules 3a68-2 and 3a68-4 will result in a narrow

    pool of potential respondents, approximately 50,\351\ to the collection

    of information requirements of proposed rule 3a68-2.

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

    \349\ See supra note 283 and accompanying text.

    \350\ See discussion supra part IV.A.

    \351\ The SEC believes that there would be approximately 50

    requests in the first year. See discussion infra part IX.A.5. The

    SEC recognizes that one person might submit more than one request,

    but for purposes of the PRA is considering each such request as one

    person in order to provide a more conservative estimate of the

    number of persons that would be subject to paperwork burdens.

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

    Similarly, because the SEC believes that both the category of mixed

    swap transactions and the number of market participants that engage in

    mixed swap transactions are small, the SEC believes that the pool of

    potential persons requesting a joint order regarding the regulation of

    a specified, or specified class of, mixed swap pursuant to proposed

    rule 3a68-4(c) would be small (approximately 10 \352\). Also, those

    requests submitted pursuant to proposed rule 3a68-2 that result in an

    interpretation that the agreement, contract, or transaction (or class

    thereof) is not a mixed swap would reduce the pool of possible persons

    submitting a request regarding the regulation of particular mixed swaps

    (or class thereof) pursuant to proposed rule 3a68-4(c). In addition,

    not only the requesting party, but also any other person or persons

    that subsequently lists, trades, or clears that mixed swap, would be

    subject to, and must comply with, the joint order regarding the

    regulation of the specified, or specified class of, mixed swap, as

    issued by the Commissions. Therefore, the SEC believes that the number

    of requests for a joint order regarding the regulation of mixed swaps,

    particularly involving specified classes of mixed would decrease over

    time.

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

    \352\ See id.

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

    The SEC seeks comment on the number of persons that potentially

    would submit requests pursuant to rules 3a68-2 and 3a68-4(c).

    5. Paperwork Reduction Act Burden Estimates

    Proposed rules 3a68-2 and 3a68-4(c) would, if adopted, require

    submission of certain information to the Commissions to the extent

    persons elect to request an interpretation and/or alternative

    regulatory treatment. Proposed rules 3a68-2 and 3a68-4(c) each require

    the information that a requesting party must include in its request to

    the Commissions in order to receive a joint interpretation or order, as

    applicable.

    (a) Proposed Rule 3a68-2

    Proposed rule 3a68-2 would require any party requesting a joint

    interpretation under the rule to include disclosures about the

    agreement, contract, or transaction (or class thereof) in question as

    well as a statement of economic purpose and the requesting party's

    initial determination regarding whether the agreement, contract, or

    transaction (or class thereof) is a swap, security-based swap, or both

    (i.e., a mixed swap). The proposed rule would apply only to requests

    made by persons that desire an interpretation from the Commissions. For

    each agreement, contract, or transaction (or class thereof) for which a

    person requests the Commissions' joint interpretation, the requesting

    person would be required to provide a copy of all material information

    regarding the applicable terms; a statement of the economic

    characteristics and purpose; and the requesting person's determination

    as to whether such agreement, contract, or transaction (or class

    thereof) is a swap, security-based swap, or both (i.e., a mixed swap),

    including the basis for the requesting person's determination. The

    requesting person also would be required to provide such other

    information as the Commissions may request.

    As discussed above, the SEC believes the number of persons that

    would submit requests pursuant to proposed rule 3a68-2 is quite small

    given the proposed rules and interpretive guidance regarding swaps,

    security-based swaps, and mixed swaps the Commissions are

    providing.\353\ Although the SEC does not have precise figures for the

    number of requests that persons would submit, the SEC believes it is

    reasonable to estimate that it likely

    [[Page 29878]]

    would be fewer than 50 requests in the first year. For purposes of the

    PRA, the SEC estimates the total paperwork burden associated with

    preparing and submitting a person's request to the Commissions pursuant

    to proposed rule 3a68-2 would be 20 hours per request and associated

    costs of $9,480.\354\ Assuming 50 requests in the first year, the SEC

    estimates that this would result in an aggregate burden for the first

    year of 1000 hours of company time (50 requests x 20 hours/request) and

    $474,000 for the services of outside professionals (e.g., attorneys)

    (50 requests x 30 hours/request x $316).

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

    \353\ This estimate is based on comments from and discussions

    with market participants regarding uncertainty concerning whether

    certain contracts might be considered swaps, security-based swaps,

    or both, i.e., mixed swaps, and the size of the mixed swaps

    category, although the SEC has not received data regarding the

    specific number of potential transaction types for which there is

    uncertainty or that are mixed swaps.

    \354\ This estimate is based on information indicating that the

    average burden associated with preparing and submitting a no-action

    request to the SEC staff in connection with the identification of

    whether certain products were securities, which the SEC believes is

    a process similar to the process under proposed rule 3a68-2, was

    approximately 20 hours and associated costs of $9,480. Assuming

    these costs correspond to legal fees, which we estimate at an hourly

    cost of $316, we estimate that this cost is equivalent to

    approximately 30 hours ($9,480/$316).

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

    As discussed above, the SEC believes that as the Commissions

    provide joint interpretations or joint notices of proposed rulemaking,

    the number of requests received will decrease over time. Although the

    SEC does not have precise figures for the number of requests that

    persons would submit after the first year, the SEC believes it is

    reasonable to estimate that it likely would be fewer than 10 requests

    on average in ensuing years. Assuming 10 requests in ensuing years, the

    SEC estimates that this would result in an aggregate burden in each

    ensuing year of 200 hours of company time (10 requests x 20 hours/

    request) and $94,800 for the services of outside professionals (e.g.,

    attorneys) (10 requests x 30 hours/request x $316).

    (b) Proposed Rule 3a68-4(c)

    Proposed rule 3a68-4(c) would require any party requesting a joint

    order regarding the regulation of a specified, or specified class of,

    mixed swap under the rule to include disclosure about the agreement,

    contract, or transaction (or class thereof) that is a mixed swap as

    well as a statement of economic purpose for the mixed swap (class

    thereof). In addition, a person would provide the specified parallel

    provisions that the person believes should apply to the mixed swap (or

    class thereof), the reasons the person believes the specified parallel

    provisions would be appropriate for the mixed swap, and an analysis of:

    (i) The nature and purposes of the parallel provisions that are the

    subject of the request; (ii) the comparability of such parallel

    provisions; and (iii) the extent of any conflicts or differences

    between such parallel provisions. The requesting person also would be

    required to provide such other information as the Commissions may

    request.

    As discussed above, the SEC believes the number of requests that

    persons would submit pursuant to proposed rule 3a68-4(c) is quite small

    given the limited types of agreements, contracts, or transactions (or

    class thereof) the Commissions believe would constitute mixed

    swaps.\355\ In addition, depending on the characteristics of a mixed

    swap (or class thereof), a person may choose not to submit a request

    pursuant to proposed rule 3a68-4(c). The SEC also notes that any joint

    order issued by the Commissions would apply to any person that

    subsequently lists, trades, or clears that specified, or specified

    class of, mixed swap, so that requests for joint orders could diminish

    over time. Also, persons may submit requests for an interpretation

    under proposed rule 3a68-4(c) that do not result in an interpretation

    that the agreement, contract, or transaction (or class thereof) is a

    mixed swap. Therefore, although the SEC does not have precise figures

    for the number of requests that persons would submit, the SEC believes

    it is reasonable to estimate that it likely would be fewer than 20

    requests in the first year. For purposes of the PRA, the SEC estimates

    the total paperwork burden associated with preparing and submitting a

    party's request to the Commissions pursuant to proposed rule 3a68-4(c)

    would be 30 hours and associated costs of $15,800 per request for mixed

    swaps for which a request for a joint interpretation pursuant to

    proposed rule 3a68-4(c) was not previously made.\356\ Assuming 20

    requests in the first year, the SEC estimates that this would result in

    an aggregate burden for the first year of 600 hours of company time (20

    requests x 30 hours/request) and $316,000 for the services of outside

    professionals (20 requests x 50 hours/request x $316).

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

    \355\ See supra note 283 and accompanying text.

    \356\ This estimate is based on information indicating that the

    average burden associated with preparing and submitting a no-action

    request to the SEC staff in connection with the regulatory treatment

    of certain securities products which the SEC believes is a process

    similar to the process under proposed rule 3a68-4(c), was

    approximately 30 hours and associated costs of $15,800. Assuming

    these costs correspond to legal fees, which we estimate at an hourly

    cost of $316, we estimate that this cost is equivalent to

    approximately 50 hours ($15,800/$316).

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

    For mixed swaps for which a request for a joint interpretation

    pursuant to proposed rule 3a68-2 was previously made, the SEC estimates

    the total paperwork burden under the PRA associated with preparing and

    submitting a party's request to the Commissions pursuant to proposed

    rule 3a68-4(c) would be 10 hours fewer and $4,740 less per request than

    for mixed swaps for which a request for a joint interpretation pursuant

    to proposed rule 3a68-2 was not previously made because certain,

    although not all, of the information required to be submitted and

    necessary to prepare pursuant to proposed rule 3a68-4(c) would have

    been required to be submitted and necessary to prepare pursuant to

    proposed rule 3a68-2.\357\ Although certain requests made pursuant to

    proposed rule 3a68-4(c) may be made without a previous request for a

    joint interpretation pursuant to proposed rule 3a68-2, the SEC believes

    that most requests under proposed rule 3a68-2 that result in the

    interpretation that an agreement, contract, or transaction (or class

    thereof) is a mixed swap will result in a subsequent request for

    alternative regulatory treatment pursuant to proposed rule 3a68-4(c).

    Assuming, therefore, that 90 percent, or 18 of the estimated 20

    requests pursuant to proposed rule 3a68-4(c) in the first year, as

    discussed above, would be such ``follow-on'' requests, the SEC

    estimates that this would result in an aggregate burden in the first

    year of 360 hours of company time (18 requests x 20 hours/request) and

    $199,080 for the services of outside professionals (18 requests x 35

    hours/request x $316).

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

    \357\ This estimate takes into account that certain information

    regarding the mixed swap (or class thereof), namely the material

    terms and the economic purpose, will have already been gathered and

    prepared as part of the request submitted pursuant to proposed rule

    3a68-2. The SEC estimates that these items constitute approximately

    10 hours fewer and a reduction in associated costs of $4,740.

    Assuming these costs correspond to legal fees, which we estimate at

    an hourly cost of $316, we estimate that this cost is equivalent to

    approximately 15 hours ($4,740/$316).

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

    As discussed above, the SEC believes that as the Commissions

    provide joint orders regarding alternative regulatory treatment, the

    number of requests received will decrease over time. The SEC believes

    it is reasonable to estimate that it likely would be fewer than 5

    requests on average in ensuing years. Assuming 5 requests in ensuing

    years, the SEC estimates that this would result in an aggregate burden

    in each ensuing year of 150 hours of company time (5 requests x 30

    hours/request) and $79,000 for the services of outside professionals (5

    requests x 50 hours/request x $316). As discussed above, assuming that

    approximately 90 percent, or 4 of the estimated 5 requests pursuant to

    proposed rule 3a68-4(c) in

    [[Page 29879]]

    ensuing years would be ``follow-on'' requests to requests for joint

    interpretation from the Commissions under proposed rule 3a68-4(c), the

    SEC estimates that this would result in an aggregate burden in each

    ensuing year of 80 hours of company time (4 requests x 20 hours/

    request) and $44,240 for the services of outside professionals (4

    requests x 35 hours/request x $316).

    Request for Comment

    Pursuant to 44 U.S.C. 3506(c)(2)(B), the SEC solicits comments to:

    (i) Evaluate whether the proposed collection of information is

    necessary for the proper performance of the functions of the agency,

    including whether the information will have practical utility; (ii)

    evaluate the accuracy of the SEC's estimate of 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) evaluate whether there are ways to minimize the

    burden of the collection of information on those that are to respond,

    including through the use of automated collection techniques or other

    forms of information technology. In addition, the SEC requests comment

    on the accuracy of the estimates regarding the total paperwork burden.

    In particular, the SEC requests comment for purposes of the PRA on

    the following:

    149. How many requests for a joint interpretation from the

    Commissions would be submitted pursuant to rule 3a68-2?

    150. How many requests for a joint order from the Commissions would

    be submitted pursuant to rule 3a68-4(c)?

    151. How many requests for a joint order from the Commissions would

    be submitted pursuant to rule 3a68-4(c) regarding the same agreement,

    contract, or transaction (or class thereof) that was the subject of a

    request for a joint interpretation from the Commissions submitted

    pursuant to rule 3a68-2?

    152. Are the paperwork burden estimates, for both company time and

    outside services, as discussed above accurate? Do these estimates

    reflect the paperwork burdens and costs associated with requests made

    pursuant to proposed rules 3a68-2 and 3a68-4(c)?

    Commenters should, when possible, provide empirical data to support

    their views.

    Any member of the public may direct to us or to OMB any comments

    concerning the accuracy of these burden estimates and any suggestions

    for reducing these burdens. Persons submitting comments on the

    collection of information requirements should direct the comments 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 send a copy to

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

    Washington, DC 20549-1090, with reference to File No. S7-16-11.

    Requests for materials submitted to OMB by the SEC with regard to these

    collections of information should be in writing, refer to File No. S7-

    16-11, and be submitted to the Securities and Exchange Commission,

    Office of Investor Education and Advocacy, 100 F Street NE.,

    Washington, DC 20549-0213. OMB is required to make a decision

    concerning the collection of information between 30 and 60 days after

    publication of this release. Consequently, a comment to OMB is best

    ensured of having its full effect if OMB receives it within 30 days of

    publication.

    B. Cost-Benefit Analysis

    1. Background

    Title VII establishes a regulatory framework for OTC derivatives.

    As part of that framework, Title VII amends the CEA and the Exchange

    Act to broadly categorize covered derivative products as swaps,

    security-based swaps, SBSAs, and/or mixed swaps. In particular, section

    712(d)(1) of the Dodd-Frank Act provides that the Commissions, in

    consultation with the Board, shall jointly further define, among other

    things, the terms ``swap,'' ``security-based swap,'' and ``security-

    based swap agreement.'' Section 712(a)(8) of the Dodd-Frank Act

    provides further that the Commissions shall jointly prescribe such

    regulations regarding ``mixed swaps'' as may be necessary to carry out

    the purposes of Title VII. In addition, sections 712(d)(2)(B) and (C)

    of the Dodd-Frank Act require the Commissions, in consultation with the

    Board, to jointly adopt rules governing books and records for SBSAs for

    SDRs that are registered under the CEA, swap dealers, major swap

    participants, security-based swap dealers, and major security-based

    swap participants.

    The Product Definitions and the regulation of mixed swaps are part

    of the Dodd-Frank Act's comprehensive framework for regulating the

    swaps markets whereby the CFTC is given regulatory authority over

    ``swaps,'' \358\ the SEC is given regulatory authority over ``security-

    based swaps,'' \359\ and the Commissions shall jointly prescribe such

    regulations regarding mixed swaps as may be necessary to carry out the

    purposes of Title VII.\360\ In addition, the SEC is given antifraud

    authority over, and access to information from certain CFTC-regulated

    entities (e.g., DCOs, SEFs, and swap dealers) regarding, SBSAs.\361\

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

    \358\ See CEA section 1a(47), 7 U.S.C. 1a(47) (cross-referenced

    in section 3(a)(69) of the Exchange Act, 15 U.S.C. 78c(a)(69)).

    \359\ See section 3(a)(68) of the Exchange Act, 15 U.S.C.

    78c(a)(68) (cross-referenced in CEA section 1a(42), 7 U.S.C.

    1a(42)).

    \360\ See CEA section 1a(47)(D), 7 U.S.C. 1a(47)(D); section

    3(a)(68)(D) of the Exchange Act, 15 U.S.C. 78c(68)(D).

    \361\ See section 3(a)(78) of the Exchange Act, 15 U.S.C.

    78c(a)(78); CEA section 1a(47)(A)(v), 7 U.S.C. 1a(47)(A)(v).

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

    In most instances, the Commissions' proposed rules and guidance

    merely clarify the application of the Product Definitions to specific

    products as is required by the relevant provisions of the CEA and

    Exchange Act, as modified by the Dodd-Frank Act and the regulation of

    mixed swaps. However, for some of the rules the Commissions are

    proposing, the Commissions are exercising their discretion to further

    define the Product Definitions and to regulate mixed swaps, which would

    generate costs and benefits to market participants. The Commissions

    also are fulfilling the requirement in Dodd-Frank that they establish

    requirements regarding books and records with respect to SBSAs, which

    also would generate costs and benefits to market participants. The

    costs and benefits regarding these rules are discussed below.

    2. Proposed Rule 3a68-1a

    (a) Benefits

    A security-based swap includes a swap that is based on the

    ``occurrence, nonoccurrence, or extent of the occurrence of an event

    relating to a single issuer of a security or the issuers of securities

    in a narrow-based security index, provided that such event directly

    affects the financial statements, financial condition, or financial

    obligations of the issuer'' (the ``Event Provision'').\362\ Proposed

    rule 3a68-1a would provide that, solely for purposes of determining

    whether a CDS is a security-based swap under the Event Provision, the

    term ``issuers of securities in a narrow-based security index'' would

    have the meaning as set forth in proposed rule 3a68-1a.

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

    \362\ Section 3(a)(68)(A)(ii)(III) of the Exchange Act, 15

    U.S.C. 78c(a)(68)(A)(ii)(III).

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

    Because index CDS typically are written on indexes of entity names,

    not on indexes of the specific securities of those entities, the

    Commissions are

    [[Page 29880]]

    concerned that the application of the Event Provision, without further

    clarification, may cause uncertainty about whether certain index CDS

    would be security-based swaps or swaps. Therefore, proposed rule 3a68-

    1a would eliminate the potential uncertainty of the treatment of index

    CDS as either security-based swaps or swaps by setting forth clear and

    objective criteria for meeting the definition of ``issuers of

    securities in a narrow-based security index'' and therefore being a

    security-based swap.

    The SEC requests comments, data, and estimates regarding the

    benefits associated with proposed rule 3a68-1a. The SEC also requests

    comments, data, and estimates regarding any additional benefits that

    could be realized with proposed rule 3a68-1a.

    (b) Costs

    In complying with proposed rule 3a68-1a, a market participant will

    need to ascertain whether an index CDS is a security-based swap or swap

    according to the criteria set forth for meeting the definition of

    ``issuers of securities in a narrow-based security index.'' This

    analysis will have to be performed by market participants upon entering

    into an index CDS to determine whether the index CDS is subject to the

    SEC's regulatory regime for security-based swaps or the CFTC's

    regulatory regime for swaps. The SEC notes, however, that any such

    costs would be in lieu of the costs of doing the same analysis under

    the statutory security-based swap definition. Because the statutory

    security-based swap definition lacks the specificity provided by

    proposed rule 3a68-1a, the SEC believes analysis of an index CDS would

    under proposed rule 3a68-1a would lead to less uncertainty than would

    the same analysis under the statutory security-based swap definition.

    Providing a clear rule to persons to determine whether an index CDS is

    a security-based swap under section 3(a)(68)(A)(ii)(III) of the

    Exchange Act \363\ could alleviate additional costs to persons of

    inquiring with the Commissions about whether an index CDS is a swap or

    security-based swap under that provision, as well as costs of obtaining

    an opinion of counsel regarding the applicability of that provision to

    a particular index CDS.

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

    \363\ 15 U.S.C. 78c(a)(68)(A)(ii)(III).

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

    In addition, proposed rule 3a68-1a is generally consistent with the

    definition of ``narrow-based security index'' that exists in section

    3(a)(55)(B) of the Exchange Act, as modified to address debt securities

    in the context of security futures.\364\ Because some market

    participants are familiar with this definition, as well as with

    performing analyses of products in the security futures context based

    on this definition, the SEC believes that the proposed definition of

    ``issuers of securities in a narrow-based security index'' will

    mitigate uncertainty for those market participants regarding the

    treatment of index CDS. In addition, because such market participants

    would be familiar with many of the criteria in proposed rule 3a68-1a,

    such market participants would require less time and effort, and thus

    incur less cost, in determining the scope and applicability of such

    criteria to the determination of whether an index CDS is a swap or

    security-based swap.

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

    \364\ See July 2006 Rules, supra note 199.

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

    The SEC requests comment as to the costs that determinations under

    proposed rule 3a68-1a would impose on market participants, as well as

    estimates and empirical data to support these costs. In addition, the

    SEC requests comment on any other costs associated with proposed rule

    3a68-1a that have not been considered and what the extent of those

    costs would be.

    3. Proposed Rule 3a68-1b

    (a) Benefits

    A security-based swap includes a swap that is based on ``an index

    that is a narrow-based security index, including any interest therein

    or on the value thereof.'' \365\ Proposed rule 3a68-1b would provide

    that, solely for purposes of determining whether a CDS is a security-

    based swap under section 3(a)(68)(A)(ii)(I) of the Exchange Act,\366\

    the term ``narrow-based security index'' would have the meaning as set

    forth in proposed rule 3a68-1b.

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

    \365\ Section 3(a)(68)(A)(ii)(I) of the Exchange Act, 15 U.S.C.

    78c(a)(68)(A)(ii)(I).

    \366\ 15 U.S.C. 78c(a)(68)(A)(ii)(I).

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

    Because index CDS may be written in indexes of the specific

    securities of entities as well as on indexes of entity names, the

    Commissions are concerned that the application of section

    3(a)(68)(A)(ii)(I) of the Exchange Act,\367\ without further

    clarification, may cause uncertainty about whether certain index CDS

    would be security-based swaps or swaps. Therefore, proposed rule 3a68-

    1b would eliminate the potential uncertainty of the treatment of index

    CDS as either security-based swaps or swaps by setting forth clear and

    objective criteria for meeting the definition of ``narrow-based

    security index'' and therefore being a security-based swap.

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

    \367\ 15 U.S.C. 78c(a)(68)(A)(ii)(I).

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

    The SEC requests comments, data, and estimates regarding the

    benefits associated with proposed rule 3a68-1b. The SEC also requests

    comments, data, and estimates regarding any additional benefits that

    could be realized with proposed rule 3a68-1b.

    (b) Costs

    In complying with proposed rule 3a68-1b, a market participant will

    need to ascertain whether an index CDS is a security-based swap or swap

    according to the criteria set forth for meeting the definition of

    ``narrow-based security index.'' This analysis will have to be

    performed by market participants upon entering into an index CDS to

    determine whether the index CDS is subject to the SEC's regulatory

    regime for security-based swaps or the CFTC's regulatory regime for

    swaps. The SEC notes, however, that any such costs would be in lieu of

    the costs of doing the same analysis under the statutory security-based

    swap definition. Because the statutory security-based swap definition

    lacks the specificity provided by proposed rule 3a68-1b, the SEC

    believes analysis of an index CDS would under proposed rule 3a68-1b

    lead to less uncertainty than would the same analysis under the

    statutory security-based swap definition. Providing a clear rule to

    persons to determine whether an index CDS is a security-based swap

    under section 3(a)(68)(A)(ii)(I) of the Exchange Act \368\ could

    alleviate additional costs to persons of inquiring with the Commissions

    about whether an index CDS is a swap or security-based swap under that

    provision, as well as costs of obtaining an opinion of counsel

    regarding the applicability of that provision to a particular index

    CDS.

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

    \368\ 15 U.S.C. 78c(a)(68)(A)(ii)(I).

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

    In addition, proposed rule 3a68-1b is generally consistent with the

    definition of ``narrow-based security index'' that exists in section

    3(a)(55)(B) of the Exchange Act, as modified to address debt securities

    in the context of security futures.\369\ Because some market

    participants are familiar with this definition, as well as with

    performing analyses of products in the security futures context based

    on this definition, the SEC believes that the proposed definition of

    ``narrow-based security index'' will mitigate uncertainty for those

    market participants regarding the treatment of index CDS. In addition,

    because such market participants would be familiar with many of the

    criteria in proposed rule 3a68-1b, such market

    [[Page 29881]]

    participants would require less time and effort, and thus incur less

    cost, in determining the scope and applicability of such criteria to

    the determination of whether an index CDS is a swap or security-based

    swap.

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

    \369\ See July 2006 Rules, supra note 199.

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

    The SEC requests comment as to the costs that determinations under

    proposed rule 3a68-1a would impose on market participants, as well as

    estimates and empirical data to support these costs. In addition, the

    SEC requests comment on any other costs associated with proposed rule

    3a68-1a that have not been considered and what the extent of those

    costs would be.

    4. Proposed Rule 3a68-2

    (a) Benefits

    Proposed rule 3a68-2 would establish a process for persons to

    request an interpretation of whether an agreement, contract, or

    transaction (or class of agreements, contracts, or transactions) is a

    swap, security-based swap, or both (i.e., a mixed swap).

    Proposed rule 3a68-2 would afford persons with the opportunity to

    obtain greater certainty from the Commissions regarding whether certain

    products are swaps, security-based swaps, or both, i.e., mixed swaps.

    The SEC believes that this provision would decrease the possibility

    that market participants inadvertently might violate regulatory

    requirements regarding products that may constitute swaps, security-

    based swaps, or mixed swaps, which could lead to enforcement action. It

    also would decrease the likelihood that products might fall into

    regulatory gaps by providing a method for market participants to seek

    interpretations regarding the status of products for which the

    applicable regulatory regime might otherwise remain uncertain. In

    addition, the SEC believes the proposed rule will provide the

    opportunity for financial innovation by providing a flexible structure

    that will allow for the development of new products that otherwise

    might be hindered by the lack of regulatory certainty.

    (b) Costs

    Under proposed rule 3a68-2, a person could request the Commissions

    to provide an interpretation of whether an agreement, contract, or

    transaction (or class thereof) is a swap, security-based swap, or mixed

    swap. The SEC estimates that the cost of requesting this interpretation

    for a particular agreement, contract, or transaction (or class thereof)

    would be approximately 20 hours of internal company or individual time

    and a cost of approximately $9,480 for the services of outside

    professionals.\370\ The SEC notes, however, that any such costs are in

    lieu of the costs of doing the same analysis without requesting the

    Commissions to provide an interpretation. In addition, as noted above,

    if the Commissions provide an interpretation pursuant to a request

    under proposed rule 3a68-2, a market participant, and other market

    participants that desire to transact in the same (or same class of)

    agreement, contract, or transaction, would have regulatory certainty

    about whether that agreement, contract, or transaction (or class

    thereof) is a swap, security-based swap, or both (i.e., a mixed swap).

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

    \370\ See discussion supra part VIII.

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

    Also, the SEC believes that as persons make requests for

    interpretations about whether agreements, contracts, or transactions

    (or classes thereof agreements) are swaps, security-based swaps, or

    both, i.e., mixed swaps, pursuant to proposed rule 3a68-2, the

    subsequent costs for persons transacting in those products for which

    the Commissions have provided interpretations should be reduced.

    The SEC requests comment as to the costs that proposed rule 3a68-2

    would impose on market participants, as well as estimates and empirical

    data to support these costs. In addition, the SEC requests comment on

    any other costs associated with proposed rule 3a68-2 that have not been

    considered herein and what the extent of those costs would be.

    5. Proposed Rule 3a68-3

    (a) Benefits

    Proposed rule 3a68-3 would provide that, except as otherwise

    provided in proposed rule 3a68-3, for purposes of section 3(a)(68) of

    the Exchange Act,\371\ the term ``narrow-based security index'' has the

    meaning set forth in section 3(a)(55) of the Exchange Act,\372\ and the

    rules, regulations, and orders of the SEC thereunder. This definition

    would eliminate potential uncertainty regarding the treatment of a

    narrow-based security index to which section 3(a)(55) of the Exchange

    Act also applies.\373\

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

    \371\ 15 U.S.C. 78c(a)(68).

    \372\ 15 U.S.C. 78c(a)(55).

    \373\ 15 U.S.C. 78c(a)(55).

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

    Proposed rule 3a68-3 also would provide a tolerance period for the

    definition of ``narrow-based security index'' to ensure that, under

    certain conditions, a security index underlying a swap will not be

    considered a narrow-based security index and a security index

    underlying a security-based swap will be considered a narrow-based

    security index, even when the security index underlying the swap or

    security-based swap temporarily assumes characteristics that would

    render it a narrow-based security index or not a narrow-based security

    index, respectively. In addition, proposed rule 3a68-3 would provide

    for an additional 3-month grace period applicable to a security index

    that becomes narrow-based, or broad-based, as applicable, for more than

    45 business days over 3 consecutive calendar months.

    Because security indexes underlying Title VII instruments may

    migrate from narrow-based to broad-based, or vice versa, the

    Commissions are concerned that application of the narrow-based security

    index definition, without further clarification, may cause uncertainty

    regarding treatment of Title VII instruments traded on trading

    platforms when such migration has occurred. Therefore, proposed rule

    3a68-3 would eliminate the potential uncertainty of the treatment of

    such Title VII instruments by setting forth clear and objective

    criteria regarding the application of the narrow-based security index

    definition to security indexes that have migrated from narrow-based to

    broad-based or from broad-based to narrow-based.

    The SEC requests comments, data, and estimates regarding the

    benefits associated with proposed rule 3a68-3. The SEC also requests

    comments, data, and estimates regarding any additional benefits that

    could be realized with proposed rule 3a68-3.

    (b) Costs

    In complying with proposed rule 3a68-3, a market participant will

    need to ascertain whether a security index underlying a Title VII

    instrument is narrow-based or broad-based according to the criteria set

    forth for the tolerance periods and grace periods in the proposed rule.

    This analysis would be performed upon entering into Title VII

    instrument on a security index to ensure compliance with proposed rule

    3a68-3. The SEC notes, however, that any such costs would be in lieu of

    the costs of doing the same analysis under the narrow-based security

    index definition, which the SEC believes would be more difficult and

    lead to greater uncertainty, rather than the clarity provided under

    proposed rule 3a68-3. Providing a clear rule to market participants to

    determine whether a Title VII instrument traded on a trading platform

    where the underlying security index has so migrated could alleviate

    additional costs to persons of inquiring with the Commissions about

    whether a Title VII instrument is a swap or a security-based swap, as

    well as costs of obtaining an opinion of counsel

    [[Page 29882]]

    regarding a particular Title VII instrument.

    In addition, proposed rule 3a68-3 is generally consistent with the

    tolerance period and grace period that exist in section 3(a)(55) of the

    Exchange Act for futures contracts.\374\ Because market participants

    are familiar with such tolerance period and grace period as well as

    with performing analyses of products in the futures context based on

    these provisions, the SEC believes that the proposed tolerance period

    and grace period in proposed rule 3a68-3 will mitigate uncertainty for

    market participants regarding the treatment of these Title VII

    instruments. Proposed rule 3a68-3 also would allow market participants

    to minimize the costs of determining whether a security index

    underlying a Title VII instrument is considered narrow-based or not by

    providing a test that is substantially similar to a test with which

    they are familiar in the futures context. In addition, the tolerance

    period under proposed rule 3a68-3 mitigates uncertainty for market

    participants trading Title VII instruments on trading platforms by

    allowing temporary migration of an underlying security index within

    certain specifications without disrupting the status of Title VII

    instruments based on that security index. Similarly, the grace period

    under proposed rule 3a68-3 mitigates uncertainty for market

    participants trading Title VII instruments on trading platforms by

    allowing time for any necessary actions to be made to accommodate the

    non-temporary migration of a security index underlying Title VII

    instruments.

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

    \374\ See supra note 261 and accompanying text.

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

    The SEC requests comment as to the costs that determinations under

    proposed rule 3a68-3 would impose on market participants, as well as

    estimates and empirical data to support these costs. In addition, the

    SEC requests comment on any other costs associated with proposed rule

    3a68-3 that have not been considered, and what the extent of those

    costs would be.

    6. Proposed Rule 3a68-4

    (a) Benefits

    A mixed swap is both a security-based swap and a swap, subject to

    dual regulation by the Commissions, and proposed rule 3a68-4 would

    define the term ``mixed swap'' in the same manner as the term is

    defined in both the Exchange Act.\375\ Proposed rule 3a68-4 would also

    provide that a mixed swap that is not executed on or subject to the

    rules of a DCM, SEF, FBOT, NSE, or security-based SEF and that will not

    be submitted to a DCO or registered or exempt clearing agency to be

    cleared (``bilateral uncleared mixed swap''), and where at least one

    party to the mixed swap is registered with the SEC as a security-based

    swap dealer or major security-based swap participant and also with the

    CFTC as a swap dealer or major swap participant, shall be subject to

    the provisions of the Securities Act and the rules and regulations

    promulgated thereunder and only to certain provisions of the CEA and

    the rules and regulations promulgated thereunder. In addition, proposed

    rule 3a68-4 would establish a process for persons to request that such

    persons be permitted to comply, as to parallel provisions only, with

    the specified parallel provisions, instead of being required to comply

    with parallel provisions of both the CEA and the Exchange Act.

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

    \375\ Section 3(a)(68)(D) of the Exchange Act, 15 U.S.C.

    78c(a)(68)(D); CEA section 1(a)(47)(D), 7 U.S.C. 1(a)(47)(D).

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

    Because, as noted above, mixed swaps are both swaps and security-

    based swaps, and thus are subject to regulation as both swaps and

    security-based swaps, the Commissions are concerned that, without

    further clarification, there may be uncertainty as to the scope of, and

    the requirements applicable to, transactions that fall within the

    definition of the term ``mixed swap.''

    Proposed rule 3a68-4(a) would define the term ``mixed swap'' in the

    same manner as the term is defined in the Exchange Act. This rule,

    coupled with guidance regarding mixed swaps provided by the

    Commissions, further clarifies whether a security-based swap is a mixed

    swap and could eliminate the need to obtain an opinion of counsel

    regarding a particular security-based swap.

    The Commissions are proposing rule 3a68-4(b) to eliminate

    potentially duplicative and conflicting regulation in the context of

    mixed swaps by providing that a bilateral uncleared mixed swap, where

    at least one party to the mixed swap is dually-registered with the SEC

    as a security-based swap dealer or major security-based swap

    participant and also with the CFTC as a swap dealer or major swap

    participant, would be subject to all applicable provisions of the

    securities laws (and SEC rules and regulations promulgated thereunder)

    but would be subject only to certain CEA provisions (and CFTC rules and

    regulations promulgated thereunder). Therefore, proposed rule 3a68-4(a)

    would reduce both the number of and potential uncertainty regarding

    which requirements of each Commission will apply to bilateral uncleared

    mixed swaps entered into by dually-registered dealers and major

    participants.

    Proposed rule 3a68-4(c) also would afford persons with an

    opportunity to seek alternative regulatory treatment of a specified, or

    specified class of, mixed swap. Absent such alternative regulatory

    treatment, a person that desires or intends to list, trade, or clear a

    mixed swap would be required to comply with all the statutory

    provisions of Title VII, including all the rules and regulations

    thereunder, that are applicable to both security-based swaps and swaps.

    The SEC believes that such a requirement could pose practical

    difficulties for mixed swap transactions \376\ and that permitting

    persons to request alternative regulatory treatment of a specified, or

    specified class of, mixed swaps would allow the Commissions to address

    the potential for duplicative or contradictory regulatory requirements

    regarding a particular mixed swap.

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

    \376\ See discussion supra part IV.

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

    The information submitted by persons pursuant to proposed rule

    3a68-4(c) would assist the Commissions in more quickly identifying and

    addressing the relevant issues involved in providing alternative

    regulatory treatment.

    The SEC requests comments, data, and estimates regarding the

    benefits associated with proposed rule 3a68-4. The SEC also requests

    comments, data, and estimates regarding any additional benefits that

    could be realized with proposed rule 3a68-4.

    (b) Costs

    Providing a clear rule for persons who engage in bilateral

    uncleared mixed swaps would reduce the potential for duplicative or

    contradictory regulatory requirements that apply to such bilateral

    uncleared mixed swaps.

    Under proposed rule 3a68-4(c), a person also could request the

    Commissions to provide alternative regulatory treatment of a specified,

    or specified class of, mixed swap. The SEC estimates that the cost of

    requesting alternative regulatory treatment for a particular mixed swap

    (or class thereof) would be approximately 30 hours of internal company

    or individual time and a cost of approximately $15,800 for the services

    of outside professionals.\377\ The SEC notes, however, that any such

    costs are in lieu of the costs of complying with all the statutory

    provisions in Title VII, including all the rules and regulations

    thereunder, that are applicable to both security-based swaps and swaps,

    which the SEC

    [[Page 29883]]

    believes would be more costly than requesting alternative regulatory

    treatment, and which potentially could pose practical

    difficulties.\378\

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

    \377\ See discussion supra part VIII.

    \378\ See discussion supra part IV.B.

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

    Also, the SEC believes that as persons make requests for

    alternative regulatory treatment of specified, or specified classes of,

    mixed swaps pursuant to proposed rule 3a68-4, the subsequent costs for

    persons transacting in those products for which the Commissions have

    provided for alternative regulatory treatment should be reduced.

    The SEC requests comment as to the costs that proposed rule 3a68-4

    would impose on market participants, as well as estimates and empirical

    data to support these costs. In addition, the SEC requests comment on

    any other costs associated with proposed rule 3a68-4 that have not been

    considered herein, and what the extent of those costs would be.

    7. Proposed Rule 3a69-1

    (a) Benefits

    Proposed rule 3a69-1 would clarify that state or Federally

    regulated insurance products provided by state or Federally regulated

    insurance companies, or by certain reinsurers, provided such insurance

    products meet certain other requirements, would not be swaps.

    Specifically, proposed rule 3a69-1 would define the term ``swap'' so

    that it would not include an agreement, contract, or transaction that,

    by its terms or by law, as a condition of performance on the agreement,

    contract, or transaction: (i) Requires the beneficiary of the

    agreement, contract, or transaction to have an insurable interest that

    is the subject of the agreement, contract, or transaction and thereby

    carry the risk of loss with respect to that interest continuously

    throughout the duration of the agreement, contract, or transaction;

    (ii) requires that loss to occur and to be proved, and that any payment

    or indemnification therefor be limited to the value of the insurable

    interest; (iii) is not traded, separately from the insured interest, on

    an organized market or over-the-counter; and (iv) with respect to

    financial guarantee insurance only, in the event of payment default or

    insolvency of the obligor, any acceleration of payments under the

    policy is at the sole discretion of the insurer. Proposed rule 3a69-1

    also would require that the agreement, contract, or transaction: (i) Be

    provided by a company that is organized as an insurance company whose

    primary and predominant business activity is the writing of insurance

    or the reinsuring of risks underwritten by insurance companies and that

    is subject to supervision by the insurance commissioner, or similar

    official or agency, of a state, as defined under section 3(a)(16) of

    the Exchange Act,\379\ or by the United States or an agency or

    instrumentality thereof, and be regulated as insurance under the laws

    of such state or the United States; (ii) be provided by the United

    States or any of its agents or instrumentalities, or pursuant to a

    statutorily authorized program thereof; or (iii) in the case of

    reinsurance only, be provided by a person located outside the United

    States to an insurance company that meets the above requirements,

    provided that such person is not prohibited by the law of any state or

    the United States from offering such agreement, contract, or

    transaction to such insurance company, the product to be reinsured

    meets the requirements above for insurance products, and the total

    amount reimbursable by all reinsurers for such insurance product cannot

    exceed the claims or losses paid by the cedant. An agreement, contract,

    or transaction would have to meet all of these criteria in order to

    qualify as an insurance product that falls outside of the swap and

    security-based swap definitions pursuant to the proposed rules.

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

    \379\ 15 U.S.C. 78c(a)(16).

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

    The SEC is concerned that, without further clarification, market

    participants may be uncertain about whether an agreement, contract, or

    transaction is an insurance product that is not subject to regulation

    as a swap or security-based swap. Therefore, proposed rule 3a69-1 would

    eliminate the potential uncertainty of what constitutes an insurance

    product by setting forth clear and objective criteria for meeting the

    definition of an insurance product that is not subject to regulation as

    a swap or security-based swap.

    The SEC requests comments, data, and estimates regarding the

    benefits associated with proposed rule 3a69-1. The SEC also requests

    comments, data, and estimates regarding any additional benefits that

    could be realized with proposed rule 3a69-1.

    (b) Costs

    In complying with proposed rule 3a69-1, a market participant will

    need to analyze its agreements, contracts, and transactions that are

    insurance products under the provisions of the proposed rule to

    determine whether such insurance products fall outside the definitions

    of the terms ``swaps'' and ``security-based swap.'' This analysis will

    have to be performed upon entering into the agreement, contract, or

    transaction to ensure compliance with proposed rule 3a69-1. The SEC

    notes, however, that any such costs would be in lieu of the costs of

    doing the same analysis absent proposed rule 3a69-1, which the SEC

    believes would be more difficult and lead to greater uncertainty than

    if the analysis were done under proposed rule 3a69-1. Providing an

    objective rule to determine whether an agreement, contract, or

    transaction is an insurance product could alleviate additional costs of

    inquiring with the Commissions about whether an agreement, contract, or

    transaction is an insurance product or a swap, or costs of obtaining an

    opinion of counsel regarding a particular agreement, contract, or

    transaction.

    To the extent that the criteria under proposed rule 3a69-1 lead to

    the inadvertent omission of certain types of insurance products, these

    omissions could lead to costs for market participants entering into

    agreements, contracts, or transactions that might be omitted because

    these agreements, contracts, or transactions would be regulated as

    swaps and not as insurance products. Similarly, to the extent that the

    criteria under proposed rule 3a69-1 lead to the inadvertent inclusion

    of certain types of swaps or security-based swaps, these inclusions

    could lead to costs for market participants entering into agreements,

    contracts, or transactions that are regulated as insurance products and

    not as swaps or security-based swaps. The SEC has requested comment on

    whether the criteria under proposed rule 3a69-1 inadvertently omits

    certain types of insurance products or includes certain types of swaps

    in order to minimize these potential costs. The SEC believes that,

    pursuant to comments on the proposed criteria, any subsequent

    modifications the Commissions make to proposed rule 3a69-1 would

    significantly curtail the potential for inadvertent omissions or

    inclusions.

    The SEC requests comment as to the costs that determinations under

    proposed rule 3a69-1 would impose on market participants, as well as

    estimates and empirical data to support these costs. In addition, the

    SEC requests comment on any other costs associated with proposed rule

    3a69-1 that have not been considered, and what the extent of those

    costs would be.

    8. Proposed Rule 3a69-2

    (a) Benefits

    Proposed rule 3a69-2 provides that the term ``swap'' has the

    meaning set forth in section 3(a)(69) of the Exchange

    [[Page 29884]]

    Act and that, without limiting the definition of ``swap'' in section

    3(a)(69) of the Exchange Act, an agreement, contract, or transaction

    that is a cross-currency swap, currency option, foreign currency

    option, foreign exchange option, foreign exchange rate option, foreign

    exchange forward, foreign exchange swap, FRA, or NDF would fall within

    the meaning of the term ``swap'', unless such agreement, contract, or

    transaction is otherwise excluded by section 1a(47)(B) of the CEA.\380\

    Proposed rule 3a69-2 also provides that a foreign exchange forward or a

    foreign exchange swap shall not be considered a swap if the Secretary

    of the Treasury makes a determination described in section 1a(47)(E)(i)

    of the CEA\381\ and that, notwithstanding such provision, certain

    provisions of the CEA will apply to such foreign exchange forward or

    foreign exchange swap, namely the reporting requirements in section 4r

    of the CEA,\382\ and regulations thereunder, and, in the case of a swap

    dealer or major swap participant that is a party to a foreign exchange

    swap or foreign exchange forward, the business conduct standards in

    section 4s of the CEA,\383\ and regulations thereunder. In addition,

    proposed rule 3a69-2 provides that the terms ``foreign exchange

    forward'' and ``foreign exchange swap'' have the meanings set forth in

    the CEA and that a currency swap, cross-currency swap, currency option,

    foreign currency option, foreign exchange option, foreign exchange rate

    option, and NDF is not a foreign exchange forward or foreign exchange

    swap for purposes of sections 1a(24) and 1a(25) of the CEA.\384\

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

    \380\ 15 U.S.C. 78c(a)(69); 7 U.S.C. 1a(47)(B).

    \381\ 7 U.S.C. 1a(47)(E)(i).

    \382\ 7 U.S.C. 6r.

    \383\ 7 U.S.C. 6s.

    \384\ 7 U.S.C. 1a(24) and 1a(25).

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

    Proposed rule 3a69-2 would restate portions of the statutory

    definition of ``swap'' and enumerate certain types of agreements,

    contracts, and transactions that are swaps in order to consolidate

    parts of the definition and related interpretations for ease of

    reference. Proposed rule 3a69-2 would also specify certain reporting

    and business conduct requirements that are applicable to foreign

    exchange forwards and foreign exchange swaps, and provide definitions

    for such terms.

    Because the statutory definition of the term ``swap,'' though

    broadly worded and specific regarding the status of certain agreements,

    contracts, and transactions, does not explicitly mention every

    agreement, contract, or transaction that would fall within the

    definition, the Commissions are concerned that application of the

    definition, without further clarification, may cause uncertainty about

    whether certain agreements, contracts, or transactions would be swaps.

    Proposed rule 3a69-2 would eliminate the potential uncertainty of the

    treatment of such agreements, contracts, and transactions as swaps by

    setting forth clear and objective criteria for certain agreements,

    contracts, and transactions without limiting the scope of the statutory

    definition of the term ``swap.'' Proposed rule 3a69-2 also would

    eliminate the potential uncertainty regarding the reporting and

    business conduct requirements applicable to foreign exchange forwards

    and foreign exchange swaps by specifying the provisions for which

    compliance is required.

    (b) Costs

    In complying with proposed rule 3a69-2, a market participant will

    need to analyze its agreements, contracts, and transactions under the

    provisions of the proposed rule to determine whether such agreements,

    contracts, and transactions are swaps according to the criteria set

    forth in the proposed rule. This analysis will have to be performed

    upon entering into the agreement, contract, or transaction to ensure

    compliance with proposed rule 3a69-2. The SEC notes, however, that any

    such costs would be in lieu of the costs of doing the same analysis

    absent proposed rule 3a69-2, which the SEC believes would be more

    difficult and lead to greater uncertainty than if the analysis were

    done under proposed rule 3a69-2.

    Providing an objective rule to market participants to determine

    whether certain types of agreements, contracts, or transactions are

    swaps could alleviate additional costs to persons of inquiring with the

    Commissions about whether such agreements, contracts, or transactions

    are swaps, as well as costs of obtaining an opinion of counsel

    regarding a particular agreement, contract, or transaction. In

    addition, an objective rule regarding reporting and business conduct

    requirements could alleviate additional costs to persons of inquiring

    with the Commissions about which reporting and business conduct

    requirements are applicable to foreign exchange forwards and foreign

    exchange swaps, and could reduce the costs of obtaining an opinion of

    counsel regarding a particular foreign exchange forward or foreign

    exchange swap.

    To the extent that the criteria under proposed rule 3a69-2 lead to

    the inadvertent inclusion of certain types of agreements, contracts,

    and transactions or additional reporting or business conduct

    obligations for certain swaps, these inclusions and additional

    requirements could lead to costs for market participants entering into

    agreements, contracts, or transactions to which proposed rule 3a69-2

    applies. The SEC has requested comment on whether the criteria under

    proposed rule 3a69-2 provide sufficient clarity regarding the specific

    products included in the rule and whether the criteria should clarify

    the applicability of reporting and business conduct requirements in

    order to minimize these potential costs. The SEC believes that,

    pursuant to comments on the proposed criteria, any subsequent

    modifications the Commissions make to proposed rule 3a69-2 would

    significantly curtail the potential for inadvertent inclusions or

    additional reporting or business conduct requirements.

    The SEC requests comment as to the costs that determinations under

    and compliance with proposed rule 3a69-2 would impose on market

    participants, as well as estimates and empirical data to support these

    costs. In addition, the SEC requests comment on any other costs

    associated with proposed rule 3a69-2 that have not been considered, and

    what the extent of those costs would be.

    9. Proposed Rule 3a69-3

    (a) Benefits

    Proposed rule 3a69-3 would provide that the term ``security-based

    swap agreement'' has the meaning set forth in section 3(a)(78) of the

    Exchange Act.\385\ Proposed rule 3a69-3 also would provide that

    registered SDRs, swap dealers, major swap participants, security-based

    swap dealers, and major security-based swap participants are not

    required to maintain additional books and records, or, in the case of

    registered SDRs, collect and maintain additional information regarding,

    SBSAs other than the books and records (and, in the case of registered

    SDRs, information) required to be kept (or collected) and maintained

    regarding swaps pursuant to the CEA and the CFTC rules and regulations

    promulgated thereunder.

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

    \385\ 15 U.S.C. 78c(a)(78).

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

    Because, as noted above, security-based swap agreements are subject

    the CFTC's regulatory and enforcement authority and the SEC's antifraud

    and certain other authority, the Commissions are concerned that,

    without further clarification, there may be uncertainty as to the scope

    of transactions that fall within the definition of the term ``security-

    based

    [[Page 29885]]

    swap agreement.'' Proposed rule 3a69-3(c) would define the term

    ``security-based swap agreement'' in the same manner as the term is

    defined in the Exchange Act. This rule, coupled with guidance regarding

    security-based swap agreements provided by the Commissions, further

    clarifies whether a swap is a security-based swap agreement and could

    eliminate the need to obtain an opinion of counsel regarding a

    particular security-based swap agreement.

    Section 712(d)(2)(B) and (C) of the Dodd-Frank Act requires the

    Commissions to engage in joint rulemaking regarding books and records

    requirements for SBSAs. Providing that persons required to keep and

    maintain books and records regarding, or collect and maintain data

    regarding, swaps are not required to keep or maintain additional books

    and records regarding, or collect and maintain additional data

    regarding, SBSAs alleviates any additional books and records or

    information costs to such persons.

    (b) Costs

    The SEC believes that, because proposed rule 3a69-3 includes within

    the definition of SBSA no agreements, contracts, or transactions that

    would not be an SBSA in the absence of the proposed rule, proposed rule

    3a69-3 would impose no costs other than those that are required with

    respect to swaps in the absence of proposed rule 3a69-3. In addition,

    the SEC believes that, because proposed rule 3a69-3 imposes no

    requirements with respect to SBSAs other than those that exist for

    swaps, proposed rule 3a69-3 would impose no costs other than those that

    are required with respect to swaps in the absence of proposed rule

    3a69-3.

    To the extent that the criteria under proposed rule 3a69-3

    inadvertently lead to additional requirements with respect to SBSAs,

    these additional requirements could lead to costs for market

    participants entering into the SBSAs to which proposed rule 3a69-3

    applies. The SEC has requested comment regarding whether the

    requirements under proposed rule 3a69-3 are sufficient. The SEC

    believes that, pursuant to comments on the proposed rule, any

    subsequent modifications the Commissions make to proposed rule 3a69-3

    would significantly curtail the potential for inadvertent additional

    requirements.

    The SEC requests comment as to the costs that compliance with

    proposed rule 3a69-3 would impose on market participants, as well as

    estimates and empirical data to support these costs. In addition, the

    SEC requests comment on any other costs associated with proposed rule

    3a69-3 that have not been considered, and what the extent of those

    costs would be.

    Request for Comment

    153. The SEC has considered the costs and benefits of the proposed

    rules and clarifications regarding the Product Definitions, the

    regulation of mixed swaps, and the books and records requirements for

    SBSAs. The SEC is sensitive to these costs and benefits, and encourages

    commenters to discuss any additional costs or benefits beyond those

    discussed here, as well as any reductions in costs. In particular, the

    SEC requests comment on the potential costs, as well as any potential

    benefits, resulting from the proposed rules and clarifications

    regarding the Product Definitions, the regulation of mixed swaps, and

    the books and records requirements for SBSAs for issuers, investors,

    broker-dealers, security-based swap dealers, major security-based swap

    participants, persons associated with a security-based swap dealer or a

    major security-based swap participant, other security-based swap

    industry professionals, regulators, and other market participants. The

    SEC also seeks comment on the accuracy of any of the benefits

    identified and also welcomes comment on any of the costs identified

    here. In addition, the SEC encourages commenters to identify, discuss,

    analyze, and supply relevant data, information, or statistics regarding

    any such costs or benefits, including estimates and views regarding

    these costs and benefits for particular types of market participants,

    as well as any other costs or benefits that may result from the

    adoption of the proposed rules, as well as the clarifications provided.

    C. Consideration of Burden on Competition, and Promotion of Efficiency,

    Competition, and Capital Formation

    Section 3(f) of the Exchange Act \386\ 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. In addition, section 23(a)(2) of the Exchange

    Act \387\ 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.\388\

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

    \386\ 15 U.S.C. 78c(f).

    \387\ 15 U.S.C. 78w(a)(2).

    \388\ Id.

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

    1. Proposed Rule 3a68-1a

    The SEC believes that proposed rule 3a68-1a would create an

    efficient process for a market participant to determine whether an

    index CDS is a swap or a security-based swap by setting forth clear

    methods and guidelines, thereby reducing potential uncertainty. Because

    swaps and security-based swaps both are regulated pursuant to the Dodd-

    Frank Act by either the CFTC or the SEC, and an index CDS would be

    either a swap or a security-based swap, regardless of whether the SEC

    proposed rule 3a68-1a, the SEC believes that the proposed rule would

    not have an adverse effect on capital formation.

    Similarly, the SEC believes that proposed rule 3a68-1a would not

    impose any significant burdens on competition because an index CDS

    would be regulated as a swap or security-based swap regardless of

    whether the SEC proposed rule 3a68-1a. The proposed rule is a means of

    providing greater clarity for market participants on whether a specific

    index CDS is a swap or a security-based swap.

    2. Proposed Rule 3a68-1b

    The SEC believes that proposed rule 3a68-1b would create an

    efficient process for a market participant to determine whether an

    index CDS is a swap or a security-based swap by setting forth clear

    methods and guidelines, thereby reducing potential uncertainty. Because

    swaps and security-based swaps both are regulated pursuant to the Dodd-

    Frank Act by either the CFTC or the SEC, and an index CDS would be

    either a swap or a security-based swap, regardless of whether the SEC

    proposed rule 3a68-1b, the SEC believes that the proposed rule would

    not have an adverse effect on capital formation.

    Similarly, the SEC believes that proposed rule 3a68-1b would not

    impose any significant burdens on competition because an index CDS

    would be regulated as a swap or security-based swap regardless of

    whether the SEC proposed rule 3a68-1b. The proposed rule is a means of

    providing greater clarity for market participants on whether a specific

    index CDS is a swap or a security-based swap.

    3. Proposed Rule 3a68-2

    The SEC believes that proposed rule 3a68-2 would create an

    efficient process for a market participant to request the Commissions

    to determine whether an

    [[Page 29886]]

    agreement, contract, or transaction (or class thereof) is a swap,

    security-based swap, or both (i.e., a mixed swap) by setting forth

    clear methods and guidelines, thereby reducing potential uncertainty.

    Because swaps, security-based swaps, and mixed swaps all are regulated

    pursuant to the Dodd-Frank Act by either the CFTC, the SEC, or both the

    CFTC and SEC, and because market participants still would need to

    determine whether an agreement, contract, or transaction (or class

    thereof) is a swap, security-based swap, or mixed swap regardless of

    whether the SEC proposed rule 3a68-2, the SEC believes that the

    proposed rule would not have an adverse effect on capital formation.

    In addition, the SEC believes the proposed rule will provide the

    opportunity for financial innovation by providing a flexible structure

    that will allow for the development of new products, which may promote

    capital formation.

    Similarly, the SEC believes that proposed rule 3a68-2 would not

    impose any significant burdens on competition because, to the extent an

    agreement, contract, or transaction (or class thereof) is a swap,

    security-based swap, or both (i.e., a mixed swap), that agreement,

    contract, or transaction (or class thereof) would be regulated as a

    swap, security-based swap, or mixed swap regardless of whether the SEC

    proposed rule 3a68-2. The proposed rule is a means of providing a

    process for market participants to request clarity regarding whether a

    specific agreement, contract, or transaction (or class thereof) is a

    swap, security-based swap, or mixed swap.

    4. Proposed Rule 3a68-3

    The SEC believes that proposed rule 3a68-3 would create an

    efficient process for a market participant to determine whether a

    security index underlying a Title VII instrument is narrow-based or

    broad-based, and therefore whether the Title VII instrument is a swap

    or a security-based swap, by setting forth clear methods and

    guidelines, thereby reducing potential uncertainty. Because swaps and

    security-based swaps both are regulated pursuant to the Dodd-Frank Act

    by either the CFTC or the SEC, and a Title VII instrument on a security

    index would be either a swap or a security-based swap regardless of

    whether the SEC proposed rule 3a68-3, the SEC believes that the

    proposed rule would not have an adverse effect on capital formation.

    Similarly, the SEC believes that proposed rule 3a68-3 would not

    impose any significant burdens on competition because a Title VII

    instrument on a security index would be regulated as a swap or

    security-based swap regardless of whether the SEC proposed rule 3a68-3.

    The proposed rule is a means of providing greater clarity for market

    participants regarding whether a specific Title VII instrument on a

    security index is a swap or a security-based swap.

    5. Proposed Rule 3a68-4

    The SEC believes that proposed rule 3a68-4 would create an

    efficient process for a market participant to request alternative

    regulatory treatment regarding a specified, or specified class of,

    mixed swap by setting forth clear methods and guidelines, thereby

    reducing potential uncertainty and dual regulatory requirements.

    Because a mixed swap is regulated pursuant to the Dodd-Frank Act, and,

    absent proposed rule 3a68-4, persons that desire or intend to list,

    trade, or clear a mixed swap would be required to comply with all the

    statutory provisions in Title VII, including all the rules and

    regulations thereunder, that are applicable to both swaps and security-

    based swaps, the SEC believes that the proposed rule would not have an

    adverse effect on capital formation. Proposed rule 3a68-4 would permit

    such persons to request a joint order permitting themto comply with an

    alternative regulatory regime that would address the potential dual

    regulatory requirements applicable to transactions in mixed swaps under

    Title VII.

    Similarly, the SEC believes that proposed rule 3a68-4 would not

    impose any significant burdens on competition because to the extent an

    agreement, contract, or transaction (or class thereof) is a mixed swap,

    transactions in that mixed swap would be subject to all of the

    statutory provisions of Title VII, including all the rules and

    regulations thereunder, that are applicable to both swaps and security-

    based swaps, if the Commissions were not to provide alternative

    regulatory treatment pursuant to proposed rule 3a68-4.

    6. Proposed Rule 3a69-1

    The SEC believes that proposed rule 3a69-1 would create an

    efficient process for a market participant to determine whether an

    agreement, contract, or transaction is an insurance product and is not

    a swap by setting forth clear methods and guidelines, thereby reducing

    potential uncertainty. Because insurance products and insurance

    companies currently are regulated pursuant to state insurance law, and

    would continue to be so regardless of whether the SEC proposed rule

    3a69-1, the SEC believes that the proposed rule would not have an

    adverse effect on capital formation.

    Similarly, the SEC believes that proposed rule 3a69-1 would not

    impose any significant burdens on competition because insurance

    products and insurance companies currently are regulated pursuant to

    state insurance law and would continue to be so regardless of whether

    the SEC proposed rule 3a69-1. The proposed rule is a means of providing

    greater clarity for market participants on whether a specific

    agreement, contract, or transaction is an insurance product and is not

    a swap.

    7. Proposed Rule 3a69-2

    The SEC believes that proposed rule 3a69-2 would create an

    efficient process for a market participant to determine whether an

    agreement, contract, or transaction is a swap, a foreign exchange

    forward, or a foreign exchange swap or is subject to certain reporting

    and business conduct requirements, by setting forth clear methods and

    guidelines, thereby reducing potential uncertainty. Because agreements,

    contracts, and transactions that are swaps, foreign exchange forwards,

    or foreign exchange swaps under proposed rule 3a69-2 would be swaps,

    foreign exchange forwards, or foreign exchange swaps and, in the case

    of foreign exchange forwards and foreign exchange swaps, would be

    subject to reporting and business conduct requirements under the CEA,

    in the absence of proposed rule 3a69-2, the SEC believes that the

    proposed rule would not have an adverse effect on capital formation.

    Similarly, the SEC believes that proposed rule 3a69-2 would not

    impose any significant burdens on competition because swaps, foreign

    exchange swaps, and foreign exchange forwards continue to be regulated

    as such regardless of whether the SEC proposed rule 3a69-2. The

    proposed rule is a means of providing greater clarity for market

    participants on whether a specific agreement, contract, or transaction

    is a swap, foreign exchange forward, or foreign exchange swap and

    whether certain reporting and business conduct requirements apply in

    the case of foreign exchange forwards and foreign exchange swaps.

    8. Proposed Rule 3a69-3

    The SEC believes that proposed rule 3a69-3 would create an

    efficient process for registered SDRs, SDs, MSPs, security-based swap

    dealers, and major security-based swap participants to determine the

    books and records requirements for SBSAs by setting forth

    [[Page 29887]]

    clear guidelines, thereby reducing potential uncertainty. Proposed rule

    3a69-3(c) also would define the term ``security-based swap agreement''

    in the same manner as the term is defined in the Exchange Act. Because

    SBSAs are swaps, they are subject to certain books and records

    requirements under the CEA (and CFTC rules and regulations promulgated

    thereunder) that are applicable to swaps and would continue to be so

    regardless of whether the SEC proposed rule 3a69-3. The SEC believes

    that the proposed rule would thus not have an adverse effect on capital

    formation.

    Similarly, the SEC believes that proposed rule 3a69-3 would not

    impose any significant burdens on competition because SBSAs would be

    regulated as swaps regardless of whether the SEC proposed rule 3a69-3.

    The proposed rule is a means of providing greater clarity for market

    participants regarding SBSAs, including the books and records

    requirements for SBSAs.

    Request for Comment

    154. The SEC requests comment on the possible effects of the

    proposed rules under the Exchange Act regarding efficiency,

    competition, and capital formation. The SEC requests that commenters

    provide views and supporting information regarding any such effects.

    The SEC notes that such effects are difficult to quantify. The SEC

    seeks comment on possible anti-competitive effects of the proposed

    rules under the Exchange Act not already identified. The SEC also

    requests comment regarding the competitive effects of pursuing

    alternative regulatory approaches that are consistent with section

    712(a) and 712(d) of the Dodd-Frank Act. In addition, the SEC requests

    comment on how the other provisions of the Dodd-Frank Act for which SEC

    rulemaking is required will interact with and influence the competitive

    effects of the proposed rules and clarifications under the Exchange

    Act.

    D. Consideration of Impact on the Economy

    For purposes of SBREFA the SEC must advise the OMB as to whether

    the proposed rules and interpretive guidance under the Exchange Act

    constitute ``major'' rules. 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.

    The SEC requests comment on the potential impact of the proposed

    rules and interpretive guidance under the Exchange Act 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 view to the extent possible.

    E. Initial Regulatory Flexibility Act Certification

    The RFA requires Federal agencies, in promulgating rules, to

    consider the impact of those rules on small entities. Section 603(a)

    \389\ of the Administrative Procedure Act,\390\ 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.'' \391\

    Section 605(b) of the RFA states that this requirement shall not apply

    to any proposed rule or proposed rule amendment, that, if adopted,

    would not have a significant economic impact on a substantial number of

    small entities.\392\

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

    \389\ 5 U.S.C. 603(a).

    \390\ 5 U.S.C. 551 et seq.

    \391\ Although section 601(b) of the RFA defines the term

    ``small entity,'' the statute permits agencies 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 Statement of Management

    on Internal Accounting Control, 47 FR 5215, Feb. 4, 1982.

    \392\ 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,\393\ 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,\394\ 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.\395\ Under the

    standards adopted by the Small Business Administration, small entities

    in the finance and insurance industry include the following: (i) For

    entities in credit intermediation and related activities, entities with

    $175 million or less in assets or, for non-depository credit

    intermediation and certain other activities, $7 million or less in

    annual receipts; (ii) for entities in financial investments and related

    activities, entities with $7 million or less in annual receipts; (iii)

    for insurance carriers and entities in related activities, entities

    with $7 million or less in annual receipts; and (iv) for funds, trusts,

    and other financial vehicles, entities with $7 million or less in

    annual receipts.\396\

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

    \393\ See 17 CFR 240.0-10(a).

    \394\ See 17 CFR 240.17a-5(d).

    \395\ See 17 CFR 240.0-10(c).

    \396\ See 13 CFR 121.201.

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

    Based on the SEC's existing information about the swap markets, the

    SEC believes that the swap markets, while broad in scope, are largely

    dominated by entities such as those that would be covered by the ``swap

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

    and ``major security-based swap participant'' definitions.\397\ The SEC

    believes that such entities exceed the thresholds defining ``small

    entities'' set out above. Moreover, although it is possible that other

    persons may engage in swap and security-based swap transactions, the

    SEC does not believe that any of these entities would be ``small

    entities'' as defined in rule 0-10 under the Exchange Act.\398\

    Feedback from industry participants about the swap markets indicates

    that only persons or entities with assets significantly in excess of $5

    million (or with annual receipts significantly in excess of $7 million)

    participate in the swap markets.

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

    \397\ See, e.g., CEA section 1a(49), 7 U.S.C. 1a(49) (defining

    ``swap dealer''); section 3(a)(71)(A) of the Exchange Act, 15 U.S.C.

    78c(a)(71)(A) (defining ``security-based swap dealer''); CEA section

    1a(33), 7 U.S.C. 1a(33) (defining ``major swap participant'');

    section 3(a)(67)(A) of the Exchange Act, 15 U.S.C. 78c(a)(67)(A)

    (defining ``major security-based swap participant''). Such entities

    also would include commercial entities that may use swaps to hedge

    or mitigate commercial risk.

    \398\ See 17 CFR 240.0-10(a).

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

    To the extent that a small number of transactions did have a

    counterparty that was defined as a ``small entity'' under SEC rule 0-

    10, the SEC believes it is unlikely that the proposed rules and

    clarifications regarding the Product Definitions, the regulation of

    mixed swaps, and the books and records requirements for SBSAs would

    have a significant economic impact on that

    [[Page 29888]]

    entity. The proposed rules and clarifications simply would address

    whether certain products fall within the swap definition, address

    whether certain products are swaps, security-based swaps, SBSAs, or

    mixed swaps, provide a process for requesting interpretations of

    whether agreements, contracts, and transactions are swaps, security-

    based swaps, and mixed swaps, provide a process for requesting

    alternative regulatory treatment for mixed swaps, and establish books

    and records requirements for SBSAs, which are applicable to all

    entities.

    For the foregoing reasons, the SEC certifies that the proposed

    rules and clarifications regarding the Product Definitions, the

    regulation of mixed swaps, and the books and records requirements for

    SBSAs 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 support the extent of the impact.

    X. Statutory Basis and Rule Text

    List of Subjects

    17 CFR Part 1

    Definitions, General swap provisions.

    17 CFR Part 240

    Reporting and recordkeeping requirements, Securities.

    Commodity Futures Trading Commission

    Pursuant to the Commodity Exchange Act, 7 U.S.C. 1 et seq., as

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

    Protection Act, Public Law 111-203, 124 Stat. 1376 (2010) (``Dodd-Frank

    Act''), and sections 712(a)(8), 712(d), 721(a), 721(b), 721(c), 722(d),

    and 725(g) of the Dodd-Frank Act, the CFTC is proposing to adopt rules

    1.3(xxx) through 1.3(aaaa) and 1.6 through 1.9 under the Commodity

    Exchange Act.

    Text of Proposed Rules

    For the reasons stated in the preamble, the CFTC is proposing to

    further amend Title 17, Chapter I, of the Code of Federal Regulations,

    as amended at 75 FR 63732, October 18, 2010, 75 FR 65586, Oct. 26,

    2010, 75 FR 77576, Dec. 13, 2010, 75 FR 80174, Dec. 21, 2010, and 76 FR

    722, Jan. 6, 2011, 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, 6c, 6e, 6f, 6g, 6h,

    6i, 6j, 6k, 6l, 6m, 6n, 6o, 6p, 6r, 7, 7a, 7b, 8, 9, 10, 12, 12a,

    12c, 13a, 13a-1, 16, 16a, 21, 23, and 24.

    2. Amend Sec. 1.3 by adding paragraphs (xxx), (yyy), (zzz), and

    (aaaa) to read as follows:

    Sec. 1.3 Definitions.

    * * * * *

    (xxx) Swap. (1) In general. The term swap has the meaning set forth

    in section 1a(47) of the Commodity Exchange Act.

    (2) Inclusion of particular products. (i) The term swap includes,

    without limiting the meaning set forth in section 1a(47) of the

    Commodity Exchange Act, the following agreements, contracts, and

    transactions:

    (A) A cross-currency swap;

    (B) A currency option, foreign currency option, foreign exchange

    option and foreign exchange rate option;

    (C) A foreign exchange forward;

    (D) A foreign exchange swap;

    (E) A forward rate agreement; and

    (F) A non-deliverable forward involving foreign exchange.

    (ii) The term swap does not include an agreement, contract, or

    transaction described in paragraph (xxx)(2)(i) of this section that is

    otherwise excluded by section 1a(47)(B) of the Commodity Exchange Act.

    (3) Foreign exchange forwards and foreign exchange swaps.

    Notwithstanding paragraph (xxx)(2) of this section:

    (i) A foreign exchange forward or a foreign exchange swap shall not

    be considered a swap if the Secretary of the Treasury makes a

    determination described in section 1a(47)(E)(i) of the Commodity

    Exchange Act.

    (ii) Notwithstanding paragraph (xxx)(3)(i) of this section:

    (A) The reporting requirements set forth in section 4r of the

    Commodity Exchange Act and regulations promulgated thereunder shall

    apply to a foreign exchange forward or foreign exchange swap; and

    (B) The business conduct standards set forth in section 4s of the

    Commodity Exchange Act and regulations promulgated thereunder shall

    apply to a swap dealer or major swap participant that is a party to a

    foreign exchange forward or foreign exchange swap.

    (iii) For purposes of section 1a(47)(E) of the Commodity Exchange

    Act and this Sec. 1.3(xxx), the term foreign exchange forward has the

    meaning set forth in section 1a(24) of the Commodity Exchange Act.

    (iv) For purposes of section 1a(47)(E) of the Commodity Exchange

    Act and this Sec. 1.3(xxx), the term foreign exchange swap has the

    meaning set forth in section 1a(25) of the Commodity Exchange Act.

    (v) For purposes of sections 1a(24) and 1a(25) of the Commodity

    Exchange Act and this Sec. 1.3(xxx), the following transactions are

    not foreign exchange forwards or foreign exchange swaps:

    (A) A currency swap or a cross-currency swap;

    (B) A currency option, foreign currency option, foreign exchange

    option, or foreign exchange rate option; and

    (C) A non-deliverable forward involving foreign exchange.

    (4) Insurance. The term swap as used in section 1a(47) of the

    Commodity Exchange Act does not include an agreement, contract, or

    transaction that:

    (i) By its terms or by law, as a condition of performance on the

    agreement, contract, or transaction:

    (A) Requires the beneficiary of the agreement, contract, or

    transaction to have an insurable interest that is the subject of the

    agreement, contract, or transaction and thereby carry the risk of loss

    with respect to that interest continuously throughout the duration of

    the agreement, contract, or transaction;

    (B) Requires that loss to occur and to be proved, and that any

    payment or indemnification therefor be limited to the value of the

    insurable interest;

    (C) Is not traded, separately from the insured interest, on an

    organized market or over-the-counter; and

    (D) With respect to financial guaranty insurance only, in the event

    of payment default or insolvency of the obligor, any acceleration of

    payments under the policy is at the sole discretion of the insurer; and

    (ii) Is provided:

    (A) By a company that is organized as an insurance company whose

    primary and predominant business activity is the writing of insurance

    or the reinsuring of risks underwritten by insurance companies and that

    is subject to supervision by the insurance commissioner (or similar

    official or agency) of any State or by the United States or an agency

    or instrumentality thereof, and such agreement, contract, or

    transaction is regulated as insurance under the laws of such State or

    of the United States;

    (B) By the United States or any of its agencies or

    instrumentalities, or pursuant to a statutorily authorized program

    thereof; or

    [[Page 29889]]

    (C) In the case of reinsurance only, by a person located outside

    the United States to an insurance company that is eligible under

    paragraph (xxx)(4)(ii) of this section, provided that:

    (1) Such person is not prohibited by any law of any State or of the

    United States from offering such agreement, contract, or transaction to

    such an insurance company;

    (2) The product to be reinsured meets the requirements under

    paragraph (xxx)(4)(i) of this section to be insurance; and

    (3) The total amount reimbursable by all reinsurers for such

    insurance product cannot exceed the claims or losses paid by the

    cedant.

    (5) State. For purposes of paragraph (xxx)(4) of this section, the

    term State means any state of the United States, the District of

    Columbia, Puerto Rico, the U.S. Virgin Islands, or any other possession

    of the United States.

    (6) Anti-evasion. (i) An agreement, contract, or transaction that

    is willfully structured to evade any provision of Subtitle A of the

    Wall Street Transparency and Accountability Act of 2010, including any

    amendments made to the Commodity Exchange Act thereby (Subtitle A),

    shall be deemed a swap for purposes of Subtitle A and the rules,

    regulations, and orders of the Commission promulgated thereunder.

    (ii) An interest rate swap or currency swap, including but not

    limited to a transaction identified in paragraph (xxx)(3)(v) of this

    section, that is willfully structured as a foreign exchange forward or

    foreign exchange swap to evade any provision of Subtitle A shall be

    deemed a swap for purposes of Subtitle A and the rules, regulations,

    and orders of the Commission promulgated thereunder.

    (iii) An agreement, contract, or transaction of a bank that is not

    under the regulatory jurisdiction of an appropriate Federal banking

    agency (as defined in section 1a(2) of the Commodity Exchange Act),

    where the agreement, contract, or transaction is willfully structured

    as an identified banking product (as defined in section 402 of the

    Legal Certainty for Bank Products Act of 2000) to evade the provisions

    of the Commodity Exchange Act, shall be deemed a swap for purposes of

    the Commodity Exchange Act and the rules, regulations, and orders of

    the Commission promulgated thereunder.

    (iv) The form, label, and written documentation of an agreement,

    contract, or transaction shall not be dispositive in determining

    whether the agreement, contract, or transaction has been willfully

    structured to evade as provided in paragraphs (xxx)(6)(i) through

    (xxx)(6)(iii) of this section.

    (v) An agreement, contract, or transaction that has been willfully

    structured to evade as provided in paragraphs (xxx)(6)(i) through

    (xxx)(6)(iii) of this section shall be considered in determining

    whether a person is a swap dealer or major swap participant.

    (vi) Notwithstanding the foregoing, no agreement, contract, or

    transaction structured as a security (including a security-based swap)

    under the securities laws (as defined in section 3(a)(47) of the

    Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(47))) shall be deemed

    a swap pursuant to this Sec. 1.3(xxx)(6) or shall be considered for

    purposes of paragraph (xxx)(6)(v) of this section.

    (yyy) Narrow-based security index as used in the definition of

    ``security-based swap.''

    (1) In general. Except as otherwise provided in paragraphs (zzz)

    and (aaaa) of this section, for purposes of section 1a(42) of the

    Commodity Exchange Act, the term narrow-based security index has the

    meaning set forth in section 1a(35) of the Commodity Exchange Act, and

    the rules, regulations and orders of the Commission thereunder.

    (2) Tolerance period for swaps traded on designated contract

    markets, swap execution facilities, and foreign boards of trade.

    Notwithstanding paragraph (yyy)(1) of this section, solely for purposes

    of swaps traded on or subject to the rules of a designated contract

    market, swap execution facility, or foreign board of trade, a security

    index underlying such swaps shall not be considered a narrow-based

    security index if:

    (i)(A) A swap on the index is traded on or subject to the rules of

    a designated contract market, swap execution facility, or foreign board

    of trade for at least 30 days as a swap on an index that was not a

    narrow-based security index; or

    (B) Such index was not a narrow-based security index during every

    trading day of the six full calendar months preceding a date no earlier

    than 30 days prior to the commencement of trading of a swap on such

    index on a market described in paragraph (yyy)(2)(i)(A) of this

    section; and

    (ii) The index has been a narrow-based security index for no more

    than 45 business days over three consecutive calendar months.

    (3) Tolerance period for security-based swaps traded on national

    securities exchanges or security-based swap execution facilities.

    Notwithstanding paragraph (yyy)(1) of this section, solely for purposes

    of security-based swaps traded on a national securities exchange or

    security-based swap execution facility, a security index underlying

    such security-based swaps shall be considered a narrow-based security

    index if:

    (i)(A) A security-based swap on the index is traded on a national

    securities exchange or security-based swap execution facility for at

    least 30 days as a security-based swap on a narrow-based security

    index; or

    (B) Such index was a narrow-based security index during every

    trading day of the six full calendar months preceding a date no earlier

    than 30 days prior to the commencement of trading of a security-based

    swap on such index on a market described in paragraph (yyy)(3)(i)(A) of

    this section; and

    (ii) The index has been a security index that is not a narrow-based

    security index for no more than 45 business days over three consecutive

    calendar months.

    (4) Grace period. (i) Solely with respect to a swap that is traded

    on or subject to the rules of a designated contract market, swap

    execution facility, or foreign board of trade, an index that becomes a

    narrow-based security index under paragraph (yyy)(2) of this section

    solely because it was a narrow-based security index for more than 45

    business days over three consecutive calendar months shall not be a

    narrow-based security index for the following three calendar months.

    (ii) Solely with respect to a security-based swap that is traded on

    a national securities exchange or security-based swap execution

    facility, an index that becomes a security index that is not a narrow-

    based security index under paragraph (yyy)(3) of this section solely

    because it was not a narrow-based security index for more than 45

    business days over three consecutive calendar months shall be a narrow-

    based security index for the following three calendar months.

    (zzz) Meaning of ``issuers of securities in a narrow-based security

    index'' as used in the definition of ``security-based swap'' as applied

    to index credit default swaps.

    (1) Notwithstanding paragraph (yyy)(1) of this section, and solely

    for purposes of determining whether a credit default swap is a

    security-based swap under the definition of ``security-based swap'' in

    section 3(a)(68)(A)(ii)(III) of the Securities Exchange Act of 1934 (15

    U.S.C. 78c(a)(68)(A)(ii)(III), as incorporated in section 1a(42) of the

    Commodity Exchange Act, the term issuers of securities in a narrow-

    based security index means issuers of

    [[Page 29890]]

    securities identified in an index in which:

    (i)(A) There are 9 or fewer non-affiliated issuers of securities

    that are reference entities in the index, provided that an issuer of

    securities shall not be deemed a reference entity for purposes of this

    section unless:

    (1) A credit event with respect to such reference entity would

    result in a payment by the credit protection seller to the credit

    protection buyer under the credit default swap based on the related

    notional amount allocated to such reference entity; or

    (2) The fact of such credit event or the calculation in accordance

    with paragraph (zzz)(1)(i)(A)(1) of this section of the amount owed

    with respect to such credit event is taken into account in determining

    whether to make any future payments under the credit default swap with

    respect to any future credit events;

    (B) The effective notional amount allocated to any reference entity

    included in the index comprises more than 30 percent of the index's

    weighting;

    (C) The effective notional amount allocated to any five non-

    affiliated reference entities included in the index comprises more than

    60 percent of the index's weighting; or

    (D) Except as provided in paragraph (zzz)(2) of this section, for

    each reference entity included in the index, none of the following

    criteria is satisfied:

    (1) The reference entity is required to file reports pursuant to

    section 13 or section 15(d) of the Securities Exchange Act of 1934 (15

    U.S.C. 78m or 78o(d));

    (2) The reference entity is eligible to rely on the exemption

    provided in rule 12g3-2(b) under the Securities Exchange Act of 1934

    (17 CFR 240.12g3-2(b));

    (3) The reference entity has a worldwide market value of its

    outstanding common equity held by non-affiliates of $700 million or

    more;

    (4) The reference entity (other than an issuing entity of an asset-

    backed security as defined in section 3(a)(77) of the Securities

    Exchange Act of 1934 (15 U.S.C. 78c(a)(77)) has outstanding securities

    that are notes, bonds, debentures, or evidences of indebtedness having

    a total remaining principal amount of at least $1 billion;

    (5) The reference entity is the issuer of an exempted security as

    defined in section 3(a)(12) of the Securities Exchange Act of 1934 (15

    U.S.C. 78c(a)(12)) (other than any municipal security as defined in

    section 3(a)(29) of the Securities Exchange Act of 1934 (15 U.S.C.

    78c(a)(29)));

    (6) The reference entity is a government of a foreign country or a

    political subdivision of a foreign country;

    (7) If the reference entity is an issuer of asset-backed securities

    as defined in section 3(a)(77) of the Securities Exchange Act of 1934

    (15 U.S.C. 78c(a)(77)), such asset-based securities were issued in a

    transaction registered under the Securities Act of 1933 (15 U.S.C. 77a

    et seq.) and have publicly available distribution reports; and

    (8) For a credit default swap entered into solely between eligible

    contract participants as defined in section 1a(18) of the Commodity

    Exchange Act:

    (i) The reference entity (other than a reference entity that is an

    issuing entity of an asset-backed security as defined in section

    3(a)(77) of the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(77)))

    provides to the public or to such eligible contract participant

    information about the reference entity pursuant to rule 144A(d)(4)

    under the Securities Act of 1933 (17 CFR 230.144A(d)(4));

    (ii) Financial information about the reference entity (other than a

    reference entity that is an issuing entity of an asset-backed security

    as defined in section 3(a)(77) of the Securities Exchange Act of 1934

    (15 U.S.C. 78c(a)(77))) is otherwise publicly available; or

    (iii) In the case of a reference entity that is an issuing entity

    of asset-backed securities as defined in section 3(a)(77) of the

    Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(77)), information of

    the type and level included in public distribution reports for similar

    asset-backed securities is publicly available about both the reference

    entity and such asset-backed securities; and

    (ii)(A) The index is not composed solely of reference entities that

    are issuers of exempted securities as defined in section 3(a)(12) of

    the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(12)), as in

    effect on the date of enactment of the Futures Trading Act of 1982

    (other than any municipal security as defined in section 3(a)(29) of

    the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(29))), as in

    effect on the date of enactment of the Futures Trading Act of 1982);

    and

    (B) Without taking into account any portion of the index composed

    of reference entities that are issuers of exempted securities as

    defined in section 3(a)(12) of the Securities Exchange Act of 1934 (15

    U.S.C. 78c(a)(12)), as in effect on the date of enactment of the

    Futures Trading Act of 1982 (other than any municipal security as

    defined in section 3(a)(29) of the Securities Exchange Act of 1934 (15

    U.S.C. 78c(a)(29))), the remaining portion of the index would be a

    narrow-based security index under paragraph (zzz)(1)(i) of this

    section.

    (2) Paragraph (zzz)(1)(i)(D) of this section will not apply with

    respect to a reference entity included in the index if:

    (i) The effective notional amounts allocated to such reference

    entity comprise less than five percent of the index's weighting; and

    (ii) The effective notional amounts allocated to reference entities

    that satisfy paragraph (zzz)(1)(i)(D) of this section comprise at least

    80 percent of the index's weighting.

    (3) For purposes of this paragraph (zzz):

    (i) A reference entity is affiliated with another entity if it

    controls, is controlled by, or is under common control with, that

    entity; provided that each reference entity that is an issuing entity

    of an asset-backed security as defined in section 3(a)(77) of the

    Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(77)) will not be

    considered affiliated with any other issuing entity of an asset-backed

    security.

    (ii) Control means ownership of 20 percent or more of an entity's

    equity, or the ability to direct the voting of 20 percent or more of

    the entity's voting equity.

    (iii) The term reference entity includes:

    (A) An issuer of securities;

    (B) An issuing entity of an asset-based security as defined in

    section 3(a)(77) of the Securities Exchange Act of 1934 (15 U.S.C.

    78c(a)(77)); and

    (C) A single reference entity or a group of affiliated entities;

    provided that each issuing entity of an asset-backed security as

    defined in section 3(a)(77) of the Securities Exchange Act of 1934 (15

    U.S.C. 78c(a)(77)) is a separate reference entity.

    (aaaa) Meaning of ``narrow-based security index'' as used in the

    definition of ``security-based swap'' as applied to index credit

    default swaps.

    (1) Notwithstanding paragraph (yyy)(1) of this section, and solely

    for purposes of determining whether a credit default swap is a

    security-based swap under the definition of ``security-based swap'' in

    section 3(a)(68)(A)(ii)(I) of the Securities Exchange Act of 1934 (15

    U.S.C. 78c(a)(68)(A)(ii)(I), as incorporated in section 1a(42) of the

    Commodity Exchange Act, the term narrow-based security index means an

    index in which:

    (i)(A) The index is composed of 9 or fewer securities or securities

    that are issued by 9 or fewer non-affiliated issuers, provided that a

    security shall

    [[Page 29891]]

    not be deemed a component of the index for purposes of this section

    unless:

    (1) A credit event with respect to the issuer of such security or a

    credit event with respect to such security would result in a payment by

    the credit protection seller to the credit protection buyer under the

    credit default swap based on the related notional amount allocated to

    such security; or

    (2) The fact of such credit event or the calculation in accordance

    with paragraph (aaaa)(1)(i)(A)(1) of this section of the amount owed

    with respect to such credit event is taken into account in determining

    whether to make any future payments under the credit default swap with

    respect to any future credit events;

    (B) The effective notional amount allocated to the securities of

    any issuer included in the index comprises more than 30 percent of the

    index's weighting;

    (C) The effective notional amount allocated to the securities of

    any five non-affiliated issuers included in the index comprises more

    than 60 percent of the index's weighting; or

    (D) Except as provided in paragraph (aaaa)(2) of this section, for

    each security included in the index, none of the following criteria is

    satisfied:

    (1) The issuer of the security is required to file reports pursuant

    to section 13 or section 15(d) of the Securities Exchange Act of 1934

    (15 U.S.C. 78m or 78o(d));

    (2) The issuer of the security is eligible to rely on the exemption

    provided in rule 12g3-2(b) under the Securities Exchange Act of 1934

    (17 CFR 240.12g3-2(b));

    (3) The issuer of the security has a worldwide market value of its

    outstanding common equity held by non-affiliates of $700 million or

    more;

    (4) The issuer of the security (other than an issuing entity of an

    asset-backed security as defined in section 3(a)(77) of the Securities

    Exchange Act of 1934 (15 U.S.C. 78c(a)(77))) has outstanding securities

    that are notes, bonds, debentures, or evidences of indebtedness having

    a total remaining principal amount of at least $1 billion;

    (5) The security is an exempted security as defined in section

    3(a)(12) of the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(12))

    (other than any municipal security as defined in section 3(a)(29) of

    the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(29)));

    (6) The issuer of the security is a government of a foreign country

    or a political subdivision of a foreign country;

    (7) If the security is an asset-backed security as defined in

    section 3(a)(77) of the Securities Exchange Act of 1934 (15 U.S.C.

    78c(a)(77)), the security was issued in a transaction registered under

    the Securities Act of 1933 (15 U.S.C. 77a et seq.) and has publicly

    available distribution reports; and

    (8) For a credit default swap entered into solely between eligible

    contract participants as defined in section 1a(18) of the Commodity

    Exchange Act:

    (i) The issuer of the security (other than an issuing entity of an

    asset-backed security as defined in section 3(a)(77) of the Securities

    Exchange Act of 1934 (15 U.S.C. 78c(a)(77))) provides to the public or

    to such eligible contract participant information about such issuer

    pursuant to rule 144A(d)(4) of the Securities Act of 1933 (17 CFR

    230.144A(d)(4));

    (ii) Financial information about the issuer of the security (other

    than an asset-backed security as defined in section 3(a)(77) of the

    Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(77))) is otherwise

    publicly available; or

    (iii) In the case of an asset-backed security as defined in section

    3(a)(77) of the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(77)),

    information of the type and level included in public distribution

    reports for similar asset-backed securities is publicly available about

    both the issuing entity and such asset-backed security; and

    (ii)(A) The index is not composed solely of exempted securities as

    defined in section 3(a)(12) of the Securities Exchange Act of 1934 (15

    U.S.C. 78c(a)(12)), as in effect on the date of enactment of the

    Futures Trading Act of 1982 (other than any municipal security as

    defined in section 3(a)(29) of the Securities Exchange Act of 1934 (15

    U.S.C. 78c(a)(29))), as in effect on the date of enactment of the

    Futures Trading Act of 1982); and

    (B) Without taking into account any portion of the index composed

    of exempted securities as defined in section 3(a)(12) of the Securities

    Exchange Act of 1934 (15 U.S.C. 78c(a)(12)), as in effect on the date

    of enactment of the Futures Trading Act of 1982 (other than any

    municipal security as defined in section 3(a)(29) of the Securities

    Exchange Act of 1934 (15 U.S.C. 78c(a)(29))), the remaining portion of

    the index would be a narrow-based security index under paragraph

    (aaaa)(1)(i) of this section.

    (2) Paragraph (aaaa)(1)(i)(D) of this section will not apply with

    respect to securities of an issuer included in the index if:

    (i) The effective notional amounts allocated to all securities of

    such issuer included in the index comprise less than five percent of

    the index's weighting; and

    (ii) The securities that satisfy paragraph (aaaa)(1)(i)(D) of this

    section comprise at least 80 percent of the index's weighting.

    (3) For purposes of this paragraph (aaaa):

    (i) An issuer is affiliated with another issuer if it controls, is

    controlled by, or is under common control with, that issuer; provided

    that each issuing entity of an asset-backed security as defined in

    section 3(a)(77) of the Securities Exchange Act of 1934 (15 U.S.C.

    78c(a)(77)) will not be considered affiliated with any other issuing

    entity of an asset-backed security.

    (ii) Control means ownership of 20 percent or more of an issuer's

    equity, or the ability to direct the voting of 20 percent or more of

    the issuer's voting equity.

    (iii) The term issuer includes:

    (A) An issuer of securities;

    (B) An issuing entity of an asset-based security as defined in

    section 3(a)(77) of the Securities Exchange Act of 1934 (15 U.S.C.

    78c(a)(77)); and

    (C) A single issuer or a group of affiliated issuers; provided that

    each issuing entity of an asset-backed security as defined in section

    3(a)(77) of the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(77))

    is a separate issuer.

    3. Add Sec. Sec. 1.6 through 1.9 to read as follows:

    Sec.

    1.6 Anti-evasion.

    1.7 Books and records requirements for security-based swap

    agreements.

    1.8 Interpretation of swaps, security-based swaps, and mixed swaps.

    1.9 Regulation of mixed swaps.

    * * * * *

    Sec. 1.6 Anti-evasion.

    (a) It shall be unlawful to conduct activities outside the United

    States, including entering into agreements, contracts, and transactions

    and structuring entities, to willfully evade or attempt to evade any

    provision of the Commodity Exchange Act as enacted by Subtitle A of the

    Wall Street Transparency and Accountability Act of 2010 or the rules,

    regulations, and orders of the Commission promulgated thereunder

    (Subtitle A).

    (b) The form, label, and written documentation of an agreement,

    contract, or transaction, or an entity, shall not be dispositive in

    determining whether the agreement, contract, or transaction, or entity,

    has been entered into or structured to willfully evade as

    [[Page 29892]]

    provided in paragraph (a) of this section.

    (c) An activity conducted outside the United States to evade as

    provided in paragraph (a) of this section shall be subject to the

    provisions of Subtitle A.

    (d) Notwithstanding the foregoing, no agreement, contract, or

    transaction structured as a security (including a security-based swap)

    under the securities laws (as defined in section 3(a)(47) of the

    Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(47))) shall be deemed

    a swap pursuant to this Sec. 1.6.

    5. Add Sec. 1.7 to read as follows:

    Sec. 1.7 Books and records requirements for security-based swap

    agreements.

    (a) A person registered as a swap data repository under section 21

    of the Commodity Exchange Act and the rules and regulations thereunder:

    (1) Shall not be required to keep and maintain additional books and

    records regarding security-based swap agreements other than the books

    and records regarding swaps required to be kept and maintained pursuant

    to section 21 of the Commodity Exchange Act and the rules and

    regulations thereunder; and

    (2) Shall not be required to collect and maintain additional data

    regarding security-based swap agreements other than the data regarding

    swaps required to be collected and maintained by such persons pursuant

    to section 21 of the Commodity Exchange Act and the rules and

    regulations thereunder.

    (b) A person shall not be required to keep and maintain additional

    books and records, including daily trading records, regarding security-

    based swap agreements other than the books and records regarding swaps

    required to be kept and maintained by such persons pursuant to section

    4s of the Commodity Exchange Act and the rules and regulations

    thereunder if such person is registered as:

    (1) A swap dealer under section 4s(a)(1) of the Commodity Exchange

    Act and the rules and regulations thereunder;

    (2) A major swap participant under section 4s(a)(2) of the

    Commodity Exchange Act and the rules and regulations thereunder;

    (3) A security-based swap dealer under section 15F(a)(1) of the

    Securities Exchange Act of 1934 (15 U.S.C. 78o-10(a)(1)) and the rules

    and regulations thereunder; or

    (4) A major security-based swap participant under section 15F(a)(2)

    of the Securities Exchange Act of 1934 (15 U.S.C. 78o-10(a)(2)) and the

    rules and regulations thereunder.

    (c) The term security-based swap agreement has the meaning set

    forth in section 1a(47)(A)(v) of the Commodity Exchange Act.

    6. Add Sec. 1.8 to read as follows:

    Sec. 1.8 Interpretation of swaps, security-based swaps, and mixed

    swaps.

    (a) In general. Any person may submit a request to the Commission

    and the Securities and Exchange Commission to provide a joint

    interpretation of whether a particular agreement, contract, or

    transaction (or class thereof) is:

    (1) A swap, as that term is defined in section 1a(47) of the

    Commodity Exchange Act and the rules and regulations promulgated

    thereunder;

    (2) A security-based swap, as that term is defined in section

    1a(42) of the Commodity Exchange Act and the rules and regulations

    promulgated thereunder; or

    (3) A mixed swap, as that term is defined in section 1a(47)(D) of

    the Commodity Exchange Act and the rules and regulations promulgated

    thereunder.

    (b) Request process. In making a request pursuant to paragraph (a)

    of this section, the requesting person must provide the Commission and

    the Securities and Exchange Commission with the following:

    (1) All material information regarding the terms of the agreement,

    contract, or transaction (or class thereof);

    (2) A statement of the economic characteristics and purpose of the

    agreement, contract, or transaction (or class thereof);

    (3) The requesting person's determination as to whether the

    agreement, contract, or transaction (or class thereof) should be

    characterized as a swap, a security-based swap, or both, (i.e., a mixed

    swap), including the basis for such determination; and

    (4) Such other information as may be requested by the Commission or

    the Securities and Exchange Commission.

    (c) Request withdrawal. A person may withdraw a request made

    pursuant to paragraph (a) of this section at any time prior to the

    issuance of a joint interpretation or joint notice of proposed

    rulemaking by the Commission and the Securities and Exchange Commission

    in response to the request; provided, however, that notwithstanding

    such withdrawal, the Commission and the Securities and Exchange

    Commission may provide a joint interpretation of whether the agreement,

    contract, or transaction (or class thereof) is a swap, a security-based

    swap, or both (i.e., a mixed swap).

    (d) Request by the Commission or the Securities and Exchange

    Commission. In the absence of a request for a joint interpretation

    under paragraph (a) of this section:

    (1) If the Commission or the Securities and Exchange Commission

    receives a proposal to list, trade, or clear an agreement, contract, or

    transaction (or class thereof) that raises questions as to the

    appropriate characterization of such agreement, contract, or

    transaction (or class thereof) as a swap, a security-based swap, or

    both (i.e., a mixed swap), the Commission or the Securities and

    Exchange Commission, as applicable, promptly shall notify the other of

    the agreement, contract, or transaction (or class thereof); and

    (2) The Commission or the Securities and Exchange Commission, or

    their Chairmen jointly, may submit a request for a joint interpretation

    as described in paragraph (a) of this section; such submission shall be

    made pursuant to paragraph (b) of this section, and may be withdrawn

    pursuant to paragraph (c) of this section.

    (e) Timeframe for joint interpretation. (1) If the Commission and

    the Securities and Exchange Commission determine to issue a joint

    interpretation as described in paragraph (a) of this section, such

    joint interpretation shall be issued within 120 days after receipt of a

    complete submission requesting a joint interpretation under paragraph

    (a) or (d) of this section.

    (2) The Commission and the Securities and Exchange Commission shall

    consult with the Board of Governors of the Federal Reserve System prior

    to issuing any joint interpretation as described in paragraph (a) of

    this section.

    (3) If the Commission and the Securities and Exchange Commission

    seek public comment with respect to a joint interpretation regarding an

    agreement, contract, or transaction (or class thereof), the 120-day

    period described in paragraph (e)(1) of this section shall be stayed

    during the pendency of the comment period, but shall recommence with

    the business day after the public comment period ends.

    (4) Nothing in this section shall require the Commission and the

    Securities and Exchange Commission to issue any joint interpretation.

    (5) If the Commission and the Securities and Exchange Commission do

    not issue a joint interpretation within the time period described in

    paragraph (e)(1) or (e)(3) of this section, each of the Commission and

    the Securities and Exchange Commission shall publicly provide the

    reasons for not issuing such a joint interpretation within the

    applicable timeframes.

    (f) Joint notice of proposed rulemaking. (1) Rather than issue a

    joint interpretation pursuant to paragraph (a) of this section, the

    Commission and the

    [[Page 29893]]

    Securities and Exchange Commission may issue a joint notice of proposed

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

    Reserve System, to further define one or more of the terms swap,

    security-based swap, or mixed swap.

    (2) A joint notice of proposed rulemaking described in paragraph

    (f)(1) of this section shall be issued within the timeframe for issuing

    a joint interpretation set forth in paragraph (e) of this section.

    7. Add Sec. 1.9 to read as follows:

    Sec. 1.9 Regulation of mixed swaps.

    (a) In general. The term mixed swap has the meaning set forth in

    section 1a(47)(D) of the Commodity Exchange Act.

    (b) Regulation of bilateral uncleared mixed swaps entered into by

    dually-registered dealers or major participants. A mixed swap:

    (1) That is neither executed on nor subject to the rules of a

    designated contract market, national securities exchange, swap

    execution facility, security-based swap execution facility, or foreign

    board of trade;

    (2) That will not be submitted to a derivatives clearing

    organization or registered or exempt clearing agency to be cleared; and

    (3) Where at least one party is registered with the Commission as a

    swap dealer or major swap participant and also with the Securities and

    Exchange Commission as a security-based swap dealer or major security-

    based swap participant, shall be subject to:

    (i) The following provisions of the Commodity Exchange Act, and the

    rules and regulations promulgated thereunder:

    (A) Examinations and information sharing: sections 4s(f) and 8 of

    the Commodity Exchange Act;

    (B) Enforcement: sections 2(a)(1)(B), 4(b), 4b, 4c, 6(c), 6(d), 6c,

    6d, 9, 13(a), 13(b), and 23 of the Commodity Exchange Act;

    (C) Reporting to a swap data repository: section 4r of the

    Commodity Exchange Act;

    (D) Real-time reporting: section 2(a)(13) of the Commodity Exchange

    Act;

    (E) Capital: section 4s(e) of the Commodity Exchange Act; and

    (F) Position Limits: section 4a of the Commodity Exchange Act; and

    (ii) The provisions of the Federal securities laws, as defined in

    section 3(a)(47) of the Securities Exchange Act of 1934 (15 U.S.C.

    78c(a)(47)), and the rules and regulations promulgated thereunder.

    (c) Process for determining regulatory treatment for other mixed

    swaps--(1) In general. Any person who desires or intends to list,

    trade, or clear a mixed swap (or class thereof) that is not subject to

    paragraph (b) of this section may request the Commission and the

    Securities and Exchange Commission to issue a joint order permitting

    the requesting person (and any other person or persons that

    subsequently lists, trades, or clears that mixed swap) to comply, as to

    parallel provisions only, with specified parallel provisions of either

    the Commodity Exchange Act or the Securities Exchange Act of 1934 (15

    U.S.C. 78a et seq.), and the rules and regulations thereunder

    (collectively, specified parallel provisions), instead of being

    required to comply with parallel provisions of both the Commodity

    Exchange Act and the Securities Exchange Act of 1934. For purposes of

    this paragraph (c), parallel provisions means comparable provisions of

    the Commodity Exchange Act and the Securities Exchange Act of 1934 that

    were added or amended by the Wall Street Transparency and

    Accountability Act of 2010 with respect to swaps and security-based

    swaps, and the rules and regulations thereunder.

    (2) Request process. A person submitting a request pursuant to

    paragraph (c)(1) of this section must provide the Commission and the

    Securities and Exchange Commission with the following:

    (i) All material information regarding the terms of the specified,

    or specified class of, mixed swap;

    (ii) The economic characteristics and purpose of the specified, or

    specified class of, mixed swap;

    (iii) The specified parallel provisions, and the reasons the person

    believes such specified parallel provisions would be appropriate for

    the mixed swap (or class thereof); and

    (iv) An analysis of:

    (A) The nature and purposes of the parallel provisions that are the

    subject of the request;

    (B) The comparability of such parallel provisions;

    (C) The extent of any conflicts or differences between such

    parallel provisions; and

    (D) Such other information as may be requested by the Commission or

    the Securities and Exchange Commission.

    (3) Request withdrawal. A person may withdraw a request made

    pursuant to paragraph (c)(1) of this section at any time prior to the

    issuance of a joint order under paragraph (c)(4) of this section by the

    Commission and the Securities and Exchange Commission in response to

    the request.

    (4) Issuance of orders. In response to a request under paragraph

    (c)(1) of this section, the Commission and the Securities and Exchange

    Commission, as necessary to carry out the purposes of the Wall Street

    Transparency and Accountability Act of 2010, may issue a joint order,

    after notice and opportunity for comment, permitting the requesting

    person (and any other person or persons that subsequently lists,

    trades, or clears that mixed swap) to comply, as to parallel provisions

    only, with the specified parallel provisions (or another subset of the

    parallel provisions that are the subject of the request, as the

    Commissions determine is appropriate), instead of being required to

    comply with parallel provisions of both the Commodity Exchange Act and

    the Securities Exchange Act of 1934. In determining the contents of

    such joint order, the Commission and the Securities and Exchange

    Commission may consider, among other things:

    (i) The nature and purposes of the parallel provisions that are the

    subject of the request;

    (ii) The comparability of such parallel provisions; and

    (iii) The extent of any conflicts or differences between such

    parallel provisions.

    (5) Timeframe. (i) If the Commission and the Securities and

    Exchange Commission determine to issue a joint order as described in

    paragraph (c)(4) of this section, such joint order shall be issued

    within 120 days after receipt of a complete request for a joint order

    under paragraph (c)(1) of this section, which time period shall be

    stayed during the pendency of the public comment period provided for in

    paragraph (c)(4) of this section and shall recommence with the business

    day after the public comment period ends.

    (ii) Nothing in this section shall require the Commission and the

    Securities and Exchange Commission to issue any joint order.

    (iii) If the Commission and the Securities and Exchange Commission

    do not issue a joint order within the time period described in

    paragraph (c)(5)(i) of this section, each of the Commission and the

    Securities and Exchange Commission shall publicly provide the reasons

    for not issuing such a joint order within that timeframe.

    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(a)(8),

    712(d), 721(a), 761(a) of the Dodd-Frank Act, the SEC is proposing to

    adopt rules 3a68-1a through 3a68-4 and

    [[Page 29894]]

    3a69-1 through 3a69-3 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 general authority citation for Part 240 is revised to read

    as follows:

    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, 78n-1, 78o, 78o-4, 78o-8,

    78p, 78q, 78s, 78u-5, 78w, 78x, 78dd(b), 78dd(c), 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.

    * * * * *

    2. Add Sec. Sec. 240.3a68-1a through 240.3a68-4 and Sec. Sec.

    240.3a69-1 through 240.3a69-3 to read as follows:

    240.3a68-1a Meaning of ``issuers of securities in a narrow-based

    security index'' as used in section 3(a)(68)(A)(ii)(III) of the Act.

    240.3a68-1b Meaning of ``narrow-based security index'' as used in

    section 3(a)(68)(A)(ii)(I) of the Act.

    240.3a68-2 Interpretation of swaps, security-based swaps, and mixed

    swaps.

    240.3a68-3 Meaning of ``narrow-based security index'' as used in the

    definition of ``security-based swap''.

    240.3a68-4 Regulation of mixed swaps.

    240.3a69-1 Definition of ``swap'' as used in section 3(a)(69) of the

    Act--insurance.

    240.3a69-2 Definition of ``swap'' as used in section 3(a)(69) of the

    Act--additional products.

    240.3a69-3 Books and records requirements for security-based swap

    agreements.

    * * * * *

    Sec. 240.3a68-1a Meaning of ``issuers of securities in a narrow-based

    security index'' as used in section 3(a)(68)(A)(ii)(III) of the Act.

    (a) Notwithstanding Sec. 240.3a68-3(a) of this chapter, and solely

    for purposes of determining whether a credit default swap is a

    security-based swap under section 3(a)(68)(A)(ii)(III) of the Act (15

    U.S.C. 78c(a)(68)(A)(ii)(III)), the term issuers of securities in a

    narrow-based security index as used in section 3(a)(68)(A)(ii)(III) of

    the Act means issuers of securities identified in an index in which:

    (1)(i) There are 9 or fewer non-affiliated issuers of securities

    that are reference entities in the index, provided that an issuer of

    securities shall not be deemed a reference entity for purposes of this

    section unless:

    (A) A credit event with respect to such reference entity would

    result in a payment by the credit protection seller to the credit

    protection buyer under the credit default swap based on the related

    notional amount allocated to such reference entity; or

    (B) The fact of such credit event or the calculation in accordance

    with paragraph (a)(1)(i)(A) of this section of the amount owed with

    respect to such credit event is taken into account in determining

    whether to make any future payments under the credit default swap with

    respect to any future credit events;

    (ii) The effective notional amount allocated to any reference

    entity included in the index comprises more than 30 percent of the

    index's weighting;

    (iii) The effective notional amount allocated to any five non-

    affiliated reference entities included in the index comprises more than

    60 percent of the index's weighting; or

    (iv) Except as provided in paragraph (b) of this section, for each

    reference entity included in the index, none of the following criteria

    is satisfied:

    (A) The reference entity is required to file reports pursuant to

    section 13 or section 15(d) of the Act (15 U.S.C. 78m or 78o(d));

    (B) The reference entity is eligible to rely on the exemption

    provided in Sec. 240.12g3-2(b) of this chapter;

    (C) The reference entity has a worldwide market value of its

    outstanding common equity held by non-affiliates of $700 million or

    more;

    (D) The reference entity (other than an issuing entity of an asset-

    backed security as defined in section 3(a)(77) of the Act (15 U.S.C.

    78c(a)(77))) has outstanding securities that are notes, bonds,

    debentures, or evidences of indebtedness having a total remaining

    principal amount of at least $1 billion;

    (E) The reference entity is the issuer of an exempted security as

    defined in section 3(a)(12) of the Act (15 U.S.C. 78c(a)(12)) (other

    than any municipal security as defined in section 3(a)(29) of the Act

    (15 U.S.C. 78c(a)(29)));

    (F) The reference entity is a government of a foreign country or a

    political subdivision of a foreign country;

    (G) If the reference entity is an issuer of asset-backed securities

    as defined in section 3(a)(77) of the Act (15 U.S.C. 78c(a)(77)), such

    asset-based securities were issued in a transaction registered under

    the Securities Act of 1933 (15 U.S.C. 77a et seq.) and have publicly

    available distribution reports; and

    (H) For a credit default swap entered into solely between eligible

    contract participants as defined in section 3(a)(65) of the Act (15

    U.S.C. 78c(a)(65)):

    (1) The reference entity (other than a reference entity that is an

    issuing entity of an asset-backed security as defined in section

    3(a)(77) of the Act (15 U.S.C. 78c(a)(77))) provides to the public or

    to such eligible contract participant information about the reference

    entity pursuant to Sec. 230.144A(d)(4)) of this chapter;

    (2) Financial information about the reference entity (other than a

    reference entity that is an issuing entity of an asset-backed security

    as defined in section 3(a)(77) of the Act (15 U.S.C. 78c(a)(77))) is

    otherwise publicly available; or

    (3) In the case of a reference entity that is an issuing entity of

    asset-backed securities as defined in section 3(a)(77) of the Act (15

    U.S.C. 78c(a)(77)), information of the type and level included in

    public distribution reports for similar asset-backed securities is

    publicly available about both the reference entity and such asset-

    backed securities; and

    (2)(i) The index is not composed solely of reference entities that

    are issuers of exempted securities as defined in section 3(a)(12) of

    the Act (15 U.S.C. 78c(a)(12)), as in effect on the date of enactment

    of the Futures Trading Act of 1982 (other than any municipal security

    as defined in section 3(a)(29) of the Act (15 U.S.C. 78c(a)(29))), as

    in effect on the date of enactment of the Futures Trading Act of 1982);

    and

    (ii) Without taking into account any portion of the index composed

    of reference entities that are issuers of exempted securities as

    defined in section 3(a)(12) of the Act (15 U.S.C. 78c(a)(12)), as in

    effect on the date of enactment of the Futures Trading Act of 1982

    (other than any municipal security as defined in section 3(a)(29) of

    the Act (15 U.S.C. 78c(a)(29))), the remaining portion of the index

    would be a narrow-based security index under paragraph (a)(1) of this

    section.

    (b) Paragraph (a)(1)(iv) of this section will not apply with

    respect to a reference entity included in the index if:

    (1) The effective notional amounts allocated to such reference

    entity comprise less than five percent of the index's weighting; and

    (2) The effective notional amounts allocated to reference entities

    that satisfy paragraph (a)(1)(iv) of this section comprise at least 80

    percent of the index's weighting.

    (c) For purposes of this Sec. 3a68-1a:

    (1) A reference entity is affiliated with another entity if it

    controls, is controlled by, or is under common control with,

    [[Page 29895]]

    that entity; provided that each reference entity that is an issuing

    entity of an asset-backed security as defined in section 3(a)(77) of

    the Act (15 U.S.C. 78c(a)(77)) will not be considered affiliated with

    any other issuing entity of an asset-backed security.

    (2) Control means ownership of 20 percent or more of an entity's

    equity, or the ability to direct the voting of 20 percent or more of

    the entity's voting equity.

    (3) The term reference entity includes:

    (i) An issuer of securities;

    (ii) An issuing entity of an asset-based security as defined in

    section 3(a)(77) of the Act (15 U.S.C. 78c(a)(77)); and

    (iii) A single reference entity or a group of affiliated entities;

    provided that each issuing entity of an asset-backed security as

    defined in section 3(a)(77) of the Act (15 U.S.C. 78c(a)(77)) is a

    separate reference entity.

    Sec. 240.3a68-1b Meaning of ``narrow-based security index'' as used

    in section 3(a)(68)(A)(ii)(I) of the Act.

    (a) Notwithstanding Sec. 240.3a68-3(a) of this chapter, and solely

    for purposes of determining whether a credit default swap is a

    security-based swap under section 3(a)(68)(A)(ii)(I) of the Act (15

    U.S.C. 78c(a)(68)(A)(ii)(I)), the term narrow-based security index as

    used in section 3(a)(68)(A)(ii)(I) of the Act means an index in which:

    (1)(i) The index is composed of 9 or fewer securities or securities

    that are issued by 9 or fewer non-affiliated issuers, provided that a

    security shall not be deemed a component of the index for purposes of

    this section unless:

    (A) A credit event with respect to the issuer of such security or a

    credit event with respect to such security would result in a payment by

    the credit protection seller to the credit protection buyer under the

    credit default swap based on the related notional amount allocated to

    such security; or

    (B) The fact of such credit event or the calculation in accordance

    with paragraph (a)(1)(i)(A) of this section of the amount owed with

    respect to such credit event is taken into account in determining

    whether to make any future payments under the credit default swap with

    respect to any future credit events;

    (ii) The effective notional amount allocated to the securities of

    any issuer included in the index comprises more than 30 percent of the

    index's weighting;

    (iii) The effective notional amount allocated to the securities of

    any five non-affiliated issuers included in the index comprises more

    than 60 percent of the index's weighting; or

    (iv) Except as provided in paragraph (b) of this section, for each

    security included in the index none of the following criteria is

    satisfied:

    (A) The issuer of the security is required to file reports pursuant

    to section 13 or section 15(d) of the Act (15 U.S.C. 78m or 78o(d));

    (B) The issuer of the security is eligible to rely on the exemption

    provided in Sec. 40.12g3-2(b) of this chapter;

    (C) The issuer of the security has a worldwide market value of its

    outstanding common equity held by non-affiliates of $700 million or

    more;

    (D) The issuer of the security (other than an issuing entity of an

    asset-backed security as defined in section 3(a)(77) of the Act (15

    U.S.C. 78c(a)(77))) has outstanding securities that are notes, bonds,

    debentures, or evidences of indebtedness having a total remaining

    principal amount of at least $1 billion;

    (E) The security is an exempted security as defined in section

    3(a)(12) of the Act (15 U.S.C. 78c(a)(12)) (other than any municipal

    security as defined in section 3(a)(29) of the Act (15 U.S.C.

    78c(a)(29)));

    (F) The issuer of the security is a government of a foreign country

    or a political subdivision of a foreign country;

    (G) If the security is an asset-backed security as defined in

    section 3(a)(77) of the Act (15 U.S.C. 78c(a)(77)), the security was

    issued in a transaction registered under the Securities Act of 1933 (15

    U.S.C. 77a et seq.) and has publicly available distribution reports;

    and

    (H) For a credit default swap entered into solely between eligible

    contract participants as defined in section 3(a)(65) of the Act (15

    U.S.C. 78c(a)(65)):

    (1) The issuer of the security (other than an issuing entity of an

    asset-backed security as defined in section 3(a)(77) of the Act (15

    U.S.C. 78c(a)(77))) provides to the public or to such eligible contract

    participant information about such issuer pursuant to Sec.

    230.144A(d)(4)) of this chapter;

    (2) Financial information about the issuer of the security (other

    than an asset-backed security as defined in section 3(a)(77) of the Act

    (15 U.S.C. 78c(a)(77))) is otherwise publicly available; or

    (3) In the case of an asset-backed security as defined in section

    3(a)(77) of the Act (15 U.S.C. 78c(a)(77)), information of the type and

    level included in public distribution reports for similar asset-backed

    securities is publicly available about both the issuing entity and such

    asset-backed security; and

    (2)(i) The index is not composed solely of exempted securities as

    defined in section 3(a)(12) of the Act (15 U.S.C. 78c(a)(12)), as in

    effect on the date of enactment of the Futures Trading Act of 1982

    (other than any municipal security as defined in section 3(a)(29) of

    the Act (15 U.S.C. 78c(a)(29))), as in effect on the date of enactment

    of the Futures Trading Act of 1982); and

    (ii) Without taking into account any portion of the index composed

    of exempted securities as defined in section 3(a)(12) of the Act (15

    U.S.C. 78c(a)(12)), as in effect on the date of enactment of the

    Futures Trading Act of 1982 (other than any municipal security as

    defined in section 3(a)(29) of the Act (15 U.S.C. 78c(a)(29))), the

    remaining portion of the index would be a narrow-based security index

    under paragraph (a)(1) of this section.

    (b) Paragraph (a)(1)(iv) of this section will not apply with

    respect to securities of an issuer included in the index if:

    (1) The effective notional amounts allocated to all securities of

    such issuer included in the index comprise less than five percent of

    the index's weighting; and

    (2) The securities that satisfy paragraph (a)(1)(iv) of this

    section comprise at least 80 percent of the index's weighting.

    (c) For purposes of this Sec. 240.3a68-1b:

    (1) An issuer is affiliated with another issuer if it controls, is

    controlled by, or is under common control with, that issuer; provided

    that each issuing entity of an asset-backed security as defined in

    section 3(a)(77) of the Act (15 U.S.C. 78c(a)(77)) will not be

    considered affiliated with any other issuing entity of an asset-backed

    security.

    (2) Control means ownership of 20 percent or more of an issuer's

    equity, or the ability to direct the voting of 20 percent or more of

    the issuer's voting equity.

    (3) The term issuer includes:

    (i) An issuer of securities;

    (ii) An issuing entity of an asset-based security as defined in

    section 3(a)(77) of the Act (15 U.S.C. 78c(a)(77)); and

    (iii) A single issuer or a group of affiliated issuers; provided

    that each issuing entity of an asset-backed security as defined in

    section 3(a)(77) of the Act (15 U.S.C. 78c(a)(77)) is a separate

    issuer.

    Sec. 240.3a68-2 Interpretation of swaps, security-based swaps, and

    mixed swaps.

    (a) In general. Any person may submit a request to the Commission

    and the Commodity Futures Trading Commission to provide a joint

    interpretation of whether a particular agreement, contract, or

    transaction (or

    [[Page 29896]]

    class thereof) is a swap, as that term is defined in section 3(a)(69)

    of the Act (15 U.S.C. 78c(a)(69)) and the rules and regulations

    promulgated thereunder, a security-based swap, as that term is defined

    in section 3(a)(68) of the Act (15 U.S.C. 78c(a)(68)) and the rules and

    regulations promulgated thereunder, or a mixed swap, as that term is

    defined in section 3(a)(68)(D) of the Act and the rules and regulations

    promulgated thereunder.

    (b) Request process. In making a request pursuant to paragraph (a)

    of this section, the requesting person must provide the Commission and

    the Commodity Futures Trading Commission with the following:

    (1) All material information regarding the terms of the agreement,

    contract, or transaction (or class thereof);

    (2) A statement of the economic characteristics and purpose of the

    agreement, contract, or transaction (or class thereof);

    (3) The requesting person's determination as to whether the

    agreement, contract, or transaction (or class thereof) should be

    characterized as a swap, a security-based swap, or both (i.e., a mixed

    swap), including the basis for such determination; and

    (4) Such other information as may be requested by the Commission or

    the Commodity Futures Trading Commission.

    (c) Request withdrawal. A person may withdraw a request made

    pursuant to paragraph (a) of this section at any time prior to the

    issuance of a joint interpretation or joint notice of proposed

    rulemaking by the Commission and the Commodity Futures Trading

    Commission in response to the request; provided, however, that

    notwithstanding such withdrawal, the Commission and the Commodity

    Futures Trading Commission may provide a joint interpretation of

    whether the agreement, contract, or transaction (or class thereof) is a

    swap, a security-based swap, or both (i.e., a mixed swap).

    (d) Request by the Commission or the Commodity Futures Trading

    Commission. In the absence of a request for a joint interpretation

    under paragraph (a) of this section:

    (1) If the Commission or the Commodity Futures Trading Commission

    receives a proposal to list, trade, or clear an agreement, contract, or

    transaction (or class thereof) that raises questions as to the

    appropriate characterization of such agreement, contract, or

    transaction (or class thereof) as a swap, a security-based swap, or

    both (i.e., a mixed swap), the Commission or the Commodity Futures

    Trading Commission, as applicable, promptly shall notify the other of

    the agreement, contract, or transaction (or class thereof); and

    (2) The Commission or the Commodity Futures Trading Commission, or

    their Chairmen jointly, may submit a request for a joint interpretation

    as described in paragraph (a) of this section; such submission shall be

    made pursuant to paragraph (b) of this section, and may be withdrawn

    pursuant to paragraph (c) of this section.

    (e) Timeframe for joint interpretation.

    (1) If the Commission and the Commodity Futures Trading Commission

    determine to issue a joint interpretation as described in paragraph (a)

    of this section, such joint interpretation shall be issued within 120

    days after receipt of a complete submission requesting a joint

    interpretation under paragraph (a) or (d) of this section.

    (2) The Commission and the Commodity Futures Trading Commission

    shall consult with the Board of Governors of the Federal Reserve System

    prior to issuing any joint interpretation as described in paragraph (a)

    of this section.

    (3) If the Commission and the Commodity Futures Trading Commission

    seek public comment with respect to a joint interpretation regarding an

    agreement, contract, or transaction (or class thereof), the 120-day

    period described in paragraph (e)(1) of this section shall be stayed

    during the pendency of the comment period, but shall recommence with

    the business day after the public comment period ends.

    (4) Nothing in this section shall require the Commission and the

    Commodity Futures Trading Commission to issue any joint interpretation.

    (5) If the Commission and the Commodity Futures Trading Commission

    do not issue a joint interpretation within the time period described in

    paragraph (e)(1) or (e)(3) of this section, each of the Commission and

    the Commodity Futures Trading Commission shall publicly provide the

    reasons for not issuing such a joint interpretation within the

    applicable timeframes.

    (f) Joint notice of proposed rulemaking.

    (1) Rather than issue a joint interpretation pursuant to paragraph

    (a) of this section, the Commission and the Commodity Futures Trading

    Commission may issue a joint notice of proposed rulemaking, in

    consultation with the Board of Governors of the Federal Reserve System,

    to further define one or more of the terms swap, security-based swap,

    or mixed swap.

    (2) A joint notice of proposed rulemaking described in paragraph

    (f)(1) of this section shall be issued within the timeframe for issuing

    a joint interpretation set forth in paragraph (e) of this section.

    Sec. 240.3a68-3 Meaning of ``narrow-based security index'' as used in

    the definition of ``security-based swap.''

    (a) In general. Except as otherwise provided in Sec. 240.3a68-1a

    and Sec. 240.3a68-1b of this chapter, for purposes of section 3(a)(68)

    of the Act (15 U.S.C. 78c(a)(68)), the term narrow-based security index

    has the meaning set forth in section 3(a)(55) of the Act (15 U.S.C.

    78c(a)(55)), and the rules, regulations, and orders of the Commission

    thereunder.

    (b) Tolerance period for swaps traded on designated contract

    markets, swap execution facilities and foreign boards of trade.

    Notwithstanding paragraph (a) of this section, solely for purposes of

    swaps traded on or subject to the rules of a designated contract

    market, swap execution facility, or foreign board of trade pursuant to

    the Commodity Exchange Act (7 U.S.C. 1 et seq.), a security index

    underlying such swaps shall not be considered a narrow-based security

    index if:

    (1)(i) A swap on the index is traded on or subject to the rules of

    a designated contract market, swap execution facility, or foreign board

    of trade pursuant to the Commodity Exchange Act (7 U.S.C. 1 et seq.)

    for at least 30 days as a swap on an index that was not a narrow-based

    security index; or

    (ii) Such index was not a narrow-based security index during every

    trading day of the six full calendar months preceding a date no earlier

    than 30 days prior to the commencement of trading of a swap on such

    index on a market described in paragraph (b)(1)(i) of this section; and

    (2) The index has been a narrow-based security index for no more

    than 45 business days over three consecutive calendar months.

    (c) Tolerance period for security-based swaps traded on national

    securities exchanges or security-based swap execution facilities.

    Notwithstanding paragraph (a) of this section, solely for purposes of

    security-based swaps traded on a national securities exchange or

    security-based swap execution facility, a security index underlying

    such security-based swaps shall be considered a narrow-based security

    index if:

    (1)(i) A security-based swap on the index is traded on a national

    securities

    [[Page 29897]]

    exchange or security-based swap execution facility for at least 30 days

    as a security-based swap on a narrow-based security index; or

    (ii) Such index was a narrow-based security index during every

    trading day of the six full calendar months preceding a date no earlier

    than 30 days prior to the commencement of trading of a security-based

    swap on such index on a market described in paragraph (c)(1)(i) of this

    section; and

    (2) The index has been a security index that is not a narrow-based

    security index for no more than 45 business days over three consecutive

    calendar months.

    (d) Grace period.

    (1) Solely with respect to a swap that is traded on or subject to

    the rules of a designated contract market, swap execution facility or

    foreign board of trade pursuant to the Commodity Exchange Act (7 U.S.C.

    1 et seq.), an index that becomes a narrow-based security index under

    paragraph (b) of this section solely because it was a narrow-based

    security index for more than 45 business days over three consecutive

    calendar months shall not be a narrow-based security index for the

    following three calendar months.

    (2) Solely with respect to a security-based swap that is traded on

    a national securities exchange or security-based swap execution

    facility, an index that becomes a security index that is not a narrow-

    based security index under paragraph (c) of this section solely because

    it was not a narrow-based security index for more than 45 business days

    over three consecutive calendar months shall be a narrow-based security

    index for the following three calendar months.

    Sec. 240.3a68-4 Regulation of mixed swaps.

    (a) In general. The term mixed swap has the meaning set forth in

    section 3(a)(68)(D) of the Act (15 U.S.C. 78c(a)(68)(D)).

    (b) Regulation of mixed swaps entered into by dually-registered

    dealers or major participants. A mixed swap:

    (1) That is neither executed on nor subject to the rules of a

    designated contract market, national securities exchange, swap

    execution facility, security-based swap execution facility, or foreign

    board of trade;

    (2) That will not be submitted to a derivatives clearing

    organization or registered or exempt clearing agency to be cleared; and

    (3) Where at least one party is registered with the Commission as a

    security-based swap dealer or major security-based swap participant and

    also with the Commodity Futures Trading Commission as a swap dealer or

    major swap participant, shall be subject to:

    (i) The following provisions of the Commodity Exchange Act (7

    U.S.C. 1 et seq.), and the rules and regulations promulgated

    thereunder, set forth in the rules and regulations of the Commodity

    Futures Trading Commission:

    (A) Examinations and information sharing: 7 U.S.C. 6s(f) and 12;

    (B) Enforcement: 7 U.S.C. 2(a)(1)(B), 6(b), 6b, 6c, 9, 13b, 13a-1,

    13a-2, 13, 13c(a), 13c(b), 15 and 26;

    (C) Reporting to a swap data repository: 7 U.S.C. 6r;

    (D) Real-time reporting: 7 U.S.C. 2(a)(13);

    (E) Capital: 7 U.S.C. 6s(e); and

    (F) Position Limits: 7 U.S.C. 6a; and

    (ii) The provisions of the Federal securities laws, as defined in

    section 3(a)(47) of the Act (15 U.S.C. 78c(a)(47)), and the rules and

    regulations promulgated thereunder.

    (c) Process for determining regulatory treatment for mixed swaps.

    (1) In general. Any person who desires or intends to list, trade,

    or clear a mixed swap (or class thereof) that is not subject to

    paragraph (b) of this section may request the Commission and the

    Commodity Futures Trading Commission to issue a joint order permitting

    the requesting person (and any other person or persons that

    subsequently lists, trades, or clears that mixed swap) to comply, as to

    parallel provisions only, with specified parallel provisions of either

    the Act (15 U.S.C. 78a et seq.) or the Commodity Exchange Act (7 U.S.C.

    1 et seq.), and the rules and regulations thereunder (collectively,

    specified parallel provisions), instead of being required to comply

    with parallel provisions of both the Act and the Commodity Exchange

    Act. For purposes of this paragraph (c), parallel provisions means

    comparable provisions of the Act and the Commodity Exchange Act that

    were added or amended by the Wall Street Transparency and

    Accountability Act of 2010 with respect to security-based swaps and

    swaps, and the rules and regulations thereunder.

    (2) Request process. A person submitting a request pursuant to

    paragraph (c)(1) of this section must provide the Commission and the

    Commodity Futures Trading Commission with the following:

    (i) All material information regarding the terms of the specified,

    or specified class of, mixed swap;

    (ii) The economic characteristics and purpose of the specified, or

    specified class of, mixed swap;

    (iii) The specified parallel provisions, and the reasons the person

    believes such specified parallel provisions would be appropriate for

    the mixed swap (or class thereof); and

    (iv) An analysis of:

    (A) The nature and purposes of the parallel provisions that are the

    subject of the request;

    (B) The comparability of such parallel provisions;

    (C) The extent of any conflicts or differences between such

    parallel provisions; and

    (D) Such other information as may be requested by the Commission or

    the Commodity Futures Trading Commission.

    (3) Request withdrawal. A person may withdraw a request made

    pursuant to paragraph (c)(1) of this section at any time prior to the

    issuance of a joint order under paragraph (c)(4) of this section by the

    Commission and the Commodity Futures Trading Commission in response to

    the request.

    (4) Issuance of orders. In response to a request under paragraph

    (c)(1) of this section, the Commission and the Commodity Futures

    Trading Commission, as necessary to carry out the purposes of the Wall

    Street Transparency and Accountability Act of 2010, may issue a joint

    order, after notice and opportunity for comment, permitting the

    requesting person (and any other person or persons that subsequently

    lists, trades, or clears that mixed swap) to comply, as to parallel

    provisions only, with the specified parallel provisions (or another

    subset of the parallel provisions that are the subject of the request,

    as the Commissions determine is appropriate), instead of being required

    to comply with parallel provisions of both the Act (15 U.S.C. 78a et

    seq.) and the Commodity Exchange Act (7 U.S.C. 1 et seq.). In

    determining the contents of such joint order, the Commission and the

    Commodity Futures Trading Commission may consider, among other things:

    (i) The nature and purposes of the parallel provisions that are the

    subject of the request;

    (ii) The comparability of such parallel provisions; and

    (iii) The extent of any conflicts or differences between such

    parallel provisions.

    (5) Timeframe.

    (i) If the Commission and the Commodity Futures Trading Commission

    determine to issue a joint order as described in paragraph (c)(4) of

    this section, such joint order shall be issued within 120 days after

    receipt of a complete request for a joint order under paragraph (c)(1)

    of this section, which time period shall be stayed

    [[Page 29898]]

    during the pendency of the public comment period provided for in

    paragraph (c)(4) of this section and shall recommence with the business

    day after the public comment period ends.

    (ii) Nothing in this section shall require the Commission and the

    Commodity Futures Trading Commission to issue any joint order.

    (iii) If the Commission and the Commodity Futures Trading

    Commission do not issue a joint order within the time period described

    in paragraph (c)(5)(i) of this section, each of the Commission and the

    Commodity Futures Trading Commission shall publicly provide the reasons

    for not issuing such a joint order within that timeframe.

    Sec. 240.3a69-1 Definition of ``swap'' as used in section 3(a)(69) of

    the Act--Insurance

    The term swap as used in section 3(a)(69) of the Act (15 U.S.C.

    78c(a)(69)) does not include an agreement, contract, or transaction

    that:

    (a) By its terms or by law, as a condition of performance on the

    agreement, contract, or transaction:

    (1) Requires the beneficiary of the agreement, contract, or

    transaction to have an insurable interest that is the subject of the

    agreement, contract, or transaction and thereby carry the risk of loss

    with respect to that interest continuously throughout the duration of

    the agreement, contract, or transaction;

    (2) Requires that loss to occur and to be proved, and that any

    payment or indemnification therefor be limited to the value of the

    insurable interest;

    (3) Is not traded, separately from the insured interest, on an

    organized market or over-the-counter; and

    (4) With respect to financial guaranty insurance only, in the event

    of payment default or insolvency of the obligor, any acceleration of

    payments under the policy is at the sole discretion of the insurer; and

    (b) Is provided:

    (1) By a company that is organized as an insurance company whose

    primary and predominant business activity is the writing of insurance

    or the reinsuring of risks underwritten by insurance companies and that

    is subject to supervision by the insurance commissioner (or similar

    official or agency) of any State, as defined in section 3(a)(16) of the

    Act (15 U.S.C. 78c(a)(16)), or by the United States or an agency or

    instrumentality thereof, and such agreement, contract, or transaction

    is regulated as insurance under the laws of such State or of the United

    States;

    (2) By the United States or any of its agencies or

    instrumentalities, or pursuant to a statutorily authorized program

    thereof; or

    (3) In the case of reinsurance only, by a person located outside

    the United States to an insurance company that is eligible under

    paragraph (b) of this section, provided that:

    (i) Such person is not prohibited by any law of any State or of the

    United States from offering such agreement, contract, or transaction to

    such an insurance company;

    (ii) The product to be reinsured meets the requirements under

    paragraph (a) of this section to be insurance; and

    (iii) The total amount reimbursable by all reinsurers for such

    insurance product cannot exceed the claims or losses paid by the

    cedant.

    Sec. 240.3a69-2 Definition of ``swap'' as used in section 3(a)(69) of

    the Act--Additional Products.

    (a) In general. The term swap has the meaning set forth in section

    3(a)(69) of the Act (15 U.S.C. 78c(a)(69)).

    (b) Inclusion of particular products. (1) The term swap includes,

    without limiting the meaning set forth in section 3(a)(69) of the Act

    (15 U.S.C. 78c(a)(69), the following agreements, contracts, and

    transactions:

    (i) A cross-currency swap;

    (ii) A currency option, foreign currency option, foreign exchange

    option and foreign exchange rate option;

    (iii) A foreign exchange forward;

    (iv) A foreign exchange swap;

    (v) A forward rate agreement; and

    (vi) A non-deliverable forward involving foreign exchange.

    (2) The term swap does not include an agreement, contract, or

    transaction described in paragraph (b)(1) of this section that is

    otherwise excluded by section 1a(47)(B) of the Commodity Exchange Act

    (7 U.S.C. 1a(47)(B)).

    (c) Foreign exchange forwards and foreign exchange swaps.

    Notwithstanding paragraph (b)(2) of this section:

    (1) A foreign exchange forward or a foreign exchange swap shall not

    be considered a swap if the Secretary of the Treasury makes a

    determination described in section 1a(47)(E)(i) of the Commodity

    Exchange Act (7 U.S.C. 1a(47)(E)(i)).

    (2) Notwithstanding paragraph (c)(1) of this section:

    (i) The reporting requirements set forth in section 4r of the

    Commodity Exchange Act (7 U.S.C. 6r) and regulations promulgated

    thereunder shall apply to a foreign exchange forward or foreign

    exchange swap; and

    (ii) The business conduct standards set forth in section 4s of the

    Commodity Exchange Act (7 U.S.C. 6s) and regulations promulgated

    thereunder shall apply to a swap dealer or major swap participant that

    is a party to a foreign exchange forward or foreign exchange swap.

    (3) For purposes of section 1a(47)(E) of the Commodity Exchange Act

    (7 U.S.C. 1a(47)(E)) and this Sec. 240.3a69-2, the term foreign

    exchange forward has the meaning set forth in section 1a(24) of the

    Commodity Exchange Act (7 U.S.C. 1a(24)).

    (4) For purposes of section 1a(47)(E) of the Commodity Exchange Act

    (7 U.S.C. 1a(47)(E)) and this Sec. 240.3a69-2, the term foreign

    exchange swap has the meaning set forth in section 1a(25) of the

    Commodity Exchange Act (7 U.S.C. 1a(25)).

    (5) For purposes of sections 1a(24) and 1a(25) of the Commodity

    Exchange Act (7 U.S.C. 1a(24) and (25)) and this Sec. 240.3a69-2, the

    following transactions are not foreign exchange forwards or foreign

    exchange swaps:

    (i) A currency swap or a cross-currency swap;

    (ii) A currency option, foreign currency option, foreign exchange

    option, or foreign exchange rate option; and

    (iii) A non-deliverable forward involving foreign exchange.

    Sec. 240.3a69-3 Books and records requirements for security-based

    swap agreements.

    (a) A person registered as a swap data repository under section 21

    of the Commodity Exchange Act (7 U.S.C. 24a) and the rules and

    regulations thereunder:

    (1) Shall not be required to keep and maintain additional books and

    records regarding security-based swap agreements other than the books

    and records regarding swaps required to be kept and maintained pursuant

    to section 21 of the Commodity Exchange Act (7 U.S.C. 24a) and the

    rules and regulations thereunder; and

    (2) Shall not be required to collect and maintain additional data

    regarding security-based swap agreements other than the data regarding

    swaps required to be collected and maintained by such persons pursuant

    to section 21 of the Commodity Exchange Act (7 U.S.C. 24a) and the

    rules and regulations thereunder.

    (b) A person shall not be required to keep and maintain additional

    books and records, including daily trading records, regarding security-

    based swap agreements other than the books and records regarding swaps

    required to be kept and maintained by such persons pursuant to section

    4s of the Commodity Exchange Act (7 U.S.C. 6s) and the rules

    [[Page 29899]]

    and regulations thereunder if such person is registered as:

    (1) A swap dealer under section 4s(a)(1) of the Commodity Exchange

    Act (7 U.S.C. 6s(a)(1)) and the rules and regulations thereunder;

    (2) A major swap participant under section 4s(a)(2) of the

    Commodity Exchange Act (7 U.S.C. 6s(a)(2)) and the rules and

    regulations thereunder;

    (3) A security-based swap dealer under section 15F(a)(1) of the Act

    (15 U.S.C. 78o-10(a)(1)) and the rules and regulations thereunder; or

    (4) A major security-based swap participant under section 15F(a)(2)

    of the Act (15 U.S.C. 78o-10(a)(2)) and the rules and regulations

    thereunder.

    (c) The term security-based swap agreement has the meaning set

    forth in section 3(a)(78) of the Act (15 U.S.C. 78c(a)(78)).

    Dated: April 29, 2011.

    By the Commodity Futures Trading Commission.

    David A. Stawick,

    Secretary.

    Dated: April 29, 2011.

    By the Securities and Exchange Commission.

    Cathy H. Ahn,

    Deputy Secretary.

    Product Definitions Contained in Title VII of the Dodd-Frank Wall

    Street Reform and Consumer Protection Act--CFTC Voting Summary and

    Statements of CFTC Commissioners

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

    Regulations.

    CFTC Voting Summary

    On this matter, Chairman Gensler and Commissioners Dunn, Chilton

    and O'Malia voted in the affirmative; Commissioner Sommers voted in the

    negative.

    Statement of CFTC Chairman Gary Gensler

    I support the proposed rulemaking to implement the Dodd-Frank Act's

    requirement to further define derivatives products that come under

    Title VII of the Act.

    The CFTC worked closely with the SEC, in consultation with the

    Federal Reserve, on this proposed rule to further define swaps,

    security-based swaps, mixed swaps and security-based swap agreements.

    The statutory definition of swap is very detailed. This rule is

    consistent with that detailed definition and Congressional intent. For

    example, interest rate swaps, currency swaps, commodity swaps,

    including energy, metals and agricultural swaps, and broad-based index

    swaps, such as index credit default swaps, are all swaps. Consistent

    with Congress's definition of swaps, the rule also defines options as

    swaps.

    In preparing the proposed rule, staff worked to address the more

    than 80 comments that were submitted by the public in response to the

    joint advance notice of proposed rulemaking on product definitions.

    Many of the commenters asked that the Commissions specifically provide

    guidance on what is not a swap or security-based swap.

    For example, under the Commodity Exchange Act, the CFTC does not

    regulate forward contracts. Over the decades, there has been a series

    of orders, interpretations and cases that market participants have come

    to rely upon regarding the exception from futures regulation for

    forwards and forwards with embedded options. Consistent with that

    history, the Dodd-Frank Act excluded from the definition of swaps ``any

    sale of a nonfinancial commodity or security for deferred shipment or

    delivery, so long as the transaction is intended to be physically

    settled.'' The proposed rule interprets that exclusion in a manner that

    is consistent with the Commission's previous history of the forward

    exclusion from futures regulation.

    Further, consistent with the Dodd-Frank Act, the proposed rule

    clarifies that state or Federally regulated insurance products that are

    provided by regulated insurance companies will not be regulated under

    Title VII of the Act. Similarly, the proposal clarifies that certain

    consumer and commercial arrangements that historically have not been

    considered swaps, such as consumer mortgage rate locks, contracts to

    lock in the price of home heating oil and contracts relating to

    inventory or equipment, also will not be regulated under Title VII of

    the Act.

    Statement of CFTC Commissioner Jill Sommers

    I respectfully dissent from the action taken today by the

    Commission to issue proposed regulations relating to ``Product

    Definitions Contained in Title VII of the Dodd-Frank Wall Street Reform

    and Consumer Protection Act.''

    I disagree with the approach taken by the Commission with regard to

    the proposed ``Anti-Evasion'' provisions. I agree that Dodd-Frank

    Section 721(c) directs the Commission to further define certain terms

    to include transactions or entities that have been structured to evade

    Dodd-Frank. I do not agree that Congress directed the Commission to

    promulgate broad ``Anti-Evasion'' provisions, and I point out that the

    Securities and Exchange Commission today has declined to promulgate

    such provisions in this joint rulemaking.

    By promulgating a broad regulation today that essentially says that

    any transaction that does not fall within the definition of ``swap''

    because it has been structured to evade Dodd-Frank nonetheless is a

    swap, the Commission is over-reading its Congressional mandate. The

    statutory definition of ``swap'' includes a laundry-list of

    transactions that Congress intended to include within the definition.

    If Congress intended the definition of ``swap'' also to include a broad

    statement that any transaction structured to evade Dodd-Frank is a

    ``swap,'' Congress would have incorporated such a provision within the

    statutory definition. By directing the Commission to ``further define''

    the term ``swap'' by rule, Congress is directing the Commission not to

    make the broad statement it declined to make, but to think through

    whether the definition of ``swap'' needs to be modified by rule to

    include specific transactions within the definition.

    In addition to my concern about the ``Anti-Evasion'' provisions

    included within this proposal, I am concerned about an important issue

    that is not raised within this proposal. Multinational organizations

    whose statutory mission is to combat poverty and foster economic

    development have raised concerns about the application of Dodd-Frank to

    their activities. This proposal omits any discussion of their issues.

    In my view the following language should be included within the

    proposal, and I urge the public to comment upon the issues raised:

    Transactions Involving Certain Foreign or Multinational Entities

    The swap definition expressly excludes ``any agreement, contract,

    or transaction a counterparty of which is a Federal Reserve bank, the

    Federal Government, or a Federal agency that is expressly backed by the

    full faith and credit of the United States.'' \399\ Some commenters

    have suggested that the Commissions should exercise their authority to

    further define the terms ``swap'' and ``security-based swap'' to

    similarly exclude transactions in which a counterparty is an

    international public organization, a foreign central bank, a foreign

    sovereign, or a multi-or supra-national organization.\400\ Commenters

    [[Page 29900]]

    have advanced international comity, national treatment, limited

    regulatory resources, limits on the Commissions' respective

    extraterritorial jurisdiction, and international harmonization as

    rationales for such an approach.\401\

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

    \399\ 7 U.S.C. 1a(47)(B)(ix).

    \400\ See, e.g., letter from Gunter Pleines, Head of Banking

    Department, and Diego Devos, General Counsel, Bank for International

    Settlements (``BIS Letter''); Cleary Letter. The Commissions note

    that various other terms may be used to refer to organizations that

    generally: (i) Limit their membership to sovereign nations; (ii) are

    established by treaty; (iii) have a separate legal identity from

    their members; and (iv) ``are usually specialized and of

    international or regional scope'' and ``formed between three or more

    nations to work on issues that relate to all of the countries in the

    organization. See, e.g., http://portal.unesco.org/en/ev.php-URL_ID=32408&URL_DO=DO_TOPIC&URL_SECCTION=201.html; http://www.geni.org/globalenergy/library/organizations/index.shtml. For

    convenience, the Commissions use the term ``supranational

    organization'' herein to refer to organizations having such

    characteristics.

    \401\ See, e.g., BIS Letter (citing Article 1, paragraph 4, of

    the proposed EU Regulation on Central Clearing of OTC Derivatives,

    available at http://register.consilium.europa.eu/pdf/en/11/st05/st05059.en11.pdf, which excludes from its coverage the BIS,

    multilateral development banks, European central banks and similarly

    situated ``other national bodies performing similar functions and

    other public bodies charged with or intervening in the management of

    the public debt'').

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

    Request for Comment

    The Commissions request comment generally on the

    appropriate application of the Dodd-Frank Act to international public

    organizations, foreign central banks, foreign sovereigns (or foreign

    sovereign wealth funds), supranational organizations, and any other

    foreign or multinational entity that may be analogous to the entities

    excluded from the swap definition in CEA Section 1a(47)(B)(ix).

    Should the Commissions further define the terms ``swap''

    and ``security-based swap'' to exclude transactions in which a

    counterparty is an international public organization, foreign central

    bank, foreign sovereign (or foreign sovereign wealth fund),

    supranational organization, or any other foreign or multinational

    entity that may be analogous to an entity excluded from the swap

    definition in CEA Section 1a(47)(B)(ix)? Why or why not? If so, how

    should the Commissions delineate the scope of entities whose

    transactions would be excluded? Please describe in detail the nature of

    the entity whose transactions would be excluded and explain the reasons

    for such an exclusion. Would such an exclusion inappropriately cause

    transactions that should be regulated as swaps or security-based swaps

    to fall outside of the regulatory regime established by the Dodd-Frank

    Act? Why or why not?

    If the Commissions further define the terms ``swap'' and

    ``security-based swap'' to exclude any such entity, should the

    exclusion be subject to any conditions, or should the exclusion be

    limited to particular requirements of Title VII? Why or why not? If so,

    what conditions would be appropriate, and/or what requirements of Title

    VII should the exclusion apply to, and why?

    If the Commissions further define the terms ``swap'' and

    ``security-based swap'' to exclude any such entity, to what extent

    should counterparties to such transactions be subject to the

    requirements of Title VII? What would be the appropriate regulatory

    treatment of such counterparties in these circumstances?

    [FR Doc. 2011-11008 Filed 5-20-11; 8:45 am]

    BILLING CODE 6351-01-P; 8011-01-P

    Last Updated: May 23, 2011



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