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2011-24124

  • Federal Register, Volume 76 Issue 182 (Tuesday, September 20, 2011)[Federal Register Volume 76, Number 182 (Tuesday, September 20, 2011)]

    [Proposed Rules]

    [Pages 58186-58197]

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

    [FR Doc No: 2011-24124]

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    COMMODITY FUTURES TRADING COMMISSION

    17 CFR Parts 37, 38, and 39

    RIN 3038-AD60

    Swap Transaction Compliance and Implementation Schedule: Clearing

    and Trade Execution Requirements under Section 2(h) of the CEA

    AGENCY: Commodity Futures Trading Commission.

    ACTION: Notice of proposed rulemaking.

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    SUMMARY: The Commodity Futures Trading Commission (Commission or CFTC)

    is proposing regulations that would establish a schedule to phase in

    compliance with certain new statutory provisions enacted under Title

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

    (Dodd-Frank Act). These provisions include the clearing requirement

    under new section 2(h)(1)(A) of the Commodity Exchange Act (CEA or

    Act), and the trade execution requirement under new section 2(h)(8)(A)

    of the CEA. The proposed schedules would provide relief in the form of

    additional time for compliance with these requirements. This relief is

    intended to facilitate the transition to the new regulatory regime

    established by the Dodd-Frank Act in an orderly manner that does not

    unduly disrupt markets and transactions. The Commission requests

    comment on the proposed compliance schedules for these clearing and

    trade execution requirements.

    DATES: Submit comments on or before November 4, 2011.

    ADDRESSES: You may submit comments, identified by RIN number 3038-AD60

    and Swap Transaction Compliance and Implementation Schedule: Clearing

    and Trade Execution Requirements under Section 2(h) of the CEA, by any

    of the following methods:

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

    through the Web site.

    Mail: David A. Stawick, Secretary of the Commission,

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

    Street, NW., Washington, DC 20581.

    Hand Delivery/Courier: Same as mail above.

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

    Follow the instructions for submitting comments.

    Please submit your comments using only one method.

    All comments must be submitted in English, or if not, accompanied

    by an English translation. Comments will be posted as received to

    http://www.cftc.gov. You should submit only information that you wish

    to make available publicly. If you wish the Commission to consider

    information that may be exempt from disclosure under the Freedom of

    Information Act, a petition for confidential treatment of the exempt

    information may be submitted according to the established procedures in

    Sec. 145.9 of the Commission's regulations, 17 CFR 145.9.

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

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

    submission from http://www.cftc.gov that it may deem to be

    inappropriate for publication, such as obscene language. All

    submissions that have been redacted or removed that contain comments on

    the merits of the rulemaking will be retained in the public comment

    file and will be considered as required under the Administrative

    Procedure Act and other

    [[Page 58187]]

    applicable laws, and may be accessible under the Freedom of Information

    Act.

    FOR FURTHER INFORMATION CONTACT: Dhaval Patel, Counsel, Office of the

    General Counsel, 202-418-5125, dpatel@cftc.gov, or Camden Nunery,

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

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

    Street, NW., Washington, DC 20581.

    SUPPLEMENTARY INFORMATION:

    I. Background

    On July 21, 2010, President Obama signed the Dodd-Frank Act.\1\

    Title VII of the Dodd-Frank Act amends the CEA \2\ to establish a

    comprehensive new regulatory framework for swaps. The legislation was

    enacted to reduce risk, increase transparency, and promote market

    integrity within the financial system by, among other things: (1)

    Providing for the registration and comprehensive regulation of swap

    dealers and major swap participants; (2) imposing clearing and trade

    execution requirements on standardized derivative products; (3)

    creating robust recordkeeping and real-time reporting regimes; and (4)

    enhancing the rulemaking and enforcement authorities of the Commission

    with respect to, among others, all registered entities and

    intermediaries subject to the Commission's oversight.

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

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

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

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    To implement the Dodd-Frank Act, the Commission has to-date issued

    55 advance notices of proposed rulemaking or notices of proposed

    rulemaking, two interim final rules, 12 final rules, and one proposed

    interpretive order. By the beginning of May 2011, the Commission had

    published in the Federal Register a significant number of notices of

    proposed rulemaking, which represented a substantially complete mosaic

    of the Commission's proposed regulatory framework under Title VII of

    the Dodd-Frank Act. In recognition of that fact and with the goal of

    giving market participants additional time to comment on the proposed

    new regulatory framework for swaps, either in part or as a whole, the

    Commission reopened or extended the comment period of many of its

    proposed rulemakings through June 3, 2011.\3\ In total, the Commission

    has received over 20,000 comments in response to its Dodd-Frank Act

    rulemaking proposals.

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    \3\ See Reopening and Extension of Comment Periods for

    Rulemakings Implementing the Dodd-Frank Wall Street Reform and

    Consumer Protection Act, 76 FR 25274, May 4, 2011.

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    To give the public an opportunity to comment further on

    implementation phasing, on May 2-3, 2011, the Commission, along with

    the Securities and Exchange Commission (SEC), held a joint, two-day

    roundtable on issues related to implementation.\4\ In connection with

    this roundtable, Commission staff proposed thirteen concepts to be

    considered regarding implementation phasing, and staff asked a series

    of questions based on the concepts outlined.\5\ The Commission received

    numerous comments in response to both its roundtable and the staff

    concepts and questions.\6\

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    \4\ The transcripts from the roundtable are available at http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/csjac_transcript050311.pdf (``Day 1 Roundtable Tr.'') and http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/csjac_transcript050211.pdf (``Day 2 Roundtable Tr.'').

    \5\ See ``CFTC Staff Concepts and Questions Regarding Phased

    Implementation of Effective Dates for Final Dodd-Frank Rules,''

    available at http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/staffconcepts050211.pdf.

    \6\ Such comments are available at http://comments.cftc.gov/PublicComments/CommentList.aspx?id=1000.

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    These comments were submitted by a number of existing and potential

    market infrastructures, including clearinghouses, trading platforms,

    and swap data repositories. Comments also were submitted by entities

    that may potentially be swap dealers (SDs) or major swap participants

    (MSPs), as well as those financial entities that may not be required to

    register with the Commission, but whose swap transactions may be

    required to comply with the clearing requirement under section

    2(h)(1)(A) of the CEA, and a trade execution requirement under section

    2(h)(8)(A) of the CEA. The Commission also received many comments from

    non-financial entities.

    One of the key themes to emerge from the comments received by the

    Commission is that some market participants may require more time to

    bring their swap transactions into compliance with certain new

    regulatory requirements.\7\ For example, one commenter requested a

    ``meaningful'' period after finalization of the suite of rulemakings

    that is applicable to it before actual compliance will be required.\8\

    Similarly, several trade associations recommended the Commission allow

    ``sufficient'' time for infrastructure and business practices to

    develop before requiring compliance with the new requirements.\9\ A

    group of international banks commented that the Commission should defer

    compliance until December 31, 2012, at which point the regulatory

    timetable as per the September 2009 G20 Pittsburgh statement will have

    reached a conclusion.\10\ Another commenter noted that some entities

    may be able to comply relatively quickly with certain documentation

    requirements that are largely consistent with current business

    practices while other requirements may need a longer implementation

    period.\11\ Although commenters varied in their recommendations

    regarding the time it would take to bring their swaps into compliance

    with the new regulatory requirements,\12\ many commenters agreed on

    phasing in compliance with these requirements by type of market

    participant based on a variety of factors, including a market

    participant's experience, resources, and the size and complexity of its

    transactions.\13\ The Commission has taken these comments into

    consideration in developing the proposed compliance schedules.

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    \7\ E.g., Letter from Karrie McMillan, Investment Company

    Institute, dated Jun. 10, 2011 at 8-11; Letter from Financial

    Services Forum, Futures Industry Association, International Swaps

    and Derivatives Association, and Securities Industry and Financial

    Markets Association, dated May 4, 2011 at 7-9; Letter from Jeff

    Gooch, MarkitSERV, dated Jun. 10, 2011 at 1-2 and 6; Letter from

    Electric Trade Association, dated May 4, 2011 at 5; Letter from John

    R. Gidman, Association of Institutional Investors, dated Jun. 10,

    2011 at 3.

    \8\ Letter from the Coalition of Physical Energy Companies,

    dated Mar. 14, 2011 at 4.

    \9\ Letter from the Futures Industry Association, the Financial

    Services Forum, the International Swaps and Derivatives Association

    and the Securities Industry and Financial Markets Association, dated

    May 4, 2011 at 5.

    \10\ Letter from the Bank of Tokyo-Mitsubishi UFJ, Ltd., et al.,

    dated May 6, 2011 at 6.

    \11\ Letter from the Financial Services Roundtable, dated May

    12, 2011 at 4.

    \12\ For example, Javelin stated that it could be open for

    business and generally be in compliance with the clearing and trade

    execution requirements within 6 months. Day 1 Roundtable Tr. at 104-

    105. Citadel suggested moving towards a voluntary clearing launch

    between day 180 and day 240, and eventually moving towards a

    mandatory clearing date. Day 1 Roundtable Tr. at 73-74. Moreover,

    the Swap Financial Group offered a different perspective stating

    that it generally thought implementation of Dodd-Drank could be

    accomplished in a year or two. Day 2 Roundtable Tr. at 269.

    \13\ These comments are more fully discussed later in the

    preamble.

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    The swap transaction compliance requirements that are the subject

    of this proposed rulemaking include compliance with the clearing

    requirement and the corresponding trade execution requirement under

    sections 2(h)(1)(A) and 2(h)(8)(A) of the CEA, respectively.\14\ The

    Commission's

    [[Page 58188]]

    proposed compliance schedules are designed to afford affected market

    participants a reasonable amount of time to bring their transactions

    into compliance with such requirements. The proposed schedules also

    would provide relief in the form of additional time for compliance with

    these transaction compliance requirements and are further explained

    below.\15\ This relief is intended to facilitate the transition to the

    new regulatory regime established by the Dodd-Frank Act in an orderly

    manner that does not unduly disrupt markets and transactions.

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    \14\ The Commission also is proposing Swap Transaction

    Compliance and Implementation Schedule: Trade Documentation and

    Margining Requirements under section 4s of the CEA.

    \15\ The proposed compliance schedules do not address the

    effective dates of the clearing and trade execution requirements in

    the Dodd-Frank Act, including the application of the Commission's

    Effective Date Order to such requirements. See Effective Date for

    Swap Regulation, 76 FR 42508, Jul. 19, 2011.

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    II. Proposed Regulation

    A. Authority to Implement Proposed Regulations

    In this Notice of Proposed Rulemaking, the Commission relies on its

    general authority to establish compliance dates with the rules and

    regulations enacted pursuant to the Dodd-Frank Act. Section 712(f) also

    authorizes the Commission to promulgate rules to prepare for the

    effective dates of the provisions of the Dodd-Frank Act.\16\ In

    addition, the Commission relies on section 8(a)(5) of the CEA, which

    authorizes the Commission to promulgate such regulations as, in the

    judgment of the Commission, are reasonably necessary to effectuate any

    of the provisions or to accomplish any of the purposes of the CEA. In

    accordance with this authority, the proposed regulations would amend

    parts 37, 38, and 39 of the Commission's regulations to phase in

    compliance dates for the clearing and trade execution requirements

    under section 2(h) of the CEA.

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    \16\ Section 712(f) of the Dodd-Frank Act states: ``Beginning on

    the date of enactment of this Act and notwithstanding the effective

    date of any provision of this Act, the [Commission] * * * may, in

    order to prepare for the effective dates of the provisions of this

    Act--(1) promulgate rules, regulations, or orders permitted or

    required by this Act * * *.''

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    B. Implementation Phasing of the Clearing Requirement under Section

    2(h)(1)

    1. Background on Mandatory Clearing Determinations

    Section 723(a)(3) of the Dodd-Frank Act amended the CEA to provide,

    under new section 2(h)(1)(A), that ``it shall be unlawful for any

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

    clearing to a derivatives clearing organization that is registered

    under this Act or a derivatives clearing organization that is exempt

    from registration under this Act if the swap is required to be

    cleared.'' \17\ Section 2(h)(2) charges the Commission with the

    responsibility for determining whether a swap is required to be

    cleared, through one of two avenues: (1) Pursuant to a Commission-

    initiated review; or (2) pursuant to a submission from a derivatives

    clearing organization (DCO) of each swap, or any group, category, type,

    or class of swaps that the DCO ``plans to accept for clearing.'' \18\

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    \17\ Section 2(h)(7) of the CEA provides an exception to the

    clearing requirement (``the end-user exception'') when one of the

    counterparties to a swap (i) Is not a financial entity, (ii) is

    using the swap to hedge or mitigate commercial risk, and (iii)

    notifies the Commission how it generally meets its financial

    obligations associated with entering into a non-cleared swap.

    \18\ Under section 2(h)(2)(B)(ii), the Commission must consider

    swaps listed for clearing by a DCO as of the date of enactment of

    the Dodd-Frank Act.

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    On July 26, 2011, the Commission published in the Federal Register

    a final rule regarding the process for review of swaps for mandatory

    clearing.\19\ Under Sec. 39.5(b)(6), the Commission will review a

    DCO's submission and determine whether the swap, or group, category,

    type, or class of swaps, described in the submission is required to be

    cleared. This determination will be made not later than 90 days after a

    complete submission has been received from a DCO, unless the submitting

    DCO agrees to an extension. Under Sec. 39.5(c), Commission-initiated

    reviews of swaps that have not been accepted for clearing by a DCO will

    take place on an ongoing basis. However, as explained in the preamble

    to the final rule, the ``Commission anticipates that the initial

    mandatory clearing determinations would only involve swaps that are

    already being cleared or that a DCO wants to clear.'' \20\

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    \19\ 76 FR 44464, Jul. 26, 2011.

    \20\ 76 FR at 44469.

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    Because the Commission initially will consider mandatory clearing

    determinations based on those swaps that DCOs are currently clearing or

    that a DCO would like to clear, the initial sequence of mandatory

    clearing determinations will be based on the market's view of which

    swaps can be cleared and which asset classes are ready for clearing, as

    reflected by the fact that a DCO is either currently clearing a group,

    category, type, or class of swaps or is intending to do so. For

    example, multiple registered DCOs currently clear interest rate,

    credit, and commodity swaps. For these swaps, the Commission will begin

    the review process for issuing mandatory clearing determinations in the

    near term.

    The Commission observes that before market participants could be

    required to comply with a mandatory clearing determination, the

    Commission must adopt its final rules related to the end-user exception

    to mandatory clearing established by section 2(h)(7) of the CEA. In

    December 2010, the Commission proposed rules governing this elective

    exception to mandatory clearing.\21\ The proposed rule generally

    provides that a swap otherwise subject to mandatory clearing is subject

    to an elective exception from clearing if one party to the swap is not

    a financial entity, is using swaps to hedge or mitigate commercial

    risk, and notifies the Commission how it generally meets its financial

    obligations associated with entering into non-cleared swaps (the ``end-

    user clearing exception'').\22\ Because this proposed rule would

    establish the process by which a non-financial entity would elect not

    to clear a swap subject to a clearing requirement, this rule would need

    to be finalized prior to requiring compliance with a mandatory clearing

    determination.

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    \21\ End-User Exception to Mandatory Clearing of Swaps, 75 FR

    80747, Dec. 23, 2010.

    \22\ 75 FR at 80748.

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    In addition, the Commission recognizes that the swap transaction

    compliance schedules that are the subject of this proposal reference

    terms such as ``swap,'' ``swap dealer,'' and ``major swap participant''

    that are the subject of rulemaking under sections 712(d)(1) and 721(c)

    of the Dodd-Frank Act.\23\ The Commission and the SEC have proposed

    rules that would further define each of these terms.\24\ As such,

    [[Page 58189]]

    and in a manner consistent with the temporary relief provided in the

    Commission's Effective Date Order,\25\ the Commission must adopt its

    final rules regarding the further definitions in question prior to

    requiring compliance with a mandatory clearing determination.\26\

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    \23\ Section 712(d)(1) provides: ``Notwithstanding any other

    provision of this title and subsections (b) and (c), the Commodity

    Futures Trading Commission and the Securities and Exchange

    Commission, in consultation with the Board of Governors [of the

    Federal Reserve System], shall further define the terms `swap',

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

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

    and `security-based swap agreement' in section 1a(47)(A)(v) of the

    Commodity Exchange Act (7 U.S.C. 1a(47)(A)(v)) and section 3(a)(78)

    of the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(78)).''

    Section 721(c) provides: ``To include transactions and entities that

    have been structured to evade this subtitle (or an amendment made by

    this subtitle), the Commodity Futures Trading Commission shall adopt

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

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

    \24\ Further Definition of ``Swap Dealer,'' ``Security-Based

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

    Swap Participant,'' and ``Eligible Contract Participant''; Proposed

    Rule, 75 FR 80174, Dec. 21, 2010 and Further Definition of ``Swap,''

    ``Security-Based Swap,'' and ``Security-Based Swap Agreement'';

    Mixed Swaps; Security-Based Swap Agreement Recordkeeping, 76 FR

    29818, May 23, 2011.

    \25\ See Effective Date for Swap Regulation, 76 FR 42508, Jul.

    19, 2011.

    \26\ Notably, under section 712(f) of the Dodd-Frank Act, these

    definitions would not have to be finalized for the Commission to

    review swap submissions from DCOs.

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    Lastly, the Commission notes that it has yet to adopt final rules

    relating to the protection of cleared swaps customer contracts and

    collateral. These rules are essential for establishing the customer

    protection regime associated with client clearing for swaps through

    Commission-registered futures commission merchants (FCMs) at DCOs.\27\

    The Commission believes that finalizing the rules regarding the

    segregation of customer collateral prior to requiring compliance with a

    mandatory clearing determination is necessary to effectuate the

    purposes of new section 4d(f) of the CEA.

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    \27\ Protection of Cleared Swaps Customer Contracts and

    Collateral; Conforming Amendments to the Commodity Broker Bankruptcy

    Provisions, 76 FR 33818, Jun. 9, 2011.

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    2. Compliance Schedule for Clearing Requirement--Sec. 39.5(e)

    Proposed Sec. 39.5(e) would provide the Commission with the

    authority to phase in compliance with a clearing requirement upon

    issuance of a mandatory clearing determination. The proposed compliance

    schedule is based on the type of market participants entering into the

    swaps subject to the clearing requirement. The triggering event for the

    application of this compliance schedule would be the Commission's

    issuance of a determination that the swap, or group, category, type, or

    class of swaps, is required to be cleared.\28\

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    \28\ See discussion below at p. 21 and above at p. 7. It would

    be possible for the Commission to issue a mandatory clearing

    determination but postpone the overall compliance date for all

    market participants for some period of time. Additionally, market

    participants may begin clearing their swap transactions as soon as a

    DCO begins accepting such swaps for clearing, regardless of whether

    the Commission determines that such swaps are required to be

    cleared.

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    In proposing phased implementation schedules for the clearing

    requirement, the Commission seeks to balance several goals. First, the

    Commission believes that certain market participants may require

    additional time to bring their swaps into compliance with the new

    regulatory requirement for mandatory clearing of a swap or class of

    swaps. This is particularly true for market participants that may not

    be registered with the Commission and those market participants that

    may have hundreds or thousands of managed accounts, referred to as

    ``third-party subaccounts'' for the purposes of this proposal. Under

    this proposal, these parties would be afforded additional time to

    document new client clearing arrangements, connect to market

    infrastructure such as DCOs, and prepare themselves and their customers

    for the new regulatory requirements. As one commenter noted, ``[i]n the

    context of asset managers, the account set up process has to be

    multiplied over hundreds of subaccounts. Processing all of these

    subaccounts will take time even for the largest and most

    technologically advanced asset managers.'' \29\

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    \29\ Letter from Karrie McMillan, Investment Company Institute,

    dated Jun. 10, 2011 at 9-10.

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    Moreover, several commenters emphasized the need to have adequate

    time to educate their clients regarding the new regulatory

    requirements.\30\ For instance, market participants not registered with

    the Commission may not be familiar with the new regulatory

    requirements. In addition, market participants with third-party

    subaccounts would have to educate additional clients. Accordingly, both

    types of participants should be given additional time to prepare for

    compliance with the new requirements.

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    \30\ See Letter from Financial Services Forum, Futures Industry

    Association, International Swaps and Derivatives Association, and

    Securities Industry Association, dated May 4, 2011 at 9; Letter from

    Karrie McMillan, Investment Company Institute, dated Jun. 10, 2011

    at 10-11.

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    Another goal of the proposed compliance schedule is to have

    adequate representation of market participants involved at the outset

    of implementing a new mandatory clearing regime for swaps. The

    Commission believes that having a cross-section of market participants

    involved at the outset of formulating and designing the rules and

    infrastructure under which mandatory clearing is implemented will best

    meet the needs of all market participants.

    Several commenters have recommended that the Commission take such

    an approach. For example, one commenter emphasized the importance of

    the initiation of so-called ``buy-side'' clearing access for credit

    default swaps in 2009 and recommended that ``[a]t the time that a class

    of products is ready for clearing, all market participants (including

    buy-side participants) should be permitted (but not required) to clear

    those products * * *.'' \31\ In another example, one commenter

    recommended that in phasing mandatory clearing the Commission should

    aim for open access to establish an ``all to all market'' with both

    sides of the trade involved with the initial implementation.\32\ In

    further response to these comments, the Commission notes that market

    participants can begin (and continue) voluntarily clearing swaps

    through eligible DCOs at any time.

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    \31\ Letter from Richard H. Baker, Managed Funds Association,

    dated Mar. 24, 2011 at Appendix 1, page 1 and Appendix 2, page 2.

    \32\ Letter from Chris Koppenheffer, Swaps & Derivatives Market

    Association, dated Jun. 1, 2011 at 2.

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    C. Implementation Phasing of the Trade Execution Requirement Under

    Section 2(h)(8)

    1. Background on Trade Execution Requirement

    Section 723 of the Dodd Frank Act amended the CEA to provide, under

    new section 2(h)(8)(A), that with respect to a swap that is subject to

    the clearing requirement of section 2(h)(1)(A), ``counterparties shall

    (i) execute the transaction on a board of trade designated as a

    contract market under section 5 [a DCM]; or (ii) execute the

    transaction on a swap execution facility [SEF] registered under section

    5h or a swap execution facility exempt from registration under section

    5h(f) of this Act.'' Under section 2(h)(8)(B), the only exceptions to

    the trade execution requirement are if no DCM or SEF ``makes the swap

    available to trade'' or the swap is subject to the clearing exception

    under section 2(h)(7) (i.e., the end-user exception).\33\

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    \33\ Section 2(h)(1)(B).

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    Based on the natural phasing provided for in the statute, a trade

    execution requirement is triggered for a swap when (1) The Commission

    has issued a determination that the swap is required to be cleared and

    (2) any DCM or SEF has made the swap available to trade.\34\

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    \34\ This rulemaking does not address the manner in which it may

    be determined or established that a DCM or a SEF has made a swap

    available for trading.

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    The Commission observes that before market participants could be

    required to comply with a trade execution requirement the Commission

    must adopt final rules related to SEFs and DCMs. The Commission has

    proposed rules related to the new core principles for DCMs and the

    changes to the 18 original DCM core principles.\35\ While

    [[Page 58190]]

    none of the new rules proposed for DCMs relate directly to the trade

    execution requirement under section 2(h)(8), the Commission believes

    that it is necessary for DCMs to have their new policies, procedures,

    and rulebooks in place prior to the DCMs making a swap available for

    trading.

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    \35\ Core Principles and Other Requirements for Designated

    Contract Markets, 75 FR 80572, Dec. 22, 2010.

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    With regard to SEFs, the Commission also observes that it would

    have to adopt final rules allowing for SEF registration, including

    procedures for provisional registration, prior to any SEF making a swap

    that is required to be cleared available for trading.\36\ The

    finalization of these rules would enable SEFs to register with the

    Commission and ensure that they have developed their new policies,

    procedures, and rulebooks.

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    \36\ Core Principles and other Requirements for Swap Execution

    Facilities, 76 FR 1214, Jan. 7, 2011. As part of the SEF rulemaking,

    the Commission proposed regulation Sec. 37.10, which would require

    each SEF to conduct an annual review of whether it has made a swap

    available for trading and to provide a report to the Commission

    regarding its assessment. Id. at 1222 and 1241.

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    2. Compliance Schedule for the Trading Execution Requirement--

    Sec. Sec. 37.12 and 38.11

    Proposed regulations Sec. Sec. 37.12 and 38.11 provide for the

    phased implementation of a trade execution requirement by setting forth

    a compliance schedule tied to the schedule proposed for the clearing

    requirement.

    The proposed compliance schedules for the trade execution

    requirement would be triggered upon the later of (1) The applicable

    deadline established under the compliance schedule for the associated

    clearing mandate; or (2) 30 days after the swap is made available for

    trading on either a SEF or a DCM. Consequently, market participants

    always will have at least thirty days after a DCM or SEF has made a

    swap available for trading to comply with a trade execution

    requirement. Prior to a Commission-issued mandatory clearing

    determination, both DCMs and SEFs would be permitted to offer swaps for

    trading by market participants on a voluntarily basis. However, those

    swaps would not be required to be traded on a DCM or SEF, pursuant to

    section 2(h)(8) of the CEA until the associated clearing requirement

    took effect.

    D. Three-Part Implementation Phasing

    The Commission proposes compliance schedules for phasing

    implementation that afford relief in the form of additional time for

    compliance with any clearing requirement or trade execution requirement

    by category of market participant. The Commission based its proposed

    categorization of entities on the definition of ``financial entity'' in

    section 2(h)(7)(C) of the CEA.\37\ Under this statutory provision,

    Congress identified financial entities that would not be eligible to

    claim an exception from a clearing requirement under section 2(h)(1) of

    the CEA.

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    \37\ CEA section 2(h)(7)(A)(i) limits availability of the end-

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

    financial entity. The term financial entity is defined in CEA

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

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

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

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

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

    1940 (15 U.S.C. 80b-2(a)); (vii) an employee benefit plan as defined

    in paragraphs (3) and (32) of section 3 of the Employee Retirement

    Income Security Act of 1974 (29 U.S.C. 1002); or (viii) a person

    predominantly engaged in activities that are in the business of

    banking or financial in nature, as defined in section 4(k) of the

    Bank Holding Company Act of 1956 (12 U.S.C. 1843(k)).

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

    Phase 1--Category 1 Entities

    The proposed compliance schedule would define ``Category 1

    Entities'' to include a swap dealer, a security-based swap dealer, a

    major swap participant, a major security-based swap participant, or an

    active fund.

    Category 1 Entities include those dealers and major participants in

    the swap and security-based swap markets that will be registered with

    the Commission or the Securities and Exchange Commission (SEC).\38\

    Title VII of the Dodd-Frank Act requires these market participants to

    register with either the CFTC or SEC as a result of their swaps or

    security-based swaps activities. Based on their level of market

    experience and based on their status as registrants with either the

    CFTC or the SEC, the Commission believes they should be capable of

    complying with a clearing requirement and a trade execution requirement

    sooner than other market participants and that 90 days is a reasonable

    timeframe for these entities to come into compliance with these

    requirements.

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

    \38\ If a security-based swap dealer or a major security-based

    swap participant is not yet required to register with the SEC at

    such time as the Commission issues mandatory clearing determination,

    then the security-based swap dealer or a major security-based swap

    participant would be treated as a Category 2 Entity.

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

    The Commission also is proposing to include those entities it

    defines as ``active funds'' in the first category of market

    participants. The proposed definition of ``active fund'' would mean

    ``any private fund as defined in section 202(a) of the Investment

    Advisors Act of 1940, that is not a third-party subaccount and that

    executes 20 or more swaps per month based on a monthly average over the

    12 months preceding the Commission issuing a mandatory clearing

    determination under section 2(h)(2) of the Act.''\39\

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

    \39\ It should be noted that many commodity pools meet the

    definition of private fund under section 202(a) of the Investment

    Advisors Act of 1940. Such a commodity pool would only be a Category

    1 Entity if it met the other criteria of an active fund.

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

    The Commission is relying on the definition of private fund from

    section 2(h)(7)(C) of the CEA, as well as section 402 of the Dodd-Frank

    Act. However, the Commission is limiting the definition in two ways.

    First, the definition excludes third-party subaccounts, as discussed

    further below. Second, the definition is limited to those private funds

    that execute 20 or more swaps per month based on the average over the

    12 months preceding the Commission's issuance of a mandatory clearing

    determination.\40\ In choosing this threshold, the Commission's goal

    was to ensure the involvement of a cross-section of market participants

    at the outset of both clearing and trading requirement implementation.

    The Commission also sought to address some commenters' concerns

    regarding adequate ``buy-side'' representation early in the mandatory

    clearing process. Based on a preliminary assessment, the Commission

    believes the proposed numerical threshold for active funds is

    appropriate because a private fund that conducts this volume of swaps

    would be likely to have: (1) Sufficient resources to enter into

    arrangements that comply with the clearing and trade execution

    requirement earlier than other types of market participants; and (2)

    sufficient market experience to contribute meaningfully to the ``buy-

    side'' perspective as industry standards are being developed.\41\ In

    defining ``active fund'' accordingly, the Commission believes it has

    included those market participants that are likely to be among the most

    experienced participants with expertise and resources needed to come

    into transaction compliance quickly.

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

    \40\ In calculating the numerical threshold, the Commission

    intends for funds to calculate all swaps it executes not just those

    that are the subject of a mandatory clearing determination.

    \41\ The Commission is unaware of any position-level or

    transaction-level data on private fund swap activity in a publicly

    available form. In order to determine private fund activity levels,

    the staff consulted with academics focusing their research in this

    area, with industry participants, and with groups that represent the

    industry.

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

    The Commission proposes to phase in compliance with the mandatory

    clearing requirement for any swap transaction between a Category 1

    Entity and another Category 1 Entity, or any other entity

    [[Page 58191]]

    that desires to clear the transaction \42\ within the first 90 days

    after the Commission issues any mandatory clearing determination. With

    respect to the trade execution requirement, the Commission proposes to

    phase in compliance with this requirement either at the same time as

    the clearing requirement or thirty days after the swap is made

    available for trading, whichever is later. The Commission proposes

    phasing in all Category 1 Entities first because these market

    participants are likely to be the most active and experienced market

    participants whose involvement in the early stages of building and

    rolling out the clearing and trading requirements is critical. The

    Commission is attempting to include in this category those market

    participants with the expertise and resources to implement mandatory

    clearing and trading most quickly. The Commission also believes

    Category 1 Entities likely will have the most existing connectivity to

    clearinghouses and trading platforms and would be able to come into

    compliance sooner than other categories of participants.

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

    \42\ The intent of this clause is to facilitate clearing by

    counterparties that desire to comply with a clearing mandate earlier

    than they would otherwise be required to under the compliance

    schedule. The Commission solicits comment on whether there would be

    a better way to accomplish this objective.

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

    Phase 2--Category 2 Entities

    The proposed compliance schedule would define ``Category 2

    Entities'' to include a commodity pool; a private fund as defined in

    section 202(a) of the Investment Advisors Act of 1940 other than an

    active fund; an employee benefit plan as defined in paragraphs (3) and

    (32) of section 3 of the Employee Retirement Income and Security Act of

    1974; or a person predominantly engaged in activities that are in the

    business of banking, or in activities that are financial in nature as

    defined in section 4(k) of the Bank Holding Company Act of 1956,

    provided that the entity is not a third-party subaccount.

    The Commission proposes to phase in compliance for swap

    transactions between a Category 2 Entity and Category 1 Entity, another

    Category 2 Entity, or any other entity that desires to clear the

    transaction.\43\ The Commission is proposing to afford swap

    transactions between these types of market participants 180 days to

    come into compliance with a clearing requirement. With respect to the

    trade execution requirement, the Commission proposes to phase in

    compliance with this requirement either at the same time as the

    clearing requirement or thirty days after the swap is made available

    for trading, whichever is later. In providing these market participants

    an additional 90 days to come into compliance, the Commission took into

    consideration the fact that Category 2 Entities may not be required to

    be registered with the Commission and may be less experienced and less

    frequent users of the swap markets than those in Category 1.

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

    \43\ See footnote 42.

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

    Additionally, Category 2 Entities may not have the same level of

    expertise and resources to bring their swaps into compliance with a

    clearing requirement as quickly as Category 1 Entities. As defined for

    purposes of these compliance schedules, Category 2 Entities do not

    include those financial entities that are third-party subaccounts, as

    described further below.

    Phase 3--Third-Party Subaccounts and all Other Swap Transactions

    Finally, the Commission proposes to phase in compliance for all

    other swap transactions not excepted from the mandatory clearing

    requirement within 270 days after the Commission issues a clearing

    requirement. The Commission proposes to phase in compliance with the

    trade execution requirement either at the same time as the clearing

    requirement or thirty days after the swap is made available for

    trading, whichever is later.

    The Commission proposes to include all entities that are third-

    party subaccounts in this 270-day period. This approach would give

    these entities the most time to bring their swaps into compliance

    because they are likely to require the most time for documentation,

    coordination, and management. A third-party subaccount is afforded 270

    days to bring its swaps into compliance because its portfolio is

    managed by an asset manager that may have to bring numerous accounts

    into compliance. The Commission also proposes to include any other swap

    transaction that would be subject to a clearing requirement into

    compliance within this proposed 270-day period.

    Under the Commission's proposed definition, a third-party

    subaccount would be a managed account that requires specific approval

    by the beneficial owner of the account to execute documentation

    necessary for executing, confirming, margining, or clearing swaps. By

    way of non-exclusive example, if investment management firm X manages

    the assets of pension fund Y, and does so in a separate account that

    requires the approval of pension fund Y to execute necessary

    documentation, then that account would be afforded 270 days to come

    into compliance. On the other hand, if pension fund Y manages its own

    assets, it would fall within Category 2 and be afforded 180 days to

    come into compliance. Likewise, if investment management firm X does

    not manage the assets of third parties, then it would fall within

    Category 2.

    The Commission is proposing to afford third-party subaccounts an

    additional 90 days beyond the 180 days proposed for Category 2 because

    such entities may have documentation obligations for hundreds or even

    thousands of third-party subaccounts, and each such account must meet

    the mandatory clearing and trading requirements. For example, according

    to a statement made during the Joint SEC-CFTC Roundtable by Mr. William

    DeLeon of the firm Pacific Investment Management Company, LLC (PIMCO),

    PIMCO manages hundreds of third-party subaccounts, as defined

    above.\44\ The proposed compliance schedules would not prohibit any

    type of market participant from voluntarily complying sooner than the

    compliance deadline. Indeed, the Commission would encourage market

    participants that can come into compliance more quickly to move their

    swaps into clearing and begin trading on trading platforms as soon as

    possible in order to facilitate development of infrastructure that

    takes into account the views of many types of market participants. As

    one commenter noted, ``Smaller entities, for example, may have unique

    issues that need to be accounted for before systems are hardwired. Many

    swap market participants are small entities; it is important to ensure

    that these entities and their liquidity are not squeezed out of the

    swaps market.'' \45\

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

    \44\ Day 2 Roundtable Tr. at 62.

    \45\ Investment Company Institute, Jun. 10, 2011 letter, at 12.

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

    E. Prospective Application of Compliance Schedules

    The Commission anticipates that it will exercise its authority to

    trigger the proposed compliance schedules each time it issues a

    mandatory clearing determination for a new group, category, type, or

    class of swaps. Under this approach, when a DCO begins offering a new

    swap for clearing and it is in the same group, category, type, or class

    of swaps and it meets the requirements imposed under a previously

    issued mandatory clearing determination, then the proposed compliance

    schedules would not be triggered. However, if the Commission issues a

    mandatory clearing determination in any entirely new group, category,

    type, or class of

    [[Page 58192]]

    swaps then the compliance schedules could once again be triggered by

    the Commission. For example, if the Commission issues a mandatory

    clearing determination for 5 year credit default swap products and a

    new 5 year credit default swap product is offered for clearing based on

    a new 5 year index, then the proposed compliance schedules may not be

    triggered. If on the other hand, the Commission has not issued a

    mandatory clearing determination for 10 year credit default swap

    products and a new 10 year credit default swap product is offered for

    clearing, then the compliance schedules could be triggered by the

    Commission.

    When issuing a mandatory clearing determination, the Commission

    would set an effective date by which all market participants would have

    to comply. In other words, the proposed compliance schedules would be

    used only when the Commission believes that phasing is necessary based

    on the considerations outlined in this release. The Commission will

    provide the public with notice of its intent to rely upon the

    compliance schedule pursuant to the process outlined in Sec.

    39.5(b)(5).

    The Commission solicits comment on the ongoing usefulness of the

    proposed compliance schedules once market participants have established

    documentation and connectivity to DCOs, DCMs, and SEFs.

    F. Comment Requested

    The Commission requests comment on all aspects of the proposed

    compliance schedules, Sec. Sec. 37.12, 38.11 and 39.5(e). The

    Commission may consider alternatives to the proposed compliance

    schedules and is requesting comment on the following questions:

    What, if any, other rules should have been taken into

    consideration when proposing an implementation schedule regarding the

    clearing and trade execution requirements? If applicable, how should

    the implementation requirements of those other rules be taken into

    consideration?

    Should there be a presumption that the Commission will

    rely on the compliance schedule for each mandatory clearing

    determination that it issues, unless the Commission finds that the

    compliance schedule is not necessary to achieve the benefits set forth

    herein (e.g., facilitating the transition to the new regulatory

    requirement established by the Dodd-Frank Act in an orderly manner that

    does not unduly disrupt markets and transactions)?

    What factors, if any, would prevent an entity in any of

    the proposed categories from adhering to the compliance schedules

    proposed by the Commission? How much additional time would be needed to

    address these factors?

    Are there other considerations that the Commission should

    have taken into account when designing this tiered implementation

    schedule? Are the timeframes outlined in this implementation schedule

    adequate? If not, what alternative schedule should the Commission

    consider, and why?

    Assuming a situation where a swap first becomes subject to

    the clearing requirement and then is made available for trading by a

    DCM or SEF, is an additional thirty days after the swap becomes made

    available for trading enough time for DCMs, SEFs, and market

    participants to come into compliance with the trade execution

    requirement? For example, would thirty days be sufficient for the

    needed technological linkages to be established between (i) the DCOs,

    DCMs, and SEFs and (ii) the DCMs, SEFs, and market participants.

    What other entities, if any, should be included in

    Category 1 or 2, and why? Should any entities be moved from Category 1

    or 2 to a later category? For example, where should the Commission

    place those entities described in section 2(h)(7)(C)(ii) of the CEA

    (e.g., small banks, savings associations, farm credit system

    institutions, and credit unions)?

    What adjustments to the compliance schedule and/or other

    steps could the Commission take to ensure there is adequate

    representation from all market participants at the outset of clearing

    and trade execution requirements?

    In suggesting phasing in transactions between Category 1

    or 2 Entities and ``any other entity that desires to clear the

    transaction,'' the Commission intended to facilitate clearing by

    counterparties that desire to comply with a clearing mandate earlier

    than they would otherwise be required to under the compliance schedule.

    Is there a better way to achieve this objective?

    Is an entity's average monthly swap transaction activity a

    useful proxy for that entity's ability to comply with the clearing and

    trade execution requirements? Or whether an entity is required to be

    registered with the Commission (rather than whether an entity is

    already registered with the Commission)?

    Is the Commission's definition of ``active fund'' overly

    inclusive or under-inclusive? Should the numerical threshold for number

    of monthly swap transactions be higher or lower than 20? If so, why?

    Should the number of monthly swap transactions be linked to swap

    activity in a particular asset class?

    Should the Commission exclude from the definition of

    ``active fund'' any investment advisor of private funds acting solely

    as an advisor to private funds with assets under management in the

    United States of less than $150,000,000, as provided for in the

    reporting exemption for private funds under section 408 of the Dodd-

    Frank Act?

    Would it be more appropriate for the Commission to measure

    a market participant's level of swap activity by measuring notional

    turnover and/or open exposure, as suggested by some commenters? \46\

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

    \46\ Letter from Adam C. Cooper, Citadel, dated June 3, 2011,

    Appendix B.

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

    Are there any anticompetitive implications to the proposed

    compliance schedules? If so, how could the proposed rules be

    implemented to achieve the purposes of the CEA in a less

    anticompetitive manner? If so, please quantify those costs, if

    possible, and provide underlying data sources, assumptions and

    calculations.

    Are there additional costs or benefits associated with the

    current proposal that the Commission has not already taken into

    account? Please discuss any such costs in detail and quantify in dollar

    terms, if possible.

    Are there any assumptions, including quantitative

    assumptions, underlying the Commission's cost benefit analysis that the

    Commission should consider?

    Should the Commission consider an alternative

    implementation schedule? Would such an alternative schedule reduce the

    costs market participants bear? Please describe any such alternative

    implementation schedule in detail, including how it will reduce costs

    and the benefits it will likely deliver. If possible, please quantify

    the cost and benefits associated with any alternative. If providing

    dollar values, please describe any data sources, assumptions, and

    calculations used to generate them.

    III. Related Matters

    A. Regulatory Flexibility Act

    The Regulatory Flexibility Act requires that agencies consider

    whether the rules they propose will have a significant economic impact

    on a substantial number of small entities and, if so, provide a

    regulatory flexibility analysis respecting the impact.\47\ The rules

    proposed by the CFTC provide compliance schedules for

    [[Page 58193]]

    certain new statutory requirements of the Dodd Frank Act and do not by

    themselves impose significant new regulatory requirements. Accordingly,

    the Chairman, on behalf of the CFTC, hereby certifies pursuant to 5

    U.S.C. 605(b) that the proposed rules will not have a significant

    economic impact on a substantial number of small entities. The CFTC

    invites public comment on this determination.

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

    \47\ 5 U.S.C. 601 et seq.

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

    B. Paperwork Reduction Act

    The Paperwork Reduction Act (PRA) \48\ imposes certain requirements

    on federal agencies (including the Commission) in connection with

    conducting or sponsoring any collection of information as defined by

    the PRA. This notice of proposed rulemaking, if approved, would not

    require a new collection of information from any persons or entities.

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

    \48\ 44 U.S.C. 3507(d).

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

    C. Consideration of Costs and Benefits

    Section 15(a) of the CEA \49\ requires the Commission to consider

    the costs and benefits of its action before promulgating a regulation

    under the CEA. Section 15(a) of the CEA specifies that the costs and

    benefits shall be evaluated in light of five broad areas of market and

    public concern: (1) Protection of market participants and the public;

    (2) efficiency, competitiveness and financial integrity of futures

    markets; (3) price discovery; (4) sound risk management practices; and

    (5) other public interest considerations. The Commission 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 regulation is necessary or appropriate to protect the

    public interest or to effectuate any of the provisions or accomplish

    any of the purposes of the Act.

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

    \49\ 7 U.S.C. 19(a).

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

    The purpose of the proposed compliance schedules is to afford

    market participants adequate time to comply with the clearing

    requirement under section 2(h)(1)(A) of the CEA and the trade execution

    requirements under section 2(h)(8). Without the proposed compliance

    schedules, market participants could be required to comply with the

    clearing requirement immediately upon issuance of a mandatory clearing

    determination by the Commission, and market participants could be

    required to comply with the trade execution requirement when (1) The

    Commission has issued a determination that the swap is required to be

    cleared and (2) any DCM or SEF has made the swap available to trade.

    The Commission recognizes that requiring such immediate compliance

    with the clearing and trade execution requirements may impose costs on

    market participants, particularly for market participants that may not

    be registered with the Commission and those market participants that

    have hundreds or thousands of third-party subaccounts to bring into

    compliance with the new requirements under section 2(h) of the CEA.\50\

    Accordingly, the Commission's proposal provides substantial benefits in

    that it affords market participants additional time to document new

    clearing arrangements, connect to market infrastructures, and prepare

    themselves and their customers for the new regulatory requirements. The

    Commission believes that such an approach will help protect the public

    interest by facilitating an orderly transition to a new regulatory

    environment.

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

    \50\ E.g., Letter from Richard H. Baker, Managed Funds

    Association, dated Mar. 24, 2011 at Appendix 1, page 1.

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

    1. Protection of Market Participants and the Public

    In devising the proposed compliance schedules, the Commission

    sought to balance the goal of protecting the public by bringing market

    participants into compliance with the clearing and trade execution

    requirements for swaps as quickly as possible while affording market

    participants adequate time to come into compliance.

    Market participants in Category 1 (e.g., SDs, MSPs, and active

    funds) are likely to be among the most experienced and active

    participants with the resources needed to come into compliance with the

    clearing and trading requirements more quickly.\51\ The swaps entered

    into by these market participants are likely to represent a significant

    portion of the total swap market volume. As a result, moving these

    transactions into central clearing and onto trading platforms before

    those of Category 2 and 3 Entities would provide additional protection

    for the public by ensuring that the most active participants in the

    swap market come into compliance as soon as possible, thus mitigating

    risk and promoting transparency in significant portions of the swap

    market.

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

    \51\ In a letter from the Financial Services Forum, Futures

    Industry Association, International Swaps and Derivatives

    Association, and Securities Industry and Financial Markets

    Association, dated May 4, 2011, commenters noted that ``market

    participants vary dramatically in their resources, market

    sophistication and rationale for using Swaps. Swap Entities, in

    general, have greater resources, access to technology and clearing

    infrastructure than their end user counterparties.''

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

    By requiring Category 2 Entities to comply within 180 days, the

    Commission is seeking to balance the needs of those market participants

    that are not registered with the Commission and may not be as active in

    the swap market with the public interest of bringing all market

    participants into compliance as soon as possible.

    The market participants in Category 2 are likely to be less

    experienced and less active participants than those in Category 1. To

    the extent these market participants are less active in the swap

    markets the balance between moving their transactions into central

    clearing and onto trading platforms and giving them additional time to

    comply with the new requirements, tips in favor of the latter approach.

    Additionally, these entities may not have the same level of resources

    as Category 1 Entities. Therefore, they will benefit from the

    opportunity to document new clearing arrangements, connect to market

    infrastructures, and prepare themselves and their customers for the new

    regulatory requirements by considering examples of how Category 1

    Entities have met these requirements.

    It should be noted that Category 2 Entities and other market

    participants wanting to come into compliance before their respective

    compliance schedule deadlines in order to take advantage of the risk-

    mitigating benefits of central clearing and executing swaps on trading

    platforms are allowed, and encouraged, to do so.

    Entities that are third-party subaccounts have the additional

    challenge of transitioning hundreds, and in some cases, thousands of

    subaccounts into compliance with the clearing and trade execution

    requirements. This process may require that these entities negotiate

    and formalize new agreements with each of their customers. In order to

    accomplish this they also will need to educate their customers about

    how clearing and trade execution requirements will affect the costs and

    processes associated with their accounts. Each of these tasks requires

    time. By giving third-party subaccounts 270 days to come into

    compliance, the Commission seeks to balance the need of these entities

    and their customers for additional time with the benefits of reducing

    risks in the swap market and protecting the public as quickly as

    possible.

    It may be that the Category 1 Entities that constitute the first

    phase under the proposed compliance schedules will bear a larger

    proportion of the ``start-up''

    [[Page 58194]]

    costs associated with implementing the clearing and trade execution

    requirements. They are the entities likely to expend the most resources

    documenting new clearing arrangements, connecting to market

    infrastructures, and preparing themselves and their customers for the

    new regulatory requirements. The Commission is aware of these costs and

    believes that it is appropriate for the entities that are likely to be

    among the most active participants in these markets to shoulder a

    larger percentage of these start-up costs.

    2. Efficiency, Competitiveness, and Financial Integrity of the Markets

    By necessity, the first group of market participants that are

    required to comply with the clearing and trade execution requirements,

    along with DCOs, DCMs, and SEFs, are likely to work together to

    establish methods for compliance that other market participants may

    later consider. The experience with swaps that the first group of

    market participants brings to this process should help to ensure the

    integrity and effectiveness of their solutions. These solutions will

    likely be helpful to other market participants that comply later. For

    example, entities that are more experienced in the swap market, such as

    those in Category 1, are likely to have greater technological expertise

    and will best be able to develop the necessary technological

    infrastructure.

    It is critical that a cross-section of market participants is

    involved in developing the solutions that become industry conventions

    in order to ensure that those approaches promote the efficiency,

    competitiveness, and integrity of participants on the buy-side and the

    sell-side. The Commission's proposed compliance schedules address this

    need. For example, Category 1 includes active funds and MSPs that are

    likely to have the experience and expertise to represent ``buy-side''

    interests, whereas SDs generally will represent ``sell-side''

    interests.

    In providing Category 1 Entities with 90 days to comply with the

    clearing and trade execution requirements, the Commission would afford

    these market participants additional time to identify issues and work

    to develop solutions. This is likely to result in more efficient

    problem-solving processes, which may reduce the system-wide start-up

    costs of implementing new regulations. Moreover, it is also likely to

    foster a greater degree of compatibility and interoperability among the

    varied methods of compliance which, in turn, is likely to reduce the

    cost and complexity of interconnectedness.\52\

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

    \52\ See TABB Group, ``Technology and Financial Reform: Data,

    Derivatives and Decision Making'', Aug. 2011 at 12.

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

    Lastly, in the absence of the proposed compliance schedules, some

    entities have expressed concern that they would be unable to comply

    with the clearing and trading requirements and would choose to leave

    the swap market or avoid the market for some period of time. If this

    occurred, it could reduce liquidity and increase spreads in the market.

    By providing additional time for compliance, this rule reduces the

    chance that these adverse effects will occur in the swap market during

    the transition period.

    3. Price Discovery

    The trade execution requirement is expected to facilitate price

    discovery in the swap market. However, a disorderly implementation may

    inhibit price discovery by creating confusion about which

    counterparties are prepared to trade specific swaps and which contracts

    are fungible. An orderly process, however, promotes good communication

    between counterparties, which is essential to price discovery during

    the transition period.

    As for costs, to the extent that market participants could comply

    sooner than the proposed compliance schedule in an effective and

    efficient manner, this proposed schedule would delay the benefits that

    would come from increased price transparency that are expected to

    accompany a trade execution requirement under section 2(h)(8) of the

    CEA. The Commission's proposed compliance schedule reflects that the

    Commission anticipates that market participants will need additional

    time, however, for an orderly implementation process.

    4. Sound Risk Management Practices

    To the extent that the proposed compliance schedule for the

    clearing requirement would delay implementation of mandatory clearing,

    the swap market could suffer costs in terms of risk management. For

    example, there are risk management costs associated with not having

    counterparty credit risk monitored and managed effectively by a DCO.

    More prompt implementation of mandatory clearing would have the benefit

    of preventing losses from accumulating over time through the settlement

    of variation margin between a DCO's clearing members each day. The

    settlement of variation margin each day reduces both the chance of

    default and the size of any default should one occur. Delay in

    implementing mandatory clearing would also postpone the use of initial

    margin as a performance bond against potential future losses such that

    if a party fails to meet its obligation to pay variation margin,

    resulting in a default, the DCO may use the defaulting party's initial

    margin to cover most or all of any loss based on the need to replace

    the open position.

    On the other hand, the proposed compliance schedule for the

    clearing requirement would provide an orderly process for implementing

    mandatory clearing of swaps, and to the extent that it does so

    successfully, it will lead to overall sounder risk management practices

    for the swap market and the broader financial system, particularly

    during the implementation period. As noted above, in the absence of

    this rule, some entities may choose not to engage in swap transactions

    while they work to come into compliance with the new requirements. This

    result could expose those entities to risks they would otherwise have

    used swaps to mitigate. Therefore, by providing a timetable for orderly

    transition, this rule encourages continued participation in the swap

    markets and makes possible the continued use of swaps during the

    transition period for risk mitigation purposes.

    Moreover, if market participants were concerned that they might not

    be able to meet the proposed compliance schedule timelines, it is

    likely that they would incur additional costs associated with the

    potential lack of regulatory compliance. Providing additional time for

    compliance may reduce the costs that participants may incur mitigating

    legal risks during the transition period, and focuses those resources

    on achieving compliance.

    5. Other Public Interest Considerations

    There are public interest benefits to phasing in compliance using

    the implementation structure proposed in this release. The proposed

    implementation structure generally allows market participants to comply

    with the requirements of Dodd-Frank as quickly and efficiently as

    possible and thereby provides a sound basis for achieving the

    overarching Dodd-Frank goals of risk reduction and increased market

    transparency.

    In sum, the Commission has considered the costs and benefits as

    required by section 15(a) and is proposing the compliance schedules

    discussed herein. The Commission invites public comment on its cost-

    benefit considerations. Commenters are also invited to submit any data

    or other

    [[Page 58195]]

    information that they may have quantifying or qualifying the costs and

    benefits of the proposal with their comment letters.

    List of Subjects

    17 CFR Part 37

    Commodity futures, Swaps, Swap execution facilities, Registration

    application, Registered entities, Reporting and recordkeeping

    requirements.

    17 CFR Part 38

    Block transaction, Commodity futures, Designated contract markets,

    Reporting and Recordkeeping requirements, Transactions off the

    centralized market.

    17 CFR Part 39

    Business and industry, Commodity futures, Reporting and

    recordkeeping requirements.

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

    amend 17 CFR parts 37, 38 and 39 as follows:

    PART 37--SWAP EXECUTION FACILITIES

    1. The authority citation for part 37 continues to read as follows:

    Authority: 7 U.S.C. 1a, 2, 5, 6, 6c, 7, 7a-2, 7b-3 and 12a, as

    amended by Titles VII and VIII of the Dodd-Frank Wall Street Reform

    and Consumer Protection Act, Pub. L. 111-203, 124 Stat. 1376 (2010).

    2. Add Sec. 37.12 to read as follows:

    Sec. 37.12 Trade execution compliance schedule.

    (a) A swap transaction shall be subject to the requirements of

    section 2(h)(8)(A) of the Act upon the later of (1) the applicable

    deadline established under the compliance schedule provided under Sec.

    39.5(e)(2); or (2) 30 days after the swap is first made available for

    trading on either a swap execution facility registered under section 5h

    of the Act or a board of trade designated as a contract market under

    section 5 of the Act.

    (b) Nothing in this rule shall prohibit any counterparty from

    complying voluntarily with the requirements of section 2(h)(8)(A) of

    the Act sooner than as provided in paragraph (a) of this section.

    PART 38--DESIGNATED CONTRACT MARKETS

    3. The authority citation for part 38 continues to read as follows:

    Authority: 7 U.S.C. 1a, 2, 6, 6a, 6c, 6d, 6e, 6f, 6g, 6i, 6j,

    6k, 6l, 6m, 6n, 7, 7a-2, 7b, 7b-1, 7b-3, 8, 9, 15, and 21, as

    amended by the Dodd-Frank Wall Street Reform and Consumer Protection

    Act, Pub. L. 111-203, 124 Stat. 1376 (2010).

    4. Add Sec. 38.11 to read as follows:

    Sec. 38.11 Trade execution compliance schedule.

    (a) A swap transaction shall be subject to the requirements of

    section 2(h)(8)(A) of the Act upon the later of (1) the applicable

    deadline established under the compliance schedule provided under Sec.

    39.5(e)(2); or (2) 30 days after the swap is first made available for

    trading on a swap execution facility registered under section 5h of the

    Act or a board of trade designated as a contract market under section 5

    of the Act.

    (b) Nothing in this rule shall prohibit any counterparty from

    complying voluntarily with the requirements of section 2(h)(8)(A) of

    the Act sooner than as provided in paragraph (a) of this section.

    PART 39--DERIVATIVES CLEARING ORGANIZATIONS

    5. The authority citation for part 39 continues to read as follows:

    Authority: 7 U.S.C. 7a-1 as amended by Pub. L. 111-203, 124

    Stat. 1376.

    6. Amend Sec. 39.5 to add paragraph (e) to read as follows:

    Sec. 39.5 Review of swaps for Commission determination on clearing

    requirement.

    * * * * *

    (e) Mandatory clearing compliance schedule. (1) Definitions. For

    the purposes of this paragraph:

    Category 1 Entity means (1) a swap dealer, (2) a security-based

    swap dealer; (3) a major swap participant; (4) a major security-based

    swap participant; or (5) an active fund.

    Category 2 Entity means (1) a commodity pool; (2) a private fund as

    defined in section 202(a) of the Investment Advisors Act of 1940 other

    than an active fund; (3) an employee benefit plan as defined in

    paragraphs (3) and (32) of section 3 of the Employee Retirement Income

    and Security Act of 1974; or (4) a person predominantly engaged in

    activities that are in the business of banking, or in activities that

    are financial in nature as defined in section 4(k) of the Bank Holding

    Company Act of 1956, provided that, in each case, the entity is not a

    third-party subaccount.

    Active Fund means any private fund as defined in section 202(a) of

    the Investment Advisors Act of 1940, that is not a third-party

    subaccount and that executes 20 or more swaps per month based on a

    monthly average over the 12 months preceding the Commission issuing a

    mandatory clearing determination under section 2(h)(2) of the Act.

    Third-party Subaccount means a managed account that requires

    specific approval by the beneficial owner of the account to execute

    documentation necessary for executing, confirming, margining, or

    clearing swaps.

    (2) Upon issuing a mandatory clearing determination under section

    2(h)(2) of the Act, the Commission may determine, based on the group,

    category, type or class of swaps subject to such determination, that

    the following schedule for compliance with the requirements of section

    2(h)(1)(A) of the Act shall apply:

    (i) A swap transaction between a Category 1 Entity and another

    Category 1 Entity, or any other entity that desires to clear the

    transaction, must comply with the requirements of section 2(h)(1)(A) of

    the Act no later than ninety (90) days after the effective date set by

    the Commission for such mandatory clearing determination.

    (ii) A swap transaction between a Category 2 Entity and a Category

    1 Entity, another Category 2 Entity, or any other entity that desires

    to clear the transaction, must comply with the requirements of section

    2(h)(1)(A) of the Act no later than one hundred and eighty (180) days

    after the effective date set by the Commission for such mandatory

    clearing determination.

    (iii) All other swap transactions not eligible to claim the

    exception from mandatory clearing set forth in section 2(h)(7) of the

    Act and Sec. 39.6, must comply with the requirements of section

    2(h)(1)(A) of the Act no later than two hundred and seventy (270) days

    after the effective date set by the Commission for such mandatory

    clearing determination.

    (3) Nothing in this rule shall be construed to prohibit any person

    from voluntarily complying with the requirements of section 2(h)(1)(A)

    of the Act sooner than the implementation schedule provided under

    paragraph (2).

    Issued in Washington, DC, on September 8, 2011, by the

    Commission.

    David A. Stawick,

    Secretary of the Commission.

    [[Page 58196]]

    Appendices to Swap Transaction Compliance and Implementation Schedule:

    Clearing and Trade Execution Requirements under Section 2(h) of the

    CEA--Commissioners Voting Summary and Statements of Commissioners

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

    Federal Regulations

    Appendix 1--Commissioners Voting Summary

    On this matter, Chairman Gensler and Commissioners Dunn,

    Sommers, and Chilton voted in the affirmative; Commissioner O'Malia

    voted in the negative.

    Appendix 2--Statement of Chairman Gary Gensler

    I support the proposed rule to establish schedules to phase in

    compliance with the clearing and trade execution requirement

    provisions in the Dodd-Frank Wall Street Reform and Consumer

    Protection Act. The proposal would provide greater clarity to market

    participants regarding the timeframe for bringing their swap

    transactions into compliance with the clearing and trade execution

    requirements. The rule also would make the market more open and

    transparent, while giving market participants an adequate amount of

    time to comply. The proposed rule would help facilitate an orderly

    transition to a new regulatory environment for swaps.

    Appendix 3--Statement of Commissioner Jill Sommers

    I support this proposal to establish a schedule to phase in

    compliance with certain statutory provisions under Title VII of the

    Dodd-Frank Act because this will give market participants some

    degree of certainty about implementation deadlines. However, I

    believe the Commission should have provided a broader implementation

    plan encompassing all of the rulemakings under Dodd Frank, rather

    than the much narrower portion covered by today's proposed

    rulemaking. In addition, the proposed rule fails to address a

    critical component of the trade execution requirement in Section

    2(h)(8) of the Commodity Exchange Act. That is, what does it mean to

    ``make a swap available to trade?''

    I believe the Commission should clarify who makes the

    determination that a swap is ``made available for trading'' and how

    the decision is to be made, just as the Commission has done with

    respect to the clearing requirement. This would provide the public

    with an opportunity to comment on a proposed mechanism for such a

    determination. In a consultation paper published by the European

    Commission's Directorate General on Internal Markets and Services on

    December 8, 2010, the European Commission put forth the idea that

    the European Securities and Markets Authority, or ESMA, ``could

    assess and decide when a derivative which is eligible for clearing

    is sufficiently liquid to be traded exclusively'' on a trading

    platform.\53\ The European Commission noted that ESMA could base its

    decision on ``the frequency of trades in a given derivative and the

    average size of transactions,'' and solicited comments from the

    public on which criteria could determine whether a derivative is

    sufficiently liquid to be required to be traded on a platform.

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

    \53\ Public Consultation: Review of the Markets in Financial

    Instruments Directive (MiFID) (December 8, 2010), available at

    http://ec.europa.eu/internal_market/consultations/docs/2010/mifid/consultation_paper_en.pdf.

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

    Both the Dodd-Frank Act and proposed regulations in the European

    Union require consideration of trading liquidity, in addition to

    other factors, before a determination is made that a swap is

    required to be cleared. The Commission should address whether any

    additional factors will be considered as part of a determination on

    the trade execution requirement.

    Though I support today's proposal, I believe the Commission

    should clarify who makes the determination that a swap is ``made

    available for trading'' and how that decision will be made.

    Appendix 4-- Statement of Commissioner Scott O'Malia

    I respectfully dissent from the Commission's decision today to

    approve for Federal Register publication two rule proposals related

    to implementation entitled ``Swap Transaction Compliance and

    Implementation Schedule: Clearing and Trade Execution Requirements

    under Section 2(h) of the CEA'' and ``Swap Transaction Compliance

    and Implementation Schedule: Trading Documentation and Margining

    Requirements under Section 4s of the CEA.'' For quite some time, I

    have been asking that the Commission publish for notice and comment

    a comprehensive implementation schedule that addresses the entire

    mosaic of rule proposals under the Dodd-Frank Act. I believe the

    Commission should have proposed a comprehensive schedule that

    detailed, at a minimum:

    for each registered entity (e.g., swap dealer and major

    swap participants), compliance dates for each of its entity-specific

    obligations (e.g., all obligations under Section 4s of the Commodity

    Exchange Act) under Dodd-Frank; and

    for each market-wide obligation (e.g., the clearing and

    trading mandates), the entities affected (whether registered or

    unregistered) along with appropriate compliance dates.

    Such a schedule would have complemented and informed existing

    proposals and provided structure to future determinations.

    Additionally, a proposal regarding such a schedule should have

    adequately analyzed the costs and benefits of alternatives,

    including appropriate quantification. Unfortunately, the two rule

    proposals that the Commission approved today fail to either propose

    a comprehensive schedule or provide an adequate cost benefit

    analysis.

    The Commission's proposals also fail to request comment on a

    number of issues that I believe are important considerations in

    developing an implementation plan. As a result, I am encouraging

    commenters to submit responses to the questions below as part of

    their comments on the two rule proposals.

    Swap Transaction Compliance and Implementation Schedule: Clearing

    and Trade Execution Requirements under Section 2(h) of the CEA

    Should the Commission provide guidance on how it will

    make and communicate a mandatory clearing determination prior to

    considering the first such determination? If so, what information

    should be included in guidance?

    As section II(E) of the proposal states: ``When issuing

    a mandatory clearing determination, the Commission would set an

    effective date by which all market participants would have to

    comply. In other words, the proposed compliance schedules would be

    used only when the Commission believes that phasing is necessary

    based on the considerations outlined in this release. The Commission

    will provide the public with notice of its intent to rely upon the

    compliance schedule pursuant to the process outlined in Sec.

    39.5(b)(5).'' To afford more certainty to market participants,

    should the Commission instead create a presumption that it will rely

    on the compliance schedule for each mandatory clearing determination

    that it issues, unless it finds that the compliance schedule is not

    necessary to achieve the benefits set forth in the proposal (e.g.,

    facilitating the transition to the new regulatory regime established

    by the Dodd-Frank Act in an orderly manner that does not unduly

    disrupt markets and transactions)?

    What, if any, other issues not addressed in current

    proposed or final rulemakings should the Commission have taken into

    consideration when proposing the compliance schedule? For example,

    should the Commission have considered the extent to which its

    clearing and trade execution requirements apply to entities and

    transactions located outside the United States? Also, should the

    Commission have considered the extent to which such requirements

    apply to transactions between affiliates (whether domestic or cross-

    border)? If applicable, how should the Commission adjust the

    proposed compliance schedule to account for such issues?

    What, if any, adjustments should the Commission make to

    the proposed compliance schedule for trade execution requirements if

    the Commission makes a determination that a group, category, type,

    or class of swaps, rather than a specific swap, is subject to

    mandatory clearing? Would such adjustments vary depending on the

    manner in which the Commission defines group, category, type, or

    class?

    Swap Transaction Compliance and Implementation Schedule: Trading

    Documentation and Margining Requirements under Section 4s of the

    CEA

    What, if any, other issues not addressed in current

    proposed or final rulemakings should the Commission have taken into

    consideration when proposing the

    [[Page 58197]]

    compliance schedule? For example, should the Commission have

    considered the extent to which its documentation and margin

    requirements apply to entities and transactions located outside the

    United States? Also, should the Commission have considered the

    extent to which such requirements apply to transactions between

    affiliates (whether domestic or cross-border)? If applicable, how

    should the Commission adjust the proposed compliance schedule to

    account for such issues?

    Finally, I want to be clear that I support completing the final

    Dodd-Frank rulemakings in a reasonable time frame. I believe that

    the timely implementation of such rulemakings is important. Knowing

    when and how the markets are required to do what is vital to the

    success of implementing the new market structure required under the

    Dodd-Frank Act. When billions of dollars are at stake, you simply do

    not rely on guesses and estimates based on vague conditions.

    [FR Doc. 2011-24124 Filed 9-19-11; 8:45 am]

    BILLING CODE 6351-01-P

    Last Updated: September 20, 2011