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2012-20508

  • Federal Register, Volume 77 Issue 162 (Tuesday, August 21, 2012)[Federal Register Volume 77, Number 162 (Tuesday, August 21, 2012)]

    [Proposed Rules]

    [Pages 50425-50443]

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

    [FR Doc No: 2012-20508]

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    COMMODITY FUTURES TRADING COMMISSION

    17 CFR Part 39

    RIN 3038-AD47

    Clearing Exemption for Swaps Between Certain Affiliated Entities

    AGENCY: Commodity Futures Trading Commission.

    ACTION: Proposed rule.

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

    ``Commission'') is proposing a rule to exempt swaps between certain

    affiliated entities within a corporate group from the clearing

    requirement (the ``inter-affiliate clearing exemption'' or the

    ``proposed exemption'') under Section 2(h)(1)(A) of the Commodity

    Exchange Act (``CEA''). The Commission also is proposing rules that

    detail specific conditions counterparties must satisfy to elect the

    proposed inter-affiliate clearing exemption, as well as reporting

    requirements for affiliated entities that avail themselves of the

    proposed exemption. The Commission has finalized a rule that addresses

    swaps that are subject to the end-user exception. Counterparties to

    inter-affiliate swaps that qualify for the end-user exception would be

    able to elect to not clear swaps pursuant to the end-user exception or

    the proposed rule. The proposed rule does not address swaps that an

    affiliate enters into with a third party that are related to inter-

    affiliate swaps that are subject to the end-user exception. The

    Commission intends separately to propose a rule addressing swaps

    between an affiliate and a third party where the swaps are used to

    hedge or mitigate commercial risk arising from inter-affiliate swaps

    for which the end-user exception has been elected.

    DATES: Comments must be received on or before September 20, 2012.

    ADDRESSES: You may submit comments, identified by RIN number 3038-AD47,

    by any of the following methods:

    The agency's Web site, 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. ``Inter-affiliate Clearing Exemption'' must

    be in the subject field of responses submitted via email, and clearly

    indicated on written submissions. 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 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 established procedures in

    CFTC regulation 145.9.\1\

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    \1\ 17 CFR 145.9. Commission regulations may be accessed through

    the Commission's Web site, http://www.cftc.gov.

    _____________________________________-

    Throughout this proposed rulemaking, the Commission requests

    comment in response to specific questions. For convenience, the

    Commission has numbered each of these comment requests. The Commission

    asks that, in submitting responses to these requests, commenters

    identify the specific number of each request to which their comments

    are responsive.

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

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

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

    publication, such as obscene language. All submissions that have been

    redacted or removed that contain comments on the merits of the

    rulemaking will be retained in the public comment file and will be

    considered as required under the Administrative Procedure Act and other

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

    Act.

    FOR FURTHER INFORMATION CONTACT: Gloria Clement, Assistant General

    Counsel, (202) 418-5122, gclement@cftc.gov, Office of General Counsel;

    Jonathan Lave, Associate Director, Exchange & Data Repository, (202)

    418-5983, jlave@cftc.gov, and Alexis Hall-Bugg, Attorney-Advisor, (202)

    418-6711, ahallbugg@cftc.gov, Division of Market Oversight; Warren

    Gorlick, Supervisory Attorney-Advisor, (202) 418-5195,

    wgorlick@cftc.gov, and Anuradha Banerjee, Attorney-Advisor, (202) 418-

    5661, abanerjee@cftc.gov, Office of International Affairs; Theodore

    Kneller, Attorney-Advisor, (202) 418-5727, tkneller@cftc.gov, Division

    of Enforcement; Elizabeth Miller, Attorney-Advisor, (202) 418-5985,

    emiller@cftc.gov, Division of Swap Dealer and Intermediary Oversight;

    Esen Onur, Research Economist, (202) 418-6146, eonur@cftc.gov, Office

    of the Chief Economist; and Jolanta Sterbenz, Counsel, (202) 418-6639,

    jsterbenz@cftc.gov, Office of General Counsel, Commodity Futures

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

    Washington, DC 20581.

    I. Background

    A. Clearing Requirement for Swaps

    On July 21, 2010, President Obama signed the Dodd-Frank Wall Street

    Reform and Consumer Protection Act (``Dodd-Frank Act'' or ``DFA'').\2\

    Title VII of the Dodd-Frank Act amended the CEA,\3\ and established a

    new regulatory framework for swaps. The legislation was enacted to

    reduce systemic risk, increase transparency, and promote market

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

    Imposing clearing and trade execution requirements on standardized

    derivative products; (2) creating rigorous recordkeeping and data

    reporting regimes with respect to swaps, including real-time public

    reporting; and (3) enhancing the Commission's rulemaking and

    enforcement authorities over all registered entities, intermediaries,

    and swap counterparties subject to the Commission's oversight.

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    \2\ See Dodd-Frank Wall Street Reform and Consumer Protection

    Act, Public Law 111-203, 124 Stat. 1376 (July 21, 2010).

    \3\ 7 U.S.C. 1 et seq. (2006).

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    Section 723 of the Dodd-Frank Act added section 2(h) to the CEA,

    which establishes a clearing requirement for swaps.\4\ The new section

    makes it unlawful for any person to engage in a swap, if the Commission

    determines such swap is required to be cleared, unless the person

    submits the swap for clearing to a registered derivatives clearing

    organization (``DCO'') (or a DCO that is exempt from registration).\5\

    The

    [[Page 50426]]

    CEA, however, permits exceptions and exemptions to the clearing

    requirement.

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    \4\ CEA section 2(h)(1)(A), 7 U.S.C. 2(h)(1)(A).

    \5\ See CEA section 2(h)(1)(A), 7 U.S.C. 2(h)(1)(A). The CEA's

    clearing requirement states that, ``[i]t 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.''

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    A person may elect not to clear certain swaps if such person

    qualifies for an exception under CEA section 2(h)(7) and the Commission

    regulations issued in connection therewith (the ``end-user

    exception'').\6\ To summarize the principal components of the end-user

    exception, for a swap to qualify, a counterparty to the swap electing

    the exception must (i) not be a ``financial entity,'' as defined in CEA

    section 2(h)(7)(C)(i) or qualify for an exemption from that defined

    term under section 2(h)(7)(D),\7\ or through a Commission-issued

    exemption under CEA sections 2(h)(7)(C)(ii) \8\ or 4(c) \9\ and (ii) be

    using the swap to hedge or mitigate commercial risk. The Commission has

    determined to exempt certain small banks, savings associations, farm

    credit institutions, and credit unions under section 2(h)(7)(C)(ii) of

    the CEA from the definition of ``financial entity.''\10\

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    \6\ CEA section 2(h)(7)(A), 7 U.S.C. 2(h)(7)(A). CEA section

    2(h)(7)(A) provides an elective exception to the clearing

    requirement to any counterparty to a swap that is not a financial

    entity, is using the swap to hedge or mitigate commercial risk, and

    notifies the Commission how it generally meets the financial

    conditions associated with entering into non-cleared swaps. The

    Commission issued the end-user exception in a rulemaking entitled,

    ``End-User Exception to the Clearing Requirement for Swaps,'' 77 FR

    42560, July 19, 2012 (final).

    \7\ CEA section 2(h)(7)(D), 7 U.S.C. 2(h)(7)(D).

    \8\ CEA section 2(h)(7)(C)(ii), 7 U.S.C. 2(h)(7)(C)(ii) (``The

    Commission shall consider whether to exempt small banks, savings

    associations, farm credit system institutions, and credit unions * *

    * '').

    \9\ CEA section 4(c), 7 U.S.C. 6(c).

    \10\ ``End-User Exception to the Clearing Requirement for

    Swaps,'' 77 FR 42560, July 19, 2012 (see Sec. 39.6(d)).

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    Importantly, a counterparty to an inter-affiliate swap that

    qualifies for both the end-user exception and the inter-affiliate

    exemption may elect not to clear the inter-affiliate swap under either

    the end-user exception or the inter-affiliate exemption. As such, the

    Commission believes that the rule proposed in this rulemaking may not

    be necessary for the vast majority of inter-affiliate swaps involving a

    non-financial entity or a small financial institution because the end-

    user exception can be elected for those swaps. Accordingly, it is

    likely the proposed rule will be used for inter-affiliate swaps between

    two financial entities that do not qualify for the end-user exception

    or for swaps involving a non-financial entity that do not qualify for

    the end-user exception because the swaps do not hedge or mitigate

    commercial risk.

    Finally, CEA section 4(c)(1), described in more detail below,

    grants the Commission general exemptive powers.\11\ Pursuant to that

    authority, the Commission has proposed a rule that would allow

    cooperatives meeting certain conditions to elect not to submit for

    clearing certain swaps subject to a clearing requirement.\12\

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    \11\ Section 4(c)(1) of the CEA empowers the Commission to

    exempt any transaction or class of transactions, including swaps,

    from certain CEA provisions, such as the clearing requirement.

    \12\ ``Clearing Exemption for Certain Swaps Entered into by

    Cooperatives,'' 77 FR 41940, July 17, 2012.

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    B. Swaps Between Affiliated Entities

    Except as provided with respect to certain financing affiliates as

    noted above, CEA section 2(h) does not provide any specific exception

    to swaps entered into by affiliates that are subject to a clearing

    requirement (``inter-affiliate swaps'').\13\ Inter-affiliate swaps that

    are hedged by back-to-back or matching book swaps entered into with

    third parties may pose risks to the financial system if the inter-

    affiliate swaps are not properly risk managed thereby raising the

    likelihood of default on the outward facing swaps. Furthermore, there

    could be systemic risk implications if an affiliate used by the

    corporate group to trade outward facing swaps (commonly referred as

    centralized treasury or conduit affiliates) has large positions and

    defaulted on obligations arising from inter-affiliate swaps if such

    swaps are hedged with third-party swaps.\14\ Such a default could harm

    third-party swap counterparties, and potentially, financial markets as

    a whole, if the treasury/conduit affiliate was unable to satisfy third-

    party obligations as a consequence of the default.

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    \13\ For the purposes of this proposed rulemaking, ``inter-

    affiliate swaps'' refers to swaps between ``affiliates,'' as that

    term is defined in proposed Sec. 39.6(g)(1): ``[c]ounterparties to

    a swap * * * may elect not to clear a swap with an affiliate if one

    party directly or indirectly holds a majority ownership interest in

    the other, or if a third party directly or indirectly holds a

    majority interest in both, based on holding a majority of the equity

    securities of an entity, or the right to receive upon dissolution,

    or the contribution of, a majority of the capital of a

    partnership.'' See infra pt. II.B.1 for further discussion.

    \14\ There does not appear to be a common definition of a

    ``treasury affiliate'' or a ``conduit affiliate.'' For purposes of

    this proposed rulemaking, a treasury/conduit affiliate (or

    structure) is an affiliate that enters into inter-affiliate swaps

    and enters into swaps with third parties that are related to such

    inter-affiliate swaps on a back-to-back or aggregate basis.

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    A number of commenters in a variety of Commission rulemakings have

    recommended that the Commission adopt an exemption to the clearing

    requirement for inter-affiliate swaps.\15\ Some commenters claimed that

    inter-affiliate swaps offer significant benefits with substantially

    less risk than swaps between unaffiliated entities. They contended that

    inter-affiliate swaps enable a corporate group to aggregate its risks

    on a global basis in one entity through risk transfers between

    affiliates. Commenters also described varying structures through which

    corporate groups entered into inter-affiliate swaps and manage risks.

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    \15\ The Commission notes that comment letters to other proposed

    rulemakings under Title VII of the Dodd-Frank Act are not part of

    the administrative record for this rulemaking unless specifically

    cited herein.

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    Prudential Financial, Inc. (``PFI''), stated that it employs a

    ``conduit'' structure where separate legal entities are commonly owned

    by PFI.\16\ Under this structure, PFI uses one affiliate to directly

    face the market as a ``conduit'' to hedge the net commercial and

    financial risk of the various operating affiliates within PFI. PFI

    contended that the use of a conduit diminishes the demands on PFI's

    financial liquidity, operational assets, and management resources,

    because ``affiliates within PFI avoid having to establish independent

    relationships and unique infrastructure to face the market.'' Moreover,

    PFI explained that its conduit facilitates the netting of its

    affiliates' trades (e.g., where one affiliate hedges floating rates

    while another hedges fixed rates). PFI stated that this conduit

    structure effectively reduces the overall risk of PFI and its

    affiliates, and it allows PFI to manage fewer outstanding positions

    with external market participants.\17\

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    \16\ Prudential Financial, Inc. comment letter to the proposed

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

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

    Participant' and `Eligible Contract Participant,' '' 75 FR 80147,

    Dec. 21, 2010.

    \17\ J.P. Morgan commented that the most efficient way to manage

    risk is often at one entity and on a portfolio level. This way all

    the risk for the corporate group resides in one entity. J.P. Morgan

    maintained that this reduces market risk at each legal entity and

    can reduce risk on a group level because offsetting positions held

    by different members of the group can be aggregated to mitigate the

    overall risk of the portfolio. J.P. Morgan asserted that portfolio

    risk management enables regulators to more easily assess the net

    risk position on a group level rather than piecing together data

    from separate affiliates to reconstruct the actual risk profile of

    the group. J.P. Morgan comment letter to the proposed rulemaking,

    ``Process for Review of Swaps for Mandatory Clearing,'' 75 FR 67277,

    Nov. 2, 2010.

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    In a letter to Congress, the Coalition for Derivatives End-Users

    (``CDEU'') asserted that inter-affiliate swaps do not create external

    counterparty exposure and, therefore, pose none of the systemic or

    other risks that the clearing requirement is designed to protect

    against.\18\ Thus, in CDEU's view, the

    [[Page 50427]]

    imposition of required clearing on inter-affiliate swaps would not

    reduce systemic risk. CDEU also commented that a conduit or treasury

    structure is beneficial because it centralizes trade expertise and

    execution in a single or limited number of entities. Finally, CDEU

    claimed that a treasury or conduit structure benefits affiliates

    because they can enjoy their parents' corporate credit ratings and

    associated pricing benefits.

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    \18\ Coalition for Derivatives End-Users comment letter for H.R.

    2682, H.R. 2779, and H.R. 2586 (Mar. 23, 2012).

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    These comments suggest that swaps entered into between corporate

    affiliates, if properly risk-managed, may be beneficial to the

    operation of the corporate group as a whole. They indicate that inter-

    affiliate swaps may improve a corporate group's risk management

    internally and allow the corporate group to use the most efficient

    means to effectuate swaps with third parties. While the Commission

    recognizes these potential benefits of inter-affiliate swaps, the

    Commission is also taking into account the systemic risk repercussions

    of inter-affiliate swaps as it considers and proposes an exemption to

    the CEA's clearing requirement applicable to those inter-affiliate

    swaps.

    II. Inter-Affiliate Clearing Exemption Under CEA Section 4(c)(1)

    A. The Commission's Section 4(c)(1) Authority

    Section 4(c)(1) of the CEA empowers the Commission to ``promote

    responsible economic or financial innovation and fair competition'' by

    exempting any transaction or class of transactions, including swaps,

    from any of the provisions of the CEA (subject to exceptions not

    relevant here).\19\ In enacting CEA section 4(c)(1), Congress noted

    that the goal of the provision ``is to give the Commission a means of

    providing certainty and stability to existing and emerging markets so

    that financial innovation and market development can proceed in an

    effective and competitive manner.'' \20\ Observant of that objective,

    the Commission has determined preliminarily that it would be

    appropriate to exempt inter-affiliate swaps from the clearing

    requirement in CEA section 2(h) under certain terms and conditions. The

    proposed exemption, however, would not extend to swaps that affiliates

    entered into with third parties.

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    \19\ Section 4(c)(1) of the CEA, 7 U.S.C. 6(c)(1), provides, in

    pertinent part, that:

    In order to promote responsible economic or financial innovation

    and fair competition, the Commission by rule, regulation, or order,

    after notice and opportunity for hearing, may (on its own initiative

    or on application of any person * * * ) exempt any agreement,

    contract, or transaction (or class thereof) that is otherwise

    subject to subsection (a) of this section * * * either

    unconditionally or on stated terms or conditions or for stated

    periods and either retroactively or prospectively, or both, from any

    of the requirements of subsection (a) of this section, or from any

    other provision of this Act.

    By issuing a proposed exemptive rule, the Commission also is

    exercising its general rulemaking authority under CEA section 8a(5),

    7 U.S.C. 12a(5).

    \20\ House Conf. Report No. 102-978, 1992 U.S.C.C.A.N. 3179,

    3213 (``4(c) Conf. Report'').

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    The primary benefit of clearing is the reduction of counterparty

    risk. The Commission notes commenters' assertions that there is less

    counterparty risk associated with inter-affiliate swaps than swaps with

    third parties to the extent that affiliated counterparties internalize

    each other's counterparty risk because they are members of the same

    corporate group. This internalization can be demonstrated by the

    example of a swap entered into between affiliates A and B that are

    majority owned by the same person.\21\ If affiliate A fails to perform,

    then affiliate B would be harmed. However, affiliate A also may be

    harmed if (1) B's harm adversely impacts the profits of A and B's

    corporate group \22\ or (2) A's failure to perform drives the group

    into bankruptcy, because, for instance, B has entered into a swap with

    a third party and B is unable to perform as a consequence of A's

    failure to perform. The potential harm to A for failing to perform is

    greater than the harm A would experience if B was not a majority-owned

    affiliate. Accordingly, A internalizes B's counterparty risk and A has

    a greater economic incentive to perform than if B were a third party.

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    \21\ The meaning of ``majority-owned'' is set forth and

    discussed in part B1.

    \22\ A's corporate group is the group that contains the person

    with a majority ownership interest of A. Similarly, B's corporate

    group is the group that contains the person with a majority

    ownership interest of B.

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    The Commission does not believe there is significantly reduced

    counterparty risk with respect to swaps between affiliates that are not

    majority-owned by the same person because there is less economic

    feedback. If A is a majority-owned affiliate and B is a minority-owned

    affiliate, then any harm that B experiences as a consequence of A's

    failure to perform is likely to have a less adverse impact on the

    profits of A's corporate group than if B was a majority-owned

    affiliate. In addition, the Commission believes that B's failure to

    perform would be significantly less likely to drive A's corporate group

    into bankruptcy than if B were majority-owned.

    On the basis of reduced counterparty risk, the Commission has

    determined preliminarily that inter-affiliate swap risk may not need to

    be mitigated through clearing, but can be reduced through other means.

    The Commission also believes at the proposal stage that exempting

    inter-affiliate swaps would enable corporations to structure their

    groups so that corporate risk is concentrated in one entity--whether it

    be at a treasury- or conduit-type affiliate, or at the parent

    company.\23\ The Commission recognizes there may be advantages for the

    corporate group and regulators if risk is appropriately managed and

    controlled on a consolidated basis and at a single affiliate. Based

    upon the comments received, the Commission understands that some

    corporate groups use this type of structure.

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    \23\ Treasury/conduit affiliates, for example, often enter into

    swaps with third parties that hedge aggregate inter-affiliate swap

    risk. The aggregation is based on risk correlations. If those

    correlations break down, then the treasury/conduit affiliate may no

    longer be able to satisfy its third-party swap obligations.

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    The Commission, nevertheless, believes that uncleared inter-

    affiliate swaps could pose risk to corporate groups and market

    participants, generally. Uncleared inter-affiliate swaps also may pose

    risk to other market participants, and therefore the financial system,

    if the treasury/conduit affiliate enters into swaps with third parties

    that are related on a back-to-back or matched book basis with inter-

    affiliate swaps. To continue the above example, if A's failure to

    perform (for whatever reason) makes it impossible for B to meet its

    third-party swap obligations, then those third parties would be harmed

    and risk could spread into the marketplace. However, A's risk of

    nonperformance is less than it would be if B were a third party to the

    extent A internalizes B's counterparty risk.

    To address these concerns, the Commission is proposing rules that

    would exempt inter-affiliate swaps from clearing if certain conditions

    are satisfied. First, the proposed exemption would be limited to swaps

    between majority-owned affiliates whose financial statements are

    reported on a consolidated basis. Second, the proposed rules would

    require the following: Centralized risk management, documentation of

    the swap agreement, variation margin payments (for financial entities),

    and satisfaction of reporting requirements. In addition, the exemption

    would be limited to swaps between U.S. affiliates, and swaps between a

    U.S. affiliate and a foreign affiliate located in a jurisdiction with a

    comparable and comprehensive clearing regime or the non-United States

    counterparty is otherwise required to clear the swaps it enters into

    with third

    [[Page 50428]]

    parties in compliance with United States law or does not enter into

    swaps with third parties. Additionally, the Commission notes that the

    proposed exemption does not limit the applicability of any CEA

    provision or Commission regulation to any person or transaction except

    as provided in the proposed rulemaking. These conditions will be

    discussed in further detail below.

    Request for Comments

    Q1. The Commission requests comment on whether it should exercise

    its authority under CEA section 4(c).

    Q2. Do inter-affiliate swaps pose risk to the corporate group? If

    so, what risk is posed? In particular, do inter-affiliate swaps pose

    less risk to a corporate group than swaps with third parties? If so,

    why is that the case?

    Q3. Do inter-affiliate swaps pose risk to the third parties that

    have entered into swaps that are related to the inter-affiliate swaps?

    If so, what risk is posed?

    Q4. Would the proposed exemption promote responsible economic or

    financial innovation and fair competition?

    Q5. Would the proposed exemption promote the public interest?

    Q6. Inter-affiliate swaps that do not meet the conditions to the

    proposed exemption would be subject to the clearing requirement under

    CEA section 2(h)(1)(A) and, potentially, the trade execution

    requirement under CEA section 2(h)(8) as well. What would be the costs

    and benefits of imposing the trade execution requirement on these

    inter-affiliate swaps? Should the Commission exempt some or all inter-

    affiliate swaps from the trade execution requirement regardless of

    whether the conditions to the proposed inter-affiliate clearing

    exemption are met?

    B. Proposed Regulations

    1. Proposed Sec. 39.6(g)(1): Definition of Affiliate Relationship

    Under proposed Sec. 39.6(g)(1), the inter-affiliate clearing

    exemption would only be available for swaps between majority-owned

    affiliates. As explained above, the Commission believes there is

    reduced counterparty risk with respect to such swaps. Under the

    proposed rule, affiliates would be majority-owned if one affiliate

    directly or indirectly holds a majority ownership interest in the other

    affiliate, or if a third party directly or indirectly holds a majority

    ownership interest in both affiliates and the financial statements of

    both affiliates are reported on a consolidated basis. A majority-

    ownership interest would be based on holding a majority of the equity

    securities of an entity, or the right to receive upon dissolution, or

    the contribution of, a majority of the capital of a partnership.\24\

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    \24\ The affiliate status required by proposed Sec. 39.6(g)(1)

    to elect the proposed exemption is based on and functionally

    equivalent to the definition of majority-owned affiliates in

    recently adopted CFTC regulation 1.3(ggg)(6)(i).

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    The Commission is not proposing to extend the exemption to

    affiliates that are related on a minority-owned basis. As explained

    above, the Commission does not believe there is significantly reduced

    counterparty risk with respect to swaps between such affiliates. The

    Commission also believes it is important for the proposed inter-

    affiliate clearing exemption to be harmonized with foreign

    jurisdictions that have or are developing comparable clearing regimes

    consistent with the 2009 G-20 Leaders' Statement.\25\ For example, the

    European Parliament and Council of the European Union have adopted the

    European Market Infrastructure Regulation (``EMIR'').\26\ Subject to

    the relevant provisions, technical standards, and regulations under

    EMIR, certain derivatives transactions between parent and subsidiary

    entities, could be exempt from its general clearing requirement.

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    \25\ In 2009, the G20 Leaders declared that, ``[a]ll

    standardized OTC derivative contracts should be traded on exchanges

    or electronic trading platforms, where appropriate, and cleared

    through central counterparties by end-2012 at the latest.'' G20

    Leaders' Final Statement at Pittsburgh Summit: Framework for Strong,

    Sustainable and Balanced Growth (Sept. 29, 2009).

    \26\ See Regulation (EU) No 648/2012 of the European Parliament

    and of the Council on OTC Derivatives, Central Counterparties and

    Trade Repositories, 2012 O.J. (L 201) available at http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:L:2012:201:0001:0059:EN:PDF.

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    Request for Comments

    Q7. The Commission requests comments on all aspects of the

    Commission's proposed requirement that the inter-affiliate clearing

    exemption be available to majority-owned affiliates.

    Q8a. Should the Commission consider requiring a percentage of

    ownership greater than majority ownership to qualify for the inter-

    affiliate clearing exemption?

    Q8b. If so, what percentage should be used and what are the

    benefits and burdens of such ownership requirements?

    Q8b. Should the Commission require a 100% ownership threshold for

    the inter-affiliate clearing exemption? Would a 100% ownership

    threshold reduce counterparty risk and protect minority owners better

    than the proposed threshold. Are there other means to lessen risk to

    minority owners, such as consent?

    Q9. Should the Commission consider an 80% ownership threshold based

    on section 1504 of the Internal Revenue Code, which establishes an 80%

    voting and value test for an affiliate group.\27\ In light of the

    potential benefits from centralized risk management in an affiliated

    group, would an 80% threshold sufficiently reduce overall risk to

    financial system

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    \27\ The Internal Revenue Service allows a business conglomerate

    to file consolidated tax returns if the parent company and its

    subsidiaries meet a relationship test that is outlined in 26 U.S.C.

    1504(a)(2):

    (a) Affiliated group defined for purposes of this subtitle--

    (1) In general. The term ``affiliated group'' means--

    (A) 1 or more chains of corporations connected through stock

    ownership with a common parent corporation which is a corporation,

    but only if--

    (B) (i) the common parent owns directly stock meeting the

    requirements of paragraph (2) in at least 1 of the other

    corporations, and

    (ii) stock meeting the requirements of paragraph (2) in each of

    the includible corporations (except the common parent) is owned

    directly by 1 or more of the other includible corporations.

    (2) 80-percent voting and value test The ownership of stock of

    any corporation meets the requirements of this paragraph if it--

    (A) possesses at least 80 percent of the total voting power of

    the stock of such corporation, and

    (B) has a value equal to at least 80 percent of the total value

    of the stock of such corporation.

    (3) Stock not to include certain preferred stock

    For purposes of this subsection, the term ``stock'' does not

    include any stock which--(A) is not entitled to vote,

    (B) is limited and preferred as to dividends and does not

    participate in corporate growth to any significant extent,

    (C) has redemption and liquidation rights which do not exceed

    the issue price of such stock (except for a reasonable redemption or

    liquidation premium), and

    (D) is not convertible into another class of stock.

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

    2. Proposed Sec. 39.6(g)(2)(i): Both Counterparties Must Elect the

    Inter-Affiliate Clearing Exemption

    The Commission believes that affiliates within a corporate group

    may make independent determinations on whether to submit an inter-

    affiliate swap for clearing. Ostensibly, each affiliate may reach

    different conclusions regarding the appropriateness of clearing. Given

    this possibility, proposed Sec. 39.6(g)(2)(i) would require that both

    counterparties elect the proposed inter-affiliate clearing exemption

    (each, an ``electing counterparty'').

    Request for Comments

    Q10. Would this requirement create any operational issues?

    3. Proposed Sec. 39.6(g)(2)(ii): Swap Documentation

    The Commission understands that affiliates may enter into swaps

    with

    [[Page 50429]]

    each other with little documentation about the terms and conditions of

    the swaps. The Commission is concerned that without proper

    documentation affiliates would be unable to effectively track and

    manage risks arising from inter-affiliate swaps or offer sufficient

    proof of claim in the event of bankruptcy. This could create challenges

    and uncertainty that could adversely affect affiliates, third party

    creditors, and potentially the financial system. The Commission also is

    concerned about transparency should there be a need for an audit or

    enforcement proceeding.

    Proposed Sec. 39.6(g)(2)(iii) would address these concerns by

    requiring affiliates to enter into swaps with a swap trading

    relationship document.\28\ The proposed rule would require the document

    to be in writing and to include all terms governing the trading

    relationship between the affiliates, including, without limitation,

    terms addressing payment obligations, netting of payments, events of

    default or other termination events, calculation and netting of

    obligations upon termination, transfer of rights and obligations,

    governing law, valuation, and dispute resolution procedures.\29\ The

    Commission believes this requirement would not be onerous because

    affiliates should be able to use a master agreement to document most of

    the terms of their inter-affiliate swaps.

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

    \28\ For swap dealers and major swap participants, these issues

    are addressed in the swap trading relationship documentation rules

    proposed by the Commission in Sec. 23.504. See ``Swap Trading

    Relationship Documentation Requirements for Swap Dealers and Major

    Swap Participants,'' 76 FR 6715, Feb. 8, 2011. The proposed rule

    requires that if one or more of the parties to the swap for which

    the inter-affiliate exemption is elected is a swap dealer or major

    swap participant, then that party shall comply with Sec. 23.504 for

    that swap. Swap dealers and major swap participants that comply with

    that provision would also satisfy the proposed requirements.

    \29\ The requirements of the swap trading relationship document

    are informed by proposed CFTC regulation 23.504(b)(1). See ``Swap

    Trading Relationship Documentation Requirements for Swap Dealers and

    Major Swap Participants,'' 76 FR 6715, Feb. 8, 2011.

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

    Request for Comments

    Q11. The Commission requests comment as to the burden or cost of

    the proposed rule requiring documentation of inter-affiliate swaps.

    Q12. The Commission also requests comment as to whether its risk

    tracking and management and proof-of-claim concerns could be addressed

    by other means of documentation.

    Q13. The Commission requests comment as to whether the Commission

    should create a specific document template. Should the industry do so?

    4. Proposed Sec. 39.6(g)(2)(iii): Centralized Risk Management

    Proposed Sec. 39.6(g)(2)(iii) would require inter-affiliate swaps

    to be subject to a centralized risk management program reasonably

    designed to monitor and manage the risks associated with the inter-

    affiliate swaps. As noted in Part I.B. above, inter-affiliate swaps may

    pose risk to third parties if risks are not properly managed.

    Accordingly, to encourage prudent risk management, the proposed inter-

    affiliate clearing exemption would be conditioned on a corporate

    group's evaluation, measurement and control of such risks. The

    Commission anticipates that the program would be implemented and run by

    the parent company or the treasury/conduit affiliate, but the rule

    provides flexibility to determine how best to satisfy this

    requirement.\30\

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

    \30\ The Commission has adopted risk management rules for swap

    dealers and major swap participants in Sec. 23.600. See ``Swap

    Dealer and Major Swap Participant Recordkeeping, Reporting, and

    Duties Rules; Futures Commission Merchant and Introducing Broker

    Conflicts of Interest Rules; and Chief Compliance Officer Rules for

    Swap Dealers, Major Swap Participants, and Futures Commission

    Merchants,'' 77 FR 20128, 20173-75, April 3, 2012 (final rule). The

    rule requires that if one or more of the parties to the swap for

    which the inter-affiliate exemption is elected is a swap dealer or

    major swap participant, then that party shall comply with Sec.

    23.600 for that swap. Swap dealers and major swap participants that

    comply with that provision will also satisfy the proposed

    requirements.

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

    The Commission understands that some groups that use inter-

    affiliate swaps, particularly large financial entities, already have a

    centralized risk management program.\31\ Indeed, several commenters--

    e.g., SIFMA and ISDA--supported centralized risk management and claimed

    that centralized risk management for inter-affiliate swaps ``would be

    compromised'' by a clearing requirement.\32\ CDEU also commented that

    inter-affiliate swaps are beneficial because they allow swaps with

    third parties to be traded at a treasury-type structure which contains

    risk management expertise.\33\ Based on comments received, the

    Commission believes that the proposed rule is in line with industry

    practice. Proposed Sec. 39.6(g)(2)(iii) also is in harmony with

    similar requirements under EMIR, which would require under certain

    circumstances for both counterparties to intra-group transactions to be

    ``subject to an appropriate centrali[z]ed risk evaluation, measurement

    and control procedures. * * *'' \34\

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

    \31\ See, e.g., Letter from SIFMA and ISDA submitted to the

    Commission on their own initiative (May 14, 2012).

    \32\ Id.

    \33\ See 3/23/23 Letter from CDEU.

    \34\ See EMIR Article 3, paragraphs 1 and 2. EMIR identifies

    factors necessary to establish a transaction as an intra-group

    transaction.

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

    Request for Comments

    Q14. The Commission requests comments that explain how current

    centralized risk management programs operate.

    Q15. The Commission requests comment on whether it should

    promulgate additional regulations that set forth minimum standards for

    a centralized risk management program. If so, what should those

    standards be? Is there a consistent industry practice which could be

    observed?

    Q16. Is the proposed rule in line with industry practice?

    5. Proposed Sec. 39.6(g)(2)(iv): Variation Margin

    Proposed Sec. 39.6(g)(2)(iv) would require that variation margin

    be collected for swaps between affiliates that are financial entities,

    as defined in CEA section 2(h)(7)(C), in compliance with the proposed

    variation margin requirements set forth in proposed Sec.

    39.6(g)(3).\35\ Variation margin is an essential risk-management tool.

    A well-designed variation margin system protects both parties to a

    trade. It serves both as a check on risk-taking that might exceed a

    party's financial capacity and as a limitation on losses when there is

    a failure. Variation margin entails marking open positions to their

    current market value each day and transferring funds between the

    parties to reflect any change in value since the previous time the

    positions were marked.\36\ This process prevents uncollateralized

    exposures from accumulating over time and thereby reduces the size of

    any loss resulting from a default should one occur. Required margining

    also might cause parties to more carefully consider the risks involved

    with swaps and manage those risks more closely over time. The

    Commission believes, at this stage, that inter-affiliate swap risk may

    be mitigated through variation margin and notes that requiring

    variation margin for inter-affiliate swaps is being discussed by

    international regulators working on harmonizing regulations governing

    swap clearing.

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

    \35\ Discussed in pt. II.B.8., below.

    \36\ Variation margin is distinguished from initial margin,

    which is intended to serve as a performance bond against potential

    future losses. If a party defaults, the other party may use initial

    margin to cover most or all of any loss that may result between the

    time the default occurs and when the non-defaulting party replaces

    the open position.

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

    The Commission understands that a number of financial entities

    currently

    [[Page 50430]]

    post variation margin for their inter-affiliate swaps. According to

    SIFMA and ISDA, ``[t]he posting of variation margin limiting the impact

    of market movements upon the respective positions of the affiliated

    parties now occurs routinely in financial groups and its imposition on

    affiliates who transact directly with affiliated swap dealers (SDs) or

    major swap participants (MSPs) should not be unduly disruptive.'' \37\

    The Commission has proposed rules requiring certain financial entities

    to pay and collect variation and initial margin for uncleared swaps

    entered into with other financial entities.\38\

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

    \37\ See, e.g., 5/14/12 Letter from SIFMA and ISDA.

    \38\ The Commission does not propose that variation margin

    posted in respect of inter-affiliate swaps be required to be held in

    a segregated account or be otherwise unavailable for use and

    rehypothecation by the counterparty holding such variation margin.

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

    The proposed requirement would not apply to 100% commonly-owned and

    commonly-guaranteed affiliates, provided that the common guarantor is

    also under 100% common ownership. As discussed above, the risk of an

    inter-affiliate swap may be mitigated through the posting of variation

    margin. The Commission believes that when the economic interests of two

    affiliates are both (i) fully aligned and (ii) a common guarantor bears

    the ultimate risk associated swaps entered into with a third party,

    non-affiliated counterparty, the posting of variation margin does not

    substantially mitigate the risk of an inter-affiliate swap. This

    exception is intended to apply to swaps between two wholly-owned

    subsidiaries of a common parent or in instances where one affiliate is

    wholly owned by the other.

    The first of the conditions required to claim the exception to the

    requirement under proposed regulation 39.6(g)(2)(iv) to post variation

    margin relates to complete common ownership. When two affiliates are

    owned by the same owner or one is wholly owned by the other, the

    underlying owners are the same and the economic interests of the two

    affiliates are aligned.\39\ In such circumstances, the two affiliates

    are subject to the control of a common owner or common set of

    owners.\40\

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

    \39\ In contrast, if two affiliates do not have the same owners,

    the potential exists that the two affiliates may have differing

    economic interests. See also Copperweld v. Independence Tube--467

    U.S. 752 (1984) at 771 (``The coordinated activity of a parent and

    its wholly owned subsidiary must be viewed as that of a single

    enterprise for purposes of Sec. 1 of the Sherman Act. A parent and

    its wholly owned subsidiary have a complete unity of interest. Their

    objectives are common, not disparate, and their general corporate

    objectives are guided or determined not by two separate corporate

    consciousnesses, but one.'').

    \40\ Under such circumstances, the two affiliates are subject to

    common control, in actuality or potentially--i.e., the common owner

    could assert full control when one or both affiliates cease to act

    in the common owner's best interest.

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

    A person would not be able to claim 100 percent ownership for the

    purposes of this provision based on a contingent right or obligation,

    by contract or otherwise, to take ownership of the equity interest in

    the affiliate by purchase or otherwise.\41\ Conversely, structures in

    which a person owns 100 percent of the equity but has an obligation or

    right, by contract or otherwise, to give up, by sale or otherwise, all

    or a portion of that equity interest would not meet the 100 percent

    ownership test. Such contingent or residual rights evidence a less than

    complete responsibility for the affiliate, including its swap

    obligations, that the 100 percent ownership and guaranty provision is

    intended to require. Under such circumstances, the interests of the

    owner and the affiliate are not fully aligned. The second condition

    requires the existence of a common guarantor. When two affiliates share

    a common guarantor that is under the same common ownership, the

    Commission believes that the risk created by a swap with a non-

    affiliated third party is ultimately borne by the enterprise (which is

    defined by an alignment of economic interests). To provide an example,

    assume that A and B are guaranteed wholly-owned subsidiaries of X. B

    enters into a swap with non-affiliated third party T. B then enters

    into a back-to-back swap (mirroring the risk created in the swap with

    T) with A (i.e., an inter-affiliate swap). In this scenario, the risk

    associated with the swap with T is effectively borne by X and therefore

    ultimately borne by the enterprise. In such circumstances therefore the

    inter-affiliate swap does not create new risks for the enterprise,

    rather, it allocates the risk from one wholly-owned subsidiary to

    another. The posting of variation margin here would not substantially

    mitigate the risk of the inter-affiliate swap because the inter-

    affiliate swap itself does not create new risks for the enterprise.

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

    \41\ For example, if a financial entity established a trust,

    partnership, corporation or other type of entity, and sells the

    equity interests therein to investors, but retains the right to

    call, repurchase, or otherwise take control of the equity interest,

    or has a contingent obligation to call, repurchase or otherwise take

    control of the equity interest, such right or obligation would not

    be sufficient to constitute ownership of the affiliate for purposes

    of this provision.

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

    Request for Comments

    Q17a. The Commission requests comment as to whether it should

    promulgate regulations that set forth minimum standards for variation

    margin. If so, what should those standards be?

    Q17b. The Commission requests comment as to whether it should

    promulgate regulations that set forth minimum standards for initial

    margin. If so, what should those standards be?

    Q17c. The Commission requests comment as to whether it should

    promulgate regulations that set forth minimum standards for both

    initial and variation margin for inter-affiliate swaps. If so, what

    should those standards be?

    Q17d. The Commission's proposed rule ``Margin Requirements for

    Uncleared Swaps for Swap Dealers and Major Swap Participants''--17 CFR

    Part 23--would require initial and variation margin for certain swaps

    that are not cleared by a registered designated clearing organization.

    Should inter-affiliate swaps that are not subject to the clearing

    requirement of CEA section 2(h)(1)(A) be subject to the margin

    requirements as set out in proposed Part 23 or otherwise?

    Q18. The Commission requests comment on the costs and benefits of

    requiring variation margin for inter-affiliate swaps, both in general

    and specifically, regarding corporate groups that do not currently

    transfer variation margin in respect of inter-affiliate swaps.

    Q19. The Commission requests comment on whether 100% commonly-owned

    affiliates sharing a common guarantor--that is, a guarantor that is

    also 100% commonly owned--should be exempt from the requirement to

    transfer variation margin. Please explain the impact on the corporate

    group, if any, if the described affiliates are required to transfer

    variation margin.

    Q20a. Should any other categories of entities or corporate groups,

    such as non-swap dealers and non-major swap participants, be exempt

    from the variation margin requirement for their inter-affiliate swaps?

    If so, which categories and why?

    Q20b. Should the Commission limit the variation margin requirements

    to those inter-affiliate swaps for which at least one counterparty is a

    swap dealer, major swap participant, or financial entity, as defined in

    paragraph (g)(6) of the proposed rule text, that is subject to

    prudential regulation?

    Q21. The Commission requests comment as to whether it should

    eliminate the proposed exemption's variation margin condition for swaps

    between 100% owned affiliates.

    Q22. The Commission requests comment as to whether it should

    eliminate the proposed exemption's

    [[Page 50431]]

    variation margin condition for swaps between 80% owned affiliates.

    Q23. The Commission requests comment on whether all types of

    financial entities identified in CEA section 2(h)(7)(C) should be

    subject to the variation margin requirement. Should entities that are

    part of a commercial corporate group and are financial entities solely

    because of CEA section 2(h)(7)(C)(i)(VIII) be excluded from such

    requirement? Why?

    6. Proposed Sec. 39.6(g)(2)(v): Both Affiliates Must Be Located in the

    United States or in a Country With a Comparable and Comprehensive

    Clearing Regime or the Non-United States Counterparty Is Otherwise

    Required To Clear Swaps With Third Parties in Compliance With United

    States Law or Does Not Enter Into Swaps With Third Parties

    The Commission is proposing to limit the inter-affiliate clearing

    exemption to inter-affiliate swaps between two U.S.-based affiliates or

    swaps where one affiliate is located abroad in a jurisdiction with a

    comparable and comprehensive clearing regime or the non-United States

    counterparty is otherwise required to clear swaps with third parties in

    compliance with United States law or does not enter into swaps with

    third parties. The limitation in Sec. 39.6(g)(2)(v) is designed to

    address the Commission's concerns about risk and to deter evasion as

    directed by CEA section 2(h)(4)(A).

    Under section 2(h)(4)(A), the Commission must prescribe rules

    necessary to prevent evasion of the clearing requirement.\42\ The

    Commission is concerned that an inter-affiliate clearing exemption

    could enable entities to evade the clearing requirement through trades,

    for example, with affiliates that are located in foreign jurisdictions

    that do not have a comparable and comprehensive clearing regime.

    Informed in part by certain relevant intra-group transactions

    provisions under EMIR,\43\ proposed Sec. 39.6(g)(2)(v) would require

    that both affiliates be U.S. persons or one of the affiliates is a U.S.

    person and the other affiliate is domiciled in a non-U.S. jurisdiction

    with a comparable and comprehensive regulatory regime for swap clearing

    or the non-United States counterparty is otherwise required to clear

    swaps with third parties in compliance with United States Law or does

    not enter into swaps with third parties.\44\

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

    \42\ See CEA section 2(h)(4)(A), 7 U.S.C. 2(h)(4)(A).

    Additionally, CEA section 6(e)(4)-(5) states that any DCO, SD, or

    MSP may be subject to double civil monetary penalties should they

    evade the clearing requirement, among other things. The relevant CEA

    sections state, ``that knowingly or recklessly evades or

    participates in or facilitates an evasion of the requirements of

    section 2(h) shall be liable for a civil monetary penalty twice the

    amount otherwise available for a violation of section 2(h).'' See

    CEA section 6(e)(4)-(5), 7 U.S.C. 9a(4)-(5).

    \43\ See, generally, EMIR Articles 3, 4, 11, 13.

    \44\ For example, a counterparty located in a country that does

    not have a comparable clearing regime may be required to clear swaps

    with third parties in compliance with United States law if it meets

    the definition of a ``conduit'' as described in the Commission's

    proposed interpretive guidance and policy statement entitled,

    ``Cross-Border Application of Certain Swaps Provisions of the

    Commodity Exchange Act,'' 77 FR 41214, July 12, 2012.

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

    The Commission recognizes that there may be a legitimate reason for

    an inter-affiliate swap where one affiliate is located in a country

    that does not have a comparable clearing regime. However, the

    Commission believes that financial markets may be at risk if the

    foreign affiliate enters into a related third-party swap that would be

    subject to clearing were it entered into in the United States, but is

    not cleared. On balance, the Commission believes that the risk of

    evasion and the systemic risk associated with uncleared swaps

    necessitates that the exemption be limited to swaps between affiliates

    located in the United States or in foreign countries with comparable

    clearing regimes or the non-United States counterparty is otherwise

    required to clear swaps with third parties in compliance with United

    States law or does not enter into swaps with third parties.

    Request for Comments

    Q24a. The Commission requests comment on proposed Sec.

    39.6(g)(2)(v). Is the proposed condition that both affiliates must be

    located in the United States or in a country with a comparable and

    comprehensive clearing jurisdiction or the non-United States

    counterparty is otherwise required to clear swaps with third parties or

    does not enter into swaps with third parties a necessary and

    appropriate means of reducing risk and evasion concerns related to

    inter-affiliate swaps? If not, how should these concerns be addressed?

    Q24b. Should the Commission limit the inter-affiliate clearing

    exemption to foreign affiliates that only enter into inter-affiliate

    swaps if such foreign affiliates are not located in a jurisdiction with

    a comparable and comprehensive clearing requirement or are otherwise

    required to clear swaps with third parties in compliance with United

    States?

    Q24c. Should the Commission limit the inter-affiliate clearing

    exemption to foreign affiliates that enter into swaps with third

    parties on an occasional basis if such foreign affiliates are not

    located in a jurisdiction with a comparable and comprehensive clearing

    requirement or are otherwise required to clear swaps with third parties

    in compliance with United States. What would constitute an occasional

    basis? For example, would once a year be an appropriate time frame?

    Q25. The Commission requests comment on (1) the prevalence of

    cross-border inter-affiliate swaps and the mechanics of moving swap-

    related risks between U.S. and non-U.S. affiliates for risk management

    and other purposes (including an identification of such purposes); (2)

    the risk implications of cross-border inter-affiliate swaps for the

    U.S. markets; and (3) specific means to address the risk issues

    potentially presented by cross-border inter-affiliate swaps.

    Q26. The Commission recently adopted anti-evasion provisions

    relating to cross-border swap activities in its new rule 1.6.\45\ To

    what extent are the risk issues potentially presented by cross-border

    inter-affiliate swaps addressed by the anti-evasion provisions in rule

    1.6?

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

    \45\ Rule 1.6 was included in the Commission's ``Product

    Definitions'' rulemaking, which was adopted jointly with the SEC.

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

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

    Agreement Recordkeeping,'' 77 FR 39626 (July 23, 2012).

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

    Q27. The Commission also is considering an alternative condition to

    address evasion. That condition would require non-U.S. affiliates to

    clear all swap transactions with non-U.S. persons, provided that such

    transactions are related to inter-affiliate swaps which would be

    subject to a clearing requirement if entered into by two U.S.

    persons.\46\ Should the Commission adopt such a condition? Would such a

    condition help enable the Commission to ensure that the proposed inter-

    affiliate clearing exemption is not abused or used to evade the

    clearing requirement? Are there any other means to prevent evasion of

    the clearing requirement or abuse of the proposed inter-affiliate

    clearing exemption that the Commission should adopt?

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

    \46\ The Commission has proposed separately interpretative

    guidance on certain entity-level and transaction-level requirements

    imposed by Title VII of Dodd-Frank for cross-border swaps. See

    Proposed Interpretive Guidance and Policy Statement entitled,

    ``Cross-Border Application of Certain Swaps Provisions of the

    Commodity Exchange Act,'' 77 FR 41214 (July 12, 2012).

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

    7. Proposed Sec. 39.6(g)(2)(vi): Notification to the Commission

    As explained in more detail below, the Commission has preliminarily

    determined that it must receive certain

    [[Page 50432]]

    information to effectively regulate inter-affiliate swaps. Proposed

    Sec. 39.6(g)(2)(vi) would require one of the counterparties to an

    inter-affiliate swap to comply with the reporting requirements set

    forth in Sec. 39.6(g)(4.).

    8. Proposed Sec. 39.6(g)(3): Variation Margin Requirements

    Proposed Sec. 39.6(g)(3) would set forth the requirements for

    transferring variation margin. Proposed Sec. 39.6(g)(3)(i) would

    require that if both counterparties to the swap are financial entities,

    each counterparty shall pay and collect variation margin for each

    inter-affiliate swap for which the proposed exemption is elected.

    Proposed Sec. 39.6(g)(3)(ii) would require that the swap trading

    relationship document set forth and describe the methodology to be used

    to calculate variation margin with sufficient specificity to allow the

    counterparties, the Commission, and any appropriate prudential

    regulator to calculate the margin requirement independently. The

    Commission believes that the proposed rule would help ensure that

    affiliates have a written methodology. The proposed rule also would

    allow affiliates to manage their risks more effectively throughout the

    life of the swap and to avoid disputes regarding issues such as

    valuation.\47\

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    \47\ For further discussion on the concept of variation margin

    for uncleared swaps, see proposed rulemaking, ``Margin Requirements

    for Uncleared Swaps for Swap Dealers and Major Swap Participants,''

    76 FR 27621, Feb. 12, 2011.

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

    9. Proposed Sec. 39.6(g)(4): Reporting Requirements

    Pursuant to CEA section 4r,\48\ uncleared swaps must be reported to

    a Swap Data Repository (``SDR''), or to the Commission if no repository

    will accept such information, by one of the counterparties (the

    ``reporting counterparty'').\49\ In addition to any general reporting

    requirements applicable under other applicable rules to a particular

    type of entity that is an affiliate or to the inter-affiliate swap,

    proposed Sec. 39.6(g)(4) would implement reporting requirements

    specifically for uncleared inter-affiliate swaps.\50\ Proposed Sec.

    39.6(g)(4)(i) would require the reporting counterparty to affirm that

    both counterparties to the inter-affiliate swap are electing not to

    clear the swap and that both counterparties meet the requirements in

    proposed Sec. 39.6(g)(1)-(2). Besides alerting the Commission of the

    election, the information would help ensure that each counterparty is

    aware of, and satisfies the definitions and conditions set forth in

    proposed Sec. 39.6(g)(1)-(2).

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

    \48\ CEA section 4r; 7 U.S.C. 6r.

    \49\ See CEA sections 2(a)(13) (reporting of swaps to SDRs) and

    4r (reporting alternatives for uncleared swaps); 7 U.S.C. 2(a)(13)

    and 7 U.S.C. 6r.

    \50\ See ``Swap Data Recordkeeping and Reporting Requirements,''

    77 FR 2136, Jan. 13, 2012 (``Swap Data Recordkeeping and

    Reporting''). Regulation 45.11 contemplates that this information

    may be delivered to the Commission directly in limited circumstances

    when a SDR is not available. 77 FR at 2168. When permitted, such

    delivery would also meet the proposed inter-affiliate clearing

    exemption reporting requirement.

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

    Proposed Sec. 39.6(g)(4)(ii)-(iii) would require the reporting

    counterparty to provide certain information, unless such information

    had been provided in a current annual filing pursuant to proposed Sec.

    39.6(g)(5). Proposed Sec. 39.6(g)(4)(ii) would require the reporting

    counterparty to submit information regarding how the financial

    obligations of both counterparties are generally satisfied with respect

    to uncleared swaps. The information is valuable because it would

    provide the Commission a more complete view of the risk characteristics

    of uncleared swaps. The information also would enhance the Commission's

    efforts to identify and reduce potential systemic risk.

    Proposed Sec. 39.6(g)(4)(iii) would implement CEA section 2(j) for

    purposes of the inter-affiliate exemption.\51\ That CEA section places

    a prerequisite on issuers of securities registered under section 12 of

    the Securities Exchange Act of 1934 (``Exchange Act'') \52\ or required

    to file reports under Exchange Act section 15(g) \53\ (``electing SEC

    Filer'') that elect exemptions from the CEA's clearing requirement

    under section 2(h)(1)(A). CEA section 2(j) requires that an appropriate

    committee of the electing SEC Filer's board or governing body review

    and approve its decision to enter into swaps subject to the clearing

    exemption.

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

    \51\ 7 U.S.C. 2(j), in pertinent part:

    Exemptions from the requirements of subsection (h)(1) to clear a

    swap and subsection (h)(8) to execute a swap through a board of

    trade or swap execution facility shall be available to a

    counterparty that is an issuer of securities that are registered

    under section 12 of the Securities Exchange Act of 1934 (15 U.S.C.

    78l) or that is required to file reports pursuant to section 15(d)

    of the Securities Exchange Act of 1934 (15 U.S.C. 78o) only if an

    appropriate committee of the issuer's board or governing body has

    reviewed and approved its decision to enter into swaps that are

    subject to such exemptions.

    \52\ 15 U.S.C. 78l.

    \53\ 15 U.S.C. 78o.

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

    Proposed Sec. 39.6(g)(4)(iii)(A) would require an electing SEC

    Filer to notify the Commission of its SEC Filer status by submitting

    its SEC Central Index Key number. This information would enable the

    Commission to cross-reference materials filed with the relevant SDR

    with information in periodic reports and other materials filed by the

    electing SEC Filer with the U.S. Securities and Exchange Commission

    (``SEC''). In addition, proposed Sec. 39.6(g)(4)(iii)(B) would require

    the counterparty to report whether an appropriate committee of its

    board of directors (or equivalent governing body) has reviewed and

    approved the decision to enter into the inter-affiliate swaps that are

    exempt from clearing.\54\ If both affiliates/counterparties are

    electing SEC Filers, both counterparties would have to report the

    additional information in proposed Sec. 39.6(g)(4)(iii).

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

    \54\ For example, a board resolution or an amendment to a board

    committee's charter could expressly authorize such committee to

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

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

    policies and procedures to review and approve decisions not to clear

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

    to be satisfactory to the board committee.

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

    Finally, proposed Sec. 39.16(g)(5) would permit counterparties to

    provide the information listed in proposed (g)(4)(ii)-(iii) on an

    annual basis in anticipation of electing the inter-affiliate clearing

    exemption for one or more swaps. Any such reporting under this

    paragraph would be effective for inter-affiliate swaps entered into

    within 365 days following the date of such reporting. During the 365-

    day period, the affiliate would be required to amend the information as

    necessary to reflect any material changes to the reported information.

    In addition, the Commission anticipates that for most corporate groups,

    affiliates would submit identical annual reports.

    Request for Comments

    Q28. The Commission requests comment on whether affiliates would

    submit identical annual reports for most corporate groups.

    Q29a. The Commission requests comment as to whether reporting

    counterparties that would not report to an SDR should be subject to

    swap-by-swap reporting requirements? Should the Commission allow such

    entities to report all information on an annual basis? Please provide

    any information as to the number of reporting counterparties that would

    be affected by such a rule change.

    Q29b. The Commission requests comment as to whether different sized

    entities should be subject to the proposed reporting requirements or

    the reporting requirements for affiliates that elect the end-user

    exception, as applicable. If different sized entities should not be

    subject to such reporting requirements, please explain why.

    Alternatively, should the Commission

    [[Page 50433]]

    allow phased compliance for different sized entities?

    III. Consideration of Costs and Benefits

    A. Introduction

    Section 15(a) of the CEA \55\ requires the Commission to consider

    the costs and benefits of its actions before promulgating a regulation

    under the CEA or issuing certain orders. Section 15(a) further

    specifies that the costs and benefits shall be evaluated in light of

    five broad areas of market and public concern: (1) Protection of market

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

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

    risk management practices; and (5) other public interest

    considerations. The Commission considers the costs and benefits

    resulting from its discretionary determinations with respect to the

    Section 15(a) factors.

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

    \55\ 7 U.S.C. 19(a).

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

    Prior to the passage of the Dodd-Frank Act, swaps were not required

    to be cleared. In the wake of the financial crisis of 2008, Congress

    adopted the Dodd-Frank Act, which, among other things, amends the CEA

    to impose a clearing requirement for swaps.\56\ This clearing

    requirement is designed to reduce counterparty risk associated with

    swaps and, in turn, mitigate the potential systemic impact of such risk

    and reduce the risk that such swaps could cause or exacerbate

    instability in the financial system.\57\ In amending the CEA, however,

    the Dodd-Frank Act preserved the Commission's authority to ``promote

    responsible economic or financial innovation and fair competition'' by

    exempting any transaction or class of transactions, including swaps,

    from select provisions of the CEA.\58\ For reasons explained above,\59\

    the Commission proposes to exercise its authority under CEA section

    4(c)(1) to exempt inter-affiliate swaps--that is, swaps between

    majority-owned affiliates--from the Section 2(h)(1)(A) clearing

    requirement.

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

    \56\ See Section 2(h)(1) of the CEA, 7 U.S.C. 2(h)(1).

    \57\ When a bilateral swap is moved into clearing, the

    clearinghouse becomes the counterparty to each of the original

    participants in the swap. This standardizes counterparty risk for

    the original swap participants in that they each bear the same risk

    attributable to facing the clearinghouse as counterparty. In

    addition, clearing mitigates counterparty risk to the extent that

    the clearinghouse is a more creditworthy counterparty relative to

    those that each participant in the trade might have otherwise faced.

    Clearinghouses have demonstrated resilience in the face of past

    market stress. Most recently, they remained financially sound and

    effectively settled positions in the midst of turbulent events in

    2007-2008 that threatened the financial health and stability of many

    other types of entities.

    \58\ Section 4(c)(1) of the CEA, 7 U.S.C. 6(c)(1). CEA section

    4(c)(1) is discussed in greater detail above in part II.A.

    \59\ See pt.II.A.

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

    In the discussion that follows, the Commission considers the costs

    and benefits of the proposed inter-affiliate exemption to the public

    and market participants generally. The Commission also separately

    considers the costs and benefits of the conditions placed on affiliates

    that would elect the proposed exemption: (1) Swap trading relationship

    documentation, which would require affiliates to document in writing

    all terms governing the trading relationship; (2) centralized risk

    management and variation-margin requirements, which would require

    affiliates to subject the swap to centralized risk management and to

    post variation margin; and (3) reporting requirements, which would

    require counterparties to advise an SDR, or the Commission if no SDR is

    available, that both counterparties elect the inter-affiliate clearing

    exemption and to identify the types of collateral used to meet

    financial obligations. In addition to the foregoing reporting

    requirements, counterparties that are issuers of securities registered

    under Section 12 of the Securities Exchange Act of 1934 or those that

    are required to file reports under Section 15(d) of that Act, would be

    required to identify the SEC central index key number and confirm that

    an appropriate committee of board of directors has approved of the

    affiliates' decision not to clear a swap. The rule also would permit

    affiliates to report certain information on an annual basis, rather

    than swap-by-swap.

    Finally, the inter-affiliate clearing exemption would require one

    of the following four conditions be satisfied for each affiliate: The

    affiliate is located in the United States; the affiliate is located in

    a jurisdiction with a comparable and comprehensive clearing

    requirement; the affiliate is required to clear all swaps it enters

    into with non-affiliated counterparties; or the affiliate does not

    enter into swaps with non-affiliated counterparties.

    B. Proposed Baseline

    The Commission's proposed baseline for consideration of the costs

    and benefits of this proposed exemption are the costs and benefits that

    the public and market participants (including potentially eligible

    affiliates) would experience in the absence of this regulatory action.

    In other words, the proposed baseline is an alternative situation in

    which the Commission takes no action, meaning that potentially eligible

    affiliates would be required to comply with the clearing requirement.

    More specifically, under the CEA, as amended by the Dodd-Frank Act, and

    Commission regulations (finalized or future) inter-affiliate swaps will

    be subject to a clearing requirement and, depending on whether the

    affiliate is an SD, MSP, or eligible contract participant, a variety of

    record-keeping and reporting requirements. In such a scenario, the

    public and market participants, including corporate affiliates

    transacting swaps with each other, would experience the costs and

    benefits related to clearing and complying with Commission regulations

    under parts 23, 45, and 46.\60\ The proposed exemption would alter

    these costs and benefits. For example, among other things, the public

    and market participants would not experience the full benefits related

    to clearing or satisfying all the requirements under parts 23, 45, and

    46. At the same time, affiliates electing the exemption would likely

    incur lower costs for two reasons. First, the cost of variation margin

    is significantly less than the cost of clearing.\61\ Second, the costs

    of satisfying the reporting requirements under the proposed exemption

    would be less than the costs associated with satisfying all of the

    requirements under parts 23, 45, and 46.

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

    \60\ See, e.g., costs and benefits discussion in the following

    rulemakings: ``Swap Dealer and Major Swap Participant Recordkeeping,

    Reporting, and Duties Rules; Futures Commission Merchant and

    Introducing Broker Conflicts of Interest Rules; and Chief Compliance

    Officer Rules for Swap Dealers, Major Swap Participants, and Futures

    Commission Merchants,'' 77 FR 20128, 20194, Apr. 3, 2012; ``Business

    Conduct Standards for Swap Dealers and Major Swap Participants with

    Counterparties,'' 77 FR 9803, 9804, Feb. 17, 2012; ``Swap Data

    Record Keeping and Reporting Requirements,'' 77 FR 2136, 2171, Jan.

    13, 2012; ``Opting Out of Segregation,'' 66 FR 20740, 20743, Apr.

    25, 2001; ``Swap Data Recordingkeeping and Reporting Requirements:

    Pre-Enactment and Transition Swaps,'' 77 FR 35200, Jun. 12, 2012.

    \61\ The cost of clearing includes posting initial and variation

    margin.

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

    The Commission also considers the regulatory landscape as it

    existed before the Dodd-Frank Act's enactment. Entities that transacted

    inter-affiliate swaps within a corporate group were neither subject to

    a clearing requirement nor compelled to comply with regulatory

    requirements, including requirements to record and report inter-

    affiliate swaps. Thus, measured against a pre-Dodd-Frank Act reference

    point, affiliates that avail themselves of the proposed exemption would

    experience incremental costs and benefits occasioned by compliance with

    the conditions for exercising the proposed exemption.

    [[Page 50434]]

    In the discussion that follows, where reasonably feasible, the

    Commission endeavors to estimate quantifiable dollar costs. The

    benefits of the proposed exemption, as well as certain costs, however,

    are not presently susceptible to meaningful quantification. Where it is

    unable to quantify, the Commission discusses proposed costs and

    benefits in qualitative terms.

    C. Costs

    1. To Market Participants and the Public

    As discussed above, inter-affiliate swaps--though possessing a

    lesser degree of counterparty risk than swaps transacted between non-

    affiliated counterparties--are not risk-free. As evidenced in the 2008

    financial crisis, counterparty swap risk, transmitted systemically, can

    exact a heavy cost on market participants as well as the public. Thus,

    unconditionally exempting inter-affiliate swaps from the clearing

    requirement would come with a cost of increased risk that clearing is

    intended to contain. This includes the risk that the failure of one

    party to perform under the terms of a swap transaction would cause the

    counterparty to be unable to perform under the terms of swaps it had

    entered into with other counterparties, thereby causing a cascading

    series of non-performance throughout the financial system. Clearing

    both reduces this risk of non-performance and promotes confidence

    throughout the financial system that the failure of one firm will not

    lead to a systemic crisis, thereby lessening the chance of such a

    crisis or the need for the federal government to intervene to prevent

    any such failures. Accordingly, the Commission does not propose an

    unconditional, blanket exemption. Rather, the Commission proposes an

    exemption with conditions carefully tailored to offset the narrower,

    counterparty-risk profile that inter-affiliate swaps present relative

    to all swaps generally. Based on the expectation that for the subset of

    inter-affiliate swaps covered by this proposed exemption these

    conditions are capable of closely approximating the risk protections

    that clearing provides to swaps more generally, the Commission foresees

    no significant additional risk cost from the proposed exemption.

    2. To Potentially Eligible Entities

    The proposed rule is exemptive and would provide potentially

    eligible affiliates with relief from the clearing requirement and

    attendant Commission regulations. As with any exemptive rule or order,

    the proposed rule is permissive, meaning that potentially eligible

    affiliates are not required to elect it. Accordingly, the Commission

    assumes that an entity would rely on the proposed exemption only if the

    anticipated benefits warrant the costs. Here, the proposed inter-

    affiliate clearing exemption identifies three categories of conditions

    that an eligible affiliate must satisfy to elect the proposed

    exemption: documentation, risk management, and reporting. The

    Commission believes that a person would have to incur costs to satisfy

    these conditions. The Commission also believes that an affiliate would

    elect the exemption only if these costs are less than the costs that an

    affiliate would incur should it decide not to elect the exemption.

    Regarding the documentation condition, the Commission believes that

    affiliates electing the exemption (other than SDs/MSPs satisfying the

    swap documentation condition and risk-management conditions by

    satisfying the requirements of regulations 23.504 and 23.600,

    respectively) would likely incur costs to develop a standardized

    document to comply with the proposed Sec. 39.6(g)(2)(ii) requirement

    that all terms governing the trading relationship be in writing.\62\

    The Commission estimates that affiliates could pay a law firm for up to

    30 hours of work at $495 per hour to modify an ISDA master agreement,

    resulting in a one-time cost of $15,000, and there may be additional

    costs related to revising documentation to address a particular swap.

    All salaries in these calculations are taken from the 2011 SIFMA Report

    on Management and Professional Earnings in the Securities Industry.

    Annual wages were converted to hourly wages assuming 1,800 work hours

    per year and then multiplying by 5.35 to account for bonuses, firm

    size, employee benefits and overhead. Unless otherwise stated, the

    remaining wage calculations used in this proposed rule also are derived

    from this source and modified in the same manner. The Commission,

    however, is unable to estimate such costs with greater specificity

    because it is unable to estimate the frequency of, and costs associated

    with modifying a swap agreement.

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

    \62\ For a discussion of the costs and benefits incurred by swap

    dealers and major swap participants that must satisfy requirements

    under Sec. 23.504, see ``Swap Trading Relationship Documentation

    Requirements for Swap Dealers and Major Swap Participants,'' 76 FR

    6715, 6724-25, Feb. 8, 2011 (proposed rule).

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

    Affiliates also would incur costs related to signing swap documents

    and retaining copies. The Commission believes that affiliates would

    incur less than $1,000 per year for such activities. The Commission

    notes, however, that these estimates may overstate the actual costs

    because it expects that affiliates within a corporate group would be

    able to share legal-drafting and record-retention costs, as well as

    labor costs.

    The second category of conditions concerns risk management.

    Affiliates electing the proposed exemption would have to subject inter-

    affiliate swaps to centralized risk management, which would include

    variation margin.\63\ To meet the centralized-risk-management condition

    under Sec. 39.16(g)(2)(iii), some affiliates may have to create a risk

    management system.\64\ To do so, affiliates would have to purchase

    equipment and software to adequately evaluate and measure inter-

    affiliate swap risk. The Commission believes that such costs could be

    possibly as high as $150,000. For example, these costs might include

    purchasing a computer network at approximately $20,000; purchasing

    personal computers and monitors for 15 staff members at approximately

    $30,000; purchasing software at approximately $20,000; purchasing other

    office equipment, such as printers, at approximately $5,000. The total

    would amount to $75,000. There also might be installation and

    unexpected costs that could increase up-front costs to approximately

    $150,000. In addition to these start-up costs, there could be ongoing

    costs. The Commission estimates that centralized risk management could

    require up to ten full-time staff at an average salary of $150,000 per

    year.\65\ Finally, a data subscription for price and other market data

    may have to be purchased at cost of up to $100,000 per year.

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

    \63\ For a discussion of the costs and benefits incurred by swap

    dealers and major swap participants that must satisfy requirements

    under Sec. 23.600, see ``Swap Dealer and Major Swap Participant

    Recordkeeping, Reporting, and Duties Rules; Futures Commission

    Merchant and Introducing Broker Conflicts of Interest Rules; and

    Chief Compliance Officer Rules for Swap Dealers, Major Swap

    Participants, and Futures Commission Merchants,'' 77 FR 20128,

    20173-75, April 3, 2012 (final rule).

    \64\ As pointed out above, industry commenters underscored the

    fact that many corporate groups that currently use inter-affiliate

    swaps have centralized-risk-management procedures in place.

    \65\ This average annual salary is based on 15 senior credit

    risk analysts only. The Commission appreciates that an affiliate

    would likely choose to employ different positions as well, such as

    risk management specialists at $130,000 per year, and computer

    supervisors at $140,000. But for the purposes of this estimate, the

    Commission has assumed salaries at the high end for risk management

    professionals.

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

    Proposed Sec. 39.6(g)(2)(iv) would require counterparties to post

    variation margin in compliance with proposed Sec. 39.6(g)(3)'s

    documentation and other

    [[Page 50435]]

    requirements. The Commission believes that companies may have to hire

    attorneys and financial analysts to develop and document the variation

    margin methodology to comply with this rule, resulting in a one-time

    cost of $29,000 per entity electing the proposed exemption. This

    estimate assumes up to 100 hours of financial analyst time at an

    average cost of $208 per hour, and up to 20 hours of compliance

    attorney time at an average cost of $390 per hour.

    The Commission also believes that affiliates would incur certain

    costs to comply with the proposed Sec. 39.16(g)(2)(iv) condition to

    post variation margin. The Commission anticipates that affiliates would

    have to hire up to three people at an average salary of $150,000 per

    year to estimate the price of inter-affiliate swaps and to manage

    variation margin payments between affiliates. In addition, the

    Commission expects that companies would have to purchase equipment and

    software to estimate the price of inter-affiliate swaps and to

    subscribe to a data service. However, the Commission anticipates that

    such costs also would be incurred to satisfy the centralized risk

    management condition in proposed Sec. 39.6(g)(2)(iii). Finally,

    affiliates would have to incur the opportunity costs associated with

    posting collateral to cover variation margin.\66\

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

    \66\ The opportunity cost of posting collateral is the highest

    return an affiliate would have earned by investing that collateral

    instead of using it to cover variation margin under similar

    conditions.

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

    The third category of conditions involves reporting requirements.

    Proposed Sec. 39.6(g)(4) would require affiliates to report specific

    information to an SDR or to the Commission if no SDR would accept such

    information. Proposed Sec. 39.16(g)(4)(i) would require notice

    reporting on a swap-by-swap basis that two affiliates are electing the

    exemption and that they both meet the requirements in proposed Sec.

    39.6(g)(1)-(2). The Commission believes that each counterparty may

    spend 15 seconds to two minutes per swap entering a notice of election

    of the exemption into the reporting system. The hourly wage for a

    compliance attorney is $390, resulting in a per transaction cost of

    $1.63-$13.00.

    Affiliates would incur costs to satisfy the conditions that the

    reporting party (1) identify how the affiliates expect to meet the

    financial obligations associated with their uncleared swap as required

    under proposed Sec. 39.6(g)(4)(ii), and (2) provide the information

    required under proposed Sec. 39.6(g)(4)(iii) if either electing

    affiliate is an SEC Filer. Affiliates may decide to report this

    information on either a swap-by-swap or annual basis, and the costs

    would vary depending on the reporting frequency. Regarding the

    financial information in proposed Sec. 39.6(g)(4)(ii)-(iii), the

    Commission believes that it may take the reporting counterparty up to

    10 minutes to collect and submit the information for the first

    transaction, and one to five minutes to collect and submit the

    information for subsequent transactions with that same counterparty.

    The hourly wage for a compliance attorney is $390 resulting in a cost

    of $65.00 for complying with proposed Sec. 39.6(g)(4)(ii)-(iii) for

    the first inter-affiliate swap, and a cost range of $6.50-$32.50 for

    complying with proposed Sec. 39.6(g)(4)(ii)-(iii) for subsequent

    inter-affiliate swaps.

    The Commission anticipates that companies electing not to clear

    would have established reporting systems to comply with other

    Commission rules regarding swap reporting. However, all reporting

    counterparties likely would need to modify their reporting systems to

    accommodate the additional data fields required by this rule. The

    Commission estimates that those modifications would create a one-time

    programming expense of approximately one to ten burden hours per

    affiliate. The Commission estimates that the hourly wage for a senior

    programmer is $341, which means that the one-time, per entity cost for

    modifying reporting systems would likely be between $341 and $3,410.

    An affiliate that does not function as the reporting counterparty

    may need to communicate information to the reporting counterparty after

    the swap is entered. That information could include, among other

    things, whether the affiliate has filed an annual report pursuant to

    proposed Sec. 39.6(g)(5) and information to facilitate any due

    diligence that the reporting counterparty may conduct. These costs

    would likely vary substantially depending on how frequently the

    affiliate enters into swaps, whether the affiliate undertakes an annual

    filing, and the due diligence that the reporting counterparty chooses

    to conduct. The Commission estimates that a non-reporting affiliate

    would incur annually between five minutes and ten hours of compliance

    attorney time to communicate information to the reporting counterparty.

    The hourly wage for a compliance attorney is $390, translating to an

    aggregate annual cost for communicating information to the reporting

    counterparty of between $33 to $3,900.

    The Commission expects a proportion of affiliates would choose to

    file an annual report pursuant to proposed Sec. 39.6(g)(5). The annual

    filing option may be less costly than swap-by-swap reporting. The

    Commission estimates that it would take an average of 30 to 90 minutes

    to complete and submit this filing. The average hourly wage for a

    compliance attorney is $390, translating to an aggregate annual cost

    for submitting the annual report of between $195 to $585.

    The Commission anticipates that SDRs and the Commission also would

    bear costs associated with the proposed reporting conditions. SDRs

    would be required to add or edit reporting data fields to accommodate

    information reported by affiliates electing the inter-affiliate

    clearing exemption.\67\ Similarly, the Commission would need to create

    a reporting system for affiliates electing the exemption should there

    be no available SDR.

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

    \67\ See generally, ``Swap Data Recordkeeping and Reporting

    Requirements,'' 77 FR 2137 at 2176-2193, Jan. 13, 2012 (for costs

    and benefits incurred by SDRs).

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

    Finally, the rule would impose a limitation on those affiliates

    electing the inter-affiliate clearing exemption. Namely, the inter-

    affiliate clearing exemption would require one of the following four

    conditions be satisfied for each affiliate: the affiliate is located in

    the United States; the affiliate is located in a jurisdiction with a

    comparable and comprehensive clearing requirement; the affiliate is

    required to clear all swaps it enters into with non-affiliated

    counterparties; or the affiliate does not enter into swaps with non-

    affiliated counterparties. This limitation would impose no additional

    cost over not providing the exemption. However, as compared to the

    state of regulation that existed pre-Dodd-Frank Act, this condition

    would impose the costs of clearing for those inter-affiliate swaps that

    occur in countries without a clearing regime comparable to the United

    States.

    D. Benefits

    The CEA does not require the Commission to issue an exemption to

    the clearing requirement for inter-affiliate swaps. Section 4(c)(1) of

    the CEA, however, provides the Commission with authority to exempt

    certain entities and types of transactions from CEA obligations. The

    statutory section requires that the Commission consider two objectives

    when it decides to issue an exemption: (1) The promotion of responsible

    economic or financial innovation, and (2) the promotion of fair

    competition.

    The Commission believes there are benefits to exempting swaps

    between certain affiliated entities. For example,

    [[Page 50436]]

    as explained above,\68\ a number of commenters stated that clearing

    swaps through treasury or conduit affiliates enables entities to more

    efficiently and effectively manage corporate risk.

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

    \68\ See pt. I.B. for in-depth discussion of relevant comments

    regarding inter-affiliate swaps and the advantages of such treasury

    or conduit structures.

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

    The Commission also is considering the previously-discussed

    comments that an exemption is appropriate because inter-affiliate swaps

    pose reduced counterparty risk relative to swaps with third

    parties.\69\ The Commission remarks that this proposition is more

    likely to hold true provided that the terms and conditions of the swaps

    are the same. The Commission believes that inter-affiliate swap risk

    may be appropriately managed, in lieu of clearing, through the proposed

    conditions that affiliates would be required to satisfy to elect the

    proposed exemption. It has considered the benefits of each of these

    conditions. The Commission believes that the first category--

    documentation of the swap trading relationship between affiliates--

    would benefit affiliates and the overall financial system.

    Specifically, the Commission believes that requiring documentation of

    inter-affiliate swaps in a swap confirmation would help ensure that

    affiliates have proof of claim in the event of bankruptcy. As explained

    earlier, insufficient proof of claim could create challenges and

    uncertainty at bankruptcy that could adversely affect affiliates and

    third party creditors. Also, though not a documentation condition, the

    proposed exemption would require that the affiliates would be able to

    elect this exemption for their inter-affiliate swaps if one of the

    following four conditions is satisfied for each affiliate: The

    affiliate is located in the United States; the affiliate is located in

    a jurisdiction with a comparable and comprehensive clearing

    requirement; the affiliate is required to clear all swaps it enters

    into with non-affiliate counterparties; or the affiliate does not enter

    into swaps with non-affiliate counterparties. This limitation should

    help mitigate systemic risk attributable to affiliates who, subsequent

    to conducting inter-affiliate swaps, transact uncleared, market-facing

    (i.e., not inter-affiliate) swaps in a jurisdiction without a clearing

    regime comparable to the United States.

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

    \69\ See pt. II.A.

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

    The Commission recognizes that there may be a legitimate reason for

    inter-affiliate swaps where one affiliate is located in a country that

    does not have a comparable clearing regime or the non-United States

    counterparty is otherwise required to clear swaps with third parties.

    However, the Commission believes that the corporate group and financial

    markets may be at risk if the foreign affiliate is free to enter into a

    related, uncleared swap with a third party that would be subject to

    clearing were it entered into in the United States. On balance, the

    Commission believes that the risk associated with uncleared swaps

    necessitates that the proposed exemption be limited to swaps between

    affiliates located in the United States or in foreign countries with

    comparable clearing regimes or the non-United States counterparty is

    otherwise required to clear swaps with third parties or the affiliates

    do not enter into swaps with third parties.

    Centralized-risk management and variation margin are also

    beneficial conditions. The requirement that an inter-affiliate swap be

    subject to centralized-risk management is beneficial because it is

    intimately connected to the variation-margin condition. Centralized-

    risk management establishes appropriate measurements and procedures so

    that affiliates can mitigate the amount being concentrated in a single

    treasury or conduit-type affiliate. Moreover, the Commission believes

    that proper risk management benefits the public by reducing risk and

    the losses related to defaults.

    The requirement that affiliates post variation margin should

    protect both parties to a trade by ensuring that each party to the swap

    has the financial wherewithal to meet the obligations of the swap.

    Variation margin also would serve as a resource that could reduce

    losses to a counterparty when there is a default. Overall, the

    variation-margin condition would benefit each affiliate and the

    financial system, at large, by increasing the security of affiliate

    positions.

    The final category of conditions, reporting certain information

    about inter-affiliate swaps, should enhance the level of transparency

    associated with inter-affiliate swaps activity, afford the Commission

    new insights into the practices of affiliates that engage in inter-

    affiliate swaps, and help the Commission and other appropriate

    regulators identify emerging or potential risks. In short, the overall

    benefit of reporting would be a greater body of information for the

    Commission to analyze with the goal of identifying and reducing

    systemic risk.

    E. Costs and Benefits as Compared to Alternatives

    The Commission considered several alternatives to the proposed

    rulemaking. For instance, the Commission could have: (1) Chosen not to

    propose an inter-affiliate clearing exemption; (2) proposed an

    alternative definition of affiliate; or (3) decided not to place

    certain conditions on those electing the inter-affiliate clearing

    exemption. The Commission, however, has proposed what it considers a

    measured approach--in terms of the implicated costs and benefits of the

    exemption--given its current understanding of inter-affiliate swaps.

    First, the Commission considered not exempting inter-affiliate

    swaps from the clearing requirement. Without an exemption, inter-

    affiliate swaps subject to a clearing requirement would have to be

    cleared. This alternative was not favored by the Commission because the

    Commission believes that there are considerable benefits of exempting

    inter-affiliate swaps from clearing to the market, as discussed in

    detail above. In addition, while the Commission does not believe inter-

    affiliate swaps are riskless, the Commission is considering comments

    that inter-affiliate swaps pose less risk than swaps with third parties

    because of reduced counterparty risk and therefore risk-reducing

    conditions may be a satisfactory alternative to clearing for these

    swaps. Commenters in other rulemakings as discussed above recognized

    implicitly risk concerns by sharing that some corporate groups manage

    inter-affiliate risk via centralized risk management programs that

    include variation-margin calculations. Consequently, it would not be

    prudent to exempt inter-affiliate swaps categorically from the CEA's

    clearing requirement without conditions that address inter-affiliate

    swap risk.

    Second, the Commission also considered ownership requirements of

    greater than, and lesser than majority ownership.\70\ Increasing the

    ownership requirement would reduce the number of affiliates that could

    benefit from the exemption.\71\ At the same time, a higher ownership

    threshold for affiliates could help protect minority owners and reduce

    counterparty risk and risk to third parties who have entered into swaps

    that are related to inter-affiliate swaps.

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

    \70\ See pt. II.B.1 for further discussion and other requests

    for comment on this issue.

    \71\ In the Paperwork Reduction Act, the Commission points out

    that it does not possess sufficient information to estimate the

    number of affiliates, even majority-owned, that might avail

    themselves of the proposed inter-affiliate clearing exemption.

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

    Nevertheless, the Commission believes that any benefit from an

    ownership requirement of greater than majority ownership, in the form

    of reduced counterparty risk, would not be

    [[Page 50437]]

    substantial due to the risk mitigation conditions such as centralized

    risk management programs that are being proposed with majority

    ownership. The Commission welcomes comments as to the costs and

    benefits of an increased ownership requirement.

    Similarly, the Commission considered an ownership requirement of

    less than majority ownership. While a reduction in the ownership

    requirement would allow more affiliates to benefit from the exemption,

    it would also considerably increase the counterparty risk in the

    market. The Commission welcomes comments as to the costs and benefits

    of a decreased ownership requirement.

    Finally, the Commission considered not requiring each condition--

    i.e., swap trading relationship documentation; centralized risk

    management that includes variation margin; or reporting. In other

    words, the Commission could have proposed an inter-affiliate clearing

    exemption with fewer or no conditions. Because there is no indication

    at this stage that inter-affiliate swaps are riskless, the Commission

    proposed conditions. The Commission's views on the costs and benefits

    of each condition are discussed above. The Commission invites comments

    as to the costs and benefit of each condition.

    F. Consideration of CEA Section 15(a) Factors

    1. Protection of Market Participants and the Public

    In deciding to propose the inter-affiliate clearing exemption, the

    Commission assessed how to protect affiliated entities, third parties

    in the swaps market, and the public. The Commission sought to ensure

    that in the absence of a clearing requirement the risks presented by

    uncleared inter-affiliate swaps would be minimized should there be

    significant losses to one affiliate counterparty or a default of one of

    the affiliate counterparties. Toward that end, the Commission proposed

    that affiliates eligible to elect the proposed exemption must execute

    swap trading relationship documentation; post variation margin as part

    of a centralized-risk management process; and report specific

    information to an SDR, or to the Commission if no SDR would accept the

    information. As explained in this cost-benefit section, these

    conditions serve multiple objectives that ultimately protect market

    participants and the public.

    For instance, the documentation requirement would reduce

    uncertainties where affiliates incur significant swaps-related losses

    or where there is a defaulting affiliate. Because the documentation

    would be in writing, the Commission expects that there would be less

    contractual ambiguity should disagreements between affiliates arise.

    The proposed condition that an inter-affiliate swap be subject to a

    centralized risk management program reasonably designed to monitor and

    manage risk would help mitigate the risks associated with inter-

    affiliate swaps. As noted throughout this proposed rulemaking, inter-

    affiliate swap risk could adversely impact third parties who enter into

    swaps that are related to an inter-affiliate swap. In addition, if

    inter-affiliate swap risk is not carefully monitored, there could be

    greater probability that an adverse financial event could lead to

    bankruptcy, which could harm market participants and the public

    overall. Similarly, the proposed condition that affiliated

    counterparties post variation margin should help to prevent unrealized

    losses from accumulating over time and thereby reduce both the chance

    of default and the size of any default should one occur. In turn, this

    should lessen the likelihood and extent of harm to third parties that

    enter into swaps that are related to inter-affiliate swaps.

    The proposed reporting obligations would help the Commission

    monitor compliance with the proposed inter-affiliate clearing

    exemption. For example, an affiliate that also is an SEC Filer must

    receive a governing board's approval for electing the proposed

    exemption. It cannot act independently. In the Commission's opinion,

    the reporting conditions promote accountability and transparency,

    offering another public safeguard by keeping the Commission informed.

    2. Efficiency, Competitiveness, and Financial Integrity of Futures

    Markets

    Exempting swaps between majority-owned affiliates within a

    corporate group from the clearing requirement would promote efficiency

    by reducing overall clearing costs for eligible counterparties. The

    Commission is also considering comments that the proposed exemption

    would increase the efficiency and financial integrity of markets

    because it would enable corporate groups to clear swaps through their

    treasury or conduit affiliates. As explained above,\72\ commenters in

    other rulemakings have stated that clearing swaps through treasury or

    conduit affiliates enables affiliates and corporate groups to more

    efficiently and effectively manage corporate risk.

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

    \72\ See pt. I.B. for in-depth discussion of relevant comments

    regarding inter-affiliate swaps and the advantages of such treasury

    or conduit structures.

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

    Certain provisions of the proposed rule, such as the requirements

    that inter-affiliate swaps be subject to centralized risk management,

    that affiliates post variation margin, and that certain information be

    reported, also would discourage abuse of the exemption. Together, these

    conditions would promote the financial integrity of swap markets and

    financial markets as a whole.

    3. Price Discovery

    Under Commission regulation 43.2, a ``publicly reportable swap

    transaction,'' means, among other things, ``any executed swap that is

    an arm's length transaction between two parties that results in a

    corresponding change in the market risk position between the two

    parties.'' \73\ The Commission does not consider non-arms-length swaps

    as contributing to price discovery in the markets.\74\ Given that

    inter-affiliate swaps as defined in this proposed rulemaking are

    generally not arm's length transactions, the Commission does not

    anticipate the proposed inter-affiliate clearing exemption would have

    any effect on price discovery.\75\

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

    \73\ 17 CFR 43.2. See also ``Real-Time Public Reporting of Swap

    Transaction Data,'' 77 FR 1182, Jan. 9, 2012 (Real-Time Reporting).

    \74\ Transactions that fall outside the definition of ``publicly

    reportable swap transaction''--that is, they are not arms-length--

    ``do not serve the price discovery objective of CEA section

    2(a)(13)(B).'' Real-Time Reporting, 77 FR at 1195. See also Id. at

    1187 (discussion entitled ``Swaps Between Affiliates and Portfolio

    Compression Exercises'').

    \75\ The definition of ``publicly reportable swap transaction''

    identifies two examples of transactions that fall outside

    definition, including ``internal swaps between one-hundred percent

    owned subsidiaries of the same parent entity.'' 17 CFR 43.2 (adopted

    by Real-Time Reporting, 77 FR at 1244). The Commission remarks that

    the list of examples is not exhaustive.

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

    4. Sound Risk Management Practices

    As a general rule, the Commission believes that clearing swaps is a

    sound risk management practice. But, in proposing the inter-affiliate

    clearing exemption, the Commission has assessed the risks of inter-

    affiliate swaps, and proposes that it can impose alternative, sound

    risk-management practices for these particular swaps in the form of

    conditions. In other words, a prudent use of the Commission's exemptive

    authority would include proposing an exemption that requires affiliates

    to manage risks appropriately.\76\ In this case, the specific

    [[Page 50438]]

    risk-management conditions include: documentation of swap terms;

    establishment of centralized risk management, and the posting of

    variation margin. The Commission also believes that SEC Filer reporting

    is a prudent practice. As detailed in this preamble and the proposed

    rule text,\77\ SEC Filers are affiliates that meet certain SEC-related

    qualifications, and their governing boards or equivalent bodies are

    directly responsible to shareholders for the financial condition and

    performance of the affiliate. The boards also have access to

    information that would give them a comprehensive picture of the

    company's financial condition and risk management strategies.

    Therefore, any oversight they provide to the affiliate's risk

    management strategies would likely encourage sound risk management

    practices. In addition, the condition that affiliates electing the

    inter-affiliate clearing exemption must report their boards' knowledge

    of the election is a sound risk management practice.

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

    \76\ Furthermore, CEA section 8a(5) states that ``in the

    judgment of the Commission,'' it is authorized to make and

    promulgate rules ``necessary to effectuate any'' CEA provisions or

    to accomplish any CEA purpose. 7 U.S.C. 12a(5).

    \77\ See pt. II.B.9 and proposed Sec. 39.6(g)(4)(iii).

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

    5. Other Public Interest Considerations

    The Commission believes that the proposed exemptive rulemaking

    would reduce the costs of transacting swaps between majority-owned

    affiliates. At the same time, the proposed rulemaking would foster the

    financial integrity of swap markets by mandating that certain

    conditions be satisfied by affiliates electing the inter-affiliate

    clearing exemption. The Commission believes that the financial savings

    by affiliates, and, ultimately, corporate groups would serve public-

    interest considerations. For example, affiliates and corporate groups

    could use the cost-savings to provide new services or products for the

    public. They could also pass-on some or all of the cost-savings through

    prices they charge the public for their services and products.

    G. Request for Public Comment on Costs and Benefits

    Q30. The Commission invites public comment on its cost-benefit

    considerations, including the consideration of reasonable alternatives.

    Q31. If the Commission were to propose a clearing exemption limited

    to 100% owned affiliates, what costs and benefits would affect market

    participants and the public?

    Q32. If the Commission were to propose a clearing exemption with an

    ownership requirement of greater or less than majority ownership what

    costs and benefits would affect market participants and the public?

    Q33. If the Commission were to issue a proposed clearing exemption

    limited to those affiliates that file consolidated tax returns, what

    costs and benefits would affect market participants and the public?

    Q34. Do inter-affiliate swaps affect price discovery? To what

    extent would the inter-affiliate clearing exemption affect price

    discovery?

    Q35. Besides variation margin, is there a less costly risk-

    management tool that would serve the same risk-management objectives as

    variation margin?

    Q36. Besides affiliates, SDRs, and the Commission, are there any

    other entities that might bear a direct cost as a result of the

    proposed inter-affiliate clearing exemption? If so, who and to what

    extent?

    Q37. Commenters are invited to submit any data or other information

    that they may have quantifying or qualifying the costs and benefits of

    the proposal with their comment letters.

    Q38. Commenters are invited to submit any data or other information

    that they may have quantifying or qualifying start-up and on-going

    costs and benefits associated with establishing a centralized risk

    management program.

    IV. Administrative Compliance

    A. Regulatory Flexibility Act

    The Regulatory Flexibility Act (``RFA'') requires that agencies

    consider whether the proposed rules will have a significant economic

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

    regulatory flexibility analysis respecting the impact.

    Consistent with other Commission rulemakings, the proposed rules

    will not have a significant economic impact on a substantial number of

    small entities. The proposed rules would affect the electing and

    reporting parties, which could be SDs, MSPs, and Eligible Contract

    Participants (``ECPs''). The Commission has certified previously that

    neither category involves small entities for purposes of the RFA in

    other Commission rulemakings, including those implementing requirements

    of the Dodd-Frank Act.\78\ The Commission is making a similar

    determination for purposes of this proposal. Accordingly, the Chairman,

    on behalf of the Commission, 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 with respect to SDs,

    MSPs, and ECPs.

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

    \78\ For SDs and MSPs, see, e.g., ``Swap Dealer and Major Swap

    Participant Recordkeeping, Reporting, and Duties Rules; Futures

    Commission Merchant and Introducing Broker Conflicts of Interest

    Rules; and Chief Compliance Officer Rules for Swap Dealers, Major

    Swap Participants, and Futures Commission Merchants,'' 77 FR 20128,

    20194, Apr. 3, 2012 (SDs and MSPs); ``Business Conduct Standards for

    Swap Dealers and Major Swap Participants with Counterparties,'' 77

    FR 9803, 9804, Feb. 17, 2012 (SDs and MSPs); ``Policy Statement and

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

    Regulatory Flexibility Act,'' 47 FR 18618, Apr. 30, 1982 (MSPs). For

    ECPs, see, e.g., ``Commodity Options,'' 77 FR 25320, 25334, Apr. 27,

    2012; ``Swap Data Record Keeping and Reporting Requirements,'' 77 FR

    2136, 2171, Jan. 13, 2012; ``Opting Out of Segregation,'' 66 FR

    20740, 20743, Apr. 25, 2001.

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

    The proposed rules also would affect SDRs, which the Commission has

    similarly determined not to be small entities for purposes of the

    RFA.\79\ The Commission is making the same determination with respect

    to the proposed rules. Accordingly, the Chairman, on behalf of the

    Commission, hereby certifies, pursuant to 5 U.S.C. 605(b), that the

    proposed regulation would not have a significant economic impact on a

    substantial number of small entities with respect to SDRs.

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

    \79\ See Swap Data Repositories, 75 FR 80898, 80926, Dec. 23,

    2010; Registration of Swap Dealers and Major Swap Participants, 75

    FR 71379, 71385, Nov. 23, 2010.

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

    Request for Comments

    Q39. The Commission invites comments on the impact of this proposed

    regulation on small entities.

    B. Paperwork Reduction Act

    1. Overview

    The Paperwork Reduction Act (``PRA'') \80\ imposes certain

    requirements on Federal agencies in connection with their conducting or

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

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

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

    valid control number issued by the Office of Management and Budget

    (``OMB''). Certain provisions of proposed Sec. 39.6(g) would result in

    new collection of information requirements within the meaning of the

    PRA. These new reporting requirements are not currently covered by any

    existing OMB control number and OMB has not yet assigned a control

    number for this new collection. The Commission therefore is submitting

    this proposal to the OMB for review in accordance with 44 U.S.C.

    3507(g) and 5 CFR 1320.11.

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

    \80\ 44 U.S.C. 3501 et seq.

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

    [[Page 50439]]

    The title for this collection of information is ``Rule 39.6(g)

    Affiliate Transaction Uncleared Swap Notification.'' If adopted,

    responses to this collection of information would be mandatory. The

    Commission will protect proprietary information according to the

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

    and Information.'' In addition, section 8(a)(1) of the CEA strictly

    prohibits the Commission, unless specifically authorized by the CEA,

    from making public ``data and information that would separately

    disclose the business transactions or market positions of any person

    and trade secrets or names of customers.'' The Commission is also

    required to protect certain information contained in a government

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

    2. Information Provided by Reporting Entities

    Proposed Sec. 39.6(g) would set forth certain reporting conditions

    that must be satisfied for affiliates to elect the inter-affiliate

    clearing exemption. As described above, these conditions are designed

    to address Commission concerns regarding inter-affiliate swap risk and

    to provide the Commission with information necessary to regulate swaps

    markets. In particular, the reporting conditions in proposed Sec.

    39.6(g)(4) and the optional annual report set forth in proposed Sec.

    39.6(g)(5) would establish new collection of information requirements

    within the meaning of the PRA. Additionally, affiliates may be required

    to update their reporting systems for purposes of complying with the

    proposed reporting requirement, and non-reporting affiliates electing

    the proposed exemption may incur costs in transmitting information to

    their reporting counterparties.

    The Commission has estimated the time burden required for entities

    to comply with the proposed requirements.\81\ The Commission has

    estimated quantifiable costs, including one-time and annual costs per

    affiliate and costs that are incurred on a swap-by-swap basis. The

    dollar estimates are offered as ranges with upper and lower bounds,

    which is necessary to accommodate uncertainty regarding the estimates.

    The Commission notes that the most likely outcome with respect to each

    estimate is the average cost. With that in mind, the Commission has

    included tables that provide the average burden hour and average cost

    for each of the PRA requirements in the proposed exemption.

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

    \81\ See 5 CFR 1320.3(b) for the definition of the term

    ``burden.''

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

    The total cost of the inter-affiliate clearing exemption would

    depend on the number of affiliates electing the proposed exemption, as

    well as the number of inter-affiliate swaps for which affiliates would

    elect to use the proposed exemption. To identify the number of

    affiliates that could elect the proposed exemption, the Commission is

    relying upon the most recent data collected by the U.S. Bureau of

    Economic Analysis (``BEA'').\82\ The BEA has determined that there are

    2,347 U.S. multinational parent companies (``MNCs''),\83\ and 25,424

    foreign subsidiaries that are majority-owned by such MNCs.\84\ Because

    the BEA does not provide the number of majority-owned U.S.

    subsidiaries, the Commission has decided to double BEA's foreign-

    subsidiary total to identify the number of potential U.S. subsidiaries

    that might elect the proposed inter-affiliate clearing exemption. The

    result is that there are an estimated 50,848 U.S. and foreign

    subsidiaries [25,424 x 2], or approximately 22 subsidiaries per MNC

    [50,848 / 2,347], that is, 11 U.S. subsidiaries and 11 foreign

    subsidiaries. This total number of U.S. and foreign subsidiaries

    combined with the total U.S. parent companies equals 53,195 [2,347 +

    50,848] affiliates that might elect the inter-affiliate clearing

    exemption.

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

    \82\ The BEA's Web site is located at http://www.bea.gov/. BEA's

    most recent data on the number of U.S. parent companies of

    multinational corporations and their affiliates is listed in the

    ``U.S. Direct Investment Abroad: Preliminary Results from the 2009

    Benchmark Survey,'' located at http://www.bea.gov/international/usdia2009p.htm.

    \83\ See Table I.A 2., ``Selected Data for Foreign Affiliates

    and U.S. Parents in All Industries,'' located at http://www.bea.gov/international/pdf/usdia_2009p/Group%20I%20tables.pdf . The BEA

    defines a U.S. Parent of an MNC as a person that is a resident in

    the United States and owns or controls 10 percent or more of the

    voting securities, or the equivalent, of a foreign business

    enterprise. A Guide to BEA Statistics on U.S. Multinational

    Companies, located at http://www.bea.gov/scb/pdf/internat/usinvest/1995/0395iid.pdf.

    \84\ See Table II.A 1., ``Selected Data for Foreign Affiliates

    in All Countries in Which Investment Was Reported,'' located at

    http://www.bea.gov/international/pdf/usdia_2009p/Group%20II%20tables.pdf. The BEA limited foreign affiliates to those

    with total assets, sales, or net income of more than $25 million.

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

    To obtain information on the average number of inter-affiliate

    swaps, the Commission surveyed five corporations.\85\ Two corporations

    were large financial companies and the other three were manufacturing

    companies. Recognizing that most MNCs are manufacturers as opposed to

    financial companies, the Commission decided to take a weighted average

    of the sample and assumed that 95% of MNCs are manufacturers and 5% are

    financial companies. Based on this weighted average, the Commission

    estimates that affiliates enter into 2,230 inter-affiliate swaps

    annually on average.\86\

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

    \85\ The Commission is unable to provide additional information

    regarding the survey because information was submitted on a

    confidential basis.

    \86\ Due to the small sample size and data inconsistencies, this

    estimate may not provide a complete representation of the affiliate

    corporate structure or inter-affiliate swaps. For instance,

    responses were not consistent in format (quarterly figures versus

    six-month or annual figures) and also provided data for different

    time periods in 2010 or 2011. To generate its estimates, the

    Commission had to extrapolate this data by assuming that the amount

    of inter-affiliate swaps transacted during one quarter would be the

    same for the remaining three quarters of the year, or that inter-

    affiliate swap data from 2010 and 2011 are comparable and can be

    combined for averaging purposes. The Commission also notes that

    responses regarding the number of inter-affiliate swap transactions

    varied widely and a much larger sample size would be required to

    generate a more accurate estimate. The Commission requests comment

    on the typical annual inter-affiliate swap activity within corporate

    groups and the total number of affiliates that would potentially

    elect the proposed inter-affiliate clearing exemption.

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

    Using the figures above, namely 2,347 MNCs with 22 subsidiaries

    each and each affiliate transacting an average of 2,230 swaps, the

    Commission has estimated that there are approximately 64,768,399 inter-

    affiliate swaps entered into annually. To make this calculation, the

    Commission assumed that all U.S. inter-affiliate swaps and most foreign

    inter-affiliate swaps are with a single U.S. treasury/conduit

    affiliate. The Commission also assumed that 75% of treasury/conduit

    affiliates would be subsidiaries and would therefore be subject to this

    rulemaking. The remaining 25% of treasury/conduit affiliates would be

    the parent MNC and would not be the subject of this rulemaking because

    in general such swaps would qualify for the end-user exception.\87\

    Finally, the Commission assumed that 50% of the inter-affiliate swaps

    entered into by foreign affiliates would be entered into with a U.S.

    treasury/conduit affiliate while the remaining swaps would be entered

    into with foreign affiliates and would not be

    [[Page 50440]]

    subject to this rulemaking. Table A summarizes the Commission's

    estimates of the number of MNCs, subsidiaries, affiliates, and annual

    inter-affiliate swaps.

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

    \87\ As noted above, the Commission assumes that 95% of MNCs are

    commercial entities and 5% are financial companies. Based on these

    numbers, the Commission believes that most of the swaps between

    affiliates are likely to qualify for the end-user exception because

    in most cases one of the affiliates will be a manufacturer and the

    inter-affiliate swap will hedge or mitigate the commercial risk of

    that affiliate. The Commission, however, does not have information

    as to how many inter-affiliate swaps would qualify for the end-user

    exception. Accordingly, the Commission has taken a conservative

    approach and assumed that none of the inter-affiliate swaps would

    qualify for the end-user exception.

    Table A--MNC, Affiliate, and Inter-Affiliate Swap Estimates

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

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

    Number of MNCs....................................... 2,347

    Number of Subsidiaries per MNC....................... 22 \88\

    Total Number of Subsidiaries......................... 50,848

    Total Number of Affiliates Potentially Electing the 53,195

    Proposed Exemption.................................. [50,848 + 2,347]

    Estimated Number of MNCs Subject to Proposed 1,760

    Reporting Requirements.............................. [2,347 x 75%]

    Estimated Number of Reporting MNCs that Would File 1,584

    Annual Reports \89\................................. [1,760 x 90%]

    Average Annual Number of Inter-Affiliate Swaps per 2,230

    Affiliate...........................................

    Total Annual Number of Inter-Affiliate Swaps \90\.... 64,768,399

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

    Request for Comments

    Q40. As discussed above, the Commission does not have information

    as to how many inter-affiliate swaps would qualify for the end-user

    exception. The Commission invites comments on whether most inter-

    affiliate swaps would qualify for the end-user exception because one of

    the affiliates is a commercial entity and the swap hedges or mitigates

    the commercial risk of that affiliate. The Commission also requests any

    information that would help to quantify the number of inter-affiliate

    swaps or the share of inter-affiliate swaps that would qualify for the

    end-user exception.

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

    \88\ Eleven of the 22 affiliates are assumed to be U.S.

    affiliates.

    \89\ The Commission assumed that at least 90% of MNCs would

    elect to file annual reports, see further discussion below.

    \90\ The Total Annual Number of Inter-Affiliate Swaps is the

    total number of inter-affiliate swaps that MNCs, U.S. subsidiaries,

    and foreign subsidiaries entered into that would be subject to this

    rule. The total number of inter-affiliate swaps that MNC's entered

    into that would be subject to this rule is the number of MNCs

    (2,347) times the number of swaps per MNC (2,230) times 75%, or 0.75

    x 2,347 x 2,230. The total number of inter-affiliate swaps that U.S.

    subsidiaries entered into that would be subject to this rule is 10 x

    (0.75 x 2,230 x 2,347). There are 11 U.S. subsidiaries per MNC and

    each subsidiary enters into as many as swaps as each MNC, on

    average. However, 1 of the U.S. subsidiaries is the treasury/conduit

    affiliate and it enters into swaps with every other affiliate,

    including foreign affiliates. To avoid double counting, that

    subsidiary is removed from the equation and the number of U.S.

    subsidiaries is 10. Finally, the total number of inter-affiliate

    swaps that foreign subsidiaries entered into that would be subject

    to this rule is 0.5 x (11 x 0.75 x 2,230 x 2,347). Each foreign

    subsidiary enters into as many swaps as each U.S. subsidiary, but

    only 50% of foreign subsidiary swaps would be subject to this rule.

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

    a. Proposed Sec. 39.6(g)(4) Reporting Requirements

    Proposed Sec. 39.6(g)(4) would require electing entities that are

    reporting counterparties to notify the Commission each time the inter-

    affiliate clearing exemption is elected by delivering specified

    information to a registered SDR or, if no registered SDR is available,

    the Commission. Except as noted below, the notification would occur

    only once at the beginning of the swap life cycle.

    The reporting counterparty would have to report the information

    required in proposed Sec. 39.6(g)(4)(i) for each swap. It would also

    have to report the information required in proposed Sec. Sec.

    39.6(g)(4)(ii)-(iii) for each swap if no annual report had been filed.

    To comply with proposed Sec. 39.6(g)(4)(i), each reporting

    counterparty would be required to check one box indicating that both

    counterparties to the swap are electing not to clear the swap. The

    Commission expects that each reporting counterparty would likely spend

    15 seconds to two minutes per transaction entering this information

    into the reporting system. Regarding the proposed Sec. Sec.

    39.6(g)(4)(ii)-(iii) information, the Commission expects that it would

    take the reporting counterparty up to 10 minutes to collect and submit

    the information for the first transaction and one to five minutes to

    collect and submit the information for subsequent transactions with

    that same counterparty. The Commission expects a compliance attorney

    may be responsible for the collection at $390 per hour, resulting in

    the following per transaction costs to reporting counterparties: A

    range of $1.63-$13.00 for proposed Sec. 39.6(g)(4)(i); a cost of

    $65.00 for complying with proposed Sec. Sec. 39.6(g)(4)(ii)-(iii) for

    the first inter-affiliate swap; and range of $6.50-$32.50 for complying

    with proposed Sec. Sec. 39.6(g)(4)(ii)-(iii) for subsequent inter-

    affiliate swaps with the same counterparty. Table B summarizes the

    estimated average burden hours and costs per reporting entity under

    proposed Sec. 39.6(g)(4), as follows:

    Table B--Burden and Cost Estimates of Proposed Sec. 39.6(g)(4)

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

    Average burden Average cost

    Proposed regulation/requirement hours per per Total average annual Total average

    description transaction transaction burden hours annual cost

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

    Sec. 39.6(g)(4)(i)............ 0.019 hours (1.14 $7.41 1,230,600 $479,933,837

    minutes). [64,768,399 x .019] [64,768,399 x

    $7.41] \91\

    Sec. Sec. 39.6(g)(4)(ii)- First Transaction: 65.00 648 [(50,848 x 75% x $247,884 [(50,848 x

    (iii) (costs incurred if no 0.17 hours (10 10% x 0.17] 75%) x 10% x $65]

    annual report filed under Sec. minutes). \93\

    39.6(g)(5) \92\).

    Subsequent 19.50 323,651 [(64,768,399 $126,224,013

    Transactions: 0.05 - 50,848 x 75%) x [(64,768,399 -

    hours (3 minutes). 10% x .05] 50,848 x 75%) x

    10% x $19.50]\94\

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

    [[Page 50441]]

    b. Other Costs

    i. Updating Reporting Procedures

    The Commission believes that companies subject to this rule would

    have established reporting systems to comply with other Commission

    rules regarding swap reporting. However, reporting counterparties may

    need to modify their reporting systems in order to accommodate the

    additional data fields required by this rule. The Commission estimates

    that those modifications would create a one-time expense of

    approximately one to ten burden hours per reporting counterparty. The

    Commission estimates that the hourly wage for a senior programmer is

    $341, which means that the one-time, per entity cost for modifying

    reporting systems to comply with proposed Sec. 39.6(g)(4) would likely

    be between $341 and $3,410.

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

    \91\ To derive the annual burden hours and cost for this row,

    the Commission calculated the following: the average burden hours or

    cost per transaction times total number of inter-affiliate swaps

    annually.

    \92\ The Commission assumes that at least 90% of corporations

    would elect to file an annual report to supply the information

    required by proposed Sec. 39.6(g)(4)(ii)-(iii) rather than report

    the information on a swap-by-swap basis; 10% of affiliates would

    report the required information on a swap-by-swap basis.

    \93\ To derive the annual burden hours and cost for this row,

    the Commission calculated the following: (A) The total number of

    subsidiaries (see Table A) times 75% to determine the number of

    affiliates involved in a first transaction subject to reporting; (B)

    then multiplied that number--38,136--with 10% to determine the

    number of affiliates that would report swap-by-swap, i.e., 3,813.6,

    and (C) then multiplied that number by 0.16667, to obtain the

    average burden hours to report, or $65, to obtain the average cost

    to report.

    \94\ To derive the annual burden hours and cost for this row,

    the Commission calculated following: (A) The total number of

    subsequent transactions, which is the total number of transactions

    (64,768,399) minus the total number of first time transactions (0.75

    x 50,848); (B) then multiplied that number--64,730,263--by 10% to

    determine the number of affiliates that would report swap-by-swap,

    i.e., 6,473,26.3, and (C) then multiplied that number by 0.05, to

    obtain the average burden hours to report, or $19.50, to obtain the

    average cost to report.

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

    ii. Burden on Non-Reporting Affiliates

    An affiliate who does not function as the reporting counterparty

    may need to communicate information to the reporting counterparty after

    the swap is entered. That information could include, among other

    things, information to facilitate any due diligence that the reporting

    counterparty may conduct. These costs would likely vary substantially

    depending on how frequently the affiliate enters into swaps and the due

    diligence that the reporting counterparty chooses to conduct. The

    Commission estimates that a non-reporting affiliate would incur a

    burden of between five minutes and ten hours annually. The hourly wage

    for a compliance attorney is $390, which means that the aggregate

    annual cost for an electing counterparty communicating information to

    the reporting counterparty would likely be between $33 and $3,900.

    iii. Annual Reporting Under Proposed Sec. 39.6(g)(5)

    The Commission expects at least 90% of MNCs would choose to file an

    annual report pursuant to proposed Sec. 39.6(g)(5). This assumption is

    based on feedback in comment letters submitted in response to other

    proposed rulemakings, in which commenters proposed an annual reporting

    requirement in lieu of swap-by-swap reporting. Additionally, the

    Commission believes that there is an economic incentive for corporate

    groups to file an annual report because filing annually is less costly

    and operationally simpler than swap-by-swap reporting. The Commission

    estimates that it would take an average of 30 minutes to 90 minutes to

    complete and submit this filing, resulting in 0.5 to 1.5 burden hours

    per MNC that elects to file the annual report. The average hourly wage

    for a compliance attorney is $390, which means that the aggregate

    annual cost for submitting the annual report would likely be

    approximately $195 to $585. Table C summarizes the estimated average

    burden hours and costs for modifying the reporting system, for non-

    reporting affiliates to communicate information to the reporting

    counterparty after the swap is entered into, and for providing the

    annual report under proposed Sec. 39.6(g)(5), as follows:

    Table C--Other Burdens and Costs to Reporting and Non-Reporting Affiliates

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

    Average burden

    Proposed regulation/requirement hours per Average cost Total average Total average

    description affiliate per affiliate annual burden hours annual cost

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

    Modifying Reporting System (One- 5.5 hours.......... $1,875.50 9,680 [5.5 x 1,760] $3,300,880

    time cost).\95\ [$1,875.50 x

    1,760] \96\

    Burden on Non-Reporting 5.04 hours......... 1,966.25 192,205 [5.04 x $74,984,910

    Affiliates. 38,136] [$1,966.25 x

    38,136] \97\

    Sec. 39.6(g)(5) Annual Report. 1 hour............. 390.00 1,584 [(1,760 x 90%) $617,760 [$390 x

    x 1] \98\ 1,760 * 90%]

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

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

    \95\ The Commission assumes that there is only one reporting

    counterparty at each MNC.

    \96\ 1,760 represents the 75% of 2,347 MNCs that the Commission

    estimates would be reporting parties.

    \97\ 38,136 represents 75% of 50,848, the total number of

    affiliates potentially electing the proposed exemption.

    \98\ This calculation represents the total burden hours for the

    estimated 90% of MNCs--1,584.2--that would file annual reports.

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

    c. Total Burden Hours

    The Commission estimates that the proposed exemption could result

    in an average total annual burden of 1,758,369 hours and average total

    annual costs of $685,309,281.\99\ The burden and cost estimates are

    approximately 1.8 minutes and $10.48 per inter-affiliate swap. Table D

    provides the total burden hours and costs of the proposed exemption and

    breaks down the totals into burden hours and costs per MNC, per

    affiliate, and per inter-affiliate swap.

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

    \99\ These numbers are obtained by adding all of the burden

    hours or costs in Tables B and C.

    Table D--Average Annual Burden and Cost Estimates of the Proposed

    Exemption

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

    Cost of

    Burden proposed

    hours exemption

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

    Total......................................... 1,758,369 685,309,281

    Total Average Annual per MNC \100\............ 999 389,380

    [[Page 50442]]

    Total Average Annual per Affiliate \101\...... 46 17,970

    Total Average per Inter-Affiliate Swap \102\.. * 0.03 \103\ 10.58

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

    * (1.8 minutes).

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

    \100\ Total Hours or Costs divided by 1,760 MNCs, which is equal

    to 75% x 2,347.

    \101\ Total Hours or Costs divided by 38,136 affiliates, which

    is equal to 75% x 50,848.

    \102\ Total Hours or Costs per Affiliate divided by 64,768,399

    inter-affiliate swaps.

    \103\ The ``Total Average per Inter-Affiliate Swap'' of $10.58

    is less than the average transaction costs listed in Table B (i.e.,

    $65 and $19.50) for two reasons. First, $10.58 is the average cost

    for over 64 million inter-affiliate swaps. Second, the ``average

    total transaction costs'' in Table B apply only to the assumed ten

    percent (10%) of reporting counterparties that might choose to

    report swap-by-swap under Sec. Sec. 39.6(g)(4)(ii)-(iii).

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

    3. Information Collection Comments

    The Commission invites public comment on any aspect of the

    reporting burdens discussed above. Pursuant to 44 U.S.C. 3506(c)(2)(B),

    the Commission solicits comments in order to: (i) Evaluate whether the

    proposed collection of information is necessary for the proper

    performance of the functions of the Commission, including whether the

    information will have practical utility; (ii) evaluate the accuracy of

    the Commission's estimate of the burden of the proposed collection of

    information; (iii) determine whether there are ways to enhance the

    quality, utility, and clarity of the information to be collected; and

    (iv) minimize the burden of the collection of information on those who

    are to respond, including through the use of automated collection

    techniques or other forms of information technology.

    Comments may be submitted directly to the Office of Information and

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

    email at OIRAsubmissions@omb.eop.gov. Please provide the Commission

    with a copy of submitted comments so that they can be considered in

    connection with a final rule. Refer to the Addresses section of this

    release for comment submission instructions to the Commission. A copy

    of the supporting statements for the collections of information

    discussed above may be obtained by visiting www.RegInfo.gov. OMB is

    required to make a decision concerning the collection of information

    between 30 and 60 days after publication of this release in the Federal

    Register. Consequently, a comment to OMB is most assured of being fully

    effective if received by OMB (and the Commission) within 30 days after

    publication.

    V. Text of Proposed Rules

    List of Subjects in 17 CFR Part 39

    Business and industry, Clearing, Cooperatives, Reporting

    requirements, Swaps.

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

    amend 17 CFR part 39 as follows:

    PART 39--DERIVATIVES CLEARING ORGANIZATIONS

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

    follows:

    Authority: 7 U.S.C. 2, 6, 12a, and 24a, 7a-1 as amended by Pub.

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

    2. In Sec. 39.6, add paragraph (g) to read as follows:

    Sec. 39.6 Exceptions to the clearing requirement.

    * * * * *

    (g) Exemption for swaps between affiliates.

    (1) Affiliate Status. Counterparties to a swap may elect not to

    clear a swap subject to the clearing requirement of section 2(h)(1)(A)

    of the Act if one counterparty directly or indirectly holds a majority

    ownership interest in the other, or if a third party directly or

    indirectly holds a majority ownership interest in both counterparties,

    and the financial statements of both counterparties are reported on a

    consolidated basis (``eligible affiliate counterparties''). A

    counterparty or third party directly or indirectly holds a majority

    ownership interest if it directly or indirectly holds a majority of the

    equity securities of an entity, or the right to receive upon

    dissolution, or the contribution of, a majority of the capital of a

    partnership.

    (2) Conditions. Eligible affiliate counterparties to a swap may

    elect the exemption described in paragraph (g)(1) of this section if:

    (i) Both counterparties elect not to clear the swap;

    (ii)(A) A swap dealer or major swap participant that is an eligible

    affiliate counterparty to the swap satisfies the requirements of Sec.

    23.504; or (B) the swap is, if neither eligible affiliate counterparty

    is a swap dealer or major swap participant, documented in a swap

    trading relationship document that shall be in writing and shall

    include all terms governing the trading relationship between the

    affiliates, including, without limitation, payment obligations, netting

    of payments, events of default or other termination events, calculation

    and netting of obligations upon termination, transfer of rights and

    obligations, governing law, valuation, and dispute resolution

    procedures;

    (iii) The swap is subject to a centralized risk management program

    that is reasonably designed to monitor and manage the risks associated

    with the swap. If at least one of the eligible affiliate counterparties

    is a swap dealer or major swap participant, this centralized risk

    management requirement shall be satisfied by complying with the

    requirements of Sec. 23.600;

    (iv) With the exception of 100% commonly-owned and commonly-

    guaranteed affiliates where the common guarantor is also 100% commonly-

    owned, for a swap for which both counterparties are financial entities,

    as defined in paragraph (g)(6), both parties shall pay and collect

    variation margin and comply with paragraph (g)(3) of this section;

    (v) Each counterparty either:

    (A) Is located in the United States;

    (B) Is located in a jurisdiction that has a clearing requirement

    that is comparable and comprehensive to the clearing requirement in the

    United States;

    (C) Is required to clear swaps with non-affiliated parties in

    compliance with United States law; or

    (D) Does not enter into swaps with non-affiliated parties; and

    (vi) The reporting counterparty for the swap, as determined in

    accordance with Sec. 45.8 of this chapter, complies with paragraph

    (g)(4) of this section with respect to each of the counterparties.

    (3) Variation Margin. When both counterparties are financial

    entities each counterparty shall pay and collect any variation margin

    as calculated pursuant to paragraph (g)(3)(i) for each uncleared swap

    for which the exemption described in paragraph (1) is elected.

    (i) The swap trading relationship documentation required in

    paragraph (g)(2)(ii) of this section must set forth the methodology to

    be used to calculate variation margin and describe it with sufficient

    specificity to allow the counterparties, the Commission, and any

    appropriate prudential regulator to calculate the margin requirement

    independently.

    (ii) Variation margin calculations and payments shall start on the

    business day after the swap is executed and continue

    [[Page 50443]]

    each business day until the swap is terminated.

    (iii) Each counterparty shall pay the entire variation margin

    amount as calculated pursuant to paragraph (g)(3)(i) when due.

    (iv) The swap trading relationship documentation required in

    paragraph (g)(2)(ii) of this section shall specify for each

    counterparty where margin assets will be held and under what terms.

    (4) Reporting Requirements. When the exemption described in

    paragraph (g)(1) of this section is elected, the reporting counterparty

    shall provide or cause to be provided the following information to a

    registered swap data repository or, if no registered swap data

    repository is available to receive the information from the reporting

    counterparty, to the Commission, in the form and manner specified by

    the Commission:

    (i) Confirmation that both counterparties to the swap are electing

    not to clear the swap and that each of the counterparties satisfies the

    requirements in paragraphs (g)(1) and (2) of this section applicable to

    it;

    (ii) For each counterparty, how the counterparty generally meets

    its financial obligations associated with entering into non-cleared

    swaps by identifying one or more of the following categories, as

    applicable:

    (A) A written credit support agreement;

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

    margin pursuant to a credit support agreement or otherwise);

    (C) A written guarantee from another party;

    (D) The counterparty's available financial resources; or

    (E) Means other than those described in subparagraphs (A), (B), (C)

    or (D); and

    (iii) If a counterparty is an entity that is an issuer of

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

    reports under section 15(d) of, the Securities Exchange Act of 1934:

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

    counterparty; and

    (B) Acknowledgment that an appropriate committee of the board of

    directors (or equivalent body) of the counterparty has reviewed and

    approved the decision not to clear the swap.

    (5) Annual Reporting. An affiliate that qualifies for the exemption

    described in paragraph (g)(1) of this section may report the

    information listed in paragraphs (g)(4)(ii) and (iii) of this section

    annually in anticipation of electing the exemption for one or more

    swaps. Any such reporting under this paragraph will be effective for

    purposes of paragraphs (g)(4)(ii) and (iii) of this section for 365

    days following the date of such reporting. During the 365-day period,

    the affiliate shall amend the report as necessary to reflect any

    material changes to the information reported.

    Each reporting counterparty shall have a reasonable basis to

    believe that the eligible affiliate counterparties meet the

    requirements for the exemption under this Sec. 39.6(g).

    (6) Financial Entity. For purposes of this Sec. 39.6(g), the term

    ``financial entity'' shall have the meaning given such term in section

    2(h)(7)(C) of the Act.

    Issued in Washington, DC, on August 15, 2012, by the Commission.

    Sauntia Warfield,

    Assistant Secretary of the Commission.

    Appendices to Clearing Exemption for Swaps Between Certain Affiliated

    Entities--Commission Voting Summary and Statements of Commissioners

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

    Federal Regulations.

    Appendix 1--Commission Voting Summary

    On this matter, Chairman Gensler and Commissioners Chilton and

    Wetjen voted in the affirmative; Commissioner Sommers and O'Malia

    voted in the negative.

    Appendix 2--Statement of Chairman Gary Gensler

    I support the proposed rules to exempt swaps between certain

    affiliated entities within a corporate group, known as inter-

    affiliates, from the clearing requirement in the Dodd-Frank Wall

    Street Reform and Consumer Protection Act.

    One of the primary benefits of swaps market reform is that

    standard swaps between financial firms will move into central

    clearing, which will significantly lower the risks of the highly

    interconnected financial system.

    Transactions between affiliates, however, pose less risk to the

    financial system because the risks are internalized within the

    financial institution.

    The proposed rule would allow for an exemption from clearing for

    swaps between affiliates under the following limitations.

    First, the proposed exemption would be limited to swaps between

    majority-owned affiliates whose financial statements are reported on

    a consolidated basis.

    Second, the proposed rules would require centralized risk

    management, documentation of the swap agreement, payment of

    variation margin and completion of reporting requirements.

    Third, the exemption would be limited to swaps between U.S.

    affiliates and swaps between a U.S. affiliate and a foreign

    affiliate located in a jurisdiction with a comparable and

    comprehensive clearing regime.

    This approach largely aligns with the Europeans' approach to an

    exemption for inter-affiliate clearing.

    I look forward to the public's comments on this proposal.

    Appendix 2--Joint Statement of Commissioners Jill Sommers and Scott

    O'Malia

    We respectfully dissent from the notice of proposed rulemaking

    to exempt swaps between certain affiliated entities from the

    clearing requirement. While we wholly support a clearing exemption

    for swaps between affiliated entities within a corporate group, we

    cannot support the proposal before the Commission today because in

    certain instances it imposes an unnecessary requirement for

    variation margin on corporate entities that engage in inter-

    affiliate trades.

    Inter-affiliate swaps enable a corporate group to aggregate risk

    on a global basis in one entity through risk transfers between

    affiliates. Once aggregated, commercial risk of various affiliates

    is netted, thereby reducing overall commercial and financial risk.

    This practice allows for more comprehensive risk management within a

    single corporate structure.

    Another benefit to this practice is that it allows one affiliate

    to face the market and hedge the risk of various operating

    affiliates within the group. Notably, inter-affiliate swaps between

    majority owned affiliates do not create external counterparty

    exposure and therefore do not pose the systemic risks that the

    clearing requirement is designed to protect against. The practice

    actually reduces risk and simply allows for more efficient business

    management of the entire group.

    We believe it is entirely appropriate that the Commission exempt

    inter-affiliate swaps from the clearing mandate. Unfortunately, this

    proposal inserts a requirement that most financial entities engaging

    in inter-affiliate swaps post variation margin to one another. It is

    not clear that this requirement will do anything other than create

    administrative burdens and operational risk while unnecessarily

    tying up capital that could otherwise be used for investment.

    The variation margin requirement is also largely inconsistent

    with the requirements included in the European Market Infrastructure

    Regulation. As we have both made clear during the implementation

    process, we believe coordination with our global counterparts is

    critical to the success of this new framework.

    Finally, the legislative history on this issue is clear. During

    the passage of the Dodd-Frank Act many Members' statements directly

    addressed the concerns regarding inter-affiliate swaps.

    Additionally, Members of the U.S. House of Representatives passed,

    by an overwhelming bi-partisan majority, an inter-affiliate swap

    exemption that does not include a variation margin requirement.

    We believe this proposal may have the unintended consequence of

    imposing substantial costs on the economy and consumers. With this

    in mind, we welcome comments from the public as to the costs and

    benefits of the variation margin requirement and hope that we

    incorporate those views in adopting the final rule.

    [FR Doc. 2012-20508 Filed 8-20-12; 8:45 am]

    BILLING CODE P

    Last Updated: August 21, 2012