2013-12242

Federal Register, Volume 78 Issue 107 (Tuesday, June 4, 2013)[Federal Register Volume 78, Number 107 (Tuesday, June 4, 2013)]

[Rules and Regulations]

[Pages 33475-33604]

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

[FR Doc No: 2013-12242]

[[Page 33475]]

Vol. 78

Tuesday,

No. 107

June 4, 2013

Part II

Commodity Futures Trading Commission

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

17 CFR Part 37

Core Principles and Other Requirements for Swap Execution Facilities;

Final Rule

Federal Register / Vol. 78 , No. 107 / Tuesday, June 4, 2013 / Rules

and Regulations

[[Page 33476]]

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

COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 37

RIN 3038-AD18

Core Principles and Other Requirements for Swap Execution

Facilities

AGENCY: Commodity Futures Trading Commission.

ACTION: Final rule.

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

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

``CFTC'') is adopting new rules, guidance, and acceptable practices to

implement certain statutory provisions enacted by Title VII of the

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

Act''). The final rules, guidance, and acceptable practices, which

apply to the registration and operation of a new type of regulated

entity named a swap execution facility (``SEF''), implement the Dodd-

Frank Act's new statutory framework that, among other requirements,

adds a new section 5h to the Commodity Exchange Act (``CEA'' or

``Act'') concerning the registration and operation of SEFs, and adds a

new section 2(h)(8) to the CEA concerning the execution of swaps on

SEFs.

DATES: The rules will become effective August 5, 2013, with the

exception of regulation 37.3(b)(5) (17 CFR 37.3(b)(5)), which shall

become effective August 5, 2015.

Compliance date: October 2, 2013, except that: (a) From August 5,

2013 until October 2, 2014 market participants may comply with the

minimum market participant requirement in regulation 37.9(a)(3) (17 CFR

37.9(a)(3)) by transmitting a request for a quote to no less than two

market participants; and (b) each affected entity shall comply with the

warning letter requirement in regulation 37.206(f) (17 CFR 37.206(f))

no later than August 5, 2014.

FOR FURTHER INFORMATION CONTACT: Amir Zaidi, Special Counsel, 202-418-

6770, [email protected], Alexis Hall-Bugg, Special Counsel, 202-418-6711,

[email protected], or David Van Wagner, Chief Counsel, 202-418-5481,

[email protected], Division of Market Oversight; Michael Penick,

Senior Economist, 202-418-5279, [email protected], or Sayee Srinivasan,

Research Analyst, 202-418-5309, [email protected], Office of the

Chief Economist, Commodity Futures Trading Commission, Three Lafayette

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

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Background

A. Swaps and Title VII of the Dodd-Frank Act

B. SEF Notice of Proposed Rulemaking

II. Part 37 of the Commission's Regulations--Final Rules

A. Adoption of Regulations, Guidance, and Acceptable Practices

B. General Regulations (Subpart A)

1. Sec. 37.1--Scope

2. Sec. 37.2--Applicable Provisions

3. Sec. 37.3--Requirements for Registration

4. Sec. 37.4--Procedures for Listing Products and Implementing

Rules

5. Sec. 37.5--Information Relating to Swap Execution Facility

Compliance

6. Sec. 37.6--Enforceability

7. Sec. 37.7--Prohibited Use of Data Collected for Regulatory

Purposes

8. Sec. 37.8--Boards of Trade Operating Both a Designated

Contract Market and a Swap Execution Facility

9. Sec. 37.9--Permitted Execution Methods

10. Sec. 37.10--Swaps Made Available for Trading

11. Sec. 37.11--Identification of Non-Cleared Swaps or Swaps

Not Made Available To Trade

C. Regulations, Guidance, and Acceptable Practices for

Compliance With the Core Principles

1. Subpart B--Core Principle 1 (Compliance With Core Principles)

2. Subpart C--Core Principle 2 (Compliance With Rules)

(a) Sec. 37.200--Core Principle 2--Compliance With Rules

(b) Sec. 37.201--Operation of Swap Execution Facility and

Compliance With Rules

(c) Sec. 37.202--Access Requirements

(d) Sec. 37.203--Rule Enforcement Program

(e) Sec. 37.204--Regulatory Services Provided by a Third Party

(f) Sec. 37.205--Audit Trail

(g) Sec. 37.206--Disciplinary Procedures and Sanctions

(h) Sec. 37.207--Swaps Subject to Mandatory Clearing

3. Subpart D--Core Principle 3 (Swaps Not Readily Susceptible to

Manipulation)

4. Subpart E--Core Principle 4 (Monitoring of Trading and Trade

Processing)

(a) Sec. 37.401--General Requirements

(b) Sec. 37.402--Additional Requirements for Physical-Delivery

Swaps

(c) Sec. 37.403--Additional Requirements for Cash-Settled Swaps

(d) Sec. 37.404--Ability To Obtain Information

(e) Sec. 37.405--Risk Controls for Trading

(f) Sec. 37.406--Trade Reconstruction

(g) Sec. 37.407--Additional Rules Required

5. Subpart F--Core Principle 5 (Ability To Obtain Information)

(a) Sec. 37.501--Establish and Enforce Rules

(b) Sec. 37.502--Collection of Information

(c) Sec. 37.503--Provide Information to the Commission

(d) Sec. 37.504--Information-Sharing Agreements

6. Subpart G--Core Principle 6 (Position Limits or

Accountability)

7. Subpart H--Core Principle 7 (Financial Integrity of

Transactions)

(a) Sec. 37.701--Mandatory Clearing

(b) Sec. 37.702--General Financial Integrity

(c) Sec. 37.703--Monitoring for Financial Soundness

8. Subpart I--Core Principle 8 (Emergency Authority)

(a) Sec. 37.801--Additional Sources for Compliance

9. Subpart J--Core Principle 9 (Timely Publication of Trading

Information)

10. Subpart K--Core Principle 10 (Recordkeeping and Reporting)

11. Subpart L--Core Principle 11 (Antitrust Considerations)

12. Subpart M--Core Principle 12 (Conflicts of Interest)

13. Subpart N--Core Principle 13 (Financial Resources)

(a) Sec. 37.1301--General Requirements

(b) Sec. 37.1302--Types of Financial Resources

(c) Sec. 37.1303--Computation of Financial Resource Requirement

(d) Sec. 37.1304--Valuation of Financial Resources

(e) Sec. 37.1305--Liquidity of Financial Resources

(f) Sec. 37.1306--Reporting Requirements

14. Subpart O--Core Principle 14 (System Safeguards)

(a) Sec. 37.1401--Requirements

15. Subpart P--Core Principle 15 (Designation of Chief

Compliance Officer)

(a) Sec. 37.1501--Chief Compliance Officer

III. Related Matters

A. Regulatory Flexibility Act

B. Paperwork Reduction Act

C. Cost Benefit Considerations

1. Introduction

2. SEF Market Structure

3. Registration

4. Recordkeeping and Reporting

5. Compliance

6. Monitoring and Surveillance

7. Financial Resources

8. Emergency Operations and System Safeguards

IV. List of Commenters

V. Text of Final Regulations, Guidance, and Acceptable Practices

I. Background

A. Swaps and Title VII of the Dodd-Frank Act

Historically, swaps have traded in over-the-counter (``OTC'')

markets, rather than on regulated exchanges given their exemption from

regulation.\1\ The OTC swaps market is less transparent than exchange-

traded futures and securities markets. This lack of transparency was a

major contributor to the 2008 financial crisis because regulators and

market participants lacked visibility to identify and assess the

implications of swaps market exposures and counterparty

relationships.\2\ As a result, on July 21,

[[Page 33477]]

2010, President Obama signed the Dodd-Frank Act,\3\ which tasked the

Commission with overseeing a large portion of the U.S. swaps market.

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

\1\ See Commodity Futures Modernization Act of 2000, Public Law

106-554, 114 Stat. 2763 (2000).

\2\ See The Financial Crisis Inquiry Commission, The Financial

Crisis Inquiry Report: Final Report of the National Commission on

the Causes of the Financial and Economic Crisis in the United States

(Official Government Edition), at 299, 352, 363-364, 386, 621 n. 56

(2011), available at http://fcic-static.law.stanford.edu/cdn_media/fcic-reports/fcic_final_report_full.pdf. The Commission has

acknowledged, however, that the benefits of enhanced market

transparency are not boundless, particularly in swap markets with

limited liquidity. See Procedures to Establish Appropriate Minimum

Block Sizes for Large Notional Off-Facility Swaps and Block Trades,

77 FR 15460, 15466 (proposed Mar. 15, 2012). In implementing these

regulations, the Commission has taken into account the benefits and

concerns related to market transparency.

\3\ Dodd-Frank Wall Street Reform and Consumer Protection Act,

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

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

Title VII of the Dodd-Frank Act \4\ amended the CEA \5\ to

establish a comprehensive new regulatory framework for swaps and

security-based swaps (``SB-swaps''). A key goal of the Dodd-Frank Act

is to bring greater pre-trade and post-trade transparency to the swaps

market. Pre-trade transparency with respect to the swaps market refers

to making information about a swap available to the market, including

bid (offers to buy) and offer (offers to sell) prices, quantity

available at those prices, and other relevant information before the

execution of a transaction. Such transparency lowers costs for

investors, consumers, and businesses; lowers the risks of the swaps

market to the economy; and enhances market integrity to protect market

participants and the public. The Dodd-Frank Act also ensures that a

broader universe of market participants receive pricing and volume

information by providing such information upon the completion of every

swap transaction (i.e., post-trade transparency).\6\ By requiring the

trading of swaps on SEFs and designated contract markets (``DCMs''),

all market participants will benefit from viewing the prices of

available bids and offers and from having access to transparent and

competitive trading systems or platforms.

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

\4\ Pursuant to section 701 of the Dodd-Frank Act, Title VII may

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

2010.''

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

\6\ See Financial Stability Board, Implementing OTC Derivatives

Market Reforms, at 41 (Oct. 25, 2010), available at http://www.financialstabilityboard.org/publications/r_101025.pdf;

Technical Committee of the International Organization of Securities

Commissions, Transparency of Structured Finance Products Final

Report, at 17, 21 (Jul. 2010), available at http://www.iosco.org/library/pubdocs/pdf/IOSCOPD326.pdf.

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

In addition to facilitating greater transparency and trading of

swaps on SEFs, Title VII of the Dodd-Frank Act establishes a

comprehensive regulatory framework, including registration, operation,

and compliance requirements for SEFs.\7\ For example, section 733 of

the Dodd-Frank Act sets forth a broad registration provision that

requires any person who operates a facility for the trading of swaps to

register as a SEF or as a DCM.\8\ In addition, section 721 of the Dodd-

Frank Act amended the CEA to define SEF as a trading platform where

multiple participants have the ability to execute swaps by accepting

bids and offers made by multiple participants in the platform.\9\

Furthermore, section 723 of the Dodd-Frank Act set forth a trade

execution requirement, which states that swap transactions subject to

the clearing requirement must be executed on a DCM or SEF, unless no

DCM or SEF makes the swap available to trade or for swap transactions

subject to the clearing exception under CEA section 2(h)(7).\10\

Section 733 of the Dodd-Frank Act provided that to be registered and

maintain registration, a SEF must comply with fifteen enumerated core

principles and any requirement that the Commission may impose by rule

or regulation.\11\

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

\7\ See CEA section 5h, as enacted by section 733 of the Dodd-

Frank Act; 7 U.S.C. 7b-3. This regulatory framework includes: (i)

Registration, operation, and compliance requirements for SEFs and

(ii) fifteen core principles. Applicants and registered SEFs are

required to comply with the core principles as a condition of

obtaining and maintaining their registration as a SEF.

\8\ CEA section 5h(a)(1), as enacted by section 733 of the Dodd-

Frank Act; 7 U.S.C. 7b-3(a)(1).

\9\ CEA section 1a(50), as amended by section 721 of the Dodd-

Frank Act; 7 U.S.C. 1a(50).

\10\ CEA section 2(h)(8), as amended by section 723 of the Dodd-

Frank Act; 7 U.S.C. 2(h)(8).

\11\ CEA section 5h, as enacted by section 733 of the Dodd-Frank

Act; 7 U.S.C. 7b-3.

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

B. SEF Notice of Proposed Rulemaking

The Dodd-Frank Act amended the CEA to provide that, under new

section 5h, the Commission may in its discretion determine by rule or

regulation the manner in which SEFs comply with the core

principles.\12\ In consideration of both the novel nature of SEFs and

its experience in overseeing DCMs' compliance with core principles, the

Commission carefully assessed which SEF core principles would benefit

from regulations, providing legal certainty and clarity to the

marketplace, and which core principles would benefit from guidance or

acceptable practices, where flexibility is more appropriate. Based on

that evaluation, on January 7, 2011, the Commission proposed a

combination of regulations, guidance, and acceptable practices for the

registration, oversight, and regulation of SEFs (``SEF NPRM'').\13\

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

\12\ CEA section 5h(f)(1); 7 U.S.C. 7b-3(f)(1).

\13\ Core Principles and Other Requirements for Swap Execution

Facilities, 76 FR 1214 (proposed Jan. 7, 2011).

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

The SEF NPRM provided, among other requirements, the following:

(1) Procedures for temporary and full SEF registration.\14\

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

\14\ Id. at 1238.

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

(2) A minimum trading functionality requirement that all SEFs must

offer,\15\ which took into account the SEF definition,\16\ the core

principles applicable to SEFs,\17\ and the goals provided in section

733 of the Dodd-Frank Act.\18\ The minimum trading functionality

required a SEF to provide a centralized electronic trading screen upon

which any market participant can post both executable and non-

executable bids and offers that are transparent to all other market

participants of the SEF.\19\ For a trader who has the ability to

execute against its customer's order or to execute two customers'

orders against each other, the SEF NPRM also required the trader be

subject to a 15 second time delay between the entry of those two

orders.\20\ In addition, the proposal allowed a Request for Quote

(``RFQ'') System \21\ that operates in conjunction with the SEF's

minimum trading functionality.\22\ Finally, the SEF NPRM stated that a

SEF may offer other functionalities in conjunction with the minimum

trading functionality, as long as those functionalities meet the SEF

definition and comply with the core principles.\23\

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

\15\ Id. at 1241.

\16\ CEA section 1a(50); 7 U.S.C. 1a(50).

\17\ CEA section 5h(f); 7 U.S.C. 7b-3(f).

\18\ The goals of section 733 of the Dodd-Frank Act are to

promote the trading of swaps on SEFs and to promote pre-trade price

transparency in the swaps market. CEA section 5h(e); 7 U.S.C. 7b-

3(e).

\19\ Core Principles and Other Requirements for Swap Execution

Facilities, 76 FR at 1241.

\20\ Id.

\21\ Id.

\22\ By ``in conjunction with the SEF's minimum trading

functionality,'' the Commission means that the SEF NPRM required a

SEF to offer the minimum trading functionality, and if that SEF also

offered an RFQ System, it was required to communicate any bids or

offers resting on the minimum trading functionality to the RFQ

requester along with the responsive quotes. See the discussion below

regarding ``Taken Into Account and Communicated'' Language in the

RFQ System Definition under Sec. 37.9(a)(1)(ii)--Request for Quote

System in the preamble for further details.

\23\ Core Principles and Other Requirements for Swap Execution

Facilities, 76 FR at 1220.

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

(3) The classification of swap transactions into two categories:

Required Transactions (i.e., transactions subject to the trade

execution mandate under section 2(h)(8) of the CEA and not block

trades) and Permitted Transactions (i.e., transactions not

[[Page 33478]]

subject to the clearing and trade execution mandates, illiquid or

bespoke swaps, or block trades).\24\ Under the SEF NPRM, Required

Transactions were required to be executed on the minimum trading

functionality, an Order Book meeting the minimum trading functionality,

or an RFQ System (in conjunction with the minimum trading

functionality).\25\ The SEF NPRM also allowed a SEF to provide

additional methods of execution for Permitted Transactions, including

Voice-Based Systems.\26\

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

\24\ Id. at 1241.

\25\ Id.

\26\ Id.

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

(4) Regulations, guidance, and acceptable practices to implement

the 15 core principles specified in section 5h(f) of the Act.\27\

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

\27\ Id. at 1241-1253, 1256-1258.

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

The initial comment period for the SEF NPRM ended on March 8, 2011.

Subsequently, the Commission reopened the comment period until June 3,

2011, as part of its global extension of comment periods for various

rulemakings implementing the Dodd-Frank Act.\28\ After the second

comment period ended, the Commission continued to accept and consider

late comments, which it did until April 30, 2013.\29\ The Commission

received approximately 107 comment letters on the SEF NPRM from members

of the public.\30\ The Chairman and Commissioners, as well as the

Commission staff, participated in numerous meetings with

representatives of single dealer platforms, interdealer brokers, DCMs,

trade associations, OTC market participants, potential SEF applicants,

and other interested parties.\31\ In addition, the Commission consulted

with the Securities and Exchange Commission (``SEC'') and international

regulators on numerous occasions.

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

\28\ Reopening and Extension of Comment Periods for Rulemakings

Implementing the Dodd-Frank Wall Street Reform and Consumer

Protection Act, 76 FR 25274 (May 4, 2011). The Commission extended

the applicable comment periods to provide the public an additional

opportunity to comment on the proposed new regulatory framework. The

Commission also opened an additional comment period, which ended on

June 10, 2011, to provide the public an opportunity to comment on

the Commission's phased implementation of the Act, as amended,

including its implementation of section 733 of Dodd-Frank Act. Joint

Public Roundtable on Issues Related to the Schedule for Implementing

Final Rules for Swaps and Security-Based Swaps Under the Dodd-Frank

Wall Street Reform and Consumer Protection Act, 76 FR 23221 (Apr.

26, 2011).

\29\ The Commission also held two roundtables touching on issues

related to the SEF NPRM: (1) ``Available to Trade'' Provision for

Swap Execution Facilities and Designated Contract Markets; and (2)

Proposed Regulations Implementing Core Principle 9 for Designated

Contract Markets. Transcripts are available through the Commission's

Web site at http://www.cftc.gov/PressRoom/Events/2012Events/index.htm.

\30\ A list of the full names and abbreviations of commenters to

the SEF NPRM is included in section IV at the end of this release.

The Commission notes that many commenters submitted more than one

comment letter. Additionally, all comment letters that pertain to

the SEF NPRM, including those from the additional comment periods

related to implementation of the final Dodd-Frank rules, are

contained in the SEF rulemaking comment file and are available

through the Commission's Web site at http://comments.cftc.gov/PublicComments/CommentList.aspx?id=955.

\31\ Meeting summaries are available through the Commission's

Web site at http://comments.cftc.gov/PublicComments/CommentList.aspx?id=955.

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

II. Part 37 of the Commission's Regulations--Final Rules

A. Adoption of Regulations, Guidance, and Acceptable Practices

In this final rulemaking, the Commission is adopting many of the

proposed regulations that each SEF must meet in order to comply with

section 5h of the CEA, both initially upon registration and on an

ongoing basis, and related guidance, and acceptable practices. As a

result of the written comments received and dialogue and meetings with

the public, the Commission has revised or eliminated a number of

regulations that were proposed in the SEF NPRM, and in a number of

instances, has codified guidance and/or acceptable practices in lieu of

the proposed regulations. In determining the scope and content of the

final SEF regulations, the Commission has carefully considered the

costs and benefits for each rule with particular attention to the

public comments. Additionally, the Commission has taken into account

the concerns raised by commenters regarding the potential effects of

specific rules on SEFs offering different swap contracts and trading

systems or platforms and the importance of the statutory differences

between SEFs and DCMs. The Commission addresses these issues below in

its discussion of specific rule provisions.

The Commission also notes that the SEC has proposed rules related

to security-based SEFs (``SB-SEFs'') as required under section 763 of

the Dodd-Frank Act (``SB-SEF NPRM'').\32\ Section 712(a) of the Dodd-

Frank Act states that before commencing any rulemaking regarding swap

execution facilities, the Commission ``shall consult and coordinate to

the extent possible with the Securities and Exchange Commission and the

prudential regulators for the purposes of assuring regulatory

consistency and comparability . . . .'' \33\ The Commission has also

received several comments stating that the Commission and the SEC

should harmonize their rules as much as possible.\34\

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

\32\ Registration and Regulation of Security-Based Swap

Execution Facilities, 76 FR 10948 (proposed Feb. 28, 2011).

\33\ 15 U.S.C. 8302(a)(1).

\34\ Tradeweb Comment Letter at 3-4 (Jun. 3, 2011); Reuters

Comment Letter 3-4 (Mar. 8, 2011); FSR Comment Letter at 10-11 (Mar.

8, 2011); WMBAA Comment Letter at 10-11 (Mar. 8, 2011).

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

The Commission has coordinated with the SEC to harmonize the SEF

and SB-SEF requirements to the extent possible and has taken into

consideration the comments for greater harmonization between the SEF

and SB-SEF regulations. However, there may be appropriate differences

in the approach that each agency may take regarding the regulation of

SEFs and SB-SEFs. Cognizant of the different products and markets

regulated by the SEC and the Commission, the SEC recognized in its SB-

SEF NPRM that there may be differences in the approach that each agency

may take regarding the regulation of SEFs and SB-SEFs.\35\

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

\35\ Registration and Regulation of Security-Based Swap

Execution Facilities, 76 FR at 10950.

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

Similarly, the Commission is mindful that swaps may also trade on

DCMs. Thus, in addition to its efforts to coordinate its approach with

the SB-SEF regulations, the Commission also seeks, where possible, to

harmonize the final SEF regulations with the DCM regulations in order

to minimize regulatory differences between SEFs and DCMs in those

instances where Congress enacted similar core principles for the two

types of registered entities. In addition, some differences in the

agencies' regulatory oversight regimes may be attributed to the fact

that, unlike the SEC that is only responsible for overseeing trading in

SB-swaps, such as single-name securities and narrow-based security

indexes, the Commission is charged with the oversight of swaps trading

over a broad range of asset categories. Consequently, the Commission

has taken into account the varied characteristics of those underlying

commodities in formulating the regulatory responsibilities of SEFs.

In the preamble sections below, the Commission responds to the

substantive comments submitted in response to the SEF NPRM. The

Commission reviewed and considered all comments in adopting this final

rulemaking. Further, the final regulations include a number of

technical revisions and non-substantive changes to the proposed rule

text intended to clarify certain provisions, standardize terminology

[[Page 33479]]

within this part 37, conform terminology to that used in other parts of

the Commission's regulations, and more precisely state regulatory

standards and requirements. For example, a minimum trading

functionality requirement was in proposed Sec. 37.9, which has been

moved to the registration section under final Sec. 37.3 to clarify

that this functionality is required in order to register as a SEF. The

final regulations will become effective 60 days after their publication

in the Federal Register.

B. General Regulations (Subpart A)

The regulations in this final rulemaking are codified in subparts A

through P under part 37 of the Commission's regulations. The general

regulations consisting of Sec. Sec. 37.1 through 37.9 are codified in

subpart A, and the regulations applicable to each of the 15 core

principles are codified in subparts B through P, respectively.\36\

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

\36\ Subparts B through P begin with a regulation containing the

language of the core principle in the Act.

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

1. Sec. 37.1--Scope

Proposed Sec. 37.1 provided that part 37 applies to entities that

are registered SEFs, have been registered SEFs, or are applying to

become registered SEFs. The proposed rule also stated that part 37 does

not restrict the eligibility of SEFs to operate under the provisions of

parts 38 or 49 of this chapter.

(a) Commission Determination

The Commission received no comments on this section and is adopting

the provision as proposed.\37\

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

\37\ The Commission has removed the phrase ``has been

registered'' from proposed Sec. 37.1 because a SEF that has been

registered is the same as a SEF that is registered.

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

2. Sec. 37.2--Applicable Provisions

Proposed Sec. 37.2 listed the Commission regulations that, in

addition to part 37, will be applicable to SEFs, including regulations

that have been codified and are proposed to be codified upon the

Commission's finalization of the rulemakings implemented pursuant to

the Dodd-Frank Act.

(a) Commission Determination

Although it received no comments on this section, the Commission is

revising proposed Sec. 37.2 to generally state that SEFs shall comply

with, in addition to part 37, all applicable Commission regulations,

and to only cite those specific provisions whose applicability to SEFs

may not be apparent. The Commission notes that a separate rulemaking

adopted conforming changes to existing regulations to clarify the pre-

Dodd Frank provisions applicable to SEFs.\38\ There are, however,

certain existing regulations that will apply to SEFs that the separate

rulemaking did not address. Accordingly, for clarity purposes, the

Commission is specifically stating that Sec. 1.60 \39\ and part 9 \40\

of its regulations will apply to SEFs. These revisions will eliminate

the need for the Commission to continually update Sec. 37.2 when new

regulations with which SEFs must comply are codified.

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

\38\ Adaptation of Regulations to Incorporate Swaps, 77 FR 66288

(Nov. 2, 2012). The Commission may promulgate a second phase of

conforming changes to its regulations once more rules relating to

swaps are finalized.

\39\ The term ``contract market'' used in Sec. 1.60 of the

Commission's regulations should be interpreted to include a SEF for

purposes of applying the requirements of Sec. 1.60 to a SEF. 17 CFR

1.60.

\40\ The term ``exchange'' used in part 9 of the Commission's

regulations should be interpreted to include a SEF for purposes of

applying the requirements of part 9 to a SEF. 17 CFR part 9.

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

3. Sec. 37.3--Requirements for Registration \41\

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

\41\ The Commission is renaming the title of this section from

``Requirements for Registration'' to ``Requirements and Procedures

for Registration'' to provide greater clarity. The Commission is

also restructuring the order of Sec. 37.3 to provide clarity.

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

Proposed Sec. 37.3 established, among other procedures,

application procedures for temporary and full registration of new SEFs,

and procedures for the transfer of a registration. To assist

prospective SEF applicants, the SEF NPRM included under appendix A to

part 37 an application form titled Form SEF. Form SEF included

information that an applicant would be required to provide to the

Commission in order for the Commission to make a determination

regarding the applicant's request for SEF registration.

With respect to which entities must register as a SEF, the SEF NPRM

stated that in order for an entity to meet the SEF definition and

satisfy the SEF registration requirements, multiple parties must have

the ability to execute or trade swaps by accepting bids and offers made

by multiple participants.\42\ In this regard, the SEF NPRM stated that

one-to-one voice services and single dealer platforms do not satisfy

the SEF definition because multiple participants do not have the

ability to execute or trade swaps with multiple participants.\43\ In

addition, the SEF NPRM stated that entities that operate exclusively as

swap processors do not meet the SEF definition and should not be

required to register.\44\ Although the SEF NPRM stated that the

registration provision in CEA section 5h(a)(1) could be read to require

the registration of entities that solely engage in trade

processing,\45\ it stated that such entities do not meet the SEF

definition and should not be required to register as SEFs because: (1)

They do not provide the ability to execute or trade a swap as required

by the SEF definition; and (2) the SEF definition does not include the

term ``process.'' \46\

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

\42\ Core Principles and Other Requirements for Swap Execution

Facilities, 76 FR at 1219.

\43\ Id.

\44\ Id.

\45\ CEA section 5h(a)(1) states that ``[n]o person may operate

a facility for the trading or processing of swaps unless the

facility is registered as a swap execution facility or designated

contract market. . . .'' 7 U.S.C. 7b-3(a)(1).

\46\ Core Principles and Other Requirements for Swap Execution

Facilities, 76 FR at 1219.

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

The SEF NPRM also noted that CEA section 2(h)(8) requires that

transactions involving swaps subject to the clearing requirement be

executed on a DCM or SEF, unless no DCM or SEF makes such swaps

available to trade or such swaps qualify for the clearing exception

under CEA section 2(h)(7).\47\ In this regard, the SEF NPRM stated that

market participants may desire to avail themselves of the benefits of

trading on SEFs for swaps that are not subject to the CEA section

2(h)(8) trade execution requirement, but it also acknowledged that such

swaps are not required to be executed on a SEF or DCM.\48\

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

\47\ Id. at 1221-22. CEA sections 2(h)(7) and 2(h)(8); 7 U.S.C.

2(h)(7) and 2(h)(8). See discussion below under Sec. 37.10--Swaps

Made Available for Trading in the preamble for further details

regarding this process.

\48\ Id. at 1222.

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

(a) Requirements for Registration

(1) Summary of Comments

Several commenters asserted that the proposed rule is ambiguous as

to who must register as a SEF as required under CEA section 5h(a)(1)

and requested clarification.\49\ For example, UBS stated that the

Commission should clarify that ``the SEF registration requirement in

[CEA section 5h(a)(1)] only applies to platforms that meet the SEF

definition.'' \50\ In addition, Barclays

[[Page 33480]]

commented that the language of CEA section 5h(a)(1) should not be read

broadly to require SEF registration for any platform or system that

executes or processes swaps to the extent it is deemed to be a

``facility'' without considering whether such swaps are or are not

subject to the CEA section 2(h)(8) trade execution mandate.\51\

Similarly, Bloomberg noted the broad language under the CEA section

5h(a)(1) registration requirement, and stated that if Congress intended

that all swaps be traded on a SEF or DCM, then the trade execution

mandate under CEA section 2(h)(8) would be unnecessary.\52\ The

Commission also received comments and specific requests for a

Commission determination as to whether certain business models or

services must register as a SEF, including one-to-many platforms, blind

auction platforms, aggregation services or portals, portfolio

compression services, risk mitigation services, and swap processing

services.

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

\49\ CEA section 5h(a)(1) states that ``[n]o person may operate

a facility for the trading or processing of swaps unless the

facility is registered as a swap execution facility or designated

contract market. . . .'' 7 U.S.C. 7b-3(a)(1). UBS Comment Letter at

1-2 (May 18, 2012); UBS Comment Letter at 2-3 (Nov. 2, 2011);

Barclays Comment Letter at 2 (Jun. 3, 2011); Deutsche Comment Letter

at 6 (Mar. 8, 2011); Bloomberg Comment Letter at 3 (Mar. 8, 2011);

State Street Comment Letter at 3 (Mar. 8, 2011); CME Comment Letter

at 8 (Mar. 8, 2011).

\50\ UBS Comment Letter at 1 (May 18, 2012). The Commission

notes that UBS submitted 2 comment letters on May 18, 2012.

\51\ Barclays Comment Letter at 2 (Jun. 3, 2011).

\52\ Bloomberg Comment Letter at 3 (Mar. 8, 2011).

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

(i) One-to-Many Systems or Platforms

AFR opined that single dealer or one-to-many platforms do not meet

the SEF definition in CEA section 1a(50), which refers to a system in

which multiple parties have the ability to execute or trade swaps by

accepting bids or offers from multiple participants.\53\ Similarly,

IECA stated that SEFs should operate in a way that publicly reveals

market prices, and that preserving the ``one-to-one'' pricing model of

existing dealer systems is inconsistent with the SEF definition.\54\

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

\53\ AFR Comment Letter at 3-4 (Mar. 8, 2011). JP Morgan also

commented that it agrees with the Commission that a single dealer

platform cannot qualify as a SEF because it fails to satisfy the

``multiple to multiple'' language in the SEF definition. JP Morgan

Comment Letter at 3 (Mar. 8, 2011).

\54\ IECA Comment Letter at 3 (May 24, 2011).

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

(ii) Blind Auction Systems or Platforms

Nodal commented that a blind auction platform should be able to

register as a SEF.\55\ Nodal contended that its blind auction platform

meets the SEF definition because multiple participants have the ability

to execute swap transactions by accepting bids and offers made by

multiple participants albeit without the pre-trade posting of bids or

offers.\56\ Nodal explained that its platform allows participants to

submit firm bids and offers without the disclosure of the terms of

those bids and offers to other participants, and that the auction

algorithmically processes the bids and offers to match participants

efficiently.\57\ Nodal further explained that auction volume is awarded

to participants at the same price and at a price equal to or better

than the participants' auction order.\58\

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

\55\ Nodal Comment Letter at 2-3 (Jun. 3, 2011); Nodal Comment

Letter at 2-3 (Mar. 8, 2011). Nodal also expressed support for blind

auction platforms in its comment letter to the Second Amendment to

July 14, 2011 Order for Swap Regulation Notice of Proposed

Amendment, 77 FR 28819 (proposed May 16, 2012).

\56\ Nodal Comment Letter at 3 (Mar. 8, 2011).

\57\ Id.

\58\ Id. at 2.

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

(iii) Aggregation Services or Portals

UBS and Bloomberg requested clarification whether aggregator

services are required to register as SEFs.\59\ UBS stated that an

aggregator service will provide customers with the ability to access

the best available liquidity and pricing on multiple SEFs through the

aggregator's screen so that customers will not have to connect to each

SEF individually.\60\ UBS stated that an aggregator service should not

be required to register as a SEF because the transaction is executed on

the relevant SEF's platform.\61\

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

\59\ UBS Comment Letter at 1 (May 18, 2012); Meeting with UBS

dated Mar. 27, 2012; Meeting with Bloomberg dated Jan. 18, 2012. See

also UBS Comment Letter at 1 (Nov. 2, 2011).

\60\ Meeting with UBS dated Mar. 27, 2012. See also UBS Comment

Letter at 1 (Nov. 2, 2011).

\61\ Meeting with UBS dated Mar. 27, 2012.

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

(iv) Services Facilitating Portfolio Compression and Risk Mitigation

Transactions

Several commenters sought clarification that portfolio compression

and risk mitigation services are not required to register as SEFs.\62\

According to TriOptima, its portfolio compression service provides a

netting mechanism that reduces the outstanding trade count and

outstanding gross notional value of swaps in participants' portfolios

by terminating or modifying existing trades.\63\ Specifically,

TriOptima stated that prospective participants may sign up for a

scheduled compression cycle and the participants must provide detailed

data about their respective portfolios and risk tolerances.\64\ Other

than to update mark-to-market values shortly before the compression

cycle is run, prospective participants have no further input into the

compression process, which is entirely controlled by the compression

algorithm.\65\ On a specified date, TriOptima runs the compression

cycle, which produces a set of proposed transactions for each

participant.\66\ The proposed transactions, if effected, would

terminate or modify participants' existing trades in order to reduce

the outstanding trade count and outstanding gross notional value of

swaps in the participants' portfolios.\67\ Each participant receives

only details of the proposed compression transactions to which it is a

party, but all of the compression transactions must be accepted in

order for the particular compression cycle to occur.\68\ If a single

participant declines to agree to the proposed compression transactions,

then the entire compression cycle fails and the pre-compression swap

transactions remain in effect.\69\ TriOptima contended that such

services do not perform the role of a trade execution venue so they

should not be regulated as a SEF.\70\

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

\62\ Meeting with ICAP and TriOptima dated Sep. 6, 2012; Meeting

with ICAP dated Aug. 29, 2012; Meeting with ICE dated Jul. 25, 2012;

WMBAA Comment Letter at 3 (Jul. 18, 2011); ICAP Comment Letter at 2

(Jul. 7, 2011); TriOptima Comment Letter at 1 (Mar. 8, 2011).

\63\ TriOptima Comment Letter at 2, 4 (Mar. 8, 2011).

\64\ Id. at 2. The service does not place any constraints on the

number of positions or risk tolerances of prospective participants.

Id.

\65\ Id. at 3.

\66\ Id.

\67\ Id.

\68\ Id.

\69\ Id.

\70\ Id.

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

ICAP stated that its bulk risk mitigation service assists market

participants in managing their risk exposures by identifying offsetting

risk requirements and executing new offsetting trades among those

participants.\71\ Specifically, ICAP stated that its risk mitigation

service sets the curve and price for all trades based on a survey of

market making entities, such as banks, or other entities that are

willing to provide quotes, as well as price quotes on DCMs.\72\ All

prospective participants in a particular risk mitigation run are first

shown the curve and prices for transactions along the curve.\73\

Subsequently, the prospective participants provide ICAP with data about

any of their positions of their choosing and their acceptable risk

tolerances.\74\ ICAP then runs a proprietary algorithm, which produces

a set of proposed transactions for each participant.\75\ The proposed

transactions, if effected, would result in new trades for the

participants that enable them to manage their exposures to market,

credit, or other sources of

[[Page 33481]]

risk.\76\ All transactions must be accepted in order for a particular

risk mitigation run to occur.\77\ If a single participant declines to

agree to the proposed risk mitigation transactions, then the entire

risk mitigation run fails and the existing swap transactions remain in

effect.\78\ While its bulk risk mitigation services result in market

participants entering into new trades, ICAP commented that such

services do not meet the SEF definition because they do not permit

participants to trade in real-time, negotiate price, or initiate

directional trades.\79\

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

\71\ Meeting with ICAP dated Aug. 29, 2012; ICAP Comment Letter

at 1, 4 (Jul. 7, 2011).

\72\ Meeting with ICAP dated Aug. 29, 2012; ICAP Comment Letter

at 4 (Jul. 7, 2011).

\73\ Id.

\74\ Id. The service does not place any constraints on the

number of positions or risk tolerances of prospective participants.

Id.

\75\ Id.

\76\ Id.

\77\ Id.

\78\ Id.

\79\ ICAP Comment Letter at 2 (Jan. 16, 2013); ICAP Comment

Letter at 4 (Jul. 7, 2011).

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

(v) Swap Processing Services

In its first comment letter, MarkitSERV agreed with the SEF NPRM

that entities operating exclusively as swap processors should not have

to register as SEFs because they only provide post-execution services

that facilitate clearing and settlement, not services relating to the

execution of swaps.\80\ However, in a subsequent comment letter, after

the SEC's proposed rule that would require certain providers of post-

trade services to register with the SEC as clearing agencies,

MarkitSERV recommended that the Commission regulate entities that

perform the confirmation and processing of swaps.\81\ While MarkitSERV

acknowledged that the SEC's authority under the Securities and Exchange

Act of 1934 to regulate swap processors as a clearing agency has no

parallel in the CEA, MarkitSERV recommended that the Commission

register such entities to avoid unnecessarily inconsistent

regulations.\82\ MarkitSERV recommended that the Commission require

swap processors to register as a sub-category of SEFs because CEA

section 5h(a)(1) references the processing of swaps.\83\

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

\80\ MarkitSERV Comment Letter at 6 (Mar. 8, 2011).

\81\ MarkitSERV Comment Letter at 1-2 (Jun. 3, 2011).

\82\ Id. at 3-4.

\83\ Id. at 5.

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

(2) Commission Determination

In response to commenters' requests for clarification regarding the

registration requirement, the Commission is clarifying how it

interprets the broad registration provision in section 5h(a)(1) of the

Act in coordination with the specific requirements for a SEF's

structure found in section 1a(50) of the Act and the trade execution

requirement in section 2(h)(8) of the Act. As noted in the SEF NPRM,

the Commission views the CEA section 5h(a)(1) registration requirement

\84\ as applying only to facilities that meet the SEF definition in CEA

section 1a(50).\85\ Section 1a(50) of the Act defines a SEF as ``a

trading system or platform in which multiple participants have the

ability to execute or trade swaps by accepting bids and offers made by

multiple participants in the facility or system, through any means of

interstate commerce, including any trading facility, that--(A)

Facilitates the execution of swaps between persons; and (B) is not a

designated contract market.'' \86\ Accordingly, the Commission is

revising proposed Sec. 37.3 to clarify the scope of the registration

requirement, which states that ``[a]ny person operating a facility that

offers a trading system or platform in which more than one market

participant has the ability to execute or trade swaps with more than

one other market participant on the system or platform shall register

the facility as a swap execution facility under this part 37 or as a

designated contract market under part 38 of this chapter.'' \87\

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

\84\ CEA section 5h(a)(1) states that ``[n]o person may operate

a facility for the trading or processing of swaps unless the

facility is registered as a swap execution facility or as a

designated contract market. . . .'' 7 U.S.C. 7b-3(a)(1).

\85\ See Core Principles and Other Requirements for Swap

Execution Facilities, 76 FR at 1219 (explaining that entities that

operate exclusively as swap processors do not meet the SEF

definition and should not be required to register as a SEF despite

the broad language in the CEA section 5h(a)(1) registration

provision).

\86\ CEA section 1a(50); 7 U.S.C. 1a(50). The Commission notes

that the Secretary of the Treasury issued a written determination

pursuant to CEA sections 1a(47)(E) and 1b that foreign exchange

swaps and foreign exchange forwards should not be regulated as swaps

under the CEA, and therefore should be exempted from the definition

of the term ``swap'' under the CEA. See Determination of Foreign

Exchange Swaps and Foreign Exchange Forwards Under the Commodity

Exchange Act, 77 FR 69694 (Nov. 20, 2012). Accordingly, if a

facility offers a trading system or platform solely for the

execution or trading of foreign exchange swaps or foreign exchange

forwards, then the facility would not be required to register as a

SEF.

\87\ The Commission is adding this new provision to Sec.

37.3(a)(1). As a result, proposed Sec. 37.3(a) is adopted as Sec.

37.3(b), proposed Sec. 37.3(b) is adopted as Sec. 37.3(c),

proposed Sec. 37.3(c) is adopted as Sec. 37.3(d), proposed Sec.

37.3(d) is adopted as Sec. 37.3(e), proposed Sec. 37.3(e) is

adopted as Sec. 37.3(f), and proposed Sec. 37.3(f) is adopted as

Sec. 37.3(g). The SEF NPRM stated that certain entities such as

one-to-one voice services and single-dealer platforms do not provide

the ability for participants to conduct multiple-to-multiple

execution or trading because they limit the provision of liquidity

to a single liquidity provider. Core Principles and Other

Requirements for Swap Execution Facilities, 76 FR at 1219.

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

The Commission also clarifies that swap transactions that are not

subject to the CEA section 2(h)(8) trade execution requirement may be

executed on either a registered SEF (i.e., a facility that meets the

SEF definition) or an alternative entity that is not required to

register as a SEF (e.g., see one-to-many system or platform discussion

below).\88\ This clarification is consistent with the Commission's

acknowledgement in the SEF NPRM that swap transactions that are not

subject to the CEA section 2(h)(8) trade execution requirement would

not have to be executed on a registered SEF.\89\

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

\88\ The Commission notes that it is not tying the registration

requirement in CEA section 5h(a)(1) to the trade execution

requirement in CEA section 2(h)(8), such that only facilities

trading swaps subject to the trade execution requirement would be

required to register as a SEF. Therefore, a facility would be

required to register as a SEF if it operates in a manner that meets

the SEF definition even though it only executes or trades swaps that

are not subject to the trade execution mandate. The Commission also

notes that transactions involving swaps on SEFs that are subject to

the trade execution mandate are considered to be ``Required

Transactions'' under part 37 of the Commission's regulations,

whereas ``Permitted Transactions'' are transactions not involving

swaps that are subject to the trade execution mandate. As discussed

further below, the regulatory obligations which pertain to Permitted

Transactions differ from, and are somewhat less rigorous than, those

for Required Transactions. See discussion below regarding Permitted

Transactions under Sec. 37.9(a)(1)(iv)--Required Transactions and

Sec. 37.9(a)(1)(v)--Permitted Transactions in the preamble. See

also Process for a Designated Contract Market or Swap Execution

Facility To Make a Swap Available To Trade, 76 FR 77728 (proposed

Dec. 14, 2011) (discussing the process by which a swap is determined

to be subject to the trade execution requirement in CEA section

2(h)(8)).

\89\ Core Principles and Other Requirements for Swap Execution

Facilities, 76 FR at 1222.

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

The Commission believes that its interpretation of the registration

provision in CEA section 5h(a)(1) is consistent with the statute and

helps further the goals provided in CEA section 5h, which are to

promote the trading of swaps on SEFs and to promote pre-trade price

transparency in the swaps market. Although the registration provision

is written in broad language and could be read to require the

registration of any facility for the trading or processing of swaps,

the Commission notes that other statutory provisions appear to narrow

the registration requirement. For example, the CEA section 2(h)(8)

trade execution requirement and CEA section 5h(d)(2), which states that

``[f]or all swaps that are not required to be executed through a swap

execution facility . . . such trades may be executed through any other

available means of interstate commerce[,]'' \90\ when read together,

contemplate alternative entities that are not required to register as

SEFs and may execute those swaps that are not

[[Page 33482]]

required to be executed on a SEF (i.e., those swaps that are not

subject to the CEA section 2(h)(8) trade execution requirement). The

Commission is interpreting the CEA section 5h(a)(1) registration

provision in a manner that is consistent with the SEF definition in CEA

section 1a(50), the trade execution requirement in CEA section 2(h)(8),

and CEA section 5h(d)(2), as discussed above.

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

\90\ CEA section 5h(d)(2); 7 U.S.C. 7b-3(d)(2).

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

The following discussion is not intended to comprehensively cover

which entities are required to register as a SEF. Whether a particular

entity falls within the scope of CEA section 5h(a)(1) depends on all of

the relevant facts and circumstances of the entity's operations. The

Commission is mindful that any rule attempting to capture all of the

possible configurations of facilities that provide for the execution or

trading of swaps may be or become over-inclusive or under-inclusive in

light of technological changes and the ever evolving swaps market.\91\

However, in response to commenters' requests, the Commission is

providing examples of how it would interpret the CEA section 5h(a)(1)

registration requirement with respect to certain categories of better

understood facilities.

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

\91\ The Commission notes that entities seeking guidance

concerning their SEF registration obligations may request such

further guidance from the Division of Market Oversight (``DMO'').

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

(i) One-to-Many Systems or Platforms

The Commission continues to believe that a one-to-many system or

platform on which the sponsoring entity is the counterparty to all swap

contracts executed through the system or platform would not meet the

SEF definition in section 1a(50) of the Act and, therefore, would not

be required to register as a SEF under section 5h(a)(1) of the Act. In

the Commission's view, such a system or platform does not meet the SEF

definition because it limits the provision of liquidity to a single

liquidity provider (i.e., the sponsoring entity). Accordingly, market

participants do not have the ability to conduct multiple-to-multiple

execution or trading on such a trading system or platform. The

Commission notes, however, that transactions in swaps that are subject

to the trade execution mandate, under CEA section 2(h)(8), must be

executed on a DCM or SEF and, accordingly, may not be executed on a

one-to-many system or platform.\92\

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

\92\ Transactions in swaps that are subject to the clearing

requirement in CEA section 2(h)(1) and ``made available to trade''

would be subject to the trade execution requirement. See CEA

sections 2(h)(1) and 2(h)(8); 7 U.S.C. 2(h)(1) and 2(h)(8). See also

Process for a Designated Contract Market or Swap Execution Facility

To Make a Swap Available To Trade, 76 FR 77728 (proposed Dec. 14,

2011) (discussing the process by which a swap is determined to be

subject to the trade execution requirement in CEA section 2(h)(8)).

The trade execution requirement provides an exception to the

requirement for swap transactions subject to the clearing exception

under CEA section 2(h)(7).

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

(ii) Blind Auction Systems or Platforms

The Commission understands from commenters that a blind auction

system or platform, as described above, allows market participants to

submit firm bids and offers without disclosure of the terms of those

bids and offers to other participants. Such bids and offers are matched

through a pre-determined algorithm. The Commission believes that an

entity that provides such a blind auction system or platform would meet

the SEF definition in CEA section 1a(50) because more than one market

participant has the ability to execute or trade swaps with more than

one other market participant on the system or platform. Accordingly, an

entity that provides such a blind auction system or platform would have

to register as a SEF under section 5h(a)(1) of the Act.

(iii) Aggregation Services or Portals

The Commission understands that certain entities may seek to

provide their users with the ability to access multiple SEFs and the

market participants thereon, but do not provide for execution on their

aggregation services as execution occurs on one of those individual

SEFs. The Commission believes that an entity that provides such an

aggregation service would not meet the SEF definition in CEA section

1a(50) because it is only providing a portal through which its users

may access multiple SEFs and swaps are not executed or traded through

the service. Accordingly, an entity that provides such an aggregation

service or portal would not have to register as a SEF under section

5h(a)(1) of the Act.\93\ However, the Commission notes that to the

extent that an aggregation service or portal itself provides a trading

system or platform whereby more than one market participant has the

ability to execute or trade swaps with more than one other market

participant on the system or platform, the aggregation service would be

required to register as a SEF.\94\

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

\93\ The Commission notes that footnote 423 below classifies

aggregator platforms as a type of independent software vendor

(``ISV''). Therefore, other types of ISVs would not have to register

as a SEF if they only provide their users with the ability to access

multiple SEFs, but do not provide for execution or trading of swaps.

See discussion below regarding ISVs under Sec. 37.202(a)--Impartial

Access by Members and Market Participants in the preamble.

\94\ For example, some aggregation services may provide their

users with a portal to multiple SEFs and also execute swap

transactions between their multiple users. These services would have

to register as a SEF under section 5h(a)(1) of the Act. The

Commission notes that if other types of ISVs provide a system or

platform whereby more than one participant has the ability to

execute or trade swaps with more than one other participant on the

system or platform, then they would also have to register as a SEF

under section 5h(a)(1) of the Act. See discussion below regarding

ISVs under Sec. 37.202(a)--Impartial Access by Members and Market

Participants in the preamble.

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

(iv) Services Facilitating Portfolio Compression and Risk Mitigation

Transactions

The Commission notes that portfolio compression services provide a

netting mechanism that reduces the outstanding trade count and

outstanding gross notional value of swaps in two or more swap

counterparties' portfolios.\95\ To achieve this result, a portfolio

compression service, for example, may wholly terminate or change the

notional value of some or all of the swaps submitted by the

counterparties for inclusion in the portfolio compression exercise and,

depending on the methodology employed, replace the terminated swaps

with other swaps whose combined notional value (or some other measure

of risk) is less than the combined notional value (or some other

measure of risk) of the terminated swaps in the compression

exercise.\96\ The swap counterparties' risk profiles are not materially

changed as a result of the portfolio compression exercise.

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

\95\ Confirmation, Portfolio Reconciliation, Portfolio

Compression, and Swap Trading Relationship Documentation

Requirements for Swap Dealers and Major Swap Participants, 77 FR

55904, 55932 (Sep. 11, 2012).

\96\ Id. at 55960.

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

The Commission does not believe that a portfolio compression

service, as described above, provides for the execution or trading of

swap transactions between counterparties because the compression

service is providing a netting mechanism whereby the outstanding trade

count and outstanding gross notional value of swaps in two or more swap

counterparties' portfolios are reduced. Therefore, an entity providing

such a portfolio compression service would not meet the SEF definition

in section 1a(50) of the Act and would not have to register as a SEF

under section 5h(a)(1) of the Act.\97\

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

\97\ The Commission notes, however, that transactions in swaps

that are subject to the trade execution mandate, under CEA section

2(h)(8), must be executed on a DCM or SEF and, accordingly, may not

be executed on a portfolio compression service (unless no DCM or SEF

makes the swap available to trade or the swap transaction is

excepted or exempted from clearing under CEA section 2(h)(7) or as

otherwise provided by the Commission).

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

The Commission understands from commenters that certain entities

provide

[[Page 33483]]

risk mitigation services, as described above, that operate to assist

market participants in managing their exposures to market, credit, and

other sources of risk. These risk mitigation services may redistribute

or mitigate market participants' risks, but they do not provide a

netting mechanism. To redistribute or mitigate risk, a risk mitigation

service, for example, may allow market participants to identify

elements of risk in their respective portfolios and to submit

information about these risks to the service. The risk mitigation

service may set the prices for all points along the maturity or credit

curve for all trades and the service's proprietary algorithm produces a

set of proposed transactions for each participant. If all participants

accept the proposed transactions, then the new trades are executed.

In the Commission's view, such an entity would meet the SEF

definition in CEA section 1a(50) because more than one market

participant has the ability to execute swaps with more than one other

market participant on the system or platform.\98\ In response to ICAP's

comment that such services do not meet the SEF definition because they

do not permit participants to trade in real-time, negotiate price, or

initiate directional trades, the Commission notes that the SEF

definition does not require any of these stated characteristics. As

noted above, the outcome of a successful risk mitigation run is the

execution of new trades between multiple participants at prices

accepted by those multiple participants.

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

\98\ The Commission also notes that ICAP's Web sites for its

Reset and ReMatch risk mitigation services support the notion that

these services are executing trades between counterparties. ICAP's

Reset Web site states that ``[t]he new RESET matching engine allows

for unilateral matching with hedging. No longer is it necessary to

have an offsetting position for each trade to be executed.'' See

http://www.reset.net/aboutus.php. A press article regarding ReMatch

states that ``ReMatch addresses the problem of minimal or no exit

liquidity . . . [by] enabling market participants to exit positions

that they may otherwise have been unable to.'' See http://www.icap.com/news-events/in-the-news/news/2011/rematch-expands-service-into-us-financials.aspx.

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

Additionally, the Commission notes that there are alternative

avenues to managing the same risks that risk mitigation services

manage, including bringing the risk mitigating orders to the open

market. For instance, a market participant could assess the various

risk elements in its portfolio using appropriate tools, and then decide

on a set of trades to mitigate these risks. The market participant

could choose to execute these trades through a risk mitigation service,

a SEF, or a DCM. In fact, in the DCM context, market participants

execute such risk mitigating trades on the DCM and not through a

separate non-DCM service. As such, risk mitigation services are

providing an alternative avenue to execute certain swap transactions

between counterparties.

Furthermore, the Commission believes that the confluence of trading

interests from a diverse range of motivations (e.g., risk mitigating

and risk taking trades) brings depth to the marketplace and helps to

build liquid markets. If the Commission did not require these risk

mitigation services to register as SEFs, then market participants would

be able to execute certain swap transactions away from the SEF, which

would hurt liquidity and also the trading of swaps on SEFs. This would

contradict one of the goals in section 5h of the Act, which is to

promote the trading of swaps on SEFs.\99\

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

\99\ CEA section 5h(e); 7 U.S.C. 7b-3(e).

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

For the reasons mentioned above, the Commission believes that an

entity that provides such a risk mitigation service would have to

register as a SEF under section 5h(a)(1) of the Act. However, the

Commission notes that such entities may not have to register as a SEF

if they only provide the analytical services that produce the proposed

risk mitigation transactions and the execution of those transactions

occurs elsewhere and, in particular, the execution of those

transactions that are subject to the trade execution mandate occurs on

a SEF.

(v) Swap Processing Services

As noted in the SEF NPRM, entities that solely engage in trade

processing would not meet the SEF definition in CEA section 1a(50)

because they do not provide the ability to execute or trade a swap as

required by the definition. Accordingly, swap processing services would

not have to register as a SEF under CEA section 5h(a)(1). Consistent

with this distinction, the Commission declines to create a sub-category

of SEFs for processing services that would be subject to some limited

subset of SEF core principles as requested by MarkitSERV.

Finally, the Commission notes that platforms seeking guidance

concerning the SEF registration obligations and its application to

their particular operations may request informal guidance from the

Division of Market Oversight (``DMO'').

(b) Sec. 37.9(b)(2)--Minimum Trading Functionality (Final Sec.

37.3(a)(2))

To further clarify what functionalities a SEF must provide if it is

required to register as a SEF, as opposed to what functionalities

trigger the registration requirement, the Commission is moving proposed

Sec. 37.9(b)(2) to final Sec. 37.3(a)(2). As discussed in the SEF

NPRM, an entity that must register as a SEF under CEA section 5h(a)(1)

must ensure that its operations comply with the minimum trading

functionality requirement.\100\ The minimum trading functionality

requirement in proposed Sec. 37.9(b)(2) provided that an applicant

seeking registration as a SEF must, at a minimum, offer trading

services to facilitate Required Transactions by providing market

participants with the ability to post both firm and indicative quotes

on a centralized electronic screen accessible to all market

participants who have access to the SEF.

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

\100\ Core Principles and Other Requirements for Swap Execution

Facilities, 76 FR at 1219.

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

(1) Summary of Comments

Several commenters stated that the minimum trading functionality is

similar to an order book, which is not required by the SEF

definition.\101\ In this regard, Commissioner Sommers offered a dissent

to the SEF NPRM, which was published as Appendix 3 to that notice.\102\

Commissioner Sommers' dissent asserted that the minimum trading

functionality requirement is not mandated by the Dodd-Frank Act.\103\

In addition, Commissioner Sommers' dissent argued for a broader

interpretation of the terms ``trading system'' and ``platform,'' which

are included in the statutory SEF definition so that SEFs can offer a

broader model for executing swaps.\104\ Many commenters also stated

that the SEF definition only requires that the facility provide

multiple participants with the ``ability'' to execute or trade swaps by

accepting bids and offers made by ``multiple participants'' and, thus,

the definition does not require making bids or offers transparent to

the entire market but rather to multiple participants.\105\ Better

Markets commented that the Commission's minimum trading

[[Page 33484]]

functionality requirement is an overly broad interpretation of the SEF

definition because it allows a SEF to be almost any type of system or

platform.\106\ Therefore, it recommended that the Commission narrowly

interpret the multiple participant to multiple participant requirement

so that the scope of acceptable execution methods has rational

boundaries.\107\

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

\101\ Reuters Comment Letter at 3-4 (Dec. 12, 2011); Rosen et

al. Comment Letter at 8-9 (Apr. 5, 2011); WMBAA Comment Letter at 4,

9 (Mar. 8, 2011); ISDA/SIFMA Comment Letter at 5-6 (Mar. 8, 2011);

FXall Comment Letter at 4-5 (Mar. 8, 2011). Commissioner Sommers'

dissent to the SEF NPRM. See Core Principles and Other Requirements

for Swap Execution Facilities, 76 FR at 1259.

\102\ Core Principles and Other Requirements for Swap Execution

Facilities, 76 FR at 1259.

\103\ Id.

\104\ Id.

\105\ Reuters Comment Letter at 3-4 (Dec. 12, 2011); Rosen et

al. Comment Letter at 8 (Apr. 5, 2011); ISDA/SIFMA Comment Letter at

5-6 (Mar. 8, 2011); CME Comment Letter at 7-8 (Mar. 8, 2011); FXall

Comment Letter at 4-5 (Mar. 8, 2011); Barclays Comment Letter at 5

(Mar. 8, 2011); MarketAxess Comment Letter at 32-33 (Mar. 8, 2011);

WMBAA Comment Letter at 8 (Mar. 8, 2011).

\106\ Better Markets Comment Letter at 6-7 (Mar. 8, 2011).

\107\ Id.

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

Several commenters expressed concern about the requirement to post

indicative quotes.\108\ Nodal and other commenters expressed concern

that indicative quotes could be used for manipulative purposes.\109\

Tradeweb commented that, under the proposal, SEFs operating an

anonymous order book system would be required to offer indicative

quotes due to the minimum trading functionality requirement, which

would not be suitable for anonymous order book marketplaces.\110\

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

\108\ Nodal Comment Letter at 3-4 (Mar. 8, 2011); ISDA/SIFMA

Comment Letter at 6 (Mar. 8, 2011); SIFMA AMG Comment Letter at 9

(Mar. 8, 2011); ICE Comment Letter at 3 (Mar. 8, 2011); Tradeweb

Comment Letter at 6 (Mar. 8, 2011).

\109\ Nodal Comment Letter at 3-4 (Mar. 8, 2011); ISDA/SIFMA

Comment Letter at 6 (Mar. 8, 2011); SIFMA AMG Comment Letter at 9

(Mar. 8, 2011); ICE Comment Letter at 3 (Mar. 8, 2011).

\110\ Tradeweb Comment Letter at 6 (Mar. 8, 2011).

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

(2) Commission Determination

The Commission reiterates its view in the SEF NPRM that an entity

that must register as a SEF under CEA section 5h(a)(1) must ensure that

its operations comply with the minimum trading functionality

requirement.\111\ The Commission reaffirms that an acceptable SEF

system or platform must provide at least a minimum functionality to

allow market participants the ability to make executable bids and

offers, and to display them to all other market participants on the

SEF. The Commission is adopting a revised version of proposed Sec.

37.9(b)(2), which now requires a SEF to provide an Order Book as

defined in final Sec. 37.3(a)(3) (i.e., an electronic trading

facility, a trading facility, or a trading system or platform in which

all market participants have the ability to enter multiple bids and

offers, observe or receive bids and offers, and transact on such bids

and offers) because, as noted by several commenters, the proposed

minimum trading functionality description is similar to the proposed

definition of an Order Book.\112\ In response to comments, like the one

provided by Commissioner Sommers, that an order book is not required by

the SEF definition, the Commission believes that an Order Book, as

defined in final Sec. 37.3(a)(3), is consistent with the SEF

definition and promotes the goals provided in section 733 of the Dodd-

Frank Act.\113\ This interpretation is also consistent with the SEF

NPRM, as the Commission noted that it took into account these

requirements when proposing the minimum trading functionality

requirement.\114\

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

\111\ Core Principles and Other Requirements for Swap Execution

Facilities, 76 FR at 1219.

\112\ The Commission is renumbering proposed Sec. 37.9(b)(2) to

Sec. 37.3(a)(2).

\113\ CEA section 1a(50); 7 U.S.C. 1a(50). In section 5h(e) of

the Act, Congress provided a ``rule of construction'' to guide the

Commission's interpretation of certain SEF provisions (stating that

the goals of section 5h of the Act are to ``promote the trading of

swaps on [SEFs] and to promote pre-trade price transparency in the

swaps market''). 7 U.S.C. 7b-3(e).

\114\ Core Principles and Other Requirements for Swap Execution

Facilities, 76 FR at 1219.

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

The Commission notes, however, that the final regulations provide

SEFs with additional flexibility in the execution methods for Required

Transactions by allowing SEFs to offer an RFQ System in conjunction

with an Order Book, as described below, to permit market participants

to access multiple market participants, but not necessarily the entire

market.\115\ The Commission also notes that a SEF may petition the

Commission under Sec. 13.2 of the Commission's regulations to amend

its regulations to include additional execution methods for Required

Transactions.\116\ The final regulations further allow a SEF to utilize

``any means of interstate commerce'' in providing the execution methods

in Sec. 37.9(a)(2)(i)(A) or (B) (i.e., an Order Book or an RFQ System

that operates in conjunction with an Order Book, as described

below).\117\ The Commission also notes that a SEF may provide any

method of execution for Permitted Transactions.\118\ By allowing SEFs

to offer additional methods of execution, and permitting flexible means

for executing swaps through these methods of execution, as discussed

below, the Commission is effectuating the Congressional direction to

allow multiple participants to execute swaps by accepting bids and

offers made by multiple participants through any means of interstate

commerce.\119\ The Commission notes that a DCM must operate as a

trading facility and in conjunction with that trading facility is also

permitted to utilize additional execution methods; however, those

additional execution methods are limited by the requirements set forth

in DCM Core Principle 9, for which there is no identical core principle

for SEFs.

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

\115\ See discussion below under Sec. 37.9(a)(1)(ii)--Request

for Quote System in the preamble.

\116\ See discussion below under Sec. 37.9(b)(1) and (b)(4)--

Execution Methods for Required Transactions in the preamble. Section

13.2 will allow the Commission to consider if a broader model for

executing on SEFs, consistent with the suggestion in Commissioner

Sommers' dissent, would be appropriate on a case-by-case basis, in

conformance with the CEA and the Commission's regulations. Core

Principles and Other Requirements for Swap Execution Facilities, 76

FR at 1259.

\117\ See discussion below under Sec. 37.9(b)(1) and (b)(4)--

Execution Methods for Required Transactions in the preamble.

\118\ See Sec. 37.9(c)(2).

\119\ CEA section 1a(50); 7 U.S.C. 1a(50).

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

Finally, given the changes to the minimum trading functionality

requirement, the Commission notes that SEFs are not required to offer

indicative quote functionality. The Commission agrees with commenters

that indicative quotes would not be appropriate for certain trading

systems or platforms complying with the Order Book definition in final

Sec. 37.3(a)(3) (e.g., central limit order books facilitating only

anonymous trading).

(c) Sec. 37.9(a)(1)(i)--Order Book (Final Sec. 37.3(a)(3))

The Commission is also moving proposed Sec. 37.9(a)(1)(i) to final

Sec. 37.3(a)(3) given the relocation of, and changes to, the minimum

trading functionality section as discussed above. Proposed Sec.

37.9(a)(1)(i) defined the term ``Order Book'' to mean: (A) An

electronic trading facility, as that term is defined in section 1a(16)

of the Act; \120\ (B) a trading facility, as that term is defined in

section 1a(51) of the Act; \121\ (C) a trading system or platform in

which all market participants in the trading system or platform can

enter multiple bids and offers, observe bids and offers entered by

other market participants, and choose to transact on such bids and

offers; or (D) any such

[[Page 33485]]

other trading system or platform as may be determined by the

Commission.

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

\120\ The term ``electronic trading facility'' means ``a trading

facility that--(A) operates by means of an electronic or

telecommunications network; and (B) maintains an automated audit

trail of bids, offers, and the matching of orders or the execution

of transactions on the facility.'' CEA section 1a(16); 7 U.S.C.

1a(16). The Commission notes that, under section 1a(16) of the Act,

the term ``electronic trading facility'' incorporates the definition

of ``trading facility'' as that term is defined under section 1a(51)

of the Act.

\121\ The term ``trading facility'' means ``a person or group of

persons that constitutes, maintains, or provides a physical or

electronic facility or system in which multiple participants have

the ability to execute or trade agreements, contracts, or

transactions--(i) by accepting bids or offers made by other

participants that are open to multiple participants in the facility

or system; or (ii) through the interaction of multiple bids or

multiple offers within a system with a pre-determined non-

discretionary automated trade matching and execution algorithm.''

CEA section 1a(51)(A); 7 U.S.C. 1a(51)(A).

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

(1) Summary of Comments

Better Markets commented that the definition of an ``order book''

should specify that SEF systems must operate pursuant to a best price,

first-in-time trade matching algorithm.\122\

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

\122\ Better Markets Comment Letter at 7 (Mar. 8, 2011).

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

(2) Commission Determination

The Commission is adopting the rule as proposed, subject to the

modification described below.\123\ The Commission notes that the Dodd-

Frank Act does not mandate that the Commission specify or require a

particular trade-matching algorithm for modes of execution provided by

SEFs. Therefore, a SEF has the discretion to use a matching algorithm

such as a price-time, price-size-time, or pro-rata allocation,

provided, however, that such matching algorithm is published in the

SEF's rulebook and submitted to the Commission for review and approval

as part of the registration application. The Commission is eliminating

proposed Sec. 37.9(a)(1)(i)(D) because, as discussed in Sec. 37.9

below, a SEF may petition the Commission under Sec. 13.2 to amend

Sec. 37.9(a)(2) to include additional execution methods for Required

Transactions.\124\

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

\123\ The Commission is renumbering proposed Sec. 37.9(a)(1)(i)

to Sec. 37.3(a)(3). The Commission is revising the definition in

proposed Sec. 37.9(a)(1)(i)(C) by replacing the word ``can'' with

the phrase ``have the ability to'' and deleting the words ``choose

to.'' The Commission is also adding the words ``or receive'' after

the word ``observe'' so that the definition is technology neutral.

See ``Through Any Means of Interstate Commerce'' Language in the SEF

Definition discussion below under Sec. Sec. 37.9(b)(1) and (b)(4)--

Execution Methods for Required Transactions in the preamble for

further details.

\124\ See discussion below under Sec. 37.9(b)(1) and (b)(4)--

Execution Methods for Required Transactions in the preamble.

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

(d) Sec. 37.3(a)--Application Procedures \125\

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

\125\ The Commission is renaming the title of this section from

``Application Procedures'' to ``Procedures for Full Registration''

to provide greater clarity.

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

Proposed Sec. 37.3(a) set forth the application and approval

procedures for the registration of new SEFs. The proposed rule required

a SEF applicant to apply to the Commission by electronically filing the

proposed Form SEF.\126\ The proposed rule also provided that the

Commission would either approve or deny the application or, if deemed

appropriate, register the applicant as a SEF subject to conditions.

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

\126\ Proposed Form SEF, as set forth in proposed appendix A to

part 37, was to be used for initial or temporary registration as a

SEF as well as for any amendments to an applicant's status otherwise

not required to be submitted under part 40 of the Commission's

regulations.

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

(1) Summary of Comments

The Commission received several comments encouraging the

harmonization of the registration procedures for SEFs with the SEC's

registration procedures for SB-SEFs.\127\ In this regard, MarketAxess

recommended that the Commission allow an SEC-registered SB-SEF to

notice register with the Commission.\128\ WMBAA recommended that the

Commission and the SEC adopt a common application form, which would

provide for a smoother, timelier transition to the new regulatory

regime.\129\

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

\127\ See Registration and Regulation of Security-Based Swap

Execution Facilities, 76 FR 10948 (proposed Feb. 28, 2011). Tradeweb

Comment Letter at 3-4 (Jun. 3, 2011); MarketAxess Comment Letter at

20-21 (Mar. 8, 2011); WMBAA Comment Letter at 14 (Mar. 8, 2011); FSR

Comment Letter at 10-11 (Mar. 8, 2011); Reuters Comment Letter at 3-

4 (Mar. 8, 2011).

\128\ MarketAxess Comment Letter at 20-21 (Mar. 8, 2011).

\129\ WMBAA Comment Letter at 14 (Mar. 8, 2011).

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

Tradeweb requested that the Commission confirm that SEF applicants

do not need to file separate applications for each mode of execution

that it will offer to participants, provided that the application

clearly identifies the different features of the separate marketplaces

and that each feature is in compliance with the rules.\130\

Additionally, MarketAxess requested clarification that the Commission

does not intend proposed Sec. 37.3(a)(6) to require amendments to Form

SEF after the Commission approves an application.\131\

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

\130\ Tradeweb Comment Letter at 13 (Mar. 8, 2011).

\131\ MarketAxess Comment Letter at 29 (Mar. 8, 2011).

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

(2) Commission Determination

The Commission is adopting Sec. 37.3(a) and Form SEF as proposed,

subject to certain modifications discussed below.\132\ The Commission

notes that there is no CEA provision which provides for SEF notice

registration for SB-SEFs. The Commission does note, however, that

section 5h(g) of the Act provides that the Commission ``may exempt'' a

SEF from registration if the facility is subject to comparable,

comprehensive supervision and regulation by the SEC, a prudential

regulator, or the appropriate governmental authorities in the home

country of the facility.\133\ The Commission observes that the SEC and

other regulators have not implemented comparable, comprehensive

supervision and regulation to the Commission's SEF regulatory scheme at

this time. The Commission also observes that, it must comprehensively

review and understand a SEF's proposed trading models and operations,

which will facilitate trading for a more diverse universe of financial

instruments and underlying commodities than SB-SEFs. Therefore, at this

time, the Commission is not allowing for exempt SEFs.

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

\132\ The Commission is renumbering proposed Sec. 37.3(a) to

Sec. 37.3(b) and making several non-substantive revisions to this

provision and Form SEF for clarity. The Commission is also moving

proposed Sec. 37.3(a)(7) regarding delegated authority to the

Director of DMO to Sec. 37.3(h).

\133\ CEA section 5h(g); 7 U.S.C. 7b-3(g).

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

In response to Tradeweb's comment about separate applications, the

Commission clarifies that a SEF applicant does not need to file

separate applications for each mode of execution that it will offer to

market participants, but its application, as noted in Exhibit Q to Form

SEF, must describe each mode of execution offered.\134\ Additionally,

in response to MarketAxess's comment about amendments to Form SEF after

the Commission registers a SEF, the Commission is revising proposed

Sec. 37.3(a)(6) \135\ and Form SEF to clarify that an amended Form SEF

is required for a SEF applicant amending a pending application for

registration or for a SEF requesting an amendment to its order of

registration. Otherwise, once registered, a SEF must file any

amendments to Form SEF as a submission under part 40 of the

Commission's regulations or as specified by the Commission (e.g., by

filing quarterly financial resources reports pursuant to Sec. 37.1306

or by filing an amended Form SEF). As stated in the SEF NPRM, the

Commission clarifies that if any information contained in Form SEF is

or becomes inaccurate for any reason, even after a SEF is registered,

the SEF must promptly make the appropriate corrections with the

Commission.\136\

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

\134\ The Commission notes that subsequent modifications to a

SEF's modes of execution or any additional SEF modes of execution

would constitute rules; therefore, the SEF must submit such rules to

the Commission for review pursuant to the procedures under part 40

of the Commission's regulations.

\135\ The Commission is renumbering proposed Sec. 37.3(a)(6) to

Sec. 37.3(b)(3).

\136\ Core Principles and Other Requirements for Swap Execution

Facilities, 76 FR at 1238.

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

The Commission is adding final Sec. 37.3(b)(5) to the rule text

that requires the Commission to review an application for registration

as a SEF pursuant to the 180-day timeframe and procedures specified in

CEA section

[[Page 33486]]

6(a).\137\ This section will be effective for SEF applicants who submit

their applications for registration as a SEF on or after two years from

the effective date of part 37. The Commission is adopting this

provision so that SEF applicants are treated comparably to DCM

applicants who currently are subject to the 180-day Commission review

period under CEA section 6(a). Although Congress did not impose a 180-

day review period for SEFs, the Commission believes that harmonization

of the review periods for DCM and SEF applicants is appropriate given

the fact that both are registered entities for the trading of swaps.

The Commission also believes that this requirement will provide greater

certainty for SEF applicants regarding the time period for the

Commission's review of their applications.

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

\137\ CEA section 6(a); 7 U.S.C. 8(a). The Commission notes that

under CEA section 6(a), if the Commission notifies an applicant that

its application is materially incomplete and specifies the

deficiencies in the application, the running of the 180-day period

is stayed from the time of such notification. The Commission also

notes that if an applicant does not provide a complete Form SEF as

provided for under Sec. 37.3(b)(1)(i), the Commission will notify

the applicant, pursuant to Sec. 37.3(b)(4), that its application

will not be deemed to have been submitted for purposes of the

Commission's review. By ``complete'' Form SEF, the Commission means

that the SEF applicant provides appropriately responsive answers to

each of the informational and exhibit items set forth in Form SEF.

The Commission notes that if the application is not deemed to have

been submitted for purposes of the Commission's review, then the

180-day review period (when effective) will not have commenced.

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

Finally, the Commission is clarifying the standard upon which the

Commission will grant or deny registration. Proposed Sec. 37.3(a)(1)

stated that ``[t]he Commission shall approve or deny the application

or, if deemed appropriate, register the applicant as a swap execution

facility subject to conditions.'' In addition, proposed Sec.

37.3(a)(2) stated that ``[t]he application must include information

sufficient to demonstrate compliance with the core principles specified

in Section 5h of the Act.'' Consistent with these provisions, the

Commission is clarifying in final Sec. 37.3(b)(6) that: (i) The

Commission will issue an order granting registration upon a Commission

determination, in its own discretion, that the applicant has

demonstrated compliance with the Act and the Commission's regulations

applicable to swap execution facilities; (ii) if deemed appropriate,

the Commission may issue an order granting registration subject to

conditions; and (iii) the Commission may issue an order denying

registration upon a Commission determination, in its own discretion,

that the applicant has not demonstrated compliance with the Act and the

Commission's regulations applicable to swap execution facilities.

(e) Sec. 37.3(b)--Temporary Grandfather Relief From Registration \138\

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

\138\ The Commission is renaming the title of this section from

``Temporary Grandfather Relief from Registration'' to ``Temporary

Registration'' to provide greater clarity.

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

Proposed Sec. 37.3(b) provided that an applicant for SEF

registration may request that the Commission grant the applicant

temporary grandfather relief from the registration requirement. The

temporary relief would allow the applicant to continue operating during

the pending application review process. Under the proposed rule, to

receive temporary relief, the applicant was required to provide the

following information to the Commission: (1) An application for SEF

registration submitted in compliance with proposed Sec. 37.3(a); (2) a

notification of its interest in operating under the temporary relief;

(3) transaction data substantiating that swaps have been traded and

continue to be traded on the applicant's trading system or platform at

the time of its application submission; and (4) a certification that

the applicant believes that it will meet the requirements of part 37 of

the Commission's regulations when it operates under temporary relief.

Under proposed Sec. 37.3(b)(2), an applicant's grant of temporary

relief would expire on the earlier of: (1) The date that the Commission

grants or denies SEF registration; or (2) the date that the Commission

rescinds the temporary relief. Proposed Sec. 37.3(b)(3) contained a

sunset date for the temporary relief provision of 365 days following

the effective date of the final SEF regulations. Finally, the

Commission proposed that the SEF rules, which include the requirements

for temporary relief, would be effective 90 days after their

publication in the Federal Register.

(1) Summary of Comments

(i) Comments on Temporary Grandfather Relief

MarketAxess commented that the phrase ``temporary grandfather

relief'' is ambiguous and recommended that the Commission rename

``temporary grandfather relief'' to ``temporary registration.'' \139\

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

\139\ MarketAxess Comment Letter at 16 (Mar. 8, 2011).

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

With respect to the substance of this provision, some commenters

expressed concern that the existing trading activity requirement in

proposed Sec. 37.3(b)(1)(ii) would prevent new entities from

qualifying for temporary relief.\140\ In this regard, MarketAxess

recommended that the Commission revise proposed Sec. 37.3(b)(1)(ii) to

permit SEF applicants, as an alternative to providing transaction data,

to provide materials substantiating that the applicant's system is

operational and therefore could facilitate trading in listed swaps upon

receiving temporary registration from the Commission.\141\

Further, several commenters recommended alternative certification

standards under proposed Sec. 37.3(b)(1)(iii).\142\ Bloomberg, for

example, recommended that SEFs be required to certify only that they

have implemented rules ``reasonably designed to ensure'' compliance

with part 37.\143\ Similarly, MarketAxess recommended a more flexible

certification requirement because compliance with certain core

principles will need to await the build-out functionality of third-

party regulatory service providers.\144\

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

\140\ MarketAxess Comment Letter at 16-17 (Mar. 8, 2011); MFA

Comment Letter at 4-5 (Mar. 8, 2011).

\141\ MarketAxess Comment Letter at 16-17 (Mar. 8, 2011).

\142\ MarketAxess Comment Letter at 4 (Jun. 3, 2011); Bloomberg

Comment Letter at 5 (Jun. 3, 2011); State Street Comment Letter at

6-7 (Mar. 8, 2011); WMBAA Comment Letter at 14-15 (Mar. 8, 2011);

Tradeweb Comment Letter at 13 (Mar. 8, 2011); MarketAxess Comment

Letter at 17-19 (Mar. 8, 2011).

\143\ Bloomberg Comment Letter at 5 (Jun. 3, 2011).

\144\ MarketAxess Comment Letter at 17-19 (Mar. 8, 2011).

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

In addition, Phoenix commented that to avoid any market

disruptions, the Commission should permit SEF applicants to operate

under temporary relief while awaiting a Commission determination to

either grant or deny the temporary relief request.\145\ MarketAxess

also noted that the Commission should not ``tie its own hands'' by

imposing a fixed one-year post-effective time period for reviewing SEF

applications.\146\

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

\145\ Phoenix Comment Letter at 2 (Mar. 7, 2011).

\146\ MarketAxess Comment Letter at 20 (Mar. 8, 2011).

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

(ii) Comments on DCM Eligibility

CME commented that if a DCM has listed cleared swaps prior to the

adoption of the final rules, then there is no reason to exclude them

from applying for temporary relief.\147\ NYSE Liffe recommended that

temporary relief remain available to DCMs either as long as it is

available to SEF applicants or on an ongoing basis so that a DCM

required under DCM Core Principle 9 to delist a futures contract at any

point in the future would be allowed to seek

[[Page 33487]]

temporary relief from registration as a SEF.\148\

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

\147\ CME Comment Letter at 11 (Mar. 8, 2011).

\148\ NYSE Liffe Comment Letter at 3-4 (Sep. 2, 2011).

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

(iii) Comments on 90-Day Effective Date of Regulations

Some commenters recommended a longer time period for the effective

date of the final regulations to provide applicants with additional

time to implement the large number of changes required.\149\ Nodal

commented that the short effective date will disadvantage smaller

exchanges because its supporting external parties will likely

prioritize compliance obligations in order to be responsive to the

largest exchanges first.\150\ MarketAxess and NFA recommended that the

Commission provide SEF applicants 180 days after adoption of the final

rules to comply with the final SEF regulations in light of forthcoming

operational challenges.\151\ However, SDMA supported the 90-day

effective date and urged the Commission to be vigilant in preventing

further delays that undermine the realization of the goals of the Dodd-

Frank Act.\152\

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

\149\ AIMA Comment Letter at 3 (Jun. 10, 2011); Nodal Comment

Letter at 3-5 (Jun. 3, 2011); WMBAA Comment Letter at 4-5 (Jun. 3,

2011); CME Comment Letter at 6 (Jun. 3, 2011); MarketAxess Comment

Letter at 19 (Mar. 8, 2011); NFA Comment Letter at 2-3 (Mar. 8,

2011); WMBAA Comment Letter at 12-13 (Mar. 8, 2011); ICAP Comment

Letter at 6 (Mar. 8, 2011); Nodal Comment Letter at 4-5 (Mar. 8,

2011).

\150\ Nodal Comment Letter at 4 (Jun. 3, 2011); Nodal Comment

Letter at 4 (Mar. 8, 2011).

\151\ MarketAxess Comment Letter at 19 (Mar. 8, 2011); NFA

Comment Letter at 2-3 (Mar. 8, 2011).

\152\ SDMA Comment Letter at 12 (Mar. 8, 2011).

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

(2) Commission Determination

(i) Temporary Grandfather Relief

The Commission agrees with MarketAxess that ``temporary

registration'' is more accurate than ``temporary grandfather relief''

and is accordingly making such change. Additionally, based on the

comments, the Commission is adopting proposed Sec. 37.3(b) as final

Sec. 37.3(c) subject to a number of modifications.\153\

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

\153\ The Commission is renumbering proposed Sec. 37.3(b) to

Sec. 37.3(c) and making several non-substantive revisions for

clarity.

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

The Commission further agrees with MarketAxess and other commenters

that the trading activity requirement as proposed in Sec.

37.3(b)(1)(ii) may limit temporary registration to incumbent platforms.

Therefore, the Commission is eliminating the trading activity

requirement and will permit all SEF applicants to apply for temporary

registration if they meet the requirements under final Sec.

37.3(c)(1). The Commission views the revised temporary registration

provision as promoting competition between SEFs by providing fair

opportunities for new entities to establish trading operations in

competition with incumbents.

The Commission is deleting the certification requirement under

proposed Sec. 37.3(b)(1)(iii) because it is unnecessary. The

Commission notes, as stated in the SEF NPRM, that once a SEF applicant

is granted temporary registration it must comply with all provisions of

the Act and the Commission's regulations that are applicable to

SEFs.\154\

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

\154\ Core Principles and Other Requirements for Swap Execution

Facilities, 76 FR at 1216.

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

The Commission is revising the temporary registration provisions to

clarify in final Sec. 37.3(c)(1) that a SEF applicant may apply for

temporary registration if it submits a complete Form SEF and a

temporary registration notice.\155\ The Commission is also revising the

temporary registration provisions to require a SEF applicant that is

already operating a swaps-trading platform, in reliance upon either an

exemption granted by the Commission or some form of no-action relief

granted by the Commission staff, to include in the temporary

registration notice a certification that it is operating pursuant to

such exemption or no-action relief. The Commission also clarifies that

a SEF applicant may submit such temporary registration application

after the final SEF regulations are published in the Federal Register

until the termination of the temporary registration provision pursuant

to final Sec. 37.3(c)(5).\156\

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

\155\ The applicant must comply with all of the requirements in

final Sec. 37.3(b)(1)(i) and must submit a temporary registration

notice to the Commission to qualify for temporary registration. See

Final Sec. 37.3(c)(1) of the Commission's regulations.

\156\ The Commission notes that certain entities may continue to

operate under current exemptions while their SEF applications are

pending, as long as the entities submit a complete application

(i.e., the SEF applicant provides substantive answers to each of the

informational and exhibit items set forth in Form SEF) and temporary

registration notice before the effective date of the final SEF

regulations. See CFTC No-Action Letter 12-48 (Dec. 11, 2012).

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

Pursuant to final Sec. 37.3(c)(1), the Commission notes that it

will grant a SEF applicant temporary registration upon a Commission

determination that the applicant has provided a complete Form SEF as

part of its registration application and submitted a notification

requesting that the Commission grant temporary registration. If an

applicant has not met these requirements, the Commission may deny its

request for temporary registration. By ``complete'' Form SEF, the

Commission means that the SEF applicant provides appropriately

responsive answers to each of the informational and exhibit items set

forth in Form SEF. The Commission notes that it will review a SEF

applicant's Form SEF to ensure that it is complete, and will not

conduct any substantive review of the form before granting or denying

temporary registration. The Commission notes that this temporary

registration process is similar to the notice registration process

followed by the Commission in the context of other types of

registrations.\157\ The Commission will review SEF applicants'

submissions on a rolling basis and the Commission will issue notices

either granting or denying temporary registration.\158\ The Commission

believes that providing a clear and streamlined path to temporary

registration will minimize the potential for regulatory arbitrage,

ensure a level playing field, and promote competition among SEFs.

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

\157\ See discussion below regarding swap dealer and major swap

participant provisional registration rules.

\158\ The Commission is delegating to the Director of DMO, upon

consultation with the General Counsel, the authority to issue a

notice granting or denying temporary registration. See Final Sec.

37.3(h) of the Commission's regulations.

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

The Commission stresses that a grant of temporary registration does

not mean that the Commission has determined that a SEF applicant is

fully compliant with the Act and Commission regulations, nor does it

guarantee that a SEF applicant will eventually be granted full SEF

registration. After granting a SEF applicant temporary registration,

the Commission will review the applicant's application to assess

whether the applicant is fully compliant with the requirements of the

Act and the Commission's regulations applicable to SEFs. During such

assessment, the Commission may request from the SEF applicant

additional information in order to make a determination whether to

issue a final order of registration.

The Commission is also revising the temporary registration

provisions to clarify in final Sec. 37.3(c)(2) that an applicant

cannot operate as a SEF under temporary registration until the

applicant receives a notice from the Commission or the Commission staff

granting temporary registration.\159\ In response to Phoenix's comment

about a SEF operating while its temporary registration is pending, the

Commission does not believe that a SEF applicant should be allowed to

operate as a SEF

[[Page 33488]]

under temporary registration before the Commission has had a chance to

review the application to ensure that it is complete. The Commission's

review is especially merited given the Commission's decision to permit

temporary registration of entities that have not previously traded

swaps.

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

\159\ This provision is contained in final Sec. 37.3(c)(2) of

the Commission's regulations. This rule also states that in no case

may an applicant begin operating as a temporarily registered SEF

until the effective date of the SEF regulations.

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

The Commission believes that permitting entities to operate as

temporarily registered SEFs, notwithstanding the lack of a substantive

review of the SEF's application by the Commission, is not a novel

concept and has been followed by the Commission in other contexts where

it is important to allow entities to quickly reach the market, before

an extensive Commission review. For instance, under the Commission's

swap dealer and major swap participant registration rules, provisional

registration is granted upon the filing of an application and

documentation demonstrating compliance or the ability to comply with

the CEA section 4s requirements in effect on such date--and not after

review and approval of the documentation by the National Futures

Association (``NFA''), as the Commission's delegee.\160\ On and after

the date on which NFA confirms that the applicant has demonstrated its

initial compliance with the applicable requirements, the provisional

registration of the applicant ceases and the applicant becomes

registered as an SD or an MSP, as the case may be.

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

\160\ Registration of Swap Dealers and Major Swap Participants,

77 FR 2613 (Jan. 19, 2012).

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

The Commission envisions the SEF temporary registration process as

operating in a similar fashion, with the Commission reviewing each

application for completeness alone before granting temporary

registration. Subsequently, and concurrent with the temporarily

registered SEF's early operations, the Commission would conduct a

comprehensive review of the application for compliance with all

applicable SEF requirements.

The Commission is revising proposed Sec. 37.3(b)(2) regarding the

expiration of temporary registration to remove the ability of the

Commission to rescind temporary registration. The Commission notes that

the SEF NPRM did not provide a standard for the Commission to rescind

temporary registration. Instead, in final Sec. 37.3(c)(3), the

Commission may rely on its ability to deny full registration, which

will also cause temporary registration to expire. Therefore, the

Commission believes that the ability to rescind temporary registration

is unnecessary.

The Commission is extending the 365-day sunset provision for

temporary registration to two years from the effective date of these

regulations in final Sec. 37.3(c)(5).\161\ Given that the projected

number of temporary SEF registrations may exceed 20 and the resource

constraints faced by the Commission, the Commission may not be able to

complete its registration reviews, enable SEFs to remedy any identified

deficiencies, and ultimately grant or deny full registration for all of

the SEF applicants within the proposed 365-day period. Extending the

temporary registration provision will provide the Commission with

adequate time to review the SEF registration applications while

ensuring that SEFs can continue their operations under temporary

registration, without interruption, until the Commission decides on

their application for full registration.

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

\161\ This provision is contained in final Sec. 37.3(c)(5) of

the Commission's regulations.

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

The Commission is also revising final Sec. 37.3(c)(5) to state

that the temporary registration provision will not terminate for an

applicant who applies for temporary registration before the termination

of the temporary registration provision and has not been granted or

denied registration under Sec. 37.3(b)(6) by the time of the

termination of the temporary registration provision. In addition, final

Sec. 37.3(c)(5) states that such an applicant may operate as a SEF

under temporary registration upon receipt of a notice from the

Commission granting temporary registration until the Commission grants

or denies full registration pursuant to Sec. 37.3(b)(6). On the

termination date of the temporary registration provision, the

Commission will review such applicant's application pursuant to the

180-day Commission review period and procedures in Sec. 37.3(b)(5).

These revisions will ensure that a temporarily registered SEF who does

not have a full registration in place by the time the temporary

registration provision terminates will not have to stop operating on

such termination date.

(ii) DCM Eligibility

The Commission is withdrawing proposed Sec. 37.3(b)(1)(ii)

regarding the existing trading activity requirement so an operational

DCM that seeks to create a new SEF would be able to qualify for

temporary SEF registration. In consideration of NYSE Liffe's comment

that temporary SEF registration for an existing DCM should not be

subject to the sunset provision, the Commission is revising proposed

Sec. 37.3(b) in final Sec. 37.3(c)(6) to allow for such an

exemption.\162\ The Commission notes that a DCM is subject to a higher

regulatory standard than a SEF such that a non-dormant DCM who seeks to

create a new SEF in order to transfer one or more of its contracts

should be able to meet many of the SEF requirements. Therefore, the

Commission believes that, on an ongoing basis, an operational DCM that

also seeks to register as a SEF in order to transfer one or more of its

contracts (whether the transfer of the contract is motivated by DCM

Core Principle 9 or another reason) may request SEF temporary

registration.

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

\162\ This provision is contained in final Sec. 37.3(c)(6) of

the Commission's regulations.

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

(iii) 90-Day Effective Date of Regulations

The Commission is shortening the proposed 90-day effective date to

60 days subsequent to publication in the Federal Register. In

consideration of the comments received and the availability of the

Commission staff resources, the Commission has determined to use its

discretion to establish alternative dates for the commencement of its

enforcement of regulatory provisions and is setting a general

compliance date of 120 days subsequent to Federal Register

publication.\163\ With this use of an effective date and compliance

date, a prospective SEF that is already operating a swaps-trading

platform in reliance on a Commission staff relief letter (e.g., CFTC

No-Action Letter 12-48) could submit a SEF application and receive

temporary registration before part 37's effective date so that it might

begin operating as a SEF upon that effective date.\164\ Alternatively,

if such a prospective SEF took additional time to prepare its SEF

application, it would have the option of forestalling the submission of

its application until after the effective date, so long as it submitted

its SEF application by the compliance date.

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

\163\ See Heckler v. Chaney, 470 U.S. 821 (1985).

\164\ This scenario is not limited to a prospective SEF that is

already operating a swaps-trading platform in reliance on a

Commission staff relief letter. As noted above, all SEF applicants

may apply for temporary registration if they meet the requirements

under final Sec. 37.3(c)(1).

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

The Commission believes that this combination of a 60-day effective

date and a 120-day compliance date subsequent to Federal Register

publication for prospective SEF applicants establishes a transition

period that appropriately balances the Commission's need to provide

regulatory certainty to potential applicants through issuance of final

SEF regulations and the Commission's statutory directives to both

promote fair

[[Page 33489]]

competition between swaps trading venues \165\ and promote the trading

of swaps on SEFs.\166\ The new transition period ensures swaps market

continuity, preserves competition between swaps trading venues, and

facilitates the orderly restructuring of the swaps market in compliance

with the Act and regulations thereunder. The Commission believes that

the 60-day effective date and the 120-day compliance date approach will

provide prospective SEF applicants with sufficient time to comply with

the final regulations and, if they choose, to prepare an application

for temporary registration.

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

\165\ Section 3(b) of the Act lists the promotion of ``fair

competition among boards of trade, other markets, and market

participants'' as a purpose of the Act. 7 U.S.C. 5(b).

\166\ Section 5h(e) of the Act lists the promotion of ``the

trading of swaps on swap executive facilities'' as one goal of the

Act. 7 U.S.C. 7b-3(e).

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

(f) Sec. 37.3(c)--Reinstatement of Dormant Registration

Proposed Sec. 37.3(c) provided procedures for a dormant SEF to

reinstate its registration. The Commission received no comments on this

section and is adopting Sec. 37.3(c) as proposed.\167\

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

\167\ The Commission is renumbering proposed Sec. 37.3(c) to

Sec. 37.3(d) and making several non-substantive revisions for

clarity.

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

(g) Sec. 37.3(d)--Request for Transfer of Registration

Proposed Sec. 37.3(d) provided procedures that a SEF must follow

when seeking to transfer its registration from its current legal entity

to a new legal entity as a result of a corporate event. The Commission

received no comments on this section and is adopting Sec. 37.3(d) as

proposed.\168\

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

\168\ The Commission is renumbering proposed Sec. 37.3(d) to

Sec. 37.3(e) and making several non-substantive revisions for

clarity.

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

(h) Sec. 37.3(e)--Request for Withdrawal of Application for

Registration

Proposed Sec. 37.3(e) provided that a SEF applicant may withdraw

its application for registration. The Commission received no comments

on this section and is adopting Sec. 37.3(e) as proposed.\169\

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

\169\ The Commission is renumbering proposed Sec. 37.3(e) to

Sec. 37.3(f) and making several non-substantive revisions for

clarity.

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

(i) Sec. 37.3(f)--Request for Vacation of Registration

Proposed Sec. 37.3(f) provided that a SEF may vacate its

registration. The Commission received no comments on this section and

is adopting Sec. 37.3(f) as proposed.\170\

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

\170\ The Commission is renumbering proposed Sec. 37.3(f) to

Sec. 37.3(g) and making several non-substantive revisions for

clarity.

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

4. Sec. 37.4--Procedures for Listing Products and Implementing Rules

Proposed Sec. 37.4 detailed the approval and self-certification

procedures under part 40 of the Commission's regulations that SEF

applicants and SEFs must follow to submit its products and rules to the

Commission. Proposed Sec. 37.4 also provided that a SEF may request

that the Commission consider, under the provisions of section 15(b) of

the Act,\171\ any of the SEF's rules or policies.

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

\171\ CEA section 15(b) requires the Commission to take into

consideration the public interest to be protected by the antitrust

laws and endeavor to take the least anticompetitive means of

achieving the objectives of the Act, as well as the policies and

purposes of the Act. 7 U.S.C. 19(b).

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

(a) Summary of Comments

WMBAA commented that SEFs should not be required to seek Commission

approval for their products and rules.\172\ WMBAA recommended that SEFs

be allowed to submit to the Commission a simple self-certification that

they complied with the applicable requirements.\173\ CME stated that

the proposed procedures for listing products would increase the burdens

associated with new product submissions and rule changes and would

create new and costly bureaucratic inefficiencies, competitive

disadvantages in the global marketplace, and impediments to

innovation.\174\ MarketAxess recommended that the Commission revise

proposed Sec. 37.4 to clarify that temporarily registered SEFs may

list swaps through the Commission's approval or self-certification

procedures.\175\

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

\172\ WMBAA Comment Letter at 15-16 (Mar. 8, 2011).

\173\ Id.

\174\ CME Comment Letter at 10, 13 (Feb. 22, 2011). CME also

provided its comments to the rulemaking titled Provisions Common to

Registered Entities, 76 FR 44776 (Jul. 27, 2011). In addition,

rather than repeat its comments that pertain to both the DCM and SEF

NPRMs, CME incorporated its entire DCM rulemaking comment letter

dated Feb. 22, 2011 as Exhibit A to its SEF comment letter dated

Mar. 8, 2011. The Commission notes these comments by referencing the

Feb. 22, 2011 date of CME's DCM comment letter. The Commission is

also changing CME's reference to ``DCM'' to ``SEF'' for these

comments.

\175\ MarketAxess Comment Letter at 19 (Mar. 8, 2011). Tradeweb

similarly commented that a SEF applicant should be able to introduce

new products while it is operating under temporary relief. Tradeweb

Comment Letter at 13 (Mar. 8, 2011).

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

(b) Commission Determination

The Commission is adopting proposed Sec. 37.4 subject to certain

modifications. The Commission is removing many of the details from the

proposed rule, which are already contained in part 40 of the

Commission's regulations, and is instead referring SEFs to part

40.\176\ The Commission is also removing the CEA section 15(b)

consideration provision because, when reviewing any SEF rule, the

Commission is already required to take into consideration the

provisions under section 15(b) of the Act.

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

\176\ 17 CFR part 40.

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

In response to WMBAA's comments that SEFs should not be required to

seek Commission approval of their products and rules, the Commission

notes that a SEF is a registered entity under the Act and pursuant to

section 5c(c) of the Act, registered entities must submit product terms

and conditions and rules to the Commission for approval or under self-

certification procedures.\177\ In addition, the Commission notes that

CME's comments were addressed in the part 40 rulemaking and are outside

the scope of this rulemaking.\178\ The Commission also clarifies that

temporarily registered SEFs may list swaps or submit rules through the

Commission's approval or self-certification procedures under part 40 of

this chapter, and that the timelines under those procedures shall

apply.

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

\177\ CEA section 5c(c); 7 U.S.C. 7a-2(c).

\178\ See Provisions Common to Registered Entities, 76 FR 44776

(Jul. 27, 2011).

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

5. Sec. 37.5--Information Relating to Swap Execution Facility

Compliance

Proposed Sec. 37.5(a) required a SEF to file with the Commission

information related to its business as a SEF as specified in the

Commission's request. Proposed Sec. 37.5(b) required a SEF to file

with the Commission a written demonstration of compliance with the core

principles. Proposed Sec. 37.5(d) delegated the Commission's authority

to seek information as set forth in Sec. 37.5(b) to the Director of

DMO or such other employee as the Director may designate.

Proposed Sec. 37.5(c) required a SEF to file with the Commission a

notice of the transfer of ten percent or more of its equity no later

than the business day following the date on which the SEF enters into a

firm obligation to transfer the equity interest.\179\ The proposed rule

also required that the notification include any relevant agreement and

a representation from the SEF that it meets all of the requirements of

section 5h of the Act and Commission regulations adopted thereunder.

Additionally, the proposed rule

[[Page 33490]]

required the SEF to notify the Commission of the consummation of the

transaction on the day on which it occurs. Furthermore, the proposed

rule required that, upon the transfer of the equity interest, the SEF

certify, no later than two business days following the date on which

the change in ownership occurs, that the SEF meets all of the

requirements of section 5h of the Act and Commission regulations

adopted thereunder.

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

\179\ See generally Core Principles and Other Requirements for

Swap Execution Facilities, 76 FR at 1217 (explaining the proposed

ten percent threshold).

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

(a) Summary of Comments

The Commission did not receive any comments on proposed Sec.

37.5(a), (b), or (d). The Commission did, however, receive comments on

the equity interest transfer provisions in proposed Sec. 37.5(c).

CME commented that the submissions required to be simultaneously

filed with the initial notification of an equity interest transfer do

not lend themselves to preparation within the 24-hour time frame

proposed in the rules.\180\ CME further commented that the

representation of compliance with the requirements of CEA section 5h

and the Commission's regulations adopted thereunder would be more

appropriate if required upon consummation of the equity interest

transfer, rather than with the initial notification.\181\

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

\180\ CME Comment Letter at 13 (Feb. 22, 2011).

\181\ Id.

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

MarketAxess commented that public companies should not have to file

a notice of an equity interest transfer because the ownership structure

of a public company does not implicate the control and influence

concerns raised by the Commission in its proposal, and shareholders are

already obligated under the SEC's regulations to report threshold

acquisitions of equity interests within ten days of such an

acquisition.\182\

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

\182\ MarketAxess Comment Letter at 29 (Mar. 8, 2011).

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

Lastly, Better Markets recognized the important implications of

transferring control in a regulated marketplace and it recommended that

the Commission lower the transfer threshold for reporting to five

percent as similarly required by the SEC for public equity

transfers.\183\

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

\183\ Better Markets Comment Letter at 21-22 (Mar. 8, 2011).

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

(b) Commission Determination

The Commission is adopting Sec. 37.5(a), (b), and (d) as proposed

subject to certain non-substantive clarifications.\184\ The Commission

is adopting proposed Sec. 37.5(c) with certain revisions discussed

below.

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

\184\ The Commission is removing the reference to ``information

relating to data entry and trade details'' in proposed Sec. 37.5(a)

because it is unnecessary. The rule text is broad enough to

encompass such information as it states that, upon the Commission's

request, a SEF shall file with the Commission information related to

its business as a SEF.

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

The Commission is revising Sec. 37.5(c) to provide that a SEF must

submit to the Commission a notification of each transaction involving

the transfer of fifty percent or more of the equity interest in the

SEF, and that such notification must be provided at the earliest

possible time, but in no event later than the open of the business day

that is ten business days following the date in which the SEF enters

into a firm obligation \185\ to transfer the equity interest. However,

in all cases, the Commission notes that a SEF must provide the

Commission staff with sufficient time, prior to consummating the equity

interest transfer, to review and consider the implications of the

change in ownership, including whether the change in ownership will

adversely impact the operations of the SEF or the SEF's ability to

comply with the core principles and the Commission's regulations

thereunder.

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

\185\ The Commission interprets ``firm obligation'' to mean when

a SEF enters into a letter of intent or any other document that

demonstrates a SEF's firm intent to transfer its equity interest as

described in Sec. 37.5(c).

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

The Commission acknowledges CME's concern regarding the one

business day time period for filing the supporting documents with the

equity interest transfer notification. Thus, in addition to extending

the time period to up to ten business days for a SEF to file

notification with the Commission, the Commission is revising the rule

to eliminate the requirement that specific documents be provided with

the notification. Rather, the Commission is revising the rule text to

clarify that upon receiving a notification of the equity interest

transfer, the Commission may request appropriate documentation pursuant

to its authority under Sec. 37.5 of the Commission's regulations. For

example, such documentation may include, but is not limited to: (i)

Relevant agreement(s), including any preliminary agreements (not

including draft documents); (ii) associated changes to relevant

corporate documents; (iii) a chart outlining any new ownership or

corporate or organizational structure, if available; and (iv) a brief

description of the purpose and any impact of the equity interest

transfer.

The Commission is deleting the requirement for a SEF to provide a

representation of compliance with section 5h of the Act and the

Commission regulations thereunder with the equity interest transfer

notification, as requested by CME. The Commission agrees with CME that

this requirement is more appropriate upon consummation of the equity

interest transfer, rather than with the initial notification.

Therefore, the Commission is maintaining the certification requirement

upon consummation of the equity interest transfer as proposed in the

SEF NPRM.

With respect to the other comments, the Commission believes that

the notice requirements should not be limited to privately-held

companies as the Commission's objective is to ensure that equity

transfers do not negatively impact the operations of registered

entities. The Commission must oversee and ensure the continued

compliance of all SEFs with the core principles and the Commission's

regulations. In order to fulfill its oversight obligations, and to

ensure that SEFs maintain compliance with their self-regulatory

obligations, the Commission must receive a notice of an equity interest

transfer. The Commission acknowledges the suggestion by Better Markets

to lower the equity interest transfer threshold to five percent;

however, the Commission believes that the revisions to Sec. 37.5(c)

will still allow the Commission to fulfill its oversight obligations,

while reducing the costs for SEFs to comply with the equity interest

transfer requirements.

Finally, the Commission is revising the rule to remind SEFs that if

any aspect of an equity interest transfer requires the SEF to file a

rule as defined in part 40 of the Commission regulations, then the SEF

must comply with the rule submission requirements of section 5c(c) of

the CEA and part 40 of this chapter, and all other applicable

Commission regulations.

6. Sec. 37.6--Enforceability

Section 37.6 is intended to provide market participants who execute

swap transactions on or pursuant to the rules of a SEF with legal

certainty with respect to such transactions. In that regard, proposed

Sec. 37.6(a) established that any transaction entered into, on, or

pursuant to the rules of a SEF cannot be voided, rescinded, or held

unenforceable as a result of: (1) The SEF violating any provision of

section 5h of the CEA or part 37; (2) any Commission proceeding to

alter or supplement a rule, term, or condition under section 8a(7) of

the CEA or to declare an emergency under section 8a(9) of the CEA; or

(3) any other proceeding the effect of which is to alter or supplement

a specific term or condition or trading rule or procedure, or require a

registered

[[Page 33491]]

SEF to adopt a specific term or condition, trading rule or procedure,

or to take or refrain from taking a specific action. Proposed Sec.

37.6(b) required that all transactions executed on or pursuant to the

rules of a SEF include written documentation memorializing all terms of

the swap transaction, the legal effect of which is to supersede any

previous agreement between the counterparties. The proposed rule also

required that the confirmation of all terms of the transaction take

place at the same time as execution.\186\

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

\186\ The Commission proposed Sec. 37.6(b) to facilitate the

process contemplated by the confirmation definition. A swap

``confirmation'' is defined as the consummation (electronically or

otherwise) of legally binding documentation (electronic or

otherwise) that memorializes the agreement of the counterparties to

all of the terms of a swap. A confirmation must be in writing

(whether electronic or otherwise) and must legally supersede any

previous agreement (electronically or otherwise). 17 CFR 45.1; Swap

Data Recordkeeping and Reporting Requirements, 77 FR 2136, 2197

(Jan. 13, 2012).

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

(a) Summary of Comments

Three commenters addressed the practicality of a SEF confirming all

terms of a transaction at the same time as execution. MarketAxess

recommended that a SEF be responsible for confirming only the swap

creation data in its possession at the time of execution, consistent

with the Commission's approach in its proposed part 45

regulations.\187\ MarketAxess also requested that the Commission

clarify that SEFs are only responsible for producing a confirmation for

swaps entered into on, and not just pursuant to the rules of, a

SEF.\188\

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

\187\ MarketAxess Comment Letter at 28-29 (Mar. 8, 2011).

Proposed Sec. 45.3 required that for all transactions executed on a

SEF, regardless of whether the swap was cleared, the SEF would be

responsible for reporting to a swap data repository only the primary

economic terms of the transaction in its possession at the time of

execution, and that reporting of confirmation data consisting of all

terms of the transaction would be the responsibility of either the

derivatives clearing organization (if cleared) or one of the

counterparties (if uncleared). Swap Data Recordkeeping and Reporting

Requirements, 75 FR 76574, 76580-81 (proposed Dec. 8, 2010). As

adopted by the Commission, however, Sec. 45.3 requires a SEF to

report both the primary economic terms data as well as all

confirmation data consisting of all transaction terms for each swap

executed on or pursuant to the rules of the SEF as soon as

technologically practicable after execution of the swap. 17 CFR

45.3; Swap Data Recordkeeping and Reporting Requirements, 77 FR

2136, 2199 (Jan. 13, 2012).

\188\ MarketAxess Comment Letter at 29 (Mar. 8, 2011).

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

MarkitSERV stated that when counterparties choose to execute a swap

on a SEF that is not subject to the clearing mandate and not submitted

for clearing to a clearinghouse, the parties will require a long-term

credit relationship to be in place, often memorialized in an ISDA

Master Agreement.\189\ MarkitSERV further stated that the confirmation

terms provided by a SEF may not be able to accommodate the specificity

of such a master agreement, thus making the SEF's confirmation

inadequate for purposes of complying with the Commission's

regulations.\190\

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

\189\ MarkitSERV Comment Letter at 4-5 (Mar. 8, 2011).

\190\ Id. MarkitSERV also expressed concern that the SEF NPRM is

conflating the concepts of confirmation and affirmation with the

audit trail requirements in proposed Sec. 37.205. For example,

MarkitSERV sought clarification regarding the SEF NPRM's statement

that ``[v]oice transactions must be entered into some form of

electronic affirmation system immediately upon execution.'' Core

Principles and Other Requirements for Swap Execution Facilities, 76

FR at 1221. Given the audit trail requirement in proposed Sec.

37.205(b)(1), which states that SEFs that ``permit intermediation

must require that all orders or requests for quotes received by

phone that are executable be immediately entered into the trading

system or platform[,]'' MarkitSERV recommended that the Commission

use the term ``electronic processing system'' instead of

``electronic affirmation system'' because audit trail records and

affirmation are different concepts. Id. at 1244. MarkitSERV Comment

Letter at 4, 6 (Mar. 8, 2011). ABC/CIEBA also sought clarification

as to whether SEFs must enter Permitted Transactions into an

affirmation system, and if so, ABC/CIEBA noted that the SEF NPRM is

inconsistent with other rules. ABC/CIEBA Comment Letter at 7-8 (Mar.

8, 2011). The Commission notes that the final SEF rules do not

require the use of an ``electronic affirmation system.'' The

Commission also clarifies that confirmation and the creation of an

audit trail in Sec. 37.205 are two separate and distinct

requirements. In addition, the Commission notes that Sec. 37.205(b)

merely establishes the requirement that SEFs must capture audit

trail data for regulatory purposes and does not address affirmation,

confirmation, or the public reporting or dissemination of such data.

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

Similarly, the Energy Working Group expressed concern over the

provision's requirement that the SEF's confirmation supersede any

previous agreement between the transacting parties, noting that this

language appears to prevent a master agreement from operating between

counterparties transacting on a SEF.\191\ The Energy Working Group also

stated that confirmation cannot take place at the same time as

execution because they are two distinct steps in the swap transaction

process.\192\

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

\191\ Energy Working Group Comment Letter at 5 (Mar. 8, 2011).

\192\ Id.

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

(b) Commission Determination

The Commission is adopting Sec. 37.6(a) as proposed.\193\ The

Commission is also adopting Sec. 37.6(b) as proposed subject to the

two revisions discussed below. Although the comments received regarding

proposed Sec. 37.6(b) did not cite ambiguity in the SEF NPRM regarding

a SEF's affirmative duty to provide confirmation documentation to

counterparties, the Commission has determined to revise Sec. 37.6(b)

to state explicitly that a ``swap execution facility shall provide each

counterparty'' with written documentation of all terms of the

transaction to serve as confirmation of such transaction. In response

to MarketAxess's comments, the Commission notes that Sec. 37.6(b) is

consistent with the requirement in final part 45 of the Commission's

regulations that a SEF report confirmation data consisting of all terms

of a transaction to a swap data repository (``SDR'') for each swap

executed on or pursuant to the rules of the SEF.\194\

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

\193\ The Commission is making certain non-substantive revisions

to Sec. 37.6(a) for clarity.

\194\ Part 45 requires a SEF to report all confirmation data and

all primary economic terms data as defined in part 23 and Sec. 45.1

of the Commission's regulations for each swap executed on or

pursuant to the rules of the SEF as soon as technologically

practicable after execution of the swap. 17 CFR 45.3; Swap Data

Recordkeeping and Reporting Requirements, 77 FR 2136, 2199 (Jan. 13,

2012). Part 45 defines confirmation data as ``all of the terms of a

swap matched and agreed upon by the counterparties in confirming the

swap.'' Id. at 2197.

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

With regard to the specific comments received about the role of

master agreements in the written confirmation provided by a SEF, the

Commission has determined that counterparties choosing to execute a

transaction not submitted for clearing on or pursuant to the rules of a

SEF must have all terms, including possible long-term credit support

arrangements, agreed to no later than execution, such that the SEF can

provide a written confirmation inclusive of those terms at the time of

execution and report complete, non-duplicative, and non-contradictory

data to an SDR as soon as technologically practicable after

execution.\195\ This requirement, as mentioned above, is necessary to

provide market participants who execute swap transactions on or

pursuant to the rules of a SEF with legal certainty with respect to

such transactions, and to promote the Commission's policy goal of

achieving ``straight-through processing'' of swap

[[Page 33492]]

transactions in order to facilitate orderly markets, whether bilateral

or facility traded.\196\ Furthermore, the Commission believes that

credit-support arrangements for uncleared transactions can impact the

ultimate price of a swap, and thus should be agreed to no later than

the time of trade execution in order to promote the statutory goal of

pre-trade price transparency.\197\

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

\195\ The Commission notes that swap trading relationship

documentation is not required for swaps cleared by a derivatives

clearing organization. See Sec. 23.504(a)(1) of the Commission's

regulations. The Commission also notes that the commenters' concerns

are most relevant to those transactions that are truly bespoke, not

subject to the clearing mandate, and not voluntarily cleared. There

is no reason why a SEF's written confirmation terms cannot

incorporate by reference the privately negotiated terms of a

freestanding master agreement for these types of transactions,

provided that the master agreement is submitted to the SEF ahead of

execution and the counterparties ensure that nothing in the

confirmation terms contradict the standardized terms intended to be

incorporated from the master agreement. See also Real-Time Public

Reporting of Swap Transaction Data, 77 FR 1182, 1193 (Jan. 9, 2012)

(discussing confirmation and incorporating documents by reference).

\196\ The OTC Derivatives Supervisors' Group, a collaboration of

market participant leadership headed by the Federal Reserve Bank of

New York, recognized the potential of electronic trading to

facilitate the objectives of straight-through processing in the wake

of the 2008 financial crisis. See Confirmation, Portfolio

Reconciliation, and Portfolio Compression Requirements for Swap

Dealers and Major Swap Participants, 75 FR 81519, 81521-22 (proposed

Dec. 28, 2010) (noting that ``[t]imely and accurate confirmation of

transactions is critical for all downstream operational and risk

management processes, including the correct calculation of cash

flows and discharge of settlement obligations as well as accurate

measurement of counterparty credit exposures.'').

\197\ See CEA section 5h(e); 7 U.S.C. 7b-3(e) (stating that the

goal of this section is to promote pre-trade price transparency in

the swaps market). While straight-through processing may not be as

relevant to credit risk associated with transactions executed on or

pursuant to the rules of a SEF but not submitted for clearing, the

data and real-time reporting requirements already finalized by the

Commission mandate reporting by the SEF of all swap transaction

terms ``as soon as technologically practicable'' in order to

effectuate the statutory mandate of post-trade price transparency.

See 17 CFR 43.3(b)(1) (real-time reporting); 17 CFR 45.3(a)(1) (swap

data recordkeeping and reporting requirements). This allowance of a

slight timing delay, however, is meant to account for ``the

prevalence, implementation and use of technology by comparable

market participants,'' and not post-execution confirmation of other

terms such as credit agreements for uncleared swaps. See, e.g., 17

CFR 43.2; Real-Time Public Reporting of Swap Transaction Data, 77 FR

1182, 1191 (Jan. 9, 2012) (discussing the definition of ``as soon as

technologically practicable'').

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

Finally, in response to the Energy Working Group's comment that

confirmation cannot take place at the same time as execution, the

Commission is revising Sec. 37.6(b) to state that ``. . . specific

customer identifiers for accounts included in bunched orders involving

swaps need not be included in confirmations provided by a swap

execution facility if the applicable requirements of Sec. 1.35(b)(5)

of this chapter are met.'' The Commission acknowledges that for bunched

orders the post-execution allocation of trades is required for

confirmation. The above revisions to Sec. 37.6 are consistent with

Commission regulation 1.35(b)(5) and provide sufficient time for the

post-execution allocation of bunched orders, but allow SEFs to meet the

requirement that confirmation takes place at the same time as

execution.\198\

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

\198\ See 17 CFR 1.35; Customer Clearing Documentation, Timing

of Acceptance for Clearing, and Clearing Member Risk Management, 77

FR 21278, 21286-287, 306 (Apr. 9, 2012); Confirmation, Portfolio

Reconciliation, Portfolio Compression, and Swap Trading Relationship

Documentation Requirements for Swap Dealers and Major Swap

Participants, 77 FR 55904, 55923 (Sep. 11, 2012) for further

details.

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

7. Sec. 37.7--Prohibited Use of Data Collected for Regulatory Purposes

Proposed Sec. 37.7 prohibited a SEF from using for commercial

purposes proprietary data or personal information that it obtains from

or on behalf of any person for regulatory purposes. The purpose of this

provision was to protect customer privacy and prevent a SEF from using

such information to advance its commercial interests.\199\

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

\199\ Core Principles and Other Requirements for Swap Execution

Facilities, 76 FR at 1218 n. 34.

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

(a) Summary of Comments

Several commenters recommended that the Commission adopt a more

flexible approach toward the use of data collected for regulatory

purposes.\200\ CME, for example, stated that a SEF should be allowed to

use information that is provided for both regulatory and non-regulatory

purposes for commercial purposes, as long as transparent rules or

policies are in place.\201\ Some commenters believed that commercial

use should be allowed, provided that market participants' identities

are protected \202\ or prior consent is obtained.\203\ For example, FSR

believed that commercial use should be allowed for aggregate data as

long as the sources of the information are not revealed.\204\

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

\200\ MarketAxess Comment Letter at 31 (Mar. 8, 2011); FSR

Comment Letter at 9 (Mar. 8, 2011); ICE Comment Letter at 5-6 (Mar.

8, 2011); CME Comment Letter at 14 (Feb. 22, 2011).

\201\ CME Comment Letter at 14 (Feb. 22, 2011).

\202\ MarketAxess Comment Letter at 31 (Mar. 8, 2011); FSR

Comment Letter at 9 (Mar. 8, 2011).

\203\ CME Comment Letter at 14 (Feb. 22, 2011); MarketAxess

Comment Letter at 31 (Mar. 8, 2011).

\204\ FSR Comment Letter at 9 (Mar. 8, 2011).

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

However, SIFMA AMG stated that, given the broad authority under the

proposed rules for SEFs to acquire information, the term ``proprietary

data'' is too narrow to adequately protect market participants from

improper disclosure.\205\ Freddie Mac requested that the Commission

strengthen the proposed rule to additionally prohibit any SEF from

asserting ownership rights over the trading information of any

transacting party.\206\

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

\205\ SIFMA AMG Comment Letter at 15-16 (Mar. 8, 2011).

\206\ Freddie Mac Comment Letter at 5 (Mar. 8, 2011).

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

Finally, WMBAA requested that the Commission clarify the meaning of

``proprietary data or personal information,'' and recommended limiting

the rule to information obtained outside the ordinary course of trade

execution and related to market surveillance activities.\207\

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

\207\ WMBAA Comment Letter at 17 (Mar. 8, 2011).

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

(b) Commission Determination

The Commission is adopting Sec. 37.7 as proposed, subject to

certain modifications. In response to the commenters, the Commission is

modifying the proposed rule to allow SEFs to use proprietary data or

personal information for business or marketing purposes if the person

from whom it collects or receives such information clearly consents to

the use of its information in such manner. The Commission is also

revising the proposed rule to prohibit a SEF from conditioning access

to its facility based upon such consent. The Commission believes that

the consent requirement will protect persons by allowing them to first

weigh the benefits and consequences of allowing a SEF to make

commercial use of their information. In response to CME's comment about

information provided for both regulatory and non-regulatory purposes,

the Commission notes that a SEF may use information that it receives

for both regulatory and non-regulatory purposes for business or

marketing purposes if the source of the information clearly consents to

the use in such a manner.

In response to comments about the definition of ``proprietary data

and personal information,'' the Commission declines to adopt a further

definition and is maintaining a flexible approach. However, the

Commission notes that some examples of proprietary data and personal

information would include information that separately discloses

business transactions, market positions, or trade secrets. The

Commission recommends that SEFs define these terms in their rulebooks,

which will be subject to Commission review during the SEF registration

process.

8. Sec. 37.8--Boards of Trade Operating Both a Designated Contract

Market and a Swap Execution Facility

Proposed Sec. 37.8(a) required that a board of trade that operates

a DCM and also intends to operate a SEF must separately register the

SEF under part 37, and on an ongoing basis, comply with the core

principles under section 5h of the Act and the part 37 regulations

issued thereunder. Proposed Sec. 37.8(b) implemented CEA section 5h(c)

by requiring a board of trade that operates both a DCM and SEF and uses

the same electronic trade execution system for executing and trading

swaps on both registered entities to clearly identify to market

participants for each swap

[[Page 33493]]

whether the execution or trading of such swaps is taking place on the

DCM or the SEF.\208\

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

\208\ CEA section 5h(c); 7 U.S.C. 7b-3(c).

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

(a) Summary of Comments

CME stated that the rules of a DCM and SEF would clearly identify,

as necessary, the trade platform upon which a swap was being executed,

rendering the requirements of proposed Sec. 37.8 unnecessary.\209\ CME

requested that the Commission clarify whether proposed Sec. 37.8

created additional substantive obligations on the part of DCMs and SEFs

given that market participants often interface with electronic

platforms via proprietary or third-party front end systems not under

the control of DCMs or SEFs.\210\

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

\209\ CME Comment Letter at 14 (Feb. 22, 2011).

\210\ Id.

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

(b) Commission Determination

The Commission is adopting Sec. 37.8(a) as proposed, subject to

one revision. Proposed Sec. 37.8(a) only addressed the SEF

registration and compliance of a board of trade that already operates a

DCM and intends to operate a SEF. To address all situations regarding

DCM and SEF registration and compliance, the Commission is revising

Sec. 37.8(a) to apply to ``[a]n entity that intends to operate both a

[DCM] and a [SEF].'' The rule requires the entity to separately

register the DCM and SEF pursuant to part 38 and part 37 of the

Commission's regulations, respectively, and to comply with the

applicable core principles and regulations.

As to CME's comments regarding Sec. 37.8(b), the Commission

clarifies that it would not be sufficient for a board of trade that

operates both a DCM and a SEF to simply have rules that identify

whether a transaction is being executed on the DCM or the SEF. The

Commission notes that section 5h(c) of the Act clearly requires a board

of trade that operates both a DCM and a SEF to identify to market

participants whether each swap is being executed on the DCM or the

SEF.\211\ Accordingly, a consolidated DCM/SEF trading screen must

identify whether the execution is occurring on the DCM or the SEF,

irrespective of how proprietary or third-party front end systems

eventually present that data to market participants.\212\

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

\211\ The Commission notes that only eligible contract

participants may execute a swap on a SEF so a board of trade that

operates both a DCM and a SEF must ensure that its SEF does not

allow for non-eligible contract participant trading on the SEF. See

CEA section 2(e); 7 U.S.C. 2(e).

\212\ The Commission notes that it is not replacing the term

``board of trade'' in Sec. 37.8(b) with the term ``entity'' as in

Sec. 37.8(a) because in Sec. 37.8(b) only a board of trade would

be able to use the same electronic trade execution system for

executing and trading swaps on the DCM and on the SEF (i.e., a

trading facility). The Commission also notes that Sec. 37.8(b)

implements CEA section 5h(c), which uses the term ``board of

trade.''

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

9. Sec. 37.9--Permitted Execution Methods \213\

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

\213\ The Commission is renaming the title of this section from

``Permitted Execution Methods'' to ``Methods of Execution for

Required and Permitted Transactions'' to provide greater clarity.

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

As mentioned above, the SEF NPRM required a SEF to offer a minimum

trading functionality (i.e., a centralized electronic trading screen

upon which any market participant can post both firm and indicative

bids and offers that are transparent to all other market participants

of the SEF). The SEF NPRM provided that Required Transactions (i.e.,

transactions subject to the trade execution mandate under section

2(h)(8) of the CEA and not block trades) must be executed through the

SEF's minimum trading functionality, Order Book meeting the minimum

trading functionality, or RFQ System that operates in conjunction with

the SEF's minimum trading functionality.\214\ The SEF NPRM made it

clear that for Required Transactions, pre-trade transparency must be

met.\215\ The SEF NPRM also allowed a SEF to provide additional

execution methods for Permitted Transactions (i.e., transactions not

subject to the clearing and trade execution mandates, illiquid or

bespoke swaps, and block trades), including Voice-Based System.

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

\214\ By ``in conjunction with the SEF's minimum trading

functionality,'' the Commission means that the SEF NPRM required a

SEF to offer the minimum trading functionality, and if that SEF also

offered an RFQ System, it was required to communicate any bids or

offers resting on the minimum trading functionality to the RFQ

requester along with the responsive quotes. See the discussion below

regarding ``Taken Into Account and Communicated'' Language in the

RFQ System Definition under Sec. 37.9(a)(1)(ii)--Request for Quote

System in the preamble for further details.

\215\ Core Principles and Other Requirements for Swap Execution

Facilities, 76 FR at 1220.

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

The Commission is restructuring the order of the rule text in Sec.

37.9 and this corresponding preamble discussion to provide clarity.

Despite the order of other preamble sections, which generally follows

the order of the SEF NPRM, the Commission's preamble discussion of

Sec. 37.9 generally follows the order of the restructured rule text.

Additionally, as discussed above in the registration section, the

Commission is moving the minimum trading functionality and Order Book

sections from proposed Sec. 37.9 to final Sec. 37.3.

(a) Sec. 37.9(a)(1)(iv)--Required Transactions and Sec.

37.9(a)(1)(v)--Permitted Transactions

Proposed Sec. 37.9(a)(1)(iv) defined Required Transactions as

transactions that are subject to the execution requirements under the

Act and are made available for trading pursuant to Sec. 37.10, and are

not block trades. Proposed Sec. 37.9(a)(1)(v) defined Permitted

Transactions as transactions that meet any of the following

requirements: (A) Are block trades; (B) are not swaps subject to the

Act's clearing and execution requirements; or (C) are illiquid or

bespoke swaps.

(1) Summary of Comments

Several commenters recommended revisions to the definition of

Permitted Transactions.\216\ To ensure that there are no gaps between

the definitions of Required Transactions and Permitted Transactions,

MarketAxess recommended that the proposed definition of Permitted

Transactions in Sec. 37.9(a)(1)(v) be revised to include all

transactions that are not Required Transactions as defined in proposed

Sec. 37.9(a)(1)(iv).\217\ Freddie Mac recommended that the Commission

revise the proposed definition of Permitted Transactions to incorporate

hedging transactions by any end-user (i.e., non-dealer)

counterparty.\218\

[[Page 33494]]

Additionally, the Coalition commented that the Commission should define

illiquid or bespoke transactions to include typical end-user

trades.\219\

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

\216\ Additionally, WMBAA commented that the distinction between

Required Transactions and Permitted Transactions is not required or

authorized by the CEA. WMBAA Comment Letter at 6-7 (Mar. 8, 2011).

In this regard, the Commission notes that the CEA sets out specific

trading requirements for swaps that are subject to the trade

execution mandate. See CEA sections 2(h)(1) and 2(h)(8); 7 U.S.C.

2(h)(1) and 2(h)(8). To meet these statutory requirements, final

Sec. 37.9(a)(1) defines these swaps as Required Transactions and

provides specific methods of execution for such swaps. To

distinguish these swaps from other swaps that are not subject to the

trade execution mandate, the Commission defines such swaps in final

Sec. 37.9(c)(1) as Permitted Transactions and allows these swaps to

be voluntarily traded on a SEF by using any method of execution. See

discussion below regarding execution methods for Required and

Permitted Transactions under Sec. 37.9(b)(1) and (b)(4)--Execution

Methods for Required Transactions and Sec. 37.9(c)--Execution

Methods for Permitted Transactions in the preamble.

\217\ MarketAxess Comment Letter at 32 (Mar. 8, 2011).

Similarly, ISDA/SIFMA and the Energy Working Group requested clarity

regarding the definition of Permitted Transactions. ISDA/SIFMA

Comment Letter at 7 (Mar. 8, 2011); Energy Working Group Comment

Letter at 4 (Mar. 8, 2011).

\218\ Freddie Mac Comment Letter at 3 (Mar. 8, 2011). Similarly,

MFA recommended that the Commission expand the definition of

Permitted Transactions to include other transactions, such as

exchanges for physical, exchanges for swaps, and linked or packaged

transactions. MFA Comment Letter at 8 (Mar. 8, 2011). The Commission

interprets MFA's comment to be a request that the Commission create

through rulemaking an exception to the CEA section 2(h)(8) trade

execution requirement similar to the centralized market trading

exception established by DCM Core Principle 9 for certain exchange

of futures for related positions. See CEA section 5(d)(9); 7 U.S.C.

7(d)(9); see also Regulation of Noncompetitive Transactions Executed

on or Subject to the Rules of a Contract Market, 63 FR 3708 (Jan.

26, 1998). The Commission notes that while DCM Core Principle 9 does

permit certain exceptions to the centralized market trading

requirements, such exceptions are all premised on there being some

``bona fide business purpose'' for the exception. MFA does not offer

a specific bona fide business purpose for any of its three suggested

off-exchange exceptions, nor is the Commission aware of any. In

addition, MFA does not explain why an exchange of swaps for swaps

transaction, where each leg of the transaction can presumably be

executed on a SEF, needs to be executed off-exchange. The Commission

observes that should swaps based on physical commodities become

subject to the trade execution mandate, there might be some bona

fide business purpose for executing exchanges of swaps for physicals

transactions. However, the market participants who are most likely

to engage in such transactions are also likely to be eligible for

the end-user exception in CEA section 2(h)(7). As an initial matter,

the Commission observes that swaps based on physical commodities may

be subject to the trade execution requirement if the Commission

determines that they are subject to the clearing requirement under

CEA section 2(h)(1) and part 50 of the Commission's regulations.

Should the circumstances arise where the Commission is determining

whether physical commodity swaps should become subject to the

clearing requirement and there are parties who seek to engage in

exchanges of swaps for physicals transactions that are not eligible

for the end-user exception, the Commission could at that time

entertain requests to permit a trade execution requirement exception

for swaps that are components of such exchanges of swaps for

physicals transactions. However, for the above reason, the

Commission believes that a broad exception for such off-exchange

transactions in the absence of bona fide business purposes could

undermine the trade execution requirement by allowing market

participants to execute swaps subject to the trade execution

requirement bilaterally rather than on a SEF or DCM.

\219\ Coalition Comment Letter at 8 (Mar. 8, 2011).

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

Several commenters also commented on the reference to block trades

in the definition of Permitted Transactions.\220\ ISDA/SIFMA commented

that the definition of block trade in part 43 of the Commission's

regulations should apply to blocks executed on a SEF.\221\ Tradeweb

sought confirmation that block size trades in swaps that are required

to be cleared and made available to trade would not be subject to the

minimum trading requirements for Required Transactions, but would be

required to be reported to and processed through a SEF in a manner

prescribed by the SEF.\222\ Similarly, GFI requested the Commission to

confirm that block transactions must be effected on a SEF, but may be

subject to special rules.\223\

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

\220\ ISDA/SIFMA Comment Letter at 10 (Mar. 8, 2011); Tradeweb

Comment Letter at 5 (Mar. 8, 2011); GFI Comment Letter at 4 (Mar. 8,

2011).

\221\ ISDA/SIFMA Comment Letter at 10 (Mar. 8, 2011).

\222\ Tradeweb Comment Letter at 5 (Mar. 8, 2011).

\223\ GFI Comment Letter at 4 (Mar. 8, 2011).

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

(2) Commission Determination

To ensure that there is consistency in the definitions, and in

response to MarketAxess's comment, the Commission is: (1) Revising the

definition of Required Transaction to mean any transaction involving a

swap that is subject to the trade execution requirement in section

2(h)(8) of the Act \224\; and (2) revising the definition of Permitted

Transaction to mean any transaction not involving a swap that is

subject to the trade execution requirement in section 2(h)(8) of the

Act.\225\ The Commission is not revising the definition of Permitted

Transaction to explicitly include ``hedging transactions involving end-

users'' or ``typical end-user'' transactions because the Commission's

revisions to the definition of Permitted Transaction are consistent

with the CEA section 2(h)(8) trade execution requirement.\226\

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

\224\ The Commission is renumbering proposed Sec.

37.9(a)(1)(iv) to Sec. 37.9(a)(1). Several commenters requested

clarification from the Commission whether inter-affiliate trades

would be subject to the CEA section 2(h)(8) trade execution

requirement. JP Morgan Comment Letter at 5 (Jun. 3, 2011); Rosen et

al. Comment Letter at 20-21 (Apr. 5, 2011); Coalition Comment Letter

at 5 (Mar. 8, 2011); ISDA/SIFMA Comment Letter at 11 (Mar. 8, 2011).

See Clearing Exemption for Swaps Between Certain Affiliated

Entities, 77 FR 50425 (proposed Aug. 21, 2012) for further details.

\225\ The Commission is renumbering proposed Sec. 37.9(a)(1)(v)

to Sec. 37.9(c)(1).

\226\ See CEA section 2(h)(8) trade execution requirement

discussion above under Sec. 37.3--Requirements for Registration;

see also discussion below under Sec. 37.9(c)--Execution Methods for

Permitted Transactions.

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

With respect to the treatment of block transactions, the Commission

notes that the definition of block trade in part 43 of the Commission's

regulations applies to such transactions involving swaps that are

listed on a SEF.\227\ The Commission also notes that the definition of

block trade states, in part, that block trades occur away from the

registered SEF's or DCM's trading system or platform and is executed

pursuant to the registered SEF's or DCM's rules and procedures.\228\ As

such, block trades are not subject to the execution methods for

Required Transactions and Permitted Transactions in final Sec.

37.9(a)(2) and Sec. 37.9(c)(2), respectively.\229\

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

\227\ Section 43.2 of the Commission's regulations states that

``block trade'' means a publicly reportable swap transaction that:

(1) Involves a swap that is listed on a registered SEF or DCM; (2)

Occurs away from the registered SEF's or DCM's trading system or

platform and is executed pursuant to the registered SEF's or DCM's

rules and procedures; (3) Has a notional or principal amount at or

above the appropriate minimum block size applicable to such swap;

and (4) Is reported subject to the rules and procedures of the

registered SEF or DCM and the rules described in this part,

including the appropriate time delay requirements set forth in Sec.

43.5 of this part. 17 CFR 43.2.

\228\ Id.

\229\ The Commission notes that the execution methods for

Required Transactions in final Sec. 37.9(a)(2) excludes block

trades.

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

(b) Sec. 37.9(a)(1)(ii)--Request for Quote System

Proposed Sec. 37.9(a)(1)(ii)(A) defined an RFQ System as a trading

system or platform in which a market participant must transmit a

request for quote to buy or sell a specific instrument to no less than

five market participants in the trading system or platform, to which

all such market participants may respond. Under the proposed rule, any

bids or offers resting on the trading system or platform pertaining to

the same instrument must be taken into account and communicated to the

requester along with the responsive quotes.

In addition, proposed Sec. 37.9(a)(1)(ii)(B) defined an RFQ System

as a trading system or platform in which multiple market participants

can both: (1) View real-time electronic streaming quotes, both firm and

indicative, from multiple potential counterparties on a centralized

electronic screen; and (2) have the option to complete a transaction

by: (i) Accepting a firm streaming quote, or (ii) transmitting a

request for quote to no less than five market participants, based upon

an indicative streaming quote, taking into account any resting bids or

offers that have been communicated to the requester along with any

responsive quotes. Finally, proposed Sec. 37.9(a)(1)(ii)(C) provided

that an RFQ System means any such other trading system or platform as

may be determined by the Commission.

(1) Summary of Comments

(i) Comments on RFQ System Definition and Transmission to Five Market

Participants

In general, some commenters stated that the Commission's definition

of an RFQ System imposes rigid requirements that are not supported by

the SEF definition.\230\ Other commenters stated that the defined RFQ

System preserves ``the single-dealer status quo,'' threatens to

diminish the transparency and efficiency of the regulated swaps

[[Page 33495]]

market, and is inconsistent with the Dodd-Frank Act.\231\

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

\230\ Rosen et al. Comment Letter at 10 (Apr. 5, 2011); Goldman

Comment Letter at 2 (Mar. 8, 2011); ISDA/SIFMA Comment Letter at 2

(Mar. 8, 2011); FXall Comment Letter at 7-8 (Mar 8, 2011); SIFMA AMG

Comment Letter at 4-5 (Mar. 8, 2011).

\231\ IECA Comment Letter at 3 (May 24, 2011); Mallers et al.

Comment Letter at 3-5 (Mar. 21, 2011); AFR Comment Letter at 4, 5

(Mar. 8, 2011). The Mallers et al. comment letter represents the

view of a number of high frequency trading firms: Allston Trading,

LLC, Atlantic Trading USA LLC, Bluefin Trading LLC, Chopper Trading

LLC, DRW Holdings, LLC, Eagle Seven, LLC, Endeavor Trading, LLC,

GETCO, Hard Eight Futures, LLC, HTG Capital Partners, IMC Financial

Markets, Infinium Capital Management LLC, Kottke Associates, LLC,

Liger Investments Limited, Marquette Partners, LP, Nico Holdings

LLC, Optiver US LLC, Quantlab Financial, LLC, RGM Advisors, LLC,

Traditum Group LLC, WH Trading, and XR Trading LLC.

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

As noted above, Sec. 37.9(a)(1)(ii) of the SEF NPRM contained a

requirement that a market participant transmit an RFQ to no less than

five market participants. In the SEF NPRM, the Commission specifically

asked for public comment on whether five is the appropriate minimum

number of respondents that the Commission should require to potentially

interact with a request for quote.\232\ The Commission also asked for

public comment on the appropriate minimum number, if not five.\233\ The

Commission received the following comments regarding the five market

participant requirement and has responded to those comments below.

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

\232\ Core Principles and Other Requirements for Swap Execution

Facilities, 76 FR at 1221. The Commission asked, ``[i]n light of the

`multiple participant to multiple participant' requirement, the

Commission has proposed that requests for quotes be requested of at

least five possible respondents. Is this the appropriate minimum

number of respondents that the Commission should require to

potentially interact with a request for quote? If not, what is an

appropriate minimum number? Some pre-proposal commenters have

suggested that market participants should transmit a request for

quote to `more than one' market participant. The Commission is

interested in receiving public comment on this matter.'' Id.

\233\ Id.

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

Several commenters objected to the requirement in proposed Sec.

37.9(a)(1)(ii) that a market participant transmit an RFQ to no less

than five market participants.\234\ The commenters raised various

concerns with this requirement, including the potential for increased

trading costs,\235\ decreased liquidity,\236\ decreased

transparency,\237\ and breaking trades into smaller sizes.\238\ Several

commenters specifically noted that the five market participant

requirement may result in increased spreads for participants because

non-executing market participants in the RFQ could ``front run'' the

transaction in anticipation of the executing market participant's

forthcoming and offsetting transactions.\239\ Many of these commenters

additionally noted that these risks would be most pronounced in

illiquid swaps or large-sized trades (i.e., transactions approaching

the block trade threshold).\240\ As a result, many of the commenters

noted that it will be difficult and costly to enter into hedging

transactions.\241\

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

\234\ Representative Garrett et al. Comment Letter at 1 (Apr. 5,

2013); Eaton Vance Comment Letter at 2 (Feb. 17, 2012); Reuters

Comment Letter at 6 (Dec. 12, 2011); Tradeweb Comment Letter at 5

(Jun. 3, 2011); Traccr Limited Comment Letter at 2 (Jun. 3, 2011);

FHLB Comment Letter at 12-13 (Jun. 3, 2011); AII Comment Letter at 5

(Jun. 2, 2011); Rosen et al. Comment Letter at 11 (Apr. 5, 2011); JP

Morgan Comment Letter at 2-3 (Mar. 8, 2011); Bloomberg Comment

Letter at 2-3 (Mar. 8, 2011); FXall Comment Letter at 8-9 (Mar. 8,

2011); Reuters Comment Letter at 3 (Mar. 8, 2011); BlackRock Comment

Letter at 3-4 (Mar. 8, 2011); Tradeweb Comment Letter at 7 (Mar. 8,

2011); FSR Comment Letter at 3 (Mar. 8, 2011); MFA Comment Letter at

6 (Mar. 8, 2011); MetLife Comment Letter at 2-3 (Mar. 8, 2011);

SIFMA AMG Comment Letter at 5-7 (Mar. 8, 2011); Deutsche Comment

Letter at 3-4 (Mar. 8, 2011); MarketAxess Comment Letter at 31 (Mar.

8, 2011); Barclays Comment Letter at 5-6 (Mar. 8, 2011); ISDA/SIFMA

Comment Letter at 3 (Mar. 8, 2011); ABC/CIEBA Comment Letter at 6

(Mar. 8, 2011); Global FX Comment Letter at 3 (Mar. 8, 2011);

TruMarx Comment Letter at 6 (Mar. 8, 2011); Coalition Comment Letter

at 5-7 (Mar. 8, 2011); WMBAA Comment Letter at 6 (Mar. 8, 2011); CME

Comment Letter at 8 (Mar. 8, 2011); Morgan Stanley Comment Letter at

2-3 (Mar. 2, 2011); CanDeal Comment Letter at 2-3 (Feb. 25, 2011).

The Commission notes that some commenters in addressing this

provision used the term ``liquidity providers'' to refer to the

minimum number of ``market participants'' that must receive RFQs.

See, e.g., Tradeweb Comment Letter at 5 (Jun. 3, 2011); AII Comment

Letter at 5 (Jun. 2, 2011); Bloomberg Comment Letter at 2 (Mar. 8,

2011); FXall Comment Letter at 9 (Mar. 8, 2011); FSR Comment Letter

at 3 (Mar. 8, 2011). The Commission clarifies that the proposed five

market participant requirement did not imply any requirement that

the requested market participants operate in any particular manner,

such as one that regularly provides liquidity or makes markets in

the particular swap.

\235\ Eaton Vance Comment Letter at 2 (Feb. 17, 2012); JP Morgan

Comment Letter at 2-3 (Mar. 8, 2011); BlackRock Comment Letter at 4

(Mar. 8, 2011); MetLife Comment Letter at 3 (Mar. 8, 2011); Global

FX Comment Letter at 3 (Mar. 8, 2011); Morgan Stanley Comment Letter

at 2 (Mar. 2, 2011); CanDeal Comment Letter at 2-3 (Feb. 25, 2011).

\236\ Tradeweb Comment Letter at 5 (Jun. 3, 2011); Traccr

Limited Comment Letter at 2 (Jun. 3, 2011); FHLB Comment Letter at

12 (Jun. 3, 2011); JP Morgan Comment Letter at 2-3 (Mar. 8, 2011);

BlackRock Comment Letter at 3 (Mar. 8, 2011); Tradeweb Comment

Letter at 7 (Mar. 8, 2011); MetLife Comment Letter at 3 (Mar. 8,

2011); CanDeal Comment Letter at 2-3 (Feb. 25, 2011).

\237\ Tradeweb Comment Letter at 5 (Jun. 3, 2011); MetLife

Comment Letter at 3 (Mar. 8, 2011).

\238\ BlackRock Comment Letter at 4 (Mar. 8, 2011).

\239\ FHLB Comment Letter at 12 (Jun. 3, 2011); AII Comment

Letter at 5 (Jun. 2, 2011); Bloomberg Comment Letter at 2-3 (Mar. 8,

2011); FXall Comment Letter at 8-9 (Mar. 8, 2011); BlackRock Comment

Letter at 3-4 (Mar. 8, 2011); MetLife Comment Letter at 3 (Mar. 8,

2011); SIFMA AMG Comment Letter at 5-6 (Mar. 8, 2011); Barclays

Comment Letter at 5-6 (Mar. 8, 2011); ISDA/SIFMA Comment Letter at 3

(Mar. 8, 2011); ABC/CIEBA Comment Letter at 6 (Mar. 8, 2011); Global

FX Comment Letter at 3 (Mar. 8, 2011); Coalition Comment Letter at

5-6 (Mar. 8, 2011); Morgan Stanley Comment Letter at 2 (Mar. 2,

2011).

\240\ FHLB Comment Letter at 12 (Jun. 3, 2011); AII Comment

Letter at 5 (Jun. 2, 2011); Bloomberg Comment Letter at 2-3 (Mar. 8,

2011); FXall Comment Letter at 8-9 (Mar. 8, 2011); MetLife Comment

Letter at 3 (Mar. 8, 2011); SIFMA AMG Comment Letter at 5-6 (Mar. 8,

2011); Barclays Comment Letter at 5-6 (Mar. 8, 2011); ISDA/SIFMA

Comment Letter at 3 (Mar. 8, 2011); Global FX Comment Letter at 3

(Mar. 8, 2011); Coalition Comment Letter at 5-6 (Mar. 8, 2011);

Morgan Stanley Comment Letter at 2 (Mar. 2, 2011).

\241\ FHLB Comment Letter at 12 (Jun. 3, 2011); AII Comment

Letter at 5 (Jun. 2, 2011); Bloomberg Comment Letter at 2-3 (Mar. 8,

2011); FXall Comment Letter at 8-9 (Mar. 8, 2011); BlackRock Comment

Letter at 3-4 (Mar. 8, 2011); MetLife Comment Letter at 3 (Mar. 8,

2011); SIFMA AMG Comment Letter at 5-6 (Mar. 8, 2011); Barclays

Comment Letter at 5-6 (Mar. 8, 2011); ISDA/SIFMA Comment Letter at 3

(Mar. 8, 2011); ABC/CIEBA Comment Letter at 6 (Mar. 8, 2011); Global

FX Comment Letter at 3 (Mar. 8, 2011); Coalition Comment Letter at

5-6 (Mar. 8, 2011); Morgan Stanley Comment Letter at 2 (Mar. 2,

2011).

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

In this regard, some commenters noted that the SEC's SB-SEF

proposal \242\ permitted RFQs to be transmitted to one or more SEF

participant(s).\243\ Morgan Stanley commented that, given the impact of

signaling transactions to multiple market participants, as trade size

grows, participants may receive better execution if their RFQs are

transmitted to fewer than five participants.\244\ Similarly, MetLife

commented that participants should have the flexibility to determine

the appropriate number of respondents for a particular trade, which

could vary based on the size and liquidity of the trade.\245\

Additionally, Commissioner Sommers' dissent suggested an alternative

approach to RFQ Systems that would permit a market participant to

transmit an RFQ to ``more than one'' potential counterparty.\246\

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

\242\ Registration and Regulation of Security-Based Swap

Execution Facilities, 76 FR 10948 (proposed Feb. 28, 2011).

\243\ Reuters Comment Letter at 6 (Dec. 12, 2011); Traccr

Limited Comment Letter at 2 (Jun. 3, 2011); AII Comment Letter at 5

(Jun. 2, 2011); Rosen et al. Comment Letter at 11 (Apr. 5, 2011); JP

Morgan Comment Letter at 5 (Mar. 8, 2011); Reuters Comment Letter at

3 (Mar. 8, 2011); Tradeweb Comment Letter at 7 (Mar. 8, 2011); FSR

Comment Letter at 3 (Mar. 8, 2011); MetLife Comment Letter at 3

(Mar. 8, 2011); SIFMA AMG Comment Letter at 5 (Mar. 8, 2011);

Deutsche Comment Letter at 4 (Mar. 8, 2011); MarketAxess Comment

Letter at 31 (Mar. 8, 2011); ISDA/SIFMA Comment Letter at 3 (Mar. 8,

2011); Global FX Comment Letter at 3 (Mar. 8, 2011); Goldman Comment

Letter at 2 (Mar. 8, 2011); TruMarx Comment Letter at 6 (Mar. 8,

2011).

\244\ Morgan Stanley Comment Letter at 2 (Mar. 2, 2011).

\245\ MetLife Comment Letter at 3 (Mar. 8, 2011).

\246\ Core Principles and Other Requirements for Swap Execution

Facilities, 76 FR at 1259.

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

Other commenters, however, stated that an RFQ should be transmitted

to all participants on the SEF.\247\ Mallers et al. stated that

participants would not be disadvantaged by disclosing an RFQ to the

entire market for transactions below

[[Page 33496]]

the block trade threshold, which would not move the market.\248\ In

their view, the five market participant requirement would allow a

participant to conduct semi-private deals with a few favored

participants to the exclusion of other market participants, which would

ultimately decrease liquidity and create a substantial barrier to entry

to the swaps market.\249\ On the other hand, SDMA supported the five

market participant requirement.\250\ In its view, this requirement

promotes price discovery and liquidity, whereas the single market

participant model facilitates abusive trading practices, such as pre-

arranged trading and ``painting the screen'' (i.e., posting of non-

competitive quotes to confuse the market).\251\

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

\247\ IECA Comment Letter at 3 (May 24, 2011); Mallers et al.

Comment Letter at 4-5 (Mar. 21, 2011); Better Markets Comment Letter

at 9 (Mar. 8, 2011); AFR Comment Letter at 4-5 (Mar. 8, 2011).

\248\ Mallers et al. Comment Letter at 4 (Mar. 21, 2011).

\249\ Id.

\250\ SDMA Comment Letter at 3 (Mar. 8, 2011). See also Better

Markets Comment Letter at 2 (Apr. 12, 2013) and Allston et al.

Comment Letter at 1 (Feb. 28, 2013).

\251\ SDMA Comment Letter at 5 (Feb. 28, 2013); SDMA Comment

Letter at 3 (Mar. 8, 2011).

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

(ii) Comments on ``Taken Into Account and Communicated'' Language in

the RFQ System Definition

Some commenters recommended that the Commission delete the

requirement that resting orders be ``taken into account and

communicated'' to the RFQ requester.\252\ FXall and Barclays stated

that this requirement is not necessary because the RFQ requester

already has the ability to view the resting orders on the SEF's minimum

trading functionality or Order Book.\253\ Several commenters stated

that this requirement is mandating that SEFs offer RFQ systems in

conjunction with the SEF's minimum trading functionality, which is not

required.\254\ Similarly, JP Morgan stated that the resting order

functionality is not mandated by the statute.\255\

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

\252\ Tradeweb Comment Letter at 5 (Jun. 3, 2011); JP Morgan

Comment Letter at 5-6 (Mar. 8, 2011); FXall Comment Letter at 9-10

(Mar. 8, 2011); SIFMA AMG Comment Letter at 9 (Mar. 8, 2011);

Barclays Comment Letter at 7 (Mar. 8, 2011); Tradeweb Comment Letter

at 6 (Mar. 8, 2011).

\253\ FXall Comment Letter at 9 (Mar. 8, 2011); Barclays Comment

Letter at 7 (Mar. 8, 2011).

\254\ ISDA/SIFMA Comment Letter at 5-6 (Mar. 8, 2011); FXall

Comment Letter at 4 (Mar. 8, 2011); MarketAxess Comment Letter at 33

(Mar. 8, 2011); SIFMA AMG Comment Letter at 4 (Mar. 8, 2011).

\255\ JP Morgan Comment Letter at 5 (Mar. 8, 2011).

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

Several commenters requested clarification regarding the

interaction between resting bids and offers and the RFQ system.\256\

Some commenters thought that the ``taken into account and

communicated'' language should mean that a SEF must only communicate to

the RFQ requester the resting bids and offers, and that the RFQ

requester has sole discretion to either respond to, or ignore, these

resting bids and offers.\257\ ISDA/SIFMA and SIFMA AMG requested

clarification that the resting bids and offers do not include

indicative prices.\258\ Several commenters also stated that SEFs should

not be required to inform the providers of resting bids and offers of

the RFQs; otherwise, the RFQ system would be subject to market abuse by

opportunistic third parties seeking market information, and the

requirement would open up RFQs beyond the minimum number of

participants.\259\

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

\256\ Reuters Comment Letter at 1 (Jun. 13, 2012); Rosen et al.

Comment Letter at 12-14 (Apr. 5, 2011); JP Morgan Comment Letter at

5-6 (Mar. 8, 2011); FXall Comment Letter at 9-10 (Mar. 8, 2011);

Tradeweb Comment Letter at 8 (Mar. 8, 2011); FSR Comment Letter at 5

(Mar. 8, 2011); MetLife Comment Letter at 3 (Mar. 8, 2011); SIFMA

AMG Comment Letter at 9 (Mar. 8, 2011); MarketAxess Comment Letter

at 32 (Mar. 8, 2011); Barclays Comment Letter at 7 (Mar. 8, 2011);

ABC/CIEBA Comment Letter at 6-7 (Mar. 8, 2011); ISDA/SIFMA Comment

Letter at 3-4; Evolution Comment Letter at 5-6 (Mar. 8, 2011).

\257\ JP Morgan Comment Letter at 5-6 (Mar. 8, 2011); FSR

Comment Letter at 5 (Mar. 8, 2011); MetLife Comment Letter at 3

(Mar. 8, 2011); SIFMA AMG Comment Letter at 9 (Mar. 8, 2011);

MarketAxess Comment Letter at 32 (Mar. 8, 2011); ABC/CIEBA Comment

Letter at 6-7 (Mar. 8, 2011); ISDA/SIFMA Comment Letter at 3-4 (Mar.

8, 2011); Evolution Comment Letter at 5-6 (Mar. 8, 2011).

\258\ ISDA/SIFMA Comment Letter at 3-4 (Mar. 8, 2011); SIFMA AMG

Comment Letter at 9 (Mar. 8, 2011).

\259\ FXall Comment Letter at 9-10 (Mar. 8, 2011); ISDA/SIFMA

Comment Letter at 3-4 (Mar. 8, 2011); SIFMA AMG Comment Letter at 9

(Mar. 8, 2011). FSR also commented that the provider of the resting

bid should not be provided with information about the identity of

the RFQ requester. FSR Comment Letter at 5 (Mar. 8, 2011).

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

(iii) Comments on RFQ Disclosure Issues

AFR and Better Markets stated that SEFs should be required to

disclose RFQ responses to all market participants.\260\ For example,

AFR commented that responses to RFQs should be made transparent to all

market participants prior to trade execution, which would serve the

statutory goal of pre-trade price transparency and would increase price

competition.\261\ Several commenters objected to the recommendation by

AFR and Better Markets.\262\ Some of these commenters noted that such a

requirement could raise the same information leakage concerns as with

the five market participant requirement.\263\

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

\260\ AFR Comment Letter at 3 (Feb. 27, 2013); AFR Comment

Letter at 5 (Mar. 8, 2011); Better Markets Comment Letter at 8 (Mar.

8, 2011).

\261\ AFR Comment Letter at 5 (Mar. 8, 2011).

\262\ Rosen et al. Comment Letter at 14 (Apr. 5, 2011);

MarketAxess Comment Letter at 32 (Mar. 8, 2011); Barclays Comment

Letter at 10 (Mar. 8, 2011); Tradeweb Comment Letter at 7-8 (Mar. 8,

2011); State Street Comment Letter at 4 (Mar. 8, 2011); Deutsche

Comment Letter at 4 (Mar. 8, 2011).

\263\ Tradeweb Comment Letter at 7 (Mar. 8, 2011); State Street

Comment Letter at 4 (Mar. 8, 2011); Deutsche Comment Letter at 4

(Mar. 8, 2011).

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

FSR commented that market participants receiving the RFQ should

have relevant information about the identity of the RFQ requester.\264\

However, Tradeweb commented that the Commission should not impose a

specific requirement that the identity of the RFQ requester be

disclosed or anonymous.\265\ FSR also stated that SEFs should not be

required to publish RFQs until after the trade has been completed, and

then only as part of aggregated disclosures.\266\ Finally, State Street

requested that the Commission clarify that an RFQ System is not

required to provide functionality to make RFQs visible to the entire

market, although it may voluntarily choose to do so.\267\

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

\264\ FSR Comment Letter at 3 (Mar. 8, 2011).

\265\ Tradeweb Comment Letter at 8 (Mar. 8, 2011).

\266\ FSR Comment Letter at 3 (Mar. 8, 2011).

\267\ State Street Comment Letter at 4 (Mar. 8, 2011).

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

(2) Commission Determination

Based on the comments, the Commission is adopting proposed Sec.

37.9(a)(1)(ii) as final Sec. 37.9(a)(3), subject to a number of

modifications discussed below.\268\

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

\268\ The Commission is renumbering proposed Sec.

37.9(a)(1)(ii) to Sec. 37.9(a)(3).

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

(i) RFQ System Definition and Transmission to Five Market Participants

The Commission is adopting the definition of RFQ System in proposed

Sec. 37.9(a)(1)(ii)(A), subject to certain modifications described

below. As explained in the SEF NPRM, the Commission believes that an

RFQ System, as defined in Sec. 37.9, operating in conjunction with a

SEF's minimum trading functionality (i.e., Order Book) is consistent

with the SEF definition and promotes the goals provided in section 733

of the Dodd-Frank Act, which are to: (1) Promote the trading of swaps

on SEFs and (2) promote pre-trade price transparency in the swaps

market.\269\ The Commission notes that the RFQ System definition

requires SEFs to provide market participants the ability to access

multiple market participants, but not necessarily the entire market, in

conformance with the SEF definition.

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

\269\ Core Principles and Other Requirements for Swap Execution

Facilities, 76 FR at 1220-21.

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

The Commission agrees with SDMA that the proposed five market

[[Page 33497]]

participant requirement would promote pre-trade price transparency, as

the RFQ requester would be required to solicit executable orders, on a

pre-trade basis, from a larger group of potential responders.\270\ A

broader group of potential responders, in turn, encourages price

competition between the potential responders to the RFQ and may provide

a more reliable assessment of market value than SEF functionality that

would permit a market participant to rely on a quote from a single RFQ

requestee. The Commission nevertheless recognizes commenters' concerns

about the proposed five market participant requirement, such as the

potential for increased trading costs and information leakage to the

non-executing market participants in the RFQ. To address these

concerns, while still complying with the multiple-to-multiple

requirement in the statutory SEF definition and promoting the goals of

pre-trade price transparency and trading of swaps on SEFs provided in

section 733 of the Dodd-Frank Act, the Commission is requiring that a

market participant transmit an RFQ to no less than two market

participants during a phase-in compliance period and, subsequent to

that period, to no less than three market participants.\271\ The

Commission believes, as noted above, that sending an RFQ to a greater

number of market participants increases the potential for price

competition among responders and provides a more reliable assessment of

market value. The Commission also believes that the three market

participant requirement, with the two market participant phase-in

period, appropriately balances the benefits of pre-trade price

transparency and the information leakage concerns raised by commenters.

The revision from five to three minimum market participants will also

provide market participants with greater flexibility in sending RFQs

for Required Transactions, while still complying with the statutory SEF

definition and promoting pre-trade price transparency.

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

\270\ The Commission notes that a SEF market participant may

send an RFQ to the entire market. See id. at 1220 and discussion

below. The Commission also notes that there are generally two

distinct differences between the requirements finalized in this

release and the RFQ-type functionality offered by DCMs. First, RFQ

functionality used by DCMs disseminates RFQs to all market

participants. Second, the responses to the RFQs take the form of

executable bids or offers that are entered into the DCM's order book

or other centralized market, such that orders from any market

participant, not just the one submitting the RFQ, can be matched

against such responsive bids or offers. Although the Commission

considered a minimum RFQ-to-all requirement similar to the current

practice in DCMs, given that swaps tend to be less standardized than

futures, the Commission believes that rules pertaining to the

execution methods for SEFs should provide appropriate flexibility

for market participants trading swaps. The Commission notes that the

less restrictive minimum market participant requirement established

by part 37 reflects the more flexible statutory provisions for SEFs

as compared to DCMs.

\271\ The Commission clarifies that the three market participant

requirement does not imply any requirement that the requested market

participants operate in any particular manner, such as a requirement

that such participants be dedicated liquidity providers or market

makers in the particular swap. The RFQ requester may send the RFQ to

any three market participants on the RFQ system, subject to the

affiliate prohibition discussed below. See supra footnote 234 for

further details.

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

The Commission has also determined to clarify that the market

participants required for inclusion in an RFQ in all cases may not be

affiliated with or controlled by the RFQ requester and may not be

affiliated with or controlled by each other, and is revising final

Sec. 37.9(a)(3) to clarify this point.\272\ For an RFQ requester to

send an RFQ to another entity who is affiliated with or controlled by

the RFQ requester is inconsistent with the purpose of requiring that

RFQs be sent to more than one market participant, as explained both in

the SEF NPRM and this release. The Commission notes that if an RFQ is

transmitted to one non-affiliate and two affiliates of the requester or

if an RFQ is transmitted to three requestees who are affiliates of each

other, then the policy objective of promoting the goal of pre-trade

price transparency and complying with the multiple-to-multiple

requirement in the SEF definition could be undermined. The Commission

is also concerned that such an outcome could disincentivize entities

from responding to an RFQ, which would reduce price competition and

liquidity.

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

\272\ The Commission notes that ``affiliate'' means: (i) One

party, directly or indirectly, holds a majority ownership interest

in the other party, and the party that holds the majority interest

in the other party reports its financial statements on a

consolidated basis under Generally Accepted Accounting Principles or

International Financial Reporting Standards, and such consolidated

financial statements include the financial results of the majority-

owned party; or (ii) a third party, directly or indirectly, holds a

majority ownership interest in both parties, and the third party

reports its financial statements on a consolidated basis under

Generally Accepted Accounting Principles or International Financial

Reporting Standards, and such consolidated financial statements

include the financial results of both of the parties. A party 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.

See Commission regulation 50.52.

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

The Commission believes, moreover, that the three market

participant requirement is consistent with current market practice

where, in certain markets, many market participants already choose to

send an RFQ to multiple market participants. Tradeweb, for example,

noted that in its experience in the U.S. Treasuries market, market

participants on average send an RFQ to three market participants.\273\

In addition, the Commission understands that many pension and other

managed funds with fiduciary obligations routinely obtain quotes from

at least three market participants in certain securities markets. The

Commission believes that the three market participant requirement, with

the two market participant transition period, supports a common

industry practice of querying multiple market participants, while still

complying with the statutory SEF definition and promoting the goals

provided in section 733 of the Dodd-Frank Act.

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

\273\ Tradeweb Comment Letter at 7 (Mar. 8, 2011).

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

Furthermore, the Commission believes that the three minimum market

participant requirement heightens the probability that multiple

participants will respond to an RFQ and, thus, will facilitate the

pricing improvements attendant to competition among RFQ responders. The

Commission is aware of numerous legal, business, and technological

issues that could prevent a market participant from responding to a

specific RFQ. The Commission notes, for example, that DCM market maker

programs often require participants to quote two-sided markets for 75

to 85 percent of the trading day.\274\ Therefore, a participant in the

market maker program may not provide quotes for a portion of the

trading day. While there is no guarantee that even a minimum market

participant requirement will ensure that multiple responses are

available for all RFQs, it increases the probability that the goal of

pre-trade price transparency is achieved and that a competitive market

exists for all market participants.

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

\274\ The Commission understands that such provisions are in

place to accommodate various operational and other reasons that

could cause a market participant to not comply with the quoting

obligations.

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

Finally, the Commission believes that setting the minimum RFQ

requirement at a uniform number for all Required Transactions in all

asset classes provides regulatory and market efficiencies and is

appropriate for the SEF market structure at this particular time. SEFs

and market participants will benefit from a clear and uniform standard

that would not require them to be subject to different minimum RFQ

requirements, and to monitor compliance with such requirements, for

every swap or class of swaps subject to

[[Page 33498]]

the CEA section 2(h)(8) trade execution requirement.

For the reasons discussed above, at this time, the Commission

believes that the three market participant requirement implements the

multiple-to-multiple requirement in the statutory SEF definition and

will create an appropriate level of pre-trade price transparency for

Required Transactions (i.e., transactions involving swaps that are

subject to the trade execution mandate of section 2(h)(8) of the CEA)

for market participants initiating RFQs. However, the Commission is

also aware of the fact that a phased implementation of this requirement

will assist market participants and prospective SEFs to make an

efficient transition from the swap industry's current market structure

to the more transparent execution framework set forth in these final

rules. Therefore, to provide market participants, SEFs, and the swaps

industry with time to adapt to the new SEF regime, the Commission is

phasing-in the three market participant requirement. From the effective

date of the final SEF regulations until one year from the compliance

date of these final regulations, a market participant transmitting an

RFQ for Required Transactions under Sec. 37.9(a)(2) must still comply

with the RFQ definition in Sec. 37.9(a)(3), but may transmit the quote

to no less than two market participants.\275\

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

\275\ The Commission notes that the affiliate prohibition in

Sec. 37.9(a)(3) applies during the interim RFQ-to-2 period.

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

Some comments expressed support for the SEC's SB-SEF proposal,

which allows for one-to-one RFQs. If the Commission eliminated the

multiple market participant requirement and instead permitted RFQ

requesters to send RFQs to a single market participant, then the

multiple-participant-to-multiple-participant requirement in the SEF

definition and the pre-trade price transparency goal would be

undermined. In this regard, the Commission notes that while the SEC's

SB-SEF proposal allows for one-to-one RFQs, it proposed to fulfill the

multiple to multiple requirement by mandating full order interaction or

best execution for RFQs.\276\ Under the SEC's SB-SEF proposal, an RFQ

requester must execute against the best priced orders of any size

within and across a SEF's modes of execution, a requirement that the

Commission is not recommending at this time.\277\

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

\276\ Registration and Regulation of Security-Based Swap

Execution Facilities, 76 FR at 10953-54, 10971-74.

\277\ Id.

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

The Commission notes that some commenters expressed concerns about

the risks with respect to information leakage for illiquid swaps or

large-size trades, and the potential risk of a winner's curse for the

market participant whose quote is accepted by the RFQ requester.

According to the commenters, the other market participants in the RFQ

will be aware of the RFQ, and some or all of those participants will

attempt to front-run the trades by the winning responder to hedge or

layoff the risk from the RFQ transaction.\278\

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

\278\ To the extent such risks potentially exist for Required

Transactions, the reduction of the minimum market participant

requirement from the proposed five will help mitigate this risk.

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

With respect to commenters' concerns about the potential winner's

curse for illiquid swaps, the Commission clarifies that the minimum

market participant requirement only applies to RFQ Systems for Required

Transactions (i.e., transactions involving swaps that are subject to

the trade execution mandate of section 2(h)(8) of the CEA); such swaps

generally should be more liquid than swaps that are not subject to the

trade execution mandate because they are subject to the clearing

mandate of section 2(h)(1) of the CEA and are made available to

trade.\279\ In this regard, the Commission notes that the interest rate

swaps and credit default swaps that the Commission has determined are

required to be cleared under CEA section 2(h)(1) (and are likely to be

subject to the trade execution mandate of CEA section 2(h)(8)) are some

of the most liquid swaps.\280\ The Commission also notes that 77 swap

dealers have registered with the Commission and nearly all of them make

markets in such swaps.\281\ Further, SEFs may offer RFQ systems without

the three market participant requirement for Permitted Transactions

(i.e., transactions not involving swaps that are subject to the trade

execution mandate of section 2(h)(8) of the CEA).

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

\279\ Clearing Requirement Determination Under Section 2(h) of

the CEA, 77 FR 74284 (Dec. 13, 2012); Process for a Designated

Contract Market or Swap Execution Facility To Make a Swap Available

To Trade, 76 FR 77728 (proposed Dec. 14, 2011).

\280\ Clearing Requirement Determination Under Section 2(h) of

the CEA, 77 FR 74284. The Commission notes that these swaps already

went through a Commission determination process that included a five

factor review, including a liquidity review. Id. ISDA, in its letter

requesting interpretive relief regarding the obligation to provide a

pre-trade mid-market mark, recognized that many of the swaps that

the Commission has determined are required to be cleared under CEA

section 2(h)(1) are ``highly-liquid, exhibit narrow bid-ask spreads

and are widely quoted by SD/MSPs in the marketplace . . . '' ISDA

Comment Letter at 2 (Nov. 30, 2012).

\281\ The Commission recognizes that not all swap dealers will

be active in all Required Transactions. The Commission also notes

that of the 77 currently registered swap dealers, 35 swap dealers

are not affiliated with any other swap dealers.

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

With respect to commenters' concerns about the potential winner's

curse for large-sized trades, the Commission notes that block trades

would not be subject to the execution methods for Required

Transactions, including the three market participant requirement.\282\

Therefore, excluding block trades from the execution methods for

Required Transactions will address the potential risk of a winner's

curse for such trades. The Commission also clarifies that SEFs are not

required to display a requester's RFQ to market participants not

participating in the RFQ.\283\

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

\282\ See definition of block trade in Sec. 43.2 of the

Commission's regulations.

\283\ Similarly, as noted below, SEFs are not required to

display responses to an RFQ to anyone but the RFQ requester.

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

The Commission believes, in response to commenters' concerns about

increased trading costs, that an increased number of participants

receiving and responding to RFQs will tighten the bid-ask spreads, and

result in lower transaction costs for market participants. The

Commission notes that the relationship between spreads and the industry

practice for the minimum number of RFQ recipients will vary across

swaps and over time. Further, the Commission believes that as SEFs

compete to grow their swaps trading volumes and deliver improved

liquidity and lower transaction costs for their customers, the final

rules in this release will provide them with the flexibility to

experiment with different minimum numbers of recipients that is higher

than the minimum articulated in this regulation. The final RFQ

requirement will provide some protection to RFQ requesters that at

least a minimum number of market participants will receive their RFQs,

and thus increase the likelihood of receiving multiple, competitive

quotes.

Finally, the Commission is deleting the additional definition of

RFQ System in proposed Sec. 37.9(a)(1)(ii)(B) because it is

unnecessary.\284\ A SEF that chooses to offer an RFQ System to

facilitate Required Transactions is required to offer the RFQ System in

conjunction with the SEF's Order Book, which would encompass the

requirements in proposed Sec. 37.9(a)(1)(ii)(B)(1) and

[[Page 33499]]

(2)(i).\285\ Additionally, a market participant is already required to

send an RFQ to three market participants, which would also be the case

if it is based upon an indicative quote as stated in proposed Sec.

37.9(a)(1)(ii)(B)(2)(ii).\286\

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

\284\ The Commission is also deleting the catch-all RFQ

definition in proposed Sec. 37.9(a)(1)(ii)(C) as it is unnecessary.

As discussed below, a SEF may petition the Commission under Sec.

13.2 to amend Sec. 37.9(a)(2) to include additional execution

methods for Required Transactions. See discussion below under Sec.

37.9(b)(1) and (b)(4)--Execution Methods for Required Transactions

in the preamble.

\285\ See discussion below under Sec. 37.9(b)(1) and (b)(4)--

Execution Methods for Required Transactions in the preamble. As

noted above in the registration section, a SEF is not required to

offer indicative quotes.

\286\ Id.

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

(ii) ``Taken Into Account and Communicated'' Language in the RFQ System

Definition

To address commenters' concern that the SEF NPRM was ambiguous with

respect to the communication requirement, the Commission is modifying

the definition of RFQ System in proposed Sec. 37.9(a)(1)(ii)(A) to

state that a SEF must provide the RFQ requester: (1) With any firm

resting bid or offer in the same instrument from any of the SEF's Order

Books at the same time as the first responsive bid or offer is received

by the RFQ requester and (2) with the ability to execute against such

firm resting bids or offers along with the responsive orders.\287\ For

example, a market participant transmits an RFQ to three market

participants to buy a US $1 million notional 10-year fixed-to-floating

US$ LIBOR interest rate swap. Any firm offer resting on the SEF's Order

Book for a 10-year fixed-to-floating US$ LIBOR interest rate swap must

be transmitted to the RFQ requester at the same time that the first

responsive offer is received by the RFQ requester. The SEF must provide

the RFQ requester with the ability to lift the firm offers and execute

against any of the responsive orders. The final rule requires that SEFs

communicate any resting bid or offer pertaining to the same instrument

back to the RFQ requester, while the requester retains the discretion

to decide whether to execute against the resting bids or offers or

responsive orders.

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

\287\ The Commission is renumbering proposed Sec.

37.9(a)(1)(ii)(A) to Sec. 37.9(a)(3). The Commission notes that

after the RFQ responses and resting bids or offers on the Order Book

are communicated to the RFQ requester, the RFQ requester may make a

counter request or order as long as it is submitted to 3 market

participants, whether it be to the same 3 market participants as the

original RFQ request, 3 different market participants, or some

combination of both.

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

Similar to the three market participant requirement, the Commission

believes that the communication requirement promotes pre-trade price

transparency and the trading of swaps on SEFs, as the RFQ requester

will have the ability to access competitive quotes and quote providers

will be able to have their quotes viewed by the RFQ requester. The

Commission also clarifies that the resting bids and offers being

communicated are not required to include indicative prices, to the

extent that indicative prices are facilitated by the Order Book, and

that SEFs are not required to inform the providers of the resting bids

and offers on the Order Book of the RFQs.

(iii) RFQ Disclosure Issues

The Commission is clarifying that SEFs are not required to disclose

responses to RFQs to all market participants. While the Commission

understands that the RFQ functionality offered by some DCMs

disseminates responses to RFQs to all market participants, it also

notes that the less restrictive disclosure requirement for SEFs

reflects the more flexible statutory provisions for SEFs as compared to

DCMs. As noted in the SEF NPRM, a market participant may access fewer

market participants than the entire market in certain situations.\288\

In response to FSR's and Tradeweb's comments about the identity of the

RFQ requester, the Commission clarifies that it is not imposing a

specific requirement that the identity of the RFQ requester be

disclosed or anonymous. The Commission is also not providing a specific

requirement regarding the publishing of the ``request'' for a quote and

notes that SEFs must comply with all reporting obligations as required

in the Act and Commission's regulations. Finally, as noted in the SEF

NPRM, acceptable RFQ Systems must permit RFQ requesters the option to

make an RFQ visible to the entire market.\289\

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

\288\ Core Principles and Other Requirements for Swap Execution

Facilities, 76 FR at 1220 (stating that market participants may

desire to interact with a limited number of market participants

(i.e., fewer than the entire market) and are permitted to do so

under the proposal).

\289\ Id.

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

(iv) Other RFQ Issues

As noted in the SEF NPRM, an acceptable RFQ System may allow for a

transaction to be consummated if the original request to five potential

counterparties receives fewer than five responses.\290\ Although the

Commission received no comment letters on this issue, some commenters

in meetings asked the Commission to clarify the amount of time required

to elapse before the RFQ requester can execute against the responsive

quotes since fewer than five responses may be received. As such, the

Commission is modifying the RFQ System definition in final Sec.

37.9(a)(3) to state that a SEF must ensure that its trading protocols

provide each of its market participants with equal priority in

receiving requests for quotes and in transmitting and displaying for

execution responsive orders. The SEF does not need to establish a

minimum latency or specific period of time for the transmission of

responsive orders, provided that the SEF's rulebook and prohibition on

transmission and display priorities are appropriately designed to

prevent market participants from seeking to avoid the three market

participant requirement. A SEF's RFQ System and rulebook must account

for this prohibition.

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

\290\ Id.

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

(c) Sec. 37.9(a)(1)(iii)--Voice-Based System

Proposed Sec. 37.9(a)(1)(iii) defined Voice-Based System as a

trading system or platform in which a market participant executes or

trades a Permitted Transaction using a telephonic line or other voice-

based service.

(1) Commission Determination

The Commission did not receive any comments on the definition of

Voice-Based System. However, the Commission is deleting the definition

of Voice-Based System in proposed Sec. 37.9(a)(1)(iii) given its

decision below to allow SEFs to provide any execution method for

Permitted Transactions.

(d) Sec. Sec. 37.9(b)(1) and (b)(4)--Execution Methods for Required

Transactions

Proposed Sec. 37.9(b)(1) stated that Required Transactions may be

executed on an Order Book or an RFQ System. As noted in the SEF NPRM, a

SEF must offer the minimum trading functionality in proposed Sec.

37.9(b)(2) (i.e., a centralized electronic screen with the ability to

post both firm and indicative quotes visible to all market

participants).\291\ Therefore, the SEF NPRM provided that Required

Transactions must be executed through the SEF's minimum trading

functionality, Order Book that meets the minimum trading functionality,

or RFQ System that operates in conjunction with the minimum trading

functionality.\292\ The SEF NPRM made it clear that for Required

Transactions, pre-trade transparency must be met.\293\ Additionally,

proposed Sec. 37.9(b)(4) stated that the Commission may, in its

discretion, require a SEF to offer a different trading method for a

particular swap.

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

\291\ Id. at 1219-20.

\292\ Id.

\293\ Id. at 1220.

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

For Required Transactions, the SEF NPRM did not provide for a

specific

[[Page 33500]]

execution method incorporating voice. The proposal stated that trading

systems or platforms facilitating the execution of Required

Transactions via voice exclusively are not multiple participant to

multiple participant and do not provide for pre-trade price

transparency.\294\ However, the SEF NPRM noted that, while not

acceptable as the sole method of execution for Required Transactions,

voice would be appropriate under certain circumstances such as for a

market participant to communicate an order to a SEF's employee or for a

SEF's employee to assist a market participant in executing a

trade.\295\ The SEF NPRM stated that the core principles and the

Commission's regulations would fully apply to such communications,

including, but not limited to, transparency, audit trail, impartial

access, and standards for RFQs.\296\

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

\294\ Id. at 1221.

\295\ Id.

\296\ Id.

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

Although the SEF NPRM did not provide for a specific execution

method incorporating voice for Required Transactions, it did

contemplate the possibility of certain functionalities that operate in

conjunction with the SEF's minimum trading functionality.\297\ In this

regard, the SEF NPRM stated that, in addition to the SEF's minimum

trading functionality, a SEF may offer other functionalities that

provide multiple participants with the ability to access multiple

participants, but not necessarily the entire market, if the market

participant so chooses.\298\ The SEF NPRM noted that certain defined

RFQ Systems or other systems that meet the SEF definition and comply

with the core principles applicable to SEFs may qualify.\299\

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

\297\ Id. at 1220.

\298\ Id.

\299\ Id.

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

(1) Summary of Comments

(i) Comments on Execution Methods for Required Transactions

Some commenters supported the use of order books for Required

Transactions.\300\ For example, Mallers et al. contended that a central

order book market structure for all Required Transactions provides the

most accurate valuation of the market, reduces systemic risks, and

results in better prices.\301\ Other commenters supported the use of

order book structures and RFQ models for Required Transactions.\302\

SDMA, for example, stated that all cleared swaps should be executed

through a central limit order book or an RFQ System.\303\

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

\300\ Mallers et al. Comment Letter at 3 (Mar. 21, 2011); Better

Markets Comment Letter at 5-6 (Mar. 8, 2011); AFR Comment Letter at

4 (Mar. 8, 2011). Similarly, SDMA supports the sole use of order

books for certain products. SDMA Comment Letter at 2 (Apr. 30,

2013).

\301\ Mallers et al. Comment Letter at 3 (Mar. 21, 2011).

\302\ Tradeweb Comment Letter at 4 (Jun. 3, 2011); SDMA Comment

Letter at 2 (Mar. 8, 2011); Deutsche Comment Letter at 3 (Mar. 8,

2011); MFA Comment Letter at 5-6 (Mar. 8, 2011); MetLife Comment

Letter at 2 (Mar. 8, 2011); Barclays Comment Letter at 4 (Mar. 8,

2011); Bloomberg Comment Letter at 2 (Mar. 8, 2011); BlackRock

Comment Letter at 4-5 (Mar. 8, 2011).

\303\ SDMA Comment Letter at 2 (Mar. 8, 2011).

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

Nodal recommended that the Commission explicitly include blind

auctions as an acceptable method of execution for Required

Transactions.\304\ Nodal commented \305\ that pre-trade transparency

for Required Transactions should not apply to blind auctions.\306\

Nodal articulated its view that the twin goals of pre-trade

transparency and promoting on-exchange trading of swaps on SEFs should

be balanced against each other, instead of being read in conjunction

with one another.\307\

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

\304\ Nodal Comment Letter at 3 (Mar. 8, 2011).

\305\ Id. at 2-3; Nodal Comment Letter at 3 (Jun. 3, 2011).

\306\ See discussion above under Sec. 37.3--Requirements for

Registration in the preamble for a description of Nodal's blind

auction.

\307\ Nodal Comment Letter at 2 (Mar. 8, 2011).

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

(ii) Comments on ``Through Any Means of Interstate Commerce'' Language

in the SEF Definition

Given the phrase ``through any means of interstate commerce'' in

the CEA section 1a(50) SEF definition, many commenters supported the

use of multiple methods of execution, such as voice, for Required

Transactions on a SEF.\308\ JP Morgan, for example, stated that the SEF

NPRM assumes that SEFs will always be electronic platforms, which it

contended, appears to directly contradict the phrase ``through any

means of interstate commerce'' in the SEF definition.\309\ According to

WMBAA, the phrase ``through any means of interstate commerce'' in the

SEF definition supports multiple methods of execution for Required

Transactions on a SEF, including a combination of voice and electronic

systems.\310\ In this regard, WMBAA stated that the Commission should

allow any execution method for Required Transactions as long as it

meets the multiple participant to multiple participant requirement in

the SEF definition and the other statutory requirements for SEFs.\311\

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

\308\ Representative Scott Garrett Comment Letter at 1 (Feb. 27,

2013); WMBAA Comment Letter at 2-3 (Jul. 18, 2011); WMBAA Comment

Letter at 6-8 (Jun. 3, 2011); Rosen et al. Comment Letter at 15

(Apr. 5, 2011); JP Morgan Comment Letter at 6 (Mar. 8, 2011); WMBAA

Comment Letter at 4-6 (Mar. 8, 2011); ICAP Comment Letter at 3, 4-5

(Mar. 8, 2011); ISDA/SIFMA Comment Letter at 4-5 (Mar. 8, 2011); CME

Comment Letter at 7-8 (Mar. 8, 2011).

\309\ JP Morgan Comment Letter at 6 (Mar. 8, 2011).

\310\ WMBAA Comment Letter at 2 (Jul. 18, 2011).

\311\ WMBAA Comment Letter at 5 (Mar. 8, 2011).

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

Furthermore, some members of the industry requested that the

Commission clarify in the final rules whether ``work-up'' sessions

would be considered an acceptable method of execution for Required

Transactions.\312\ GFI explained one example of a work-up session

where, after a trade is executed on an order book, one of the

counterparties to the trade may wish to buy or sell additional

quantities of the same instrument at the previously executed

price.\313\ In this case, the parties initiate a work-up session to

execute such additional quantity.\314\ After the initial counterparty

exercises its right of first refusal, other market participants may

also join in the trade at the previously executed price.\315\

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

\312\ Meetings with ICAP dated Mar. 21, 2012, Mar. 9, 2012, Feb.

16, 2012, Feb. 14, 2012; Meetings with GFI dated Mar. 14, 2012, Feb.

16, 2012; Meeting with WMBAA dated Feb. 16, 2012; ICAP Comment

Letter at 4 (Mar. 8, 2011).

\313\ Meetings with GFI dated Mar. 14, 2012, Feb. 16, 2012.

\314\ Id.

\315\ Id.

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

(iii) Comments on Liquidity-Based Execution Mandates

Several commenters stated that the Dodd-Frank Act does not require

certain methods of trading, such as an order book, based upon the

amount of trading activity in a particular instrument.\316\ MarketAxess

contended that nothing in the Dodd-Frank Act supports the requirement

in proposed Sec. 37.9(b)(4) that methods of execution on a SEF should

be based upon characteristics of a particular swap.\317\ MarketAxess

stated that such a requirement would create uncertainty regarding a

SEF's operational structure \318\ and, according to Tradeweb, would

likely decrease the trading activity and liquidity of those swaps

subject to the requirement.\319\ On the other hand, AFR contended that

mandatorily cleared swaps meeting a certain level of trading activity

should

[[Page 33501]]

only be traded through order book systems.\320\

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

\316\ Rosen et al. Comment Letter at 10 (Apr. 5, 2011); Barclays

Comment Letter at 11 (Mar. 8, 2011); ISDA/SFMA Comment Letter at 5

(Mar. 8, 2011); Tradeweb Comment Letter at 6 (Mar. 8, 2011);

MarketAxess Comment Letter at 33 (Mar. 8, 2011).

\317\ MarketAxess Comment Letter at 33 (Mar. 8, 2011).

\318\ Id.

\319\ Tradeweb Comment Letter at 6 (Mar. 8, 2011).

\320\ AFR Comment Letter at 5-6 (Mar. 8, 2011).

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

(2) Commission Determination

(i) Execution Methods for Required Transactions

The Commission is revising proposed Sec. 37.9(b)(1) as final Sec.

37.9(a)(2) to clarify that each Required Transaction that is not a

block trade as defined in Sec. 43.2 of the Commission's regulations

shall be executed on a SEF in accordance with one of the following

methods of execution: (1) An Order Book as defined in Sec. 37.3(a)(3)

or (2) an RFQ System, as defined in Sec. 37.9(a)(3), that operates in

conjunction with an Order Book.\321\ As explained in this final

rulemaking, the Commission believes that these execution methods are

consistent with the SEF definition and promote the goals provided in

section 733 of the Dodd-Frank Act. The Commission notes, however, that

a SEF may petition the Commission under Sec. 13.2 of the Commission's

regulations to amend Sec. 37.9(a)(2) to include additional execution

methods.\322\ This ability of SEFs to petition the Commission replaces

similar provisions in the SEF NPRM that were included in the Order Book

and RFQ System definitions and provides SEFs with additional

flexibility as existing execution methods evolve or new methods are

developed.\323\

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

\321\ The Commission is renumbering proposed Sec. 37.9(b)(1) to

Sec. 37.9(a)(2).

\322\ See 17 CFR 13.2 for further details. This will allow the

Commission to consider if a broader model for executing on SEFs,

consistent with the suggestion in Commissioner Sommers' dissent,

would be appropriate on a case-by-case basis, in conformance with

the CEA and the Commission's regulations. Core Principles and Other

Requirements for Swap Execution Facilities, 76 FR at 1259.

\323\ See proposed Sec. 37.9(a)(1)(i)(D) and Sec.

37.9(a)(1)(ii)(C).

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

In keeping with the statutory instruction that the Dodd-Frank Act

goal of SEFs is to both ``promote the trading of swaps on swap

execution facilities and to promote pre-trade price transparency in the

swaps market'' \324\ (emphasis added), the Commission is reaffirming

its view articulated in the SEF NPRM that these goals can be achieved

for Required Transactions by providing for the execution of such

transactions on trading systems or platforms that allow market

participants to post bids and offers or accept bids and offers that are

transparent to the entire market.\325\ Promoting trading on a SEF

should not result in eliminating the need to provide some degree of

pre-trade transparency. Therefore, even when recognizing the importance

of promoting the trading of swaps on SEFs, some degree of pre-trade

transparency must be met for Required Transactions.\326\ As a result,

the Commission is declining to accept Nodal's recommendation to

explicitly include blind auctions as an acceptable method of execution

for Required Transactions under this rulemaking.\327\

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

\324\ CEA section 5h(e); 7 U.S.C. 7b-3(e) (emphasis added).

\325\ Core Principles and Other Requirements for Swap Execution

Facilities, 76 FR at 1220.

\326\ The Commission notes below that pre-trade transparency can

help promote the trading of swaps on SEFs. See the Introduction

section of the Cost Benefit Considerations section for further

details.

\327\ The Commission further notes that this determination does

not accept Nodal's assertion that ``this type of blind auction

trading platform is permissible on DCMs.'' See Nodal Comment Letter

at 3 (Mar. 8, 2011).

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

(ii) ``Through Any Means of Interstate Commerce'' Language in the SEF

Definition

In consideration of the comments regarding possible limitations on

how the Commission interprets the phrase ``through any means of

interstate commerce'' in the SEF definition, the Commission is revising

the final rule text to clarify that in providing either one of the

execution methods for Required Transactions in Sec. 37.9(a)(2)(i)(A)

or (B) of this final rulemaking (i.e., Order Book or RFQ System that

operates in conjunction with an Order Book), a SEF may for purposes of

execution and communication use ``any means of interstate commerce,''

including, but not limited to, the mail, internet, email, and

telephone, provided that the chosen execution method satisfies the

requirements provided in Sec. 37.3(a)(3) for Order Books or in Sec.

37.9(a)(3) for Request for Quote Systems.\328\ With this use of the

phrase ``any means of interstate commerce,'' the Commission is not

limiting the means of execution or communication that a SEF may utilize

in implementing the required execution methods for Required

Transactions in Sec. 37.9(a)(2)(i)(A) or (B), provided that the chosen

execution method satisfies the requirements provided in Sec.

37.3(a)(3) for Order Books or in Sec. 37.9(a)(3) for Request for Quote

Systems. In this regard, the Commission notes that as the swaps market

evolves, SEFs may develop new means of execution or communication for

use in implementing the required execution methods. Although the

Commission notes that its regulations are technology neutral given the

``any means of interstate commerce'' language, it also emphasizes that,

regardless of the means of interstate commerce utilized, a SEF must

comply with the Act and the Commission's regulations, including the

Sec. 37.9 execution method, impartial access, audit trail, and

surveillance requirements. Furthermore, all transactions on the SEF

must comply with the SEF's rules.

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

\328\ The Commission interprets the phrase ``through any means

of interstate commerce'' in CEA Sec. 1a(50) to allow a SEF to

utilize a variety of means of execution or communication, including,

but not limited to, telephones, internet communications, and

electronic transmissions. Overstreet v. North Shore Corp., 318 U.S.

125, 129-30 (1943) (in general, ``instrument'' of interstate

commerce is to be interpreted broadly); United States v. Barlow, 568

F.3d 215, 220 (5th Cir. 2009) (``It is beyond debate that internet

and email are facilities or means of interstate commerce.''); United

States v. Weathers, 169 F.3d 336, 341 (6th Cir. 2000) (``It is

generally well established that telephones, even when used

intrastate, constitute instrumentalities of interstate commerce.'');

SEC v. Solucorp Indus., 274 F.Supp.2d 379, 419 (S.D.N.Y. 2003)

(defendants ``used the means and instrumentalities of interstate

commerce, including, among other things, the mails and wires,

including the Internet, news wires and telephone lines'' to commit

securities fraud). While the Commission's interpretation of ``any

means of interstate commerce'' allows a SEF to utilize a wide

variety of execution or communication means, all SEFs, regardless of

the execution or communication means they employ, must comply with

all of the substantive SEF requirements, including, but not limited

to, requirements that pertain to execution. For example, a SEF using

the telephone to execute Required Transactions must satisfy the

execution requirements set forth in Sec. 37.9(a)(2)(i)(A) or (B).

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

For example, to meet the RFQ System definition for Required

Transactions, a SEF must satisfy all of the following functions, and in

doing so, all or some of these functions may be performed over the

telephone: (1) Receiving a request from a market participant to execute

a trade, (2) submitting that request to at least 3 market participants

in accordance with the RFQ System definition, (3) communicating the RFQ

responses and resting bids or offers on the Order Book to the RFQ

requester, and (4) executing the transaction. The Commission notes that

regardless of the means of interstate commerce utilized, including the

telephone, the SEF must submit the transaction into its system or

platform so that the SEF is able to comply with the Act and the

Commission's regulations, including audit trail, clearing, and

reporting requirements. Given the different means of interstate

commerce that a SEF may utilize for purposes of communication and

execution in implementing the execution methods for Required

Transactions in Sec. 37.9(a)(2)(i)(A) or (B), the Commission notes

that it must evaluate each system or platform to determine whether it

meets the requirements of Sec. 37.9(a)(2).

The Commission, in order to provide further clarity regarding the

means of

[[Page 33502]]

interstate commerce that a SEF may utilize in order to satisfy the

execution methods for Required Transactions in Sec. 37.9(a)(2), is

providing the following example, which the Commission intends to be

instructive, though not comprehensive. The Commission emphasizes that

the following example should not be construed as bright-line rules:

RFQ System example--a market participant calls an employee

of the SEF with a request for a quote to buy or sell a swap subject to

the trade execution requirement in CEA section 2(h)(8). The SEF

employee disseminates the request for a quote to no less than three

market participants on the SEF (directly or through other SEF employees

or both) by telephone, email, instant messaging, squawk box, some other

means of communication, or some combination thereof. Based on the

responses of these market participants, the SEF employee communicates

the responsive bids or offers and the resting bids or offers on the

SEF's Order Book \329\ to the RFQ requester by one of the above

referenced means of communication. The RFQ requester communicates

acceptance of one of the bids or offers to the SEF employee by one of

the above referenced means of communication. The SEF employee informs

those two market participants by one of the above referenced means of

communication that the swap transaction is executed. The SEF employee

enters the transaction into the SEF's system or platform so that the

SEF is able to comply with the Act and the Commission's regulations,

including audit trail, clearing, and reporting requirements. The

Commission views this example as demonstrating acceptable uses of

different means of interstate commerce while meeting the RFQ System

method of execution in Sec. 37.9(a)(2).

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

\329\ See final Sec. 37.9(a)(3) and the preamble for details

regarding the communication of the resting bids or offers on the

Order Book to the RFQ requester.

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

In response to commenters, the Commission will generally allow

work-up sessions if such trading protocols are utilized after a

transaction is executed on the SEF's Order Book or RFQ System.\330\ The

Commission, in order to provide further clarity regarding work-up

sessions, is providing the following two examples, which the Commission

intends to be instructive, though not comprehensive. The Commission

notes that the following examples are two types of work-up session that

may be acceptable:

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

\330\ The Commission notes that a work-up transaction does not

qualify as a block trade even if an individual market participant's

transactions as part of the work-up transaction has a notional or

principal amount at or above the appropriate minimum block size

applicable to such swap. The Commission believes that the concepts

of work-up transactions and block trades are mutually exclusive.

Block trades are executed pursuant to a SEF's rules, but negotiated

and executed off of the SEF's trading platform. A work-up

transaction is conducted on a SEF's trading platform. See block

trade definition in Sec. 43.2 of the Commission's regulations; see

also Rules Prohibiting the Aggregation of Orders To Satisfy Minimum

Block Sizes or Cap Size Requirements, and Establishing Eligibility

Requirements for Parties to Block Trades, 77 FR 38229 (proposed Jun.

27, 2012). Accordingly, each individual transaction that is part of

the work-up transaction must be reported as it occurs pursuant to

the SEF's reporting obligations.

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

After two counterparties execute a transaction on a SEF's

Order Book, the SEF may establish a short time period for a work-up

session. The SEF must open up the work-up session to all market

participants so that they may trade an additional quantity of the same

instrument at the same price previously executed by the initial

counterparties. In addition, any resting bids or offers on the SEF's

Order Book equal to or better than the work-up session price must be

included in the work-up session.\331\ The SEF may provide the initial

counterparties execution priority in the work-up session.

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

\331\ These resting bids or offers would be included at the

work-up session price. The Commission notes that ``equal to or

better than the work-up session price'' means any resting bids that

are equal to or greater than the work-up price or any resting offers

that are equal to or less than the work-up price.

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

After two counterparties execute a transaction on a SEF's

RFQ System, the SEF may establish a short time period for a work-up

session. The SEF must open up the work-up session to all market

participants so that they may trade an additional quantity of the same

instrument at the same price previously executed by the initial

counterparties. In addition, any resting bids or offers on the SEF's

Order Book equal to or better than the work-up session price must be

included in the work-up session.\332\ The SEF may provide the initial

counterparties execution priority in the work-up session.

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

\332\ Id.

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

The SEF must have rules governing the operation of any work-up

mechanism, including the length of the session, any priorities accorded

the counterparties to the transaction that triggered the work-up

session, and the handling of any orders submitted during the session

that are not executed. A SEF must also have systems or procedures in

place to ensure that a work-up session is accessible by, and work-up

session information (e.g., the work-up session's trade price and

ongoing volume) is available to, all market participants. The

Commission believes that, if properly conducted, work-up sessions may

enhance price discovery and foster liquidity.

The Commission believes that a work-up session would be a trading

protocol and, thus, constitute a rule under Sec. 40.1 of the

Commission's regulations. Any such rule or amendment thereto must be

codified and included in a SEF's rulebook in accordance with the rule

review or approval procedures of part 40 of the Commission's

regulations or during the SEF application process. Additionally, all

transactions executed through a work-up session must comply with the

SEF's rules. The Commission staff will provide informal guidance to SEF

applicants on whether such work-up sessions are in compliance with the

Act and the Commission's regulations.

(iii) Liquidity-Based Execution Mandates

The Commission is deleting proposed Sec. 37.9(b)(4). Given the

incipience of the regulated swaps market, at this time, the Commission

is not imposing a requirement for specific methods of execution for

Required Transactions based upon the amount of trading activity in such

transactions.

(e) Sec. 37.9(b)(3)--Time Delay Requirement

Proposed Sec. 37.9(b)(3) stated that SEFs must require that

traders who have the ability to execute against a customer's order or

to execute two customers against each other be subject to a 15-second

timing delay between the entry of the two orders, such that one side of

the potential transaction is disclosed and made available to other

market participants before the second side of the potential transaction

(whether for the trader's own account or for a second customer) is

submitted for execution. The SEF NPRM stated that this requirement will

provide other market participants the opportunity to join in the

trade.\333\

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

\333\ Core Principles and Other Requirements for Swap Execution

Facilities, 76 FR at 1220.

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

(1) Summary of Comments

SDMA and Mallers et al. supported the proposed 15-second delay

requirement as necessary to increase price transparency and market

integrity.\334\ Mallers et al. stated that the 15-second rule provides

a meaningful opportunity for other SEF participants to execute against

the individual sides of the cross transaction, and that such crossing

delays have been successfully

[[Page 33503]]

implemented in the futures markets.\335\ However, several commenters

objected to the 15-second delay requirement.\336\ Some commenters

stated that there is no statutory authority for the timing delay

requirement.\337\ Commenters also stated that the timing delay will

increase prices and expose traders to market risk.\338\ Freddie Mac,

for example, stated that liquidity providers may increase prices to

account for anticipated market movements.\339\ Some commenters also

noted that the timing delay requirement may lead to unwillingness on

the part of dealers to provide liquidity because they will not know

whether they will ultimately serve as their customers' principal

counterparty or merely as their executing agent.\340\

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

\334\ Mallers et al. Comment Letter at 5 (Mar. 21, 2011); SDMA

Comment Letter at 4 (Mar. 8, 2011).

\335\ Mallers et al. Comment Letter at 5 (Mar. 21, 2011).

\336\ WMBAA Comment Letter at 3 (Jul. 18, 2011); FHLB Comment

Letter at 13 (Jun. 3, 2011); WMBAA Comment Letter at 9 (Jun. 3,

2011); Rosen et al. Comment Letter at 15-16 (Apr. 5, 2011);

BlackRock Comment Letter at 6 (Mar. 8, 2011); Global FX Comment

Letter at 3-4 (Mar. 8, 2011); JP Morgan Comment Letter at 7 (Mar. 8,

2011); Evolution Comment Letter at 6 (Mar. 8, 2011); WMBAA Comment

Letter at 7 (Mar. 8, 2011); SIFMA AMG Comment Letter at 7 (Mar. 8,

2011); TruMarx Comment Letter at 7 (Mar. 8, 2011); Deutsche Comment

Letter at 5 (Mar. 8, 2011); FCC Comment Letter at 2 (Mar. 8, 2011);

Phoenix Comment Letter at 2-3 (Mar. 7, 2011).

\337\ WMBAA Comment Letter at 3 (Jul. 18, 2011); WMBAA Comment

Letter at 9 (Jun. 3, 2011); WMBAA Comment Letter at 7 (Mar. 8,

2011); SIFMA AMG Comment Letter at 8 (Mar. 8, 2011); Deutsche

Comment Letter at 5 (Mar. 8, 2011); MFA Comment Letter at 8 (Mar. 8,

2011).

\338\ FHLB Comment Letter at 13 (Jun. 3, 2011); BlackRock

Comment Letter at 6 (Mar. 8, 2011); WMBAA Comment Letter at 7-8

(Mar. 8, 2011); SIFMA AMG Comment Letter at 7 (Mar. 8, 2011); FCC

Comment Letter at 2 (Mar. 8, 2011).

\339\ Freddie Mac Comment Letter at 3 (Mar. 8, 2011).

\340\ WMBAA Comment Letter at 9 (Jun. 3, 2011); BlackRock

Comment Letter at 6 (Mar. 8, 2011); MFA Comment Letter at 9 (Mar. 8,

2011); Phoenix Comment Letter at 3 (Mar. 7, 2011).

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

ABC/CIEBA commented that the proposed rule is unclear as to what

limitations, if any, apply to pre-execution communications.\341\ ABC/

CIEBA recommended that the Commission revise the proposed rule to

permit pre-execution communications between counterparties as long as

parties comply with the requirement to execute the trade on the

SEF.\342\

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

\341\ ABC/CIEBA Comment Letter at 9 (Mar. 8, 2011).

\342\ Id. at 10.

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

Several commenters recommended that the Commission provide

flexibility with respect to the time period of the timing delay.\343\

Goldman recommended that the Commission, in consultation with market

participants and SEFs, set the delay at 1-3 seconds depending on the

complexity of the product.\344\ FXall stated that each SEF should be

able to decide upon the appropriate delay, taking into account the

particular characteristics of that market.\345\

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

\343\ Reuters Comment Letter at 5 (Dec. 12, 2011); Goldman

Comment Letter at 3 (Mar. 8, 2011); ISDA/SIFMA Comment Letter at 6

(Mar. 8, 2011); FXall Comment Letter at 10 (Mar. 8, 2011); MFA

Comment Letter at 8-9 (Mar. 8, 2011).

\344\ Goldman Comment Letter at 3 (Mar. 8, 2011).

\345\ FXall Comment Letter at 10 (Mar. 8, 2011).

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

Several commenters requested clarification that the 15-second delay

requirement only applies to SEFs that operate an Order Book and not an

RFQ System.\346\ In this regard, SIFMA AMG commented that the timing

delay should not apply to an RFQ System because firm quotes transmitted

in response to an RFQ would already be exposed to the market.\347\

However, Better Markets contended that the requirement should apply to

responsive orders in RFQ systems.\348\

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

\346\ Reuters Comment Letter at 5 (Dec. 12, 2011); Rosen et al.

Comment Letter at 15-16 (Apr. 5, 2011); Goldman Comment Letter at 3

(Mar. 8, 2011); Global FX Comment Letter at 3-4 (Mar. 8, 2011);

ISDA/SIFMA Comment Letter at 6 (Mar. 8, 2011); Barclays Comment

Letter at 9 (Mar. 8, 2011); FSR Comment Letter at 7 (Mar. 8, 2011).

\347\ SIFMA AMG Comment Letter at 7 (Mar. 8, 2011).

\348\ Better Markets Comment Letter at 9 (Mar. 8, 2011).

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

Finally, some commenters requested that the Commission clarify the

term ``trader'' in the proposed rule.\349\ WMBAA stated that it is not

clear whether the term ``trader'' refers to a counterparty, broker, or

another entity.\350\ SIFMA AMG noted that the timing delay should not

apply to asset managers executing trades on behalf of their

clients.\351\

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

\349\ WMBAA Comment Letter at 7 (Mar. 8, 2011); SIFMA AMG

Comment Letter at 8 (Mar. 8, 2011); FSR Comment Letter at 6-7 (Mar.

8, 2011).

\350\ WMBAA Comment Letter at 7 (Mar. 8, 2011).

\351\ SIFMA AMG Comment Letter at 8 (Mar. 8, 2011).

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

(2) Commission Determination

The Commission is adopting the time delay requirement for Required

Transactions in proposed Sec. 37.9(b)(3) as final Sec. 37.9(b)(1),

subject to the modifications described below.\352\ The Commission

clarifies that the purpose of the time delay requirement is to ensure a

minimum level of pre-trade price transparency for Required Transactions

on a SEF's Order Book by allowing other market participants the

opportunity to join or participate in a trade where a broker or dealer

engages in some form of pre-arrangement or pre-negotiation of a

transaction and then attempts, through the SEF's Order Book, to either

internalize the order by executing opposite a customer or cross two

customer orders.\353\ In addition to ensuring a minimum level of pre-

trade price transparency, the Commission believes that the time delay

requirement will incentivize competition between market

participants.\354\ The Commission is revising proposed Sec. 37.9(b)(3)

to clarify the purpose of the time delay requirement as described

above.

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

\352\ The Commission is renumbering proposed Sec. 37.9(b)(3) to

Sec. 37.9(b)(1).

\353\ The Commission clarifies that the exposure of ``orders''

subject to the 15 second time delay into the Order Book in final

Sec. 37.9(b)(1) means exposure of the price, size, and other terms

of the orders.

\354\ The Commission also notes that the time delay requirement

is similar to certain timing delays for cross trades applicable to

futures transactions executed on DCMs where one side of a potential

transaction (i.e., price, size, and other terms) is exposed to the

market for a certain period of time before the second side of the

potential transaction is submitted for execution. See, e.g., NYMEX

rule 533, which provides for a 5-second delay for futures and a 15-

second delay for options, available at http://www.cmegroup.com/rulebook/NYMEX/1/5.pdf.

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

In response to ABC/CEIBA's comment about any limitations on pre-

execution communications, the Commission notes that a SEF that allows

pre-execution communications must adopt rules regarding such

communications that have been certified to or approved by the

Commission.\355\ The Commission also notes that orders that result from

pre-execution communications would be subject to the time delay

requirement in the final rule text. The Commission notes that pre-

execution communications are communications between market participants

for the purpose of discerning interest in the execution of a

transaction prior to the exposure of the market participants' orders

(i.e., price, size, and other terms) to the market. Any communication

that involves discussion of the size, side of market, or price of an

order, or a potentially forthcoming order, constitutes a pre-execution

communication.

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

\355\ See, e.g., CME Rule 539.C Pre-Execution Communications

Regarding Globex Trades, available at http://www.cmegroup.com/rulebook/CME/I/5/39.html (setting forth rules regarding pre-

execution communications in the DCM context).

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

The Commission acknowledges commenters' concerns that the time

delay requirement should take into account a product's characteristics.

Therefore, the Commission believes that the 15-second time delay

requirement should serve as a default time delay. The Commission is

revising the rule to allow SEFs to adjust the time period of the delay,

based upon liquidity or other product-specific considerations as stated

in final Sec. 37.9(b)(2). The Commission notes that such adjustments

and accompanying justifications, as well as any establishment of a 15-

second time delay requirement at a SEF, must be submitted

[[Page 33504]]

for the Commission's review pursuant to the procedures described in

part 40 of the Commission's regulations.

The Commission is clarifying that the 15-second time delay

requirement is not applicable to trades that are executed through an

RFQ System. As noted above, the purpose of the time delay requirement

is to ensure a minimum level of pre-trade price transparency for

Required Transactions on a SEF's Order Book. The Commission notes that

an RFQ System already provides pre-trade price transparency to the RFQ

requester and that a dealer attempting to cross or internalize trades

through an RFQ System would be subject to such pre-trade price

transparency. As such, the Commission is revising the rule text to

clarify that the 15-second time delay requirement only applies to a

SEF's Order Book.

Finally, the Commission is replacing the term ``traders'' in

proposed Sec. 37.9(b)(3) with the phrase ``brokers or dealers.'' The

Commission intended the provision to apply only to brokers or dealers

attempting to internalize or cross trades through a SEF's Order Book

and acknowledges that the proposal was unclear with respect to the

meaning of the term ``traders.'' \356\ In response to SIFMA AMG's

concern, the Commission does not have sufficient information at this

time to make a determination whether asset managers executing trades on

behalf of their clients would be subject to the time delay requirement.

The Commission staff will work with SEFs to determine if the time delay

requirement applies to asset managers or other market participants.

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

\356\ For example, a futures commission merchant or other market

participant acting in the role of a broker who has the ability to

execute against its customer's order or to execute two of its

customers' orders against each other would be subject to the time

delay requirement.

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

(f) Sec. 37.9(c)--Execution Methods for Permitted Transactions

Proposed Sec. 37.9(c)(1) provided that Permitted Transactions may

be executed by an Order Book, RFQ System, a Voice-Based System, or any

such other system for trading as may be permitted by the Commission. In

addition, proposed Sec. 37.9(c)(2) stated that a registered SEF may

submit a request to the Commission to offer trading services to

facilitate Permitted Transactions, and that when doing so, the SEF must

certify its compliance with Sec. 37.11 (Identification of non-cleared

swaps or swaps not made available to trade). As noted in the SEF NPRM,

market participants would not be required to utilize the minimum

trading functionality in Sec. 37.9(b) to execute Permitted

Transactions.\357\

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

\357\ The SEF NPRM stated that pre-trade price transparency is

not required for Permitted Transactions. Core Principles and Other

Requirements for Swap Execution Facilities, 76 FR at 1220.

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

(1) Summary of Comments

SIFMA AMG stated that the Commission should not limit the execution

modalities available to market participants who execute Permitted

Transactions on a SEF.\358\ SIFMA AMG also stated that no statutory

basis exists for regulatory execution requirements for Permitted

Transactions.\359\ Additionally, several commenters stated that the

Commission should not prescribe execution methods for swaps executed

off a SEF.\360\

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

\358\ SIFMA AMG Comment Letter at 10 (Mar. 8, 2011).

\359\ Id.

\360\ Rosen et al. Comment Letter at 19-20 (Apr. 5, 2011);

Deutsche Comment Letter at 6 (Mar. 8, 2011); FSR Comment Letter at 8

(Mar. 8, 2011); Global FX Comment Letter at 3 (Mar. 8, 2011);

Barclays Comment Letter at 10 (Mar. 8, 2011); ABC/CIEBA Comment

Letter at 7 (Mar. 8, 2011).

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

(2) Commission Determination

The Commission is revising proposed Sec. 37.9(c)(1) to state that

a SEF may offer any method of execution for each Permitted

Transaction.\361\ The Commission agrees that it should not limit the

execution methods that are available to market participants or require

market participants to utilize certain execution methods for Permitted

Transactions, which are not required to be executed on a SEF. The

Commission clarifies, however, that, in accordance with the minimum

trading functionality requirement in final Sec. 37.3(a)(2), a SEF must

offer an Order Book for Permitted Transactions. The Commission further

clarifies that a market participant has the option to utilize the Order

Book or any other method of execution that a SEF provides for Permitted

Transactions. Additionally, the Commission clarifies that this section

only applies to Permitted Transactions listed or traded on a SEF, and

that this section does not apply to transactions not listed or traded

on a SEF.\362\ Finally, the Commission is deleting proposed Sec.

37.9(c)(2) given the deletion to proposed Sec. 37.11 as described

below.

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

\361\ The Commission is renumbering proposed Sec. 37.9(c)(1) to

Sec. 37.9(c)(2).

\362\ This section does not apply to those entities that do not

have to register as a SEF. As noted above in the registration

section, swap transactions that are not subject to the CEA section

2(h)(8) trade execution requirement would not have to be executed on

a registered SEF.

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

(g) Future Review

Consistent with the Commission's practice of reviewing and

monitoring its regulatory programs, the Commission directs the

Commission staff to conduct a general review of SEFs' experience with

the execution methods prescribed in Commission regulations 37.3(a)(2)

(minimum trading functionality), 37.3(a)(3) (Order Book), and 37.9

(execution methods for Required and Permitted Transactions and time

delay requirement for Required Transactions). If appropriate, the

review should include any Commission staff recommendations regarding

possible modifications to Commission regulations 37.3(a)(2),

37.3(a)(3), or 37.9 that are consistent with the Act (e.g., a

recommendation to modify the minimum number of RFQ requestees required

by the RFQ definition, including whether a trading protocol in which

the minimum number of RFQ requestees differed by swap class or another

category would be appropriate). The Commission staff's review should be

completed within four years of the effective date of these final SEF

regulations, within which time the Commission believes that staff will

have gained sufficient experience and will have three years' worth of

data with respect to the execution methods.

10. Sec. 37.10--Swaps Made Available for Trading

The Dodd-Frank Act added section 2(h)(8) of the CEA to require that

transactions involving swaps subject to the clearing requirement must

be executed either on a DCM or SEF, unless no DCM or SEF makes the swap

``available to trade'' or the related transaction is subject to the

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

exception).\363\ In the SEF NPRM, the Commission proposed to require

SEFs to conduct annual assessments and to submit reports to the

Commission regarding whether it has made a swap available to

trade.\364\ In the DCM notice of proposed rulemaking (``NPRM''),\365\

the Commission did not establish any obligation for DCMs under section

2(h)(8) of the Act. After reviewing the SEF NPRM comments regarding the

proposed available to trade process, and in light of the fact that the

DCM NPRM did not establish any obligation for DCMs under section

[[Page 33505]]

2(h)(8) of the CEA, the Commission determined to separately issue a

further notice of proposed rulemaking to establish a process for a DCM

or SEF to make a swap available to trade under section 2(h)(8) of the

Act.\366\ The Commission may implement the available to trade provision

in a separate rulemaking.

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

\363\ CEA sections 2(h)(7) and 2(h)(8); 7 U.S.C. 2(h)(7) and

2(h)(8).

\364\ Core Principles and Other Requirements for Swap Execution

Facilities, 76 FR at 1241.

\365\ Core Principles and Other Requirements for Designated

Contract Markets, 75 FR 80572 (proposed Dec. 22, 2010).

\366\ Process for a Designated Contract Market or Swap Execution

Facility To Make a Swap Available To Trade, 76 FR 77728 (proposed

Dec. 14, 2011).

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

11. Sec. 37.11--Identification of Non-Cleared Swaps or Swaps Not Made

Available to Trade

Proposed Sec. 37.11 required a SEF that chooses to offer swaps:

(1) Not subject to the clearing mandate under section 2(h) of the Act,

(2) that are subject to the end-user exception from the clearing

mandate under section 2(h)(7) of the Act, or (3) that have not been

made available to trade pursuant to Sec. 37.10 of the Commission's

regulations to clearly identify to market participants that the

particular swap is to be executed bilaterally between the parties

pursuant to one of the applicable exemptions from execution and

clearing.

(a) Summary of Comments

MarketAxess expressed concern that proposed Sec. 37.11 could be

read to require that all transactions described in the provision must

only be executed bilaterally, and not on a SEF.\367\ To address this

concern, MarketAxess requested the Commission clarify that Sec. 37.11

requires a SEF choosing to facilitate Permitted Transactions to

identify to market participants why the particular swap is a Permitted

Transaction (i.e., falls under one of the three categories described in

the provision).\368\

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

\367\ MarketAxess Comment Letter at 33-34 (Mar. 8, 2011).

\368\ Id. at 34.

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

(b) Commission Determination

The Commission believes that proposed Sec. 37.11 is unnecessary

and therefore is deleting it in its entirety. Market participants

should have sufficient notice of the swaps subject to the clearing and

trade execution requirements. Therefore, in conjunction with the

definitions contained in part 37 as adopted, market participants will

know which swaps are Required Transactions and which swaps are

Permitted Transactions, and thus the execution methods deemed

acceptable for each.

C. Regulations, Guidance, and Acceptable Practices for Compliance With

the Core Principles

As noted above, this final part 37 rulemaking establishes the

relevant regulations, guidance, and acceptable practices applicable to

the 15 core principles that SEFs are required to comply with initially

and on a continuing basis as part of the conditions of registration.

The regulations applicable to the 15 core principles are set out in

separate subparts B through P to part 37, which includes a codification

within each subpart of the statutory language of the respective core

principle. The guidance and acceptable practices are set out in

appendix B to part 37.

1. Subpart B--Core Principle 1 (Compliance With Core Principles)

Core Principle 1 requires a SEF to comply with the core principles

set forth in CEA section 5h(f) and any requirement that the Commission

may impose by rule or regulation pursuant to CEA section 8a(5) as a

condition of obtaining and maintaining registration as a SEF.\369\

Additionally, Core Principle 1 provides a SEF with reasonable

discretion in establishing the manner in which it complies with the

core principles unless the Commission determines otherwise by rule or

regulation.\370\ In the SEF NPRM, the Commission proposed to codify the

statutory text of Core Principle 1 in proposed Sec. 37.100, and adopts

that rule as proposed.

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

\369\ CEA section 5h(f)(1)(A); 7 U.S.C. 7b-3(f)(1)(A).

\370\ CEA section 5h(f)(1)(B); 7 U.S.C. 7b-3(f)(1)(B).

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

2. Subpart C--Core Principle 2 (Compliance With Rules)

(a) Sec. 37.200--Core Principle 2--Compliance With Rules

Core Principle 2 requires a SEF to establish and enforce compliance

with its rules, including the terms and conditions of the swaps traded

or processed on or through the SEF and any limitations on access to the

SEF.\371\ It also requires a SEF to establish and enforce trading,

trade processing, and participation rules that will deter abuses and

have the capacity to detect, investigate, and enforce those rules.\372\

A SEF must also establish rules governing the operation of the

facility, including rules specifying trading procedures to be used in

entering and executing orders traded or posted on the facility,

including block trades.\373\ Finally, Core Principle 2 requires a SEF

to provide by its rules that when a swap dealer or major swap

participant enters into or facilitates a swap that is subject to the

mandatory clearing requirement of section 2(h) of the Act, the swap

dealer or major swap participant is responsible for complying with the

mandatory trading requirement under section 2(h)(8) of the Act.\374\ In

the SEF NPRM, the Commission proposed to codify the statutory text of

Core Principle 2 in proposed Sec. 37.200, and adopts that rule as

proposed.

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

\371\ CEA section 5h(f)(2)(A); 7 U.S.C. 7b-3(f)(2)(A).

\372\ CEA section 5h(f)(2)(B); 7 U.S.C. 7b-3(f)(2)(B). This

section also requires a SEF to provide market participants with

impartial access to the market and to capture information that may

be used in establishing whether rule violations have occurred.

\373\ CEA section 5h(f)(2)(C); 7 U.S.C. 7b-3(f)(2)(C).

\374\ CEA section 5h(f)(2)(D); 7 U.S.C. 7b-3(f)(2)(D).

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

(1) Summary of Comments

Some commenters expressed general concerns regarding the proposed

rules under Core Principle 2.\375\ FXall and State Street believed that

the proposed rules under Core Principle 2 would require a SEF to act as

a de facto self-regulatory organization (``SRO'') and impose burdens

that would impede the growth of the swaps market.\376\ These commenters

also noted that the proposed requirements were too similar to the

regulations applicable to DCMs, which would place SEFs at a

disadvantage compared to DCMs given that SEFs will operate in a

competitive environment while DCMs operate in a monopolistic

environment.\377\ ICE urged the Commission to limit its prescriptive

rulemaking to issues that it believes require specific, binding

rules.\378\ In this regard, several commenters recommended that the

Commission adopt greater flexibility in implementing Core Principle

2.\379\

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

\375\ FXall Comment Letter at 3-4, 11 (Mar. 8, 2011); State

Street Comment Letter at 5-6 (Mar. 8, 2011); ICE Comment Letter at 2

(Mar. 8, 2011); WMBAA Comment Letter at 18 (Mar. 8, 2011).

\376\ FXall Comment Letter at 3-4, 11 (Mar. 8, 2011); State

Street Comment Letter at 5-6 (Mar. 8, 2011).

\377\ Id.

\378\ ICE Comment Letter at 2 (Mar. 8, 2011).

\379\ Reuters Comment Letter at 4 (Mar. 8, 2011); FXall Comment

Letter at 3-4, 11 (Mar. 8, 2011); ICE Comment Letter at 2 (Mar. 8,

2011); State Street Comment Letter at 5-6 (Mar. 8, 2011).

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

Some commenters recommended limiting the scope of the proposed

rules under Core Principle 2.\380\ Specifically, WMBAA argued that SEFs

may not be able to satisfy all of the requirements of the proposed

rules given that SEFs cannot be held responsible for what

[[Page 33506]]

happens on a competitor's platform.\381\ Similarly, FXall believed that

SEFs would not have the requisite market data to conduct meaningful

compliance oversight.\382\ SIFMA AMG believed that the Commission's

vague use of the terms ``members,'' ``market participants,'' and

``participants'' could potentially subject dealers' customers, and thus

asset managers and their clients, to ``onerous'' requirements of

multiple SEFs.\383\ Therefore, SIFMA AMG requested clarification that a

SEF's rules would only regulate entities that actually execute

transactions on the SEF.\384\

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

\380\ WMBAA Comment Letter at 18 (Mar. 8, 2011); FXall Comment

Letter at 11 (Mar. 8, 2011); MarketAxess Comment Letter at 34 (Mar.

8, 2011); SIFMA AMG Comment Letter at 14-15 (Mar. 8, 2011).

\381\ WMBAA Comment Letter at 18 (Mar. 8, 2011).

\382\ FXall Comment Letter at 11 (Mar. 8, 2011).

\383\ SIFMA AMG Comment Letter at 14-15 (Mar. 8, 2011).

\384\ Id.

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

(2) Commission Determination

In response to comments by FXall and State Street about treating

SEFs as SROs, the Commission notes that like DCMs, it views SEFs as

SROs and amended the Commission's regulations to include them as

SROs.\385\ Treating a SEF as an SRO is consistent with a SEF's self-

regulatory obligations pursuant to CEA section 5h(f). Therefore, where

appropriate, the Commission is adopting surveillance, audit trail,

investigation, enforcement, and other requirements for SEFs.

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

\385\ See Adaptation of Regulations to Incorporate Swaps, 77 FR

66288 (Nov. 2, 2012). Section 1.3(ee) states that a self-regulatory

organization ``means a contract market (as defined in Sec. 1.3(h)),

a swap execution facility (as defined in Sec. 1.3(rrrr)), or a

registered futures association under section 17 of the Act.'' Id. at

66318.

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

In response to commenters' concerns that the proposed requirements

were similar to the regulations applicable to DCMs, the Commission

believes that adopting similar requirements for both types of entities

is warranted given the similar statutory self-regulatory obligations

for both types of entities. Given that both DCMs and SEFs, regardless

of whether they are new or existing entities, are required to fulfill

similar self-regulatory functions, the Commission does not believe that

this approach will adversely affect competition between DCMs and SEFs.

In response to commenters' requests for less prescriptive rules and

greater flexibility in applying the rules, the Commission is moving

various provisions of the proposed rules to guidance and eliminating

other provisions, as discussed below. The provisions that are adopted

as final rules reflect the Commission's opinion of what is required, at

a minimum, for any SEF to comply with the core principles. SEFs may

take any additional steps necessary, beyond the requirements of the

rules, to satisfy statutory obligations.

In response to WMBAA's and FXall's comments regarding certain

limitations faced by SEFs in terms of oversight, the Commission

recognizes the limitations faced by SEFs with respect to position

monitoring, cross-market surveillance, and rule enforcement and

addresses them in the context of comments received below. In response

to SIFMA AMG's comment about the ambiguous use of terms, the Commission

clarifies that ``market participant'' when used with respect to a SEF

means a person that directly or indirectly effects transactions on the

SEF. This includes persons with trading privileges on the SEF and

persons whose trades are intermediated. The Commission also clarifies

that ``member'' has the meaning set forth in CEA section 1a(34).\386\

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

\386\ CEA section 1a(34) defines ``member'' as ``an individual,

association, partnership, corporation, or trust--(A) owning or

holding membership in, or admitted to membership representation on,

the registered entity . . . or (B) having trading privileges on the

registered entity. . . .'' 7 U.S.C. 1a(34).

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

(b) Sec. 37.201--Operation of Swap Execution Facility and Compliance

With Rules

Proposed Sec. 37.201(a) required a SEF to establish rules

governing the operation of the SEF, including rules specifying trading

procedures for entering and executing orders traded or posted on the

SEF, including block trades.\387\ Proposed Sec. 37.201(b) further

required a SEF to establish and impartially enforce compliance with its

rules, including, but not limited to: (1) The terms and conditions of

any swaps traded or processed on or through the SEF; (2) access to the

SEF; (3) trade practice rules; (4) audit trail requirements; (5)

disciplinary rules; and (6) mandatory clearing requirements.\388\

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

\387\ The Commission notes that Sec. 37.201(a) codifies CEA

section 5h(f)(2)(C). 7 U.S.C. 7b-3(f)(2)(C).

\388\ The Commission notes that Sec. 37.201(b) codifies certain

sections of CEA section 5h(f)(2). 7 U.S.C. 7b-3(f)(2).

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

(1) Summary of Comments

MarketAxess recommended that the Commission withdraw proposed Sec.

37.201(b)(6), which required a SEF to adopt and enforce mandatory

clearing requirements, on the basis that clearing of a swap occurs

outside of a SEF's main responsibility to facilitate the

transaction.\389\

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

\389\ MarketAxess Comment Letter at 34 (Mar. 8, 2011).

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

(2) Commission Determination

The Commission is adopting Sec. 37.201 as proposed, subject to two

modifications. To address the comment by MarketAxess, the Commission

notes that proposed Sec. 37.201(b)(6) contained a drafting error, and

therefore is replacing the term ``mandatory clearing'' with ``mandatory

trading.'' The Commission also notes that the citation to ``part 45''

in proposed Sec. 37.201(a) should instead cite to ``part 43.''

Therefore, the Commission is modifying the final rule to include these

technical changes.

Additionally, the Commission notes that a SEF must establish and

enforce rules for its employees. These rules must be reasonably

designed to prevent violations of the Act and the rules of the

Commission.\390\ Towards that end, the Commission also notes that a SEF

must have systems in place reasonably designed to ensure that its

employees are operating in accordance with the SEF's rules.\391\ For

example, a SEF that is utilizing an RFQ System in conjunction with an

Order Book for Required Transactions must establish rules specifying

order handling procedures for its employees who receive and execute

orders over the telephone, email, instant messaging, squawk box, some

other method of communication, or some combination thereof so that the

employees may comply with the RFQ System requirements as specified in

final Sec. 37.9(a)(3).\392\

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

\390\ The Commission notes that under Sec. 37.1501(d), a duty

of the Chief Compliance Officer is to establish and administer

written policies and procedures reasonably designed to prevent

violations of the Act and the rules of the Commission.

\391\ The Commission notes that under Sec. 37.1501(d), a duty

of the Chief Compliance Officer is to take reasonable steps to

ensure compliance with the Act and the rules of the Commission, and

to establish and administer a compliance manual designed to promote

compliance with applicable laws, rules, and regulations.

\392\ See WMBAA Comment Letter at 2 (Feb. 15, 2013) (explaining

that employees of a SEF provide services such as disseminating bids

and offers, helping to understand market conditions, and executing

transactions between counterparties).

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

Furthermore, the Commission notes that a SEF's employees have

certain obligations under the Commission's existing regulations. For

example, under Sec. 1.59, a SEF's employees are prohibited from

disclosing for any purpose inconsistent with the performance of its

official duties any material, non-public information obtained through

special access related to the performance of its duties.\393\

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

\393\ Commission regulation 1.59(d).

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

Finally, the Commission notes that under Sec. 1.2 of the

Commission's regulations, a SEF is liable for the acts, omissions, or

failures of its employees

[[Page 33507]]

acting within the scope of their employment.\394\

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

\394\ Commission regulation 1.2.

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

(c) Sec. 37.202--Access Requirements

Proposed Sec. 37.202 addressed Core Principle 2's requirements

that SEFs provide market participants with impartial access to the

market and that SEFs adopt and enforce rules with respect to any

limitations placed on access to the SEF.\395\

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

\395\ CEA section 5h(f)(2)(A)(ii) and (2)(B)(i); 7 U.S.C. 7b-

3(f)(2)(A)(ii) and (2)(B)(i).

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

(1) Sec. 37.202(a)--Impartial Access by Members and Market

Participants \396\

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

\396\ The Commission is renaming the title of this section from

``Impartial Access by Members and Market Participants'' to

``Impartial Access to Markets and Market Services'' to provide

greater clarity.

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

Proposed Sec. 37.202(a) required that a SEF provide any eligible

contract participant (``ECP'') and any independent software vendor

(``ISV'') with impartial access to its market(s) and market services

(including any indicative quote screens or any similar pricing data

displays), providing: (1) Access criteria that are impartial,

transparent, and applied in a fair and nondiscriminatory manner; (2) a

process for confirming ECP status prior to being granted access to the

SEF; and (3) comparable fees for participants receiving comparable

access to, or services from, the SEF.

(i) Summary of Comments

Several commenters sought clarification that SEFs would be

permitted to use their own reasonable discretion to determine

individual access criteria, provided that the criteria are impartial,

transparent, and applied in a fair and non-discriminatory manner.\397\

In this regard, ISDA/SIFMA commented that a SEF should be able to limit

access to its trading systems or platforms to certain types of market

participants in order to maintain the financial integrity and

operational safety of the trading platform.\398\ JP Morgan also stated

that a SEF should be able to limit access to certain types of market

participants such as swap dealers.\399\ JP Morgan commented, however,

that the SEF NPRM's preamble language about financial and operational

soundness is problematic because it would not allow SEFs to limit

access to certain types of market participants.\400\ This could disrupt

business models such as that of inter-dealer brokers whose model is

intimately tied to the idea of serving as an intermediary to wholesale

liquidity providers.\401\ Similarly, Rosen et al. recommended that SEFs

should be able to use selective access criteria such as objective

minimum capital or credit requirements or limits on participation to

objective classes of sophisticated market participants.\402\

MarketAxess commented that the meaning of the term ``impartial'' is

unclear and recommended that the Commission revise proposed Sec.

37.202(a)(1) as follows: ``Criteria that are transparent and objective

and are applied in a fair and nondiscriminatory manner[.]'' \403\

Tradeweb noted that, because it offers multiple marketplaces, its

access criteria may reasonably differ for each mode of execution and

within one mode of execution given that each market will offer

different services and may have different types of participants.\404\

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

\397\ Reuters Comment Letter at 5 (Mar. 8, 2011); Goldman

Comment Letter at 4 (Mar. 8, 2011); Tradeweb Comment Letter at 10

(Mar. 8, 2011).

\398\ ISDA/SIFMA Comment Letter at 11 (Mar. 8, 2011).

\399\ JP Morgan Comment Letter at 11 (Mar. 8, 2011).

\400\ Id.

\401\ Id.

\402\ Rosen et al. Comment Letter at 17 (Apr. 5, 2011).

\403\ MarketAxess Comment Letter at 23-24 (Mar. 8, 2011).

\404\ Tradeweb Comment Letter at 10 (Mar. 8, 2011).

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

Mallers et al. supported the impartial access requirement and its

purpose of preventing a SEF's owners or operators from using

discriminatory access requirements as a competitive tool against

certain participants.\405\ Mallers et al. stated that impartial access

is a prerequisite to having an open market in which ECPs can compete on

a level playing field, and that the participation of additional

liquidity providers will improve the pricing and efficiency of the

market and reduce systemic risk.\406\ SDMA also supported the impartial

access requirement and stated that the ability to obtain intellectual

property licenses and the amount of royalties for intellectual property

licenses should be fair and not used to create anticompetitive

advantages for a particular SEF or group of market participants.\407\

UBS requested that the Commission clarify in the final rulemaking that

SEFs may not exclude or discriminate against participants providing

agency services solely as a result of engaging in these

activities.\408\

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

\405\ Mallers et al. Comment Letter at 2-3 (Mar. 21, 2011).

\406\ Id. at 3.

\407\ SDMA Comment Letter at 4-5 (Mar. 8, 2011).

\408\ UBS Comment Letter II at 1 (May 18, 2012). UBS submitted

two comment letters on May 18, 2012. The Commission is referencing

UBS's comment letter regarding impartial access as ``UBS Comment

Letter II.''

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

MarketAxess and WMBAA stated that a SEF should be able to restrict

access to ISVs because the Dodd-Frank Act does not require SEFs to

provide ISVs with impartial access.\409\ MarketAxess further commented

that the Commission must permit a SEF to restrict access to an ISV who

would use such direct access to provide a competitive advantage to

another SEF or DCM.\410\ Similarly, WMBAA stated that SEFs could

qualify as ISVs in order to seek access to competitors' trading systems

or platforms, which would defeat the existing structure of competitive

sources of liquidity.\411\ Bloomberg commented that the SEF NPRM's

characterization of ISV is too broad; \412\ therefore, an ISV may be

able to replicate the services of a SEF without having to register as a

SEF.\413\ Bloomberg also requested that the Commission clarify that a

user of an ISV service must be a participant of a SEF in order to

access the SEF's data and/or to execute swap transactions on that

SEF.\414\

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

\409\ MarketAxess Comment Letter at 24 (Mar. 8, 2011); WMBAA

Comment Letter at 19 (Mar. 8, 2011).

\410\ MarketAxess Comment Letter at 25 (Mar. 8, 2011).

\411\ WMBAA Comment Letter at 19 (Mar. 8, 2011).

\412\ See Core Principles and Other Requirements for Swap

Execution Facilities, 76 FR at 1222 n. 53 (providing examples of

ISVs).

\413\ Meeting with Bloomberg dated Jan. 18, 2012.

\414\ Id.

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

Under proposed Sec. 37.202(a)(2), MarketAxess recommended that

SEFs be permitted to rely on a written or electronically signed

representation by a participant seeking access to the SEF regarding its

status as an ECP.\415\ MarketAxess stated that SEFs may then adopt

rules to require that the participant notify the SEF immediately of any

change to its status after the participant makes the

representation.\416\

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

\415\ MarketAxess Comment Letter at 25 (Mar. 8, 2011).

\416\ Id.

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

Better Markets commented that proposed Sec. 37.202(a)(3) should

make clear that any form of preferential access to a SEF through fee

arrangements should not be allowed because it would defeat the goal of

impartial access.\417\ However, MarketAxess stated that SEFs should be

able to provide their market participants with volume discounts and

other pricing arrangements as long as such discounts and arrangements

are based upon objective criteria that are applied uniformly.\418\

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

\417\ Better Markets Comment Letter at 11-12 (Mar. 8, 2011).

\418\ MarketAxess Comment Letter at 25 (Mar. 8, 2011).

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

(ii) Commission Determination

The Commission is adopting Sec. 37.202(a) as proposed, subject to

the

[[Page 33508]]

modifications discussed below.\419\ The Commission does not believe

that the statute allows a SEF to adopt rules that limit access as

requested by ISDA/SIFMA, JP Morgan, and Rosen et al. The statutory

language of Core Principle 2 requires that SEFs establish and enforce

participation rules, including means to provide market participants

with impartial access to the market, and that SEFs adopt and enforce

rules with respect to any limitations they place on access (emphasis

added).\420\ As stated in the SEF NPRM, the Commission reiterates that

the purpose of the impartial access requirements is to prevent a SEF's

owners or operators from using discriminatory access requirements as a

competitive tool against certain ECPs or ISVs. The Commission also

agrees with Mallers et al. who stated that the impartial access

requirement allows ECPs to compete on a level playing field, and that

the participation of additional liquidity providers will improve the

pricing and efficiency of the market and reduce systemic risk. As such,

the Commission believes that access to a SEF should be determined, for

example, based on a SEF's impartial evaluation of an applicant's

disciplinary history and financial and operational soundness against

objective, pre-established criteria. As one example of such criteria,

any ECP should be able to demonstrate financial soundness either by

showing that it is a clearing member of a derivatives clearing

organization (``DCO'') that clears products traded on that SEF or by

showing that it has clearing arrangements in place with such a clearing

member.

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

\419\ The Commission is also making certain non-substantive

clarifications to the rule.

\420\ CEA sections 5h(f)(2)(A)(ii) and (2)(B)(i); 7 U.S.C. 7b-

3(f)(2)(A)(ii) and (2)(B)(i).

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

In this regard, the Commission believes that the impartial access

requirement of Core Principle 2 does not allow a SEF to limit access to

its trading systems or platforms to certain types of ECPs or ISVs as

requested by some commenters.\421\ The Commission notes that the rule

states ``impartial'' criteria and not ``selective'' criteria as

recommended by some commenters. The Commission is using the term

``impartial'' as intended in the statute. ``Impartial'' should be

interpreted in the ordinary sense of the word: fair, unbiased, and

unprejudiced. Subject to these requirements, a SEF may use its own

reasonable discretion to determine its access criteria, provided that

the criteria are impartial, transparent and applied in a fair and non-

discriminatory manner, and are not anti-competitive.

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

\421\ In this regard, the Commission is clarifying in response

to UBS's comment that a SEF may not exclude or discriminate against

a market participant providing agency services subject to any

limitation on such services contained in this final rulemaking.

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

In response to Tradeweb's comment about different access criteria

for different markets, the Commission notes that a SEF may establish

different access criteria for each of its markets. Core Principle 2

does not specify whether impartial access criteria must be the same for

all of a SEF's markets or may differ for each market. Therefore, the

Commission believes that it is within its discretion to allow a SEF to

establish different access criteria for each of its markets. However,

the Commission reiterates that the access criteria must be impartial

and must not be used as a competitive tool against certain ECPs or

ISVs. The Commission also reiterates that each similarly situated group

of ECPs and ISVs must be treated similarly.

In response to MarketAxess's and WMBAA's comments regarding ISVs,

the Commission notes that Congress required SEFs to establish

participation rules, including means to provide market participants

with impartial access to the market.\422\ The Commission believes that

ISVs \423\ provide market participants with additional opportunities to

access SEFs and that, similar to ECPs, SEFs should apply impartial

criteria in a fair and non-discriminatory manner when deciding whether

or not to grant an ISV access. In response to MarketAxess's and WMBAA's

comments regarding ISVs providing a competitive advantage to other

SEFs, the Commission notes that SEFs may set rules for ISVs so they do

not misuse data, for example, by providing the data to another SEF for

purely competitive reasons to the exclusion of market participants. The

Commission also notes that SEFs may charge fees to ISVs based on the

access or services they receive from the SEF.

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

\422\ CEA section 5h(f)(2)(B)(i); 7 U.S.C. 7b-3(f)(2)(B)(i).

WMBAA also commented that ISVs should comply with a SEF's rules, the

SEF core principles, and the oversight or supervision by the SEF in

the same manner as a market participant. WMBAA Comment Letter at 19

(Mar. 8, 2011). The Commission disagrees with WMBAA's comment

because ISVs provide market participants with greater options to

access SEFs and ISVs are not executing swaps on a SEF as are market

participants. Therefore, the Commission believes that ISVs should

not be subject to the same requirements as market participants.

\423\ The Commission notes that examples of independent software

vendors include: smart order routers, trading software companies

that develop front-end trading applications, and aggregator

platforms. Smart order routing generally involves scanning of the

market for the best-displayed price and then routing orders to that

market for execution. Software that serves as a front-end trading

application is typically used by traders to input orders, monitor

quotations, and view a record of the transactions completed during a

trading session. As noted above in the registration section,

aggregator platforms generally provide a portal to market

participants so that they can access multiple SEFs, but do not

provide for execution as execution remains on SEFs. Aggregator

platforms may also provide access to news and analytics. The

Commission believes that transparency and trading efficiency would

be enhanced as a result of innovations in this field for market

services. For instance, certain providers of market services with

access to multiple trading systems or platforms could provide

consolidated transaction data from such trading systems or platforms

to market participants.

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

In response to Bloomberg's comments, the Commission agrees that

ISVs should not be able to replicate the services of a SEF without

having to register as a SEF. The Commission notes that an ISV that

merely provides a service to SEFs will not, merely because it provides

such a service, be deemed to be a SEF as defined in CEA section 1a(50).

However, pursuant to the registration requirements in final Sec.

37.3(a), if an ISV offers a trading system or platform in which more

than one market participant has the ability to execute or trade swaps

with more than one other market participant on that system or platform,

then the ISV has to register as a SEF.\424\ The Commission also notes

that the user of an ISV must have been granted access by a SEF in order

to access that SEF's data and/or to execute a swap transaction on that

SEF through the ISV.\425\

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

\424\ See Aggregation Services or Portals discussion above under

Sec. 37.3--Requirements for Registration in the preamble. The

Commission notes that footnote 423 above classifies aggregator

platforms as a type of ISV so the discussion in this section

regarding ISVs also applies to aggregator platforms.

\425\ The Commission notes, however, that the user of an ISV may

not need to have been granted access to the SEF if the ISV is only

providing a composite quote or top level quote for multiple SEFs.

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

The Commission notes that under Sec. 37.202(a)(2), a SEF that is

determining whether to grant an ECP access to its facilities may rely

on a signed representation of its ECP status.\426\ By not prescribing a

process, the Commission is providing SEFs with flexibility and

discretion on how to meet this requirement. The Commission also notes

that for SEFs that permit intermediation, customers of ECPs must also

be ECPs.\427\ In this regard, a SEF must obtain a signed representation

[[Page 33509]]

from an intermediary that its customers are ECPs.

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

\426\ The Commission is replacing the term ``participant'' in

proposed Sec. 37.202(a)(2) with the term ``eligible contract

participant'' in final Sec. 37.202(a)(2) because the term

``participant'' was not defined in the SEF NPRM and the revised term

more clearly communicates the persons to whom this rule applies. In

this regard, the Commission notes that, prior to granting a person

access to its facility, a SEF must obtain confirmation from the

person of its ECP status.

\427\ For example, the Commission notes that a customer of a

futures commission merchant must be an ECP and a customer of a

broker must be an ECP.

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

To address comments submitted in connection with proposed Sec.

37.202(a)(3) regarding fees, the Commission clarifies that Sec.

37.202(a)(3) neither sets nor limits the fees that SEFs may charge. A

SEF may establish different categories of ECPs or ISVs seeking access

to, or services from, the SEF, but may not discriminate with respect to

fees within a particular category.\428\ The Commission notes that Sec.

37.202(a)(3) is not designed to be a rigid requirement that fails to

take into account legitimate business justifications for offering

different fees to different categories of entities seeking access to

the SEF. For example, a SEF may consider the services it receives from

members such as market making services when it determines its fee

structure.

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

\428\ The Commission is replacing the term ``participant'' in

proposed Sec. 37.202(a)(3) with the terms ``eligible contract

participants'' and ``independent software vendors'' in final Sec.

37.202(a)(3) because the term ``participant'' was not defined in the

SEF NPRM and the revised terms more clearly communicates the persons

to whom this rule applies.

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

(2) Sec. 37.202(b)--Jurisdiction

Proposed Sec. 37.202(b) required that prior to granting any ECP

access to its facilities, a SEF must require that the ECP consents to

its jurisdiction.

(i) Summary of Comments

CME recommended that the Commission withdraw the proposed

rule.\429\ CME contended that requiring clearing firms to obtain every

customer's consent to the regulatory jurisdiction of each SEF would be

costly.\430\ Moreover, CME commented that even if such consent were

obtained, the proposed rule would be entirely ineffective in achieving

the Commission's desired outcome.\431\ CME explained that if a non-

member, who had consented to the SEF's jurisdiction under the proposed

rule, committed a rule violation and subsequently elected not to

cooperate in the investigation or disciplinary process, the SEF's only

recourse would be to deny the non-member access and, if appropriate,

refer the matter to the Commission.\432\ CME further explained that a

SEF's enforcement options, and the regulatory outcomes, do not change

based on whether or not there is a record of the non-member consenting

to jurisdiction, but rather depend on whether the non-member chooses to

participate in the SEF's investigative and disciplinary processes.\433\

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

\429\ CME Comment Letter at 17 (Feb. 22, 2011).

\430\ Id. at 16.

\431\ Id.

\432\ Id.

\433\ Id.

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

Similarly, Bloomberg requested that the Commission clarify that

proposed Sec. 37.202(b) would only apply to a SEF's members and not

customers of members whose orders are executed on a SEF.\434\ Bloomberg

stated that, rather than subject all market participants to a SEF's

jurisdiction, it would be sufficient and more practical for each SEF

member to provide to the SEF specific information about its

customers.\435\ WMBAA noted that a SEF may only exercise jurisdiction

over a market participant with respect to its own rules and that the

SEF's ultimate sanction would be to ban a market participant from its

trading system or platform.\436\ WMBAA also stated that prohibiting a

market participant from trading on one particular SEF has little

utility because a market participant could continue to execute swaps on

other SEFs.\437\

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

\434\ Bloomberg Comment Letter at 6 (Mar. 8, 2011).

\435\ Id.

\436\ WMBAA Comment Letter at 19 (Mar. 8, 2011).

\437\ Id.

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

(ii) Commission Determination

The Commission is adopting Sec. 37.202(b) as proposed. While

acknowledging the comments described above, the Commission believes

that Sec. 37.202(b) codifies jurisdictional requirements necessary to

effectuate the statutory mandate of Core Principle 2 that a SEF shall

have the capacity to detect, investigate, and enforce rules of the

SEF.\438\ In the Commission's view, jurisdiction must be established by

a SEF prior to granting eligible contract participants access to its

markets in order to effectively investigate and sanction persons that

violate SEF rules. In particular, a SEF should not be in the position

of asking market participants to voluntarily submit to its jurisdiction

and cooperate in investigatory proceedings after a potential rule

violation has been found. Similarly, market participants should have

advanced notice that their trading practices are subject to the rules

of a SEF, including rules that require cooperating in investigatory and

disciplinary processes.

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

\438\ CEA section 5h(f)(2)(B); 7 U.S.C. 7b-3(f)(2)(B).

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

For the avoidance of doubt, the Commission clarifies that the scope

of Sec. 37.202(b) is not limited to members. To the contrary, all

members and market participants of a SEF, as defined above under Sec.

37.200, are within the scope of Sec. 37.202(b).

In response to CME's and WMBAA's comments, the Commission notes

that a SEF's ultimate recourse against a market participant is to deny

such market participant access to the SEF and, if appropriate, refer

the market participant to the Commission. The Commission has the

authority to issue broader sanctions for market participants who commit

SEF rule violations that also violate the CEA and Commission

regulations. Therefore, the Commission expects that a SEF would not

only sanction market participants as appropriate, but also refer

matters to the Commission for additional action when necessary. The

Commission does not agree that this action absolves SEFs from their

responsibility to establish jurisdiction over members and market

participants.

(3) Sec. 37.202(c)--Limitations on Access

Proposed Sec. 37.202(c) required a SEF to establish and

impartially enforce rules governing any decision to allow, deny,

suspend, or permanently bar participants' access to the SEF, including

when such decisions are made as part of a disciplinary or emergency

action taken by the SEF.

(i) Commission Determination

Although no comments were received on Sec. 37.202(c), the

Commission is adopting the proposed rule subject to one

modification.\439\ The Commission is replacing the term ``participant''

with ``eligible contract participant'' because the term ``participant''

was not defined in the SEF NPRM and the revised term more clearly

communicates the persons to whom this rule applies.\440\ The Commission

notes that Sec. 37.202(c) implements Core Principle 2's requirement

regarding limitations on access to the SEF.\441\

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

\439\ The Commission is making certain non-substantive

clarifications to the rule.

\440\ For the avoidance of doubt, the Commission notes that this

rule applies to the SEF's members and market participants.

\441\ CEA section 5h(f)(2)(A)(ii); 7 U.S.C. 7b-3(f)(2)(A)(ii).

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

(d) Sec. 37.203--Rule Enforcement Program

Proposed Sec. 37.203 required a SEF to establish and enforce

trading, trade processing, and participation rules that will deter

abuses and have the capacity to detect, investigate, and enforce those

rules.\442\

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

\442\ The Commission notes that Sec. 37.203 codifies CEA

section 5h(f)(2)(B). 7 U.S.C. 7b-3(f)(2)(B).

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

(1) Sec. 37.203(a)--Abusive Trading Practices Prohibited

Proposed Sec. 37.203(a) required a SEF to prohibit certain abusive

trading practices, including front-running, wash trading, pre-arranged

trading, fraudulent

[[Page 33510]]

trading, money passes, and any other trading practices that the SEF

deems to be abusive. The proposed rule further obligated a SEF to

``prohibit any other manipulative or disruptive trading practices

prohibited by the Act or by the Commission pursuant to Commission

regulations.'' SEFs permitting intermediation were required to prohibit

additional trading practices, such as trading ahead of customer orders,

trading against customer orders, accommodation trading, and improper

cross trading. As explained in the SEF NPRM, prohibited trading

practices include those proscribed by section 747 of the Dodd-Frank

Act.\443\

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

\443\ Core Principles and Other Requirements for Swap Execution

Facilities, 76 FR at 1223 n.61. Section 747 of the Dodd-Frank Act

amended CEA section 4c(a) to make it unlawful for any person to

engage in any trading, practice, or conduct on or subject to the

rules of a registered entity that--(A) violates bids or offers; (B)

demonstrates intentional or reckless disregard for the orderly

execution of transactions during the closing period; or (C) is, is

of the character of, or is commonly known to the trade as, spoofing

(bidding or offering with the intent to cancel the bid or offer

before execution). See Antidisruptive Practices Authority, 76 FR

14943 (proposed Mar. 18, 2011) for proposed interpretive guidance on

these three new statutory provisions of CEA section 4c(a)(5).

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

(i) Summary of Comments

CME and ABC/CIEBA commented that the proposed rule is problematic

because it enumerated prohibited trade practices without specifically

defining them.\444\ CME stated that SEFs should have reasonable

discretion to establish rules appropriate to their markets that are

consistent with the CEA and that satisfy the core principles.\445\ CME

questioned, in particular, how to interpret the proposed prohibition on

pre-arranged trading with respect to rules that allow for block

trading, exchange for related position transactions, and pre-execution

communications subject to specified conditions.\446\

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

\444\ ABC/CIEBA Comment Letter at 9 (Mar. 8, 2011); CME Comment

Letter at 17-18 (Feb. 22, 2011).

\445\ CME Comment Letter at 17 (Feb. 22, 2011).

\446\ Id. at 17-18.

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

WMBAA contended that the enumerated abusive trading practices

appear more commonly in markets with retail participants, and therefore

are more likely to occur on a DCM rather than a SEF.\447\ Accordingly,

WMBAA recommended that the Commission include in the final rule abusive

trading practices that are more likely to occur on a SEF.\448\ Finally,

Better Markets recommended that the Commission expand its list of

prohibited trade practices to ban certain high-frequency trading

practices, including exploiting a large quantity or block trade, price

spraying (which it views as a form of front-running), rebate

harvesting, and layering the market (which it analogizes to

spoofing).\449\

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

\447\ WMBAA Comment Letter at 20 (Mar. 8, 2011).

\448\ Id.

\449\ Better Markets Comment Letter at 13-17 (Mar. 8, 2011).

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

(ii) Commission Determination

The Commission is adopting proposed Sec. 37.203(a), subject to one

modification described below. In response to CME's and ABC/CIEBA's

comments regarding the perceived vagueness of the enumerated trading

practices, the Commission notes that the enumerated abusive trading

practices reflect the trading practices that are typically accepted as

prohibited conduct by regulators and derivatives exchanges in the

industry. In the SEF NPRM, the Commission stated that the proposed

prohibited trading practices are a compilation of abusive trading

practices that DCMs already prohibit.\450\ The Commission also noted in

the final DCM rulemaking that the prohibited trading practices are

typically already prohibited in DCM rulebooks.\451\ Although the

Commission believes, as noted by CME, that a SEF should have reasonable

discretion to establish rules for its markets, the Commission believes,

at a minimum, that a SEF must prohibit the abusive trading practices

identified in the rule.

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

\450\ Core Principles and Other Requirements for Swap Execution

Facilities, 76 FR at 1223.

\451\ Core Principles and Other Requirements for Designated

Contract Markets, 77 FR 36612, 36626 (Jun. 19, 2012).

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

In response to CME's comment about how to interpret the prohibition

on pre-arranged trading with respect to rules that allow for block

trading and other types of trading, the Commission is amending proposed

Sec. 37.203(a) to clarify that a SEF must prohibit pre-arranged

trading, except for block trades permitted under part 43 of the

Commission's regulations or other types of transactions certified to or

approved by the Commission pursuant to the procedures under part 40 of

the Commission's regulations. This change clarifies that these types of

transactions will not be subject to the prohibition on pre-arranged

trading. The Commission also clarifies, as discussed above under the

time delay requirement, that the prohibition on pre-arranged trading

does not limit pre-execution communications between market

participants, subject to the rules of the SEF. Accordingly, SEFs that

permit pre-execution communications must establish and enforce rules

relating to such communications.

In response to WMBAA's comment that the enumerated abusive trading

practices are more suited to DCMs rather than SEFs, the Commission

believes that similar prohibitions are necessary to promote consistent

protection for all market participants across the swaps market.

Therefore, the Commission believes that the enumerated abusive trading

practices should be prohibited by DCMs and SEFs. The Commission notes

that requiring SEFs to proscribe trading practices which are prohibited

by the Act and Commission regulations does not create any additional

obligations beyond the existing statutory and regulatory requirements

applicable to all SEFs.

The Commission agrees with WMBAA and Better Markets that other

abusive trading practices may exist. In this regard, Sec. 37.203(a)

provides a non-exhaustive, non-exclusive list. The regulations adopted

in this final release provide a SEF with reasonable discretion to

establish rules that prohibit additional abusive trading practices.

Additionally, not only must a SEF prohibit any other trading practices

that a SEF deems abusive,\452\ it must also establish and enforce rules

that will deter abuses under statutory Core Principle 2.\453\

Therefore, if a SEF identifies additional abusive trading practices

that are likely to occur on its trading systems and platforms, then the

SEF is required, by statute and Commission regulation, to prohibit such

abusive trading practices. The Commission anticipates that as SEFs gain

experience with exchange-listed swaps, it may periodically revisit the

list of prohibited abusive trading practices under Sec. 37.203(a).

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

\452\ See Final Sec. 37.203(a) in the Commission's regulations.

\453\ CEA section 5h(f)(2); 7 U.S.C. 7b-3(f)(2).

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

(2) Sec. 37.203(b)--Capacity to Detect and Investigate Rule Violations

Proposed Sec. 37.203(b) required a SEF to have arrangements and

resources for effective rule enforcement, which included a SEF's

authority to collect information and examine books and records of SEF

members and market participants. As discussed in the preamble to the

SEF NPRM, the Commission believes that a SEF can best administer its

compliance and rule enforcement obligations by having the ability to

reach the books and records of all market participants.\454\ Proposed

Sec. 37.203(b) also required a SEF's arrangements and resources to

facilitate

[[Page 33511]]

the direct supervision of the market and the analysis of data collected

to determine whether a rule violation has occurred.

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

\454\ Core Principles and Other Requirements for Swap Execution

Facilities, 76 FR at 1223.

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

(i) Summary of Comments

FXall and CME requested that the Commission clarify the provision

in proposed Sec. 37.203(b) that requires a SEF to have the authority

to examine the books and records of its members and market

participants.\455\ Specifically, CME expressed concern that the

proposed rule would subject non-registered market participants to

recordkeeping requirements that currently apply only to member,

registrants, and direct access clients of its platform, which it does

not believe would be effective.\456\ CME also commented that the

proposed rule does not detail which books, records, and information a

SEF must be able to obtain from its non-member market

participants.\457\ FXall expressed concern that the requirement for a

SEF to have the authority to examine the books and records of its

members and market participants could be interpreted to require a SEF

to conduct a full regulatory examination program.\458\ FXall,

therefore, recommended that the Commission clarify that this

requirement only applies as may be necessary for a SEF to investigate a

specific potential rule violation that the SEF has detected in the

ordinary course of its trade practice surveillance routine or has

otherwise been brought to its attention.\459\

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

\455\ FXall Comment Letter at 11-12 (Mar. 8, 2011); CME Comment

Letter at 18 (Feb. 22, 2011).

\456\ CME Comment Letter at 18 (Feb. 22, 2011).

\457\ Id.

\458\ FXall Comment Letter at 11-12 (Mar. 8, 2011).

\459\ Id.

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

(ii) Commission Determination

The Commission is adopting Sec. 37.203(b) as proposed, subject to

the following modification. To address CME's concerns about the scope

of proposed Sec. 37.203(b), the Commission is replacing the term

``market participant'' with ``persons under investigation.'' The

Commission recognizes that using the term ``market participant'' could

significantly increase the regulatory responsibilities for SEFs. Thus,

the Commission clarifies that Sec. 37.203(b) places upon a SEF an

affirmative obligation to have the authority to examine books and

records from its members and from any persons under investigation for

effective enforcement of its rules. The Commission also notes that the

books and records collected by the SEF should encompass all information

and documents that are necessary to detect and prosecute rule

violations. In response to FXall's comment, the Commission clarifies

that the requirement for a SEF to have the authority to examine books

and records does not require a SEF to conduct a full regulatory

examination program. However, the Commission notes that in addition to

the SEF's obligations pursuant to Sec. 37.203(b), the audit trail

requirements in Sec. 37.205(c)(2) require a SEF to establish a program

for effective enforcement of its audit trail and recordkeeping

requirements, which would require the examination of books and records.

(3) Sec. 37.203(c)--Compliance Staff and Resources

Proposed Sec. 37.203(c)(1) provided that a SEF must establish and

maintain sufficient compliance staff and resources to conduct a number

of enumerated tasks, such as audit trail reviews, trade practice

surveillance, market surveillance, and real-time monitoring. Proposed

Sec. 37.203(c)(2) required a SEF to continually monitor the size and

workload of its compliance staff and, on at least an annual basis,

formally evaluate the need to increase its compliance staff and

resources. The proposed rule also set forth certain factors that a SEF

should consider in determining the appropriate level of compliance

staff and resources.

(i) Summary of Comments

Two commenters sought clarification regarding a SEF's compliance

resources.\460\ WMBAA requested that the Commission clarify whether the

resources and staff of a compliance department may be shared with

affiliates or between multiple SEFs, and if so, how these shared

resources would be considered in meeting the requirements for

sufficient compliance staff and resources.\461\ WMBAA also requested

clarification as to whether a SEF could consider its third party

service provider's resources and staff for purposes of evaluating the

adequacy of its compliance staff and resources.\462\ MarketAxess

believed that the process by which a SEF must conduct a formal

evaluation of its compliance resources was unclear.\463\ MarketAxess

also noted that while the findings of such an evaluation could result

in the need to increase a SEF's compliance staff and resources, it

could also result in a decrease.\464\ Accordingly, MarketAxess

suggested that the Commission remove the term ``formally'' and clarify

that the evaluation of compliance resources could result in either an

increase or decrease in compliance staff and resources.\465\

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

\460\ WMBAA Comment Letter at 21 (Mar. 8, 2011); MarketAxess

Comment Letter at 35 (Mar. 8, 2011).

\461\ WMBAA Comment Letter at 21 (Mar. 8, 2011).

\462\ Id.

\463\ MarketAxess Comment Letter at 35 (Mar. 8, 2011).

\464\ Id.

\465\ Id.

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

(ii) Commission Determination

The Commission is adopting Sec. 37.203(c) as proposed, subject to

one modification discussed below.\466\ The Commission agrees in part

with WMBAA's recommendation that some SEF compliance staff can be

shared among affiliated entities under the appropriate circumstances.

However, such arrangements would require prior review by the Commission

staff and appropriate legal documentation between the affiliated

entities with respect to any shared staff (e.g., secondment or

regulatory services agreements that define responsibilities; establish

decision-trees for matters of regulatory consequence; and provide for

exclusive authority and responsibility by each SEF with respect to

matters on its markets). The Commission also emphasizes that any

sharing of compliance staff does not diminish each SEF's obligation to

maintain sufficient staff to meet its own regulatory needs. The

Commission believes that compliance resources may not be shared between

non-affiliated SEFs given potential conflict issues. However, the

Commission recognizes that a SEF may provide regulatory services to a

non-affiliated SEF pursuant to a regulatory services agreement.

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

\466\ The Commission is making certain non-substantive

clarifications to proposed Sec. 37.203(c)(1). The Commission is

also renumbering proposed Sec. 37.203(c)(1) to Sec. 37.203(c).

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

The Commission believes that a SEF may take into consideration the

staff and resources of its regulatory service provider when evaluating

the sufficiency of its own compliance staff. Regardless of whether a

SEF utilizes a regulatory service provider or shares its compliance

staff with an affiliate, the Commission emphasizes that the SEF must

maintain sufficient internal compliance staff to oversee the quality

and effectiveness of the regulatory services provided and to make

certain regulatory decisions, as required by Sec. 37.204.

Finally, the Commission is deleting proposed Sec. 37.203(c)(2),

which required that a SEF monitor the size and workload of its

compliance staff on a continuous basis and, on at least an annual

basis, formally evaluate the need to increase its compliance resources

and

[[Page 33512]]

staff. The Commission believes that the obligation that a SEF monitor

the adequacy of its compliance staff and resources are implicit in

proposed Sec. 37.203(c)(1). The final rule provides greater

flexibility to SEFs in determining their approach to monitoring their

compliance resources.

(4) Sec. 37.203(d)--Automated Trade Surveillance System

Proposed Sec. 37.203(d) required a SEF to maintain an automated

trade surveillance system capable of detecting and investigating

potential trade practice violations. The proposed rule also required

that an acceptable automated trade surveillance system must have the

capability to generate alerts on a trade date plus one day (T+1) basis

to assist staff in detecting potential violations. The automated trade

surveillance system, among other requirements, must maintain all trade

and order data, including order modifications and cancellations, and

must have the capability to compute, retain, and compare trading

statistics; compute trade gains and losses; and reconstruct the

sequence of trading activity.

(i) Summary of Comments

CME and WMBAA expressed concern about the capabilities required of

an automated trade surveillance system under the proposed rule.\467\

Specifically, CME stated that it has been unable to design an automated

surveillance system that automates the actual investigation of

potential trade practice violations.\468\ CME also challenged the use

of what it deemed as ``broad and ambiguous'' terms to describe the

required capabilities of such a system, and recommended that the

Commission consider applying a more flexible, core principles-based

approach to implementing the requirement.\469\ WMBAA argued that it

would be impossible to create an automated trade surveillance system

with the capabilities described in the proposed rule without knowledge

of a participant's complete trading activity, including trading

activity that takes place on other SEFs.\470\

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

\467\ CME Comment Letter at 19-20 (Feb. 22, 2011); WMBAA Comment

Letter at 21 (Mar. 8, 2011).

\468\ CME Comment Letter at 19-20 (Feb. 22, 2011).

\469\ Id. at 20.

\470\ WMBAA Comment Letter at 21 (Mar. 8, 2011).

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

Better Markets recommended that data recorded by an automated trade

surveillance system be time-stamped at intervals consistent with the

capabilities of high-frequency traders that will transact on SEFs.\471\

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

\471\ Better Markets Comment Letter at 18 (Mar. 8, 2011).

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

(ii) Commission Determination

The Commission is adopting proposed Sec. 37.203(d), subject to two

modifications discussed below. First, the Commission is moving the

requirement that an automated trade surveillance system maintain all

data reflecting the details of each order entered into the trading

system to final Sec. 37.205(b). The Commission believes that Sec.

37.205(b) is a more logical place in the Commission's rules to address

this aspect of a SEF's automated surveillance system because it also

specifies the requirements for a SEF's audit trail program, including a

history of all orders and trades.

Second, the Commission is deleting the word ``investigating'' from

proposed Sec. 37.203(d) to remove any confusion, as noted by CME. The

Commission notes, in response to CME's comment, that the final rules do

not require a SEF's automated trade surveillance system to conduct the

actual investigations. The Commission believes that the actual

investigation would be carried out by a SEF's compliance staff with the

assistance of automated surveillance tools.

In response to CME's comment pertaining to the breadth of the rule,

the Commission believes that effective surveillance of trading markets

requires that a SEF maintain an automated trade surveillance system

capable of detecting trade practice violations to assist compliance

staff in analyzing large data sets and investigating patterns of

conduct that may go otherwise unnoticed. The Commission also believes

that the analytical tools enumerated in the rule are a necessary

component of an effective trade surveillance system. This rule, as

modified, therefore fulfills the statutory requirement of Core

Principle 2 by assisting the SEF in detecting, investigating, and

enforcing trading rules that will deter abuses.\472\

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

\472\ CEA section 5h(f)(2)(B); 7 U.S.C. 7b-3(f)(2)(B).

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

The Commission acknowledges the inter-SEF surveillance limitations

expressed by WMBAA. The Commission notes that the purpose of Sec.

37.203(d) is to ensure that a SEF's compliance staff has the necessary

tools to detect, analyze, and investigate potential trade practice

violations on the SEF's trading systems or platforms; it does not

obligate a SEF to establish a cross-market trade practice surveillance

program.

Although the Commission acknowledges the merits of the

recommendation by Better Markets to include time stamps at intervals

consistent with the capabilities of high-frequency traders, the

Commission does not believe that it is necessary to modify Sec.

37.203(d) to address this concern. As discussed in Sec. 37.401 below,

there are efforts underway both within and outside of the Commission to

define and develop approaches for better monitoring of high-frequency

and algorithmic trading.\473\ However, while the rule does not specify

the granularity of time-stamped data, a SEF's automated trade

surveillance system should have the ability to readily determine the

sequence in which orders are entered. This reflects the Commission's

belief that an automated trade surveillance system should time-stamp

data with the granularity necessary to conduct effective surveillance

of all trade-related activity, including high-frequency trading, while

leaving the details of the system to the SEF.

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

\473\ See discussion below regarding high-frequency trading

under Sec. 37.401--General Requirements in the preamble.

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

The Commission notes that the accurate time-stamping of data is

particularly important for SEFs that use an RFQ System, including an

RFQ System with a voice component. For such SEFs, the accurate time-

stamping of both their Order Book and RFQ System activity is critical

for ensuring both that the SEF itself has a robust surveillance system

and that the Commission is able to monitor the SEF's adherence to part

37's Order Book-RFQ System integration requirements.

(5) Sec. 37.203(e)--Real-Time Market Monitoring

Proposed Sec. 37.203(e) required a SEF to conduct real-time market

monitoring of all trading activity on its electronic trading platform

to ensure orderly trading and to identify market or system anomalies.

The proposed rule further required a SEF to have the authority to

adjust prices and cancel trades when needed to mitigate ``market

disrupting events'' caused by platform malfunctions or errors in orders

submitted by market participants. In addition, proposed Sec. 37.203(e)

required that any trade price adjustments or trade cancellations be

transparent to the market and subject to standards that are clear,

fair, and publicly available.

(i) Summary of Comments

CME stated that the proposed standards would be difficult for any

SEF to reasonably meet because they require

[[Page 33513]]

monitoring of all trading activity on a platform to ensure orderly

trading.\474\ CME also reiterated its belief that the proposed rules

are overly prescriptive and recommended that the Commission provide

application guidance instead of a rule.\475\ WMBAA requested

clarification that a SEF's obligation to conduct real-time market

monitoring does not include the requirement to conduct automated trade

surveillance under Sec. 37.203(d).\476\

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

\474\ CME Comment Letter at 21 (Feb. 22, 2011).

\475\ Id. at 20-21.

\476\ WMBAA Comment Letter at 21 (Mar. 8, 2011).

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

Two commenters opined on the requirement for a SEF to modify or

cancel a swap transaction.\477\ SIFMA AMG argued that a SEF should not

be able to modify or cancel a swap transaction under any circumstances

without the express consent of the counterparties.\478\ SIFMA AMG also

stated that if counterparties consent to an adjustment, then clearing

entities, executing brokers, DCMs, and middleware platforms should also

make the appropriate adjustment.\479\ ISDA/SIFMA recommended that the

Commission adopt a uniform standard for ``market disrupting events.''

\480\

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

\477\ SIFMA AMG Comment Letter at 14 (Mar. 8, 2011); ISDA/SIFMA

Comment Letter at 13 (Mar. 8, 2011).

\478\ SIFMA AMG Comment Letter at 14 (Mar. 8, 2011).

\479\ Id.

\480\ ISDA/SIFMA Comment Letter at 13 (Mar. 8, 2011).

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

Better Markets stated that a SEF's obligation to conduct real-time

market monitoring should include monitoring orders and cancellations

that are time-stamped at intervals consistent with the capabilities of

high-frequency traders to identify abusive high frequency trading

strategies.\481\

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

\481\ Better Markets Comment Letter at 18 (Mar. 8, 2011).

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

(ii) Commission Determination

The Commission is adopting proposed Sec. 37.203(e), subject to one

modification. The Commission agrees with CME that real-time market

monitoring cannot ``ensure'' orderly trading at all times, but the

Commission believes that such monitoring must identify disorderly

trading when it occurs. Accordingly, the Commission is modifying

proposed Sec. 37.203(e) to require a SEF to conduct real-time market

monitoring ``to identify disorderly trading,'' instead of ``to ensure

orderly trading.''

In response to CME's comment that the rule is overly prescriptive,

the Commission believes that Sec. 37.203(e) grants a SEF the

flexibility to determine the best way to conduct real-time market

monitoring so that it can effectively monitor its markets. The

Commission also believes that the rule correctly mandates that a SEF

conduct real-time market monitoring of all trading activity that occurs

on its system or platform in order to detect disorderly trading and

market or system anomalies, and take appropriate regulatory action. The

Commission believes that this rule fulfills the statutory requirement

of Core Principle 2, which requires a SEF to have the capacity to

detect, investigate, and enforce trading rules that will deter

abuses.\482\

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

\482\ CEA section 5h(f)(2)(B); 7 U.S.C. 7b-3(f)(2)(B).

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

In response to WMBAA's comment, the Commission clarifies that a

SEF's obligation to conduct real-time market monitoring does not

encompass the automated trade surveillance requirement in Sec.

37.203(d). The Commission notes that while real-time market monitoring

and trade practice surveillance are both self-regulatory functions

assigned to all SEFs, these functions are generally independent and

serve different purposes. As discussed in the SEF NPRM, market

monitoring is conducted on a real-time basis so that a SEF can take

mitigating action against any market or system anomalies on its trading

system or platform.\483\ Trade practice surveillance, on the other

hand, involves reconstructing and analyzing order, trade, and other

data post-execution to identify potential violations and anomalies

found in trade data.\484\ Further, as noted in the SEF NPRM, the

automated trade surveillance system typically differs from the system

used to conduct real-time market monitoring.\485\

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

\483\ Core Principles and Other Requirements for Swap Execution

Facilities, 76 FR at 1224.

\484\ Id. at 1223-24.

\485\ Id. at 1224.

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

The Commission disagrees with SIFMA AMG's comment that a SEF should

not be able to modify or cancel a swap transaction under any

circumstances without the express consent of the counterparties. The

Commission believes that a SEF should have the authority to modify or

cancel a swap transaction without the consent of the counterparties

under certain limited circumstances. For example, a SEF should be able

to cancel a trade when such trade was executed due to a technological

error on the part of the SEF. Further, the Commission believes that the

rule's requirement that any modifications or cancellations by the SEF

be transparent to the market and subject to standards that are clear,

fair, and publicly available will provide protection to counterparties.

The Commission also acknowledges the validity of SIFMA AMG's concern

that any adjustment to a swap transaction should also be reflected by

entities involved in the clearing and processing of the swap. However,

since imposing such a requirement on entities involved in the clearing

and processing of swaps is outside the scope of this SEF rulemaking,

the Commission declines to address this issue in these final rules.

The Commission also rejects ISDA/SIFMA's recommendation to define

the term ``market disrupting events,'' as it does not believe that a

rule definition could reasonably capture the universe of potentially

market disrupting events. The Commission notes that industry

definitions for terms such as ``market disrupting events'' generally

only establish a process or framework for counterparties and other

third parties to determine whether such an event has occurred and can

be subject to challenge, resulting in delayed determinations with

limited utility for effective trade monitoring. Although the Commission

believes that coordination among SEFs regarding market disrupting

events may be appropriate, and encourages SEFs to do so, the Commission

is not defining ``market disrupting events'' at this time. The

Commission may provide examples at a later time once it gains further

knowledge regarding the types of market disrupting events that are

likely to occur on a SEF.

In response to the comment by Better Markets about high-frequency

trading, the Commission declines to modify proposed Sec. 37.203(e) to

include concepts related specifically to high-frequency trading at this

time.\486\ The Commission believes that a SEF's real-time market

monitoring system should be structured to conduct effective market

monitoring for all order and trade types, including, but not limited

to, high frequency trading.

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

\486\ See discussion below regarding high-frequency trading

under Sec. 37.401--General Requirements in the preamble.

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

(6) Sec. 37.203(f)--Investigations and Investigation Reports

Proposed Sec. 37.203(f) required a SEF to establish procedures for

conducting investigations, provided timelines for completing such

investigations, detailed the requirements of an investigation report,

and provided for warning letters.

(i) Sec. 37.203(f)(1)--Procedures

Proposed Sec. 37.203(f)(1) required a SEF to have procedures that

require its compliance staff to conduct investigations of possible rule

[[Page 33514]]

violations. The proposed rule required that an investigation be

commenced upon the Commission staff's request or upon discovery of

information by the SEF indicating a possible basis for finding that a

violation has occurred or will occur.

(A) Summary of Comments

CME argued that the proposed rule diminishes a SEF's discretion to

determine the matters that warrant a formal investigation because at

the time of discovery or upon receipt of information, and before any

review has occurred, there will always be ``a possible basis'' that a

violation has occurred or will occur.\487\ CME agreed that formal

written referrals from the Commission, law enforcement authorities,

other regulatory agencies, or other SROs should result in a formal

investigation in every instance.\488\ However, CME contended that a SEF

should have reasonable discretion to determine how it responds to

complaints, leads, and other types of referrals, including the

discretion to follow-up with a less formal inquiry in certain

situations.\489\

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

\487\ CME Comment Letter at 21 (Feb. 22, 2011).

\488\ Id.

\489\ Id.

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

MarketAxess expressed concern that the proposed rule is not clear

as to whether a SEF can contract its investigations to its regulatory

service provider.\490\ MarketAxess recommended that the Commission

modify the proposed rule by replacing ``compliance staff'' with ``swap

execution facility'' to clarify that a regulatory service provider that

is responsible for a SEF's rule enforcement program can conduct

investigations on behalf of the SEF.\491\

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

\490\ MarketAxess Comment Letter at 35 (Mar. 8, 2011).

\491\ Id. at 35-36.

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

(B) Commission Determination

The Commission is adopting Sec. 37.203(f)(1) as proposed, subject

to certain modifications described below. The Commission confirms that

in certain circumstances a SEF should have reasonable discretion

regarding whether or not to open an investigation, as noted by CME.

Accordingly, the Commission is amending proposed Sec. 37.203(f)(1) to

provide that an investigation must be commenced by the SEF upon the

receipt of a request from Commission staff or upon the discovery or

receipt of information that indicates a ``reasonable basis'' for

finding that a violation may have occurred or will occur.

In response to MarketAxess's comment that the proposed rule is

unclear, the Commission confirms that a SEF may contract with a

regulatory service provider, as provided for under Sec. 37.204, whose

staff may perform the functions assigned to a SEF's compliance staff

under this rule. In this regard, the Commission also notes that the SEF

must maintain sufficient internal compliance staff to oversee the

quality and effectiveness of the regulatory services provided on its

behalf, and to make certain regulatory decisions, as required by Sec.

37.204.

(ii) Sec. 37.203(f)(2)--Timeliness

Under proposed Sec. 37.203(f)(2), the Commission required that

investigations be completed in a timely manner, defined as 12 months

after an investigation is opened, absent enumerated mitigating

circumstances.

(A) Summary of Comments

CME generally supported the proposed rule, but recommended that the

list of possible mitigating circumstances also include the domicile of

the subjects and cooperative enforcement matters since the SEF may not

have independent control over the pace of the investigation.\492\ CME

also requested that the Commission clarify that the twelve month period

for completing an investigation referenced in proposed Sec.

37.203(f)(2) is separate from the time period necessary to prosecute an

investigation.\493\

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

\492\ CME Comment Letter at 21 (Feb. 22, 2011).

\493\ Id. at 21-22.

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

(B) Commission Determination

The Commission is adopting Sec. 37.203(f)(2) as proposed. The

Commission believes that a 12-month period to complete an investigation

is appropriate and timely. Although the Commission agrees with CME that

additional mitigating factors could justifiably contribute to a delay

in completing an investigation within a 12-month period, the Commission

notes that the factors included in the proposed rule were not intended

to be an exhaustive list of mitigating circumstances. In the

Commission's view, the factors listed in the proposed rule represent

some of the more common examples that could delay completion of an

investigation within the 12-month period. The Commission also confirms

that Sec. 37.203(f)(2) only applies to the investigation phase of a

matter, and is separate from the time period necessary to prosecute an

investigation.

(iii) Sec. 37.203(f)(3)--Investigation Reports When a Reasonable Basis

Exists for Finding a Violation

Proposed Sec. 37.203(f)(3) required a SEF's compliance staff to

submit an investigation report for disciplinary action any time staff

determined that a reasonable basis existed for finding a rule

violation. The proposed rule also enumerated the items that must be

included in the investigation report, including the market

participant's disciplinary history.

(A) Summary of Comments

CME and ICE commented on the requirement that a respondent's

disciplinary history be included in the investigation report that is

submitted to a Review Panel.\494\ CME asserted that a respondent's

disciplinary history would only be relevant if a prior offense is an

element of proof for the potential rule violation under review.\495\

ICE commented that only substantive violations in the respondent's

history would be relevant to the Review Panel's deliberations.\496\

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

\494\ ICE Comment Letter at 7 (Mar. 8, 2011); CME Comment Letter

at 22, 35 (Feb. 22, 2011).

\495\ CME Comment Letter at 35 (Feb. 22, 2011).

\496\ ICE Comment Letter at 7 (Mar. 8, 2011).

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

CME commented that rule violations can range from very minor to

egregious and not every rule violation merits formal disciplinary

action.\497\ CME argued that warning letters are sufficient to address

minor rule violations, rather than the issuance of a formal

investigatory report.\498\

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

\497\ CME Comment Letter at 22 (Feb. 22, 2011).

\498\ Id.

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

MarketAxess stated that the proposed rule does not specify to whom

the investigation reports must be submitted, and recommended that the

reports be submitted to the SEF's Chief Compliance Officer, consistent

with Core Principle 15.\499\

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

\499\ MarketAxess Comment Letter at 36 (Mar. 8, 2011).

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

(B) Commission Determination

The Commission is adopting Sec. 37.203(f)(3) as proposed, subject

to one modification. The Commission agrees with CME and ICE that a

respondent's disciplinary history is not always relevant to the

determination of whether the respondent has committed a further

violation of a SEF's rules. Accordingly, the Commission is removing

this requirement from the final rule. The Commission notes, however,

that all disciplinary sanctions, including sanctions imposed pursuant

to an accepted settlement offer, must take into account the

respondent's disciplinary history.

[[Page 33515]]

The Commission confirms, as recommended by CME, that ``minor

transgressions'' can be addressed by a SEF's compliance staff with the

issuance of warning letters as discussed below in Sec. 37.203(f)(5).

However, as further discussed below in Sec. 37.203(f)(5), no more than

one warning letter may be issued to the same person or entity found to

have committed the same rule violation more than once within a rolling

12-month period.\500\

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

\500\ The Commission notes that a SEF's issuance of a warning

letter for the violation of a SEF rule neither precludes the

Commission from taking an enforcement action against the recipient

of the warning letter based upon the same underlying conduct, nor

does it provide a defense against any such Commission enforcement

action.

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

Finally, the Commission clarifies that a SEF's compliance staff

should submit all completed investigation reports to the member or

members of the SEF's compliance department responsible for reviewing

such reports and determining the next steps in the process, such as

whether to refer the matter to the SEF's disciplinary panel or

authorized compliance staff under Sec. 37.206(c).

(iv) Sec. 37.203(f)(4)--Investigation Reports When No Reasonable Basis

Exists for Finding a Violation

Proposed Sec. 37.203(f)(4) required compliance staff to prepare an

investigation report upon concluding an investigation and determining

that no reasonable basis exists for finding a rule violation. If the

investigation report recommended that a disciplinary panel should issue

a warning letter, then the investigation report must also include a

copy of the warning letter and the market participant's disciplinary

history, including copies of warning letters.

(A) Summary of Comments

CME noted that its Market Regulation Department currently has the

authority to administratively close a case and issue a warning letter

without disciplinary committee approval.\501\ Accordingly, CME

recommended that the Commission amend the proposed rule to reflect that

a SEF will also have such authority.\502\

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

\501\ CME Comment Letter at 21 (Feb. 22, 2011).

\502\ Id.

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

(B) Commission Determination

The Commission is adopting Sec. 37.203(f)(4) as proposed, subject

to one modification.\503\ The Commission is eliminating the provision

that discussed the concept of warning letters because the Commission

does not believe that a SEF would need to limit the number of warning

letters that can be issued when a rule violation has not been found.

The Commission notes, however, that this modification does not impact

the limitation on the number of warning letters that may be issued by a

disciplinary panel or by compliance staff to the same person or entity

for the same violation committed more than once in a rolling 12-month

period when a rule violation has been found. The Commission clarifies,

in response to CME's comment, that a SEF may authorize its compliance

staff to close a case administratively and issue a warning letter

without disciplinary panel approval when a reasonable basis does not

exist for finding a rule violation.

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

\503\ Similar to Sec. 37.203(f)(3), the Commission notes that a

SEF's compliance staff should submit all completed investigation

reports to the member or members of the SEF's compliance department

responsible for reviewing such reports and determining the next

steps to take.

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

(v) Sec. 37.203(f)(5)--Warning Letters

Proposed Sec. 37.203(f)(5) provided that a SEF may authorize its

compliance staff to issue a warning letter or to recommend that a

disciplinary committee issue a warning letter. The proposed rule also

prohibited a SEF from issuing more than one warning letter to the same

person or entity for the same potential violation during a rolling 12-

month period.

(A) Summary of Comments

Some commenters opposed the proposed limitation on the number of

warning letters issued during a rolling 12-month period.\504\ CME

contended that the rule does not consider important factors that are

relevant to a SEF when evaluating potential sanctions in a disciplinary

matter.\505\ CME believed that the SEF should have discretion to

determine the appropriate actions in all cases based on the ``totality

of the circumstances.'' \506\ ICE stated that this limitation would

discourage self-reporting of violations because of the lack of

discretion in a resulting penalty assessment.\507\ MarketAxess

requested that the Commission adopt a more uniform approach with

respect to warning letters, permitting them to be issued as a sanction

or an indication of a finding of a violation in all SEF contexts.\508\

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

\504\ ICE Comment Letter at 7 (Mar. 8, 2011); CME Comment Letter

at 22 (Feb. 22, 2011).

\505\ CME Comment Letter at 22 (Feb. 22, 2011).

\506\ Id.

\507\ ICE Comment Letter at 7 (Mar. 8, 2011).

\508\ MarketAxess Comment Letter at 36 (Mar. 8, 2011).

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

(B) Commission Determination

The Commission is adopting proposed Sec. 37.203(f)(5), subject to

certain modifications, including converting a portion of the rule to

guidance in appendix B to part 37.

The Commission is maintaining in the final rule the limitation on

the number of warning letters issued. The Commission acknowledges the

comments from CME and ICE concerning the issuance of warning letters,

but believes that to ensure that warning letters serve as effective

deterrents and to preserve the value of disciplinary sanctions, no more

than one warning letter may be issued to the same person or entity

found to have committed the same rule violation more than once within a

rolling 12-month period.\509\ As discussed in the SEF NPRM, while a

warning letter may be appropriate for a first-time violation, the

Commission does not believe that more than one warning letter in a

rolling 12-month period for the same violation is ever

appropriate.\510\ Further, a policy of issuing repeated warning

letters, rather than issuing meaningful sanctions, to market

participants who repeatedly violate the same rules reduces the

effectiveness of a SEF's rule enforcement program.\511\

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

\509\ For purposes of this rule, the Commission does not

consider a ``reminder letter'' or such other similar letter to be

any different than a warning letter.

\510\ Core Principles and Other Requirements for Swap Execution

Facilities, 76 FR at 1224.

\511\ Id.

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

However, in response to commenters' concerns, the Commission is

narrowing the application of this rule to warning letters that contain

an affirmative finding that a rule violation has occurred. Therefore,

the Commission is removing the provision in the proposed rule that a

warning letter issued in accordance with this section is not a penalty

or an indication that a finding of a violation has been made. To remain

consistent with the modifications to proposed Sec. 37.203(f)(3) and

(f)(4), the Commission is also deleting the proposed requirement that

investigation reports required by paragraphs (f)(3) and (f)(4) of this

section must include a copy of the warning letter issued by compliance

staff.

As noted above, the Commission agrees with CME's comment that minor

transgressions can be addressed by a SEF's compliance staff issuing a

warning letter. Accordingly, in order to provide a SEF with flexibility

in this regard, the Commission is moving this provision of the rule to

the guidance in appendix B to part 37. The text of the guidance

provides that the rules of a SEF may authorize its compliance staff to

issue a warning letter to a person or entity under investigation or to

[[Page 33516]]

recommend that a disciplinary panel take such action.

(7) Sec. 37.203(g)--Additional Rules Required

Proposed Sec. 37.203(g) required a SEF to adopt and enforce any

additional rules that it believes are necessary to comply with the

requirements of Sec. 37.203.

(i) Commission Determination

The Commission did not receive any comments on proposed Sec.

37.203(g); however, the Commission is moving this rule to the guidance

in appendix B to part 37. The Commission believes that this requirement

is already implicit in Core Principle 2 and need not be addressed

separately as a final rule. Additionally, moving proposed Sec.

37.203(g) to guidance provides SEFs with added flexibility in adopting

additional rules that it believes are necessary to comply with the

rules related to Core Principle 2. Consistent with this determination,

the Commission is replacing proposed Sec. 37.203(g) with final Sec.

37.203(g) (titled ``Additional sources for compliance'') that simply

permits SEFs to rely upon the guidance in appendix B to part 37 to

demonstrate to the Commission compliance with Sec. 37.203.

(e) Sec. 37.204--Regulatory Services Provided by a Third Party

(1) Sec. 37.204(a)--Use of Third-Party Provider Permitted \512\

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

\512\ The Commission is renaming the title of this section from

``Use of Third-Party Provider Permitted'' to ``Use of Regulatory

Service Provider Permitted'' to provide greater clarity.

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

Proposed Sec. 37.204(a) allowed a SEF to contract with a

registered futures association or another registered entity to assist

in complying with the SEF core principles, as approved by the

Commission. The proposed rule also stated that a SEF that elects to use

the services of a regulatory service provider must ensure that such

provider has the capacity and resources to provide timely and effective

regulatory services. The proposed rule further stated that a SEF will

at all times remain responsible for the performance of any regulatory

services received, for compliance with the SEF's obligations under the

Act and Commission regulations, and for the regulatory service

provider's performance on its behalf.

(i) Summary of Comments

Commenters generally supported the Commission's proposal to allow

third parties to provide regulatory services.\513\ However, MarketAxess

argued that the Commission should permit an entity that is not a

registered futures association or another registered entity with the

Commission to perform regulatory services on behalf of a SEF, such as

the Financial Industry Regulatory Authority (``FINRA'').\514\ In the

alternative, MarketAxess recommended that the Commission should permit

SEFs, if desired, to form a joint venture to create a special

regulatory service provider for SEFs that would not be a registered

entity.\515\ Similarly, several commenters supported a centralized,

common regulatory organization (``CRO'') that would facilitate

compliance with SEF core principles.\516\ In this regard, WMBAA stated

that a CRO would establish a uniform SEF standard of conduct,

streamline the Commission's evaluation of each SEF registration

application, and conduct effective surveillance of fungible swap

products trading on multiple SEFs.\517\

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

\513\ MarketAxess Comment Letter at 14-15 (Mar. 8, 2011);

Reuters Comment Letter at 5 (Mar. 8, 2011); Bloomberg Comment Letter

at 4-5 (Mar. 8, 2011); NFA Comment Letter at 1 (Mar. 8, 2011).

\514\ MarketAxess Comment Letter at 15 (Mar. 8, 2011).

\515\ Id.

\516\ Parity Energy Comment Letter at 5 (Mar. 25, 2011); WMBAA

Comment Letter at 22 (Mar. 8, 2011); FXall Comment Letter at 12

(Mar. 8, 2011).

\517\ WMBAA Comment Letter at 22 (Mar. 8, 2011).

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

MarketAxess and Tradeweb requested clarification on how the

Commission will assess and approve regulatory service providers.\518\

In this regard, Tradeweb commented that SEFs should have flexibility in

contracting with third party service providers, so long as the SEF uses

reasonable diligence and acts in a manner consistent with market

practice.\519\

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

\518\ MarketAxess Comment Letter at 15 (Mar. 8, 2011); Tradeweb

Comment Letter at 10 (Mar. 8, 2011).

\519\ Tradeweb Comment Letter at 10 (Mar. 8, 2011).

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

(ii) Commission Determination

The Commission is adopting Sec. 37.204(a) as proposed, subject to

two modifications. In response to MarketAxess's comment about non-

registered entities performing regulatory services, the Commission is

revising the proposed rule to allow FINRA to assist SEFs in complying

with the core principles. The Commission notes that FINRA has provided

similar regulatory services for the securities industry for many years

and may serve as a self-regulatory organization for SB-SEFs. Therefore,

the Commission believes that allowing FINRA to serve as a regulatory

service provider for SEFs is appropriate because FINRA is likely to

have the qualifications, capacity, and resources to provide timely and

effective regulatory services for SEFs.

The Commission recognizes the concerns that WMBAA and others have

with respect to SEFs conducting market-wide surveillance activities. As

discussed elsewhere in this final rulemaking,\520\ an individual SEF

may have limited ability to monitor trading activities across markets

since individual swaps may be listed on multiple SEFs (as well as any

DCMs listing swaps). The Commission clarifies that a SEF (or a

regulatory service provider on a SEF's behalf), under Core Principle 2

and the Commission's regulations thereunder, is only responsible for

surveillance and rule enforcement of the SEF's systems and platforms,

and Core Principle 2 does not impose a cross-market surveillance

requirement on a SEF.\521\ Therefore, the final rules do not require

the use of a single industry-wide CRO to assist SEFs with cross-market

surveillance. While not requiring it, the final rules also do not

prohibit the use of a single industry-wide CRO.

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

\520\ See, e.g., discussion under Sec. 37.203(d)--Automated

Trade Surveillance System and Core Principle 6--Position Limits or

Accountability in the preamble.

\521\ The Commission notes that other core principles, such as

Core Principle 4, and the Commission's regulations thereunder may

require SEFs to conduct certain cross-market monitoring.

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

In response to MarketAxess's and Tradeweb's comments regarding the

Commission's assessment and approval of regulatory service providers,

the Commission notes that it will assess and approve the use of such

service providers during the full registration process. The Commission

also notes that Exhibit N to Form SEF requests executed or executable

copies of any agreements with regulatory service providers.

Finally, the Commission is modifying Sec. 37.204(a) to make clear

that a SEF may use the services of a regulatory service provider for

the provision of services to assist the SEF in complying with ``the Act

and Commission regulations thereunder'' rather than simply the SEF core

principles as stated in proposed Sec. 37.204(a). The modification

aligns the rule text with what the Commission has always intended to be

the range of a SEF's self-regulatory obligations.

(2) Sec. 37.204(b)--Duty To Supervise Third Party \522\

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

\522\ The Commission is renaming the title of this section from

``Duty to Supervise Third Party'' to ``Duty to Supervise Regulatory

Service Provider'' to provide greater clarity.

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

Proposed Sec. 37.204(b) required that a SEF maintain sufficient

compliance staff to supervise any services performed by

[[Page 33517]]

a regulatory service provider. The proposed rule also required that the

SEF hold regular meetings with its regulatory service provider to

discuss current work and other matters of regulatory concern, as well

as conduct periodic reviews of the adequacy and effectiveness of

services provided on its behalf. In addition, proposed Sec. 37.204(b)

required a SEF to carefully document the reviews and make them

available to the Commission upon request.

(i) Summary of Comments

Two commenters recommended that the Commission adopt a more

flexible rule with respect to a SEF's duty to supervise its regulatory

service provider.\523\ In this regard, NFA recommended that the

Commission provide flexibility to a SEF and its regulatory service

provider to mutually determine the necessary process for a SEF to

supervise its regulatory service provider.\524\ CME recommended that

the Commission move the rule to guidance or acceptable practices.\525\

In particular, CME pointed to the requirements that a SEF conduct

periodic reviews of the services provided and hold regular meetings

with the regulatory service provider to discuss ongoing investigations,

trading patterns, market participants, and any other matters of

regulatory concern.\526\ CME stated that ``[w]hile it may well be that

it is constructive for the [SEF] to hold regular meetings with its

service provider and `discuss market participants,' the core principle

should stand on its own and the [SEF] should have the flexibility to

determine how best to demonstrate compliance with the core principle.''

\527\

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

\523\ NFA Comment Letter at 2 (Mar. 8, 2011); CME Comment Letter

at 18-19 (Feb. 22, 2011).

\524\ NFA Comment Letter at 2 (Mar. 8, 2011).

\525\ CME Comment Letter at 19 (Feb. 22, 2011).

\526\ Id. at 18-19.

\527\ Id. at 19.

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

(ii) Commission Determination

The Commission is adopting Sec. 37.204(b) as proposed.\528\ The

Commission acknowledges the commenters' desire for a flexible approach,

but notes that a SEF that elects to use a regulatory service provider

remains responsible for the regulatory services received and for

compliance with the Act and Commission regulations. The SEF therefore

must properly supervise the quality and effectiveness of the regulatory

services provided on its behalf. The Commission believes that proper

supervision will require that a SEF have complete and timely knowledge

of relevant work performed by the SEF's regulatory service provider on

its behalf. The Commission also believes that this knowledge can only

be acquired through periodic reviews and regular meetings required

under Sec. 37.204(b).

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

\528\ The Commission is making certain non-substantive

clarifications to Sec. 37.204(b).

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

(3) Sec. 37.204(c)--Regulatory Decisions Required From the SEF

Proposed Sec. 37.204(c) required a SEF that utilizes a regulatory

service provider to retain exclusive authority over all substantive

decisions made by its regulatory service provider, including the

cancellation of trades, issuance of disciplinary charges, denials of

access to the trading platform for disciplinary reasons, and any

decision to open an investigation into a possible rule violation.

Further, the proposed rule required a SEF to document any instance

where its actions differed from those recommended by its regulatory

service provider.

(i) Summary of Comments

CME objected to the idea that all decisions concerning the

cancellation of trades remain in the exclusive authority of the

SEF.\529\ CME contended that a SEF may be better served by granting

such authority to a regulatory service provider because such decisions

require prompt decision-making.\530\

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

\529\ CME Comment Letter at 19 (Feb. 22, 2011).

\530\ Id.

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

(ii) Commission Determination

The Commission is adopting Sec. 37.204(c) as proposed, subject to

two modifications. First, the Commission is removing the requirement

that a decision to open an investigation reside exclusively with the

SEF. The final rule grants a SEF the latitude to determine whether

investigations will be opened by the SEF, by its regulatory service

provider, or some combination of the two. The Commission believes that

opening investigations is an administrative task and does not

necessarily imply the threat of formal disciplinary action or sanctions

against a market participant. Second, the Commission is amending the

rule to clarify that when a SEF documents instances when its actions

differ from those recommended by its regulatory service provider, the

SEF must include the reasons for the course of action recommended by

the regulatory service provider and the reasons why the SEF chose a

different course of action.

The Commission disagrees with CME's comment concerning the

``cancellation of trades'' and believes that a SEF must retain

exclusive authority in this regard. Cancelling trades is an important

exercise of a SEF's authority over its markets and market participants.

Cancelled trades may have meaningful economic consequences to the swap

counterparties involved in the transaction, and may be the subject of

contention between the counterparties if they do not both agree to the

cancellation. The Commission emphasizes that permanent, consequential

decisions must remain with the SEF.

(f) Sec. 37.205--Audit Trail

Proposed Sec. 37.205 implements Core Principle 2's requirement

that SEFs capture information that may be used in establishing whether

rule violations have occurred.\531\ Accordingly, proposed Sec. 37.205

required a SEF to establish procedures to capture and retain

information that may be used in establishing whether rule violations

have occurred. The proposed rule, along with its subparts, established

the requirements of an acceptable audit trail program and the

enforcement of such program.

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

\531\ CEA section 5h(f)(2)(B)(ii); 7 U.S.C. 7b-3(f)(2)(B)(ii).

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

(1) Sec. 37.205(a)--Audit Trail Required

Proposed Sec. 37.205(a) required a SEF to capture and retain all

audit trail data so that the SEF has the ability to detect,

investigate, and prevent customer and market abuses. The proposed rule

also provided that the audit trail data must be sufficient to

reconstruct all transactions within a reasonable period of time and to

provide evidence of any rule violations that may have occurred.

Proposed Sec. 37.205(a) further provided that the audit trail must

permit the SEF to track a customer order from the time of receipt

through fill, allocation, or other disposition, and must include both

order and trade data.

(i) Summary of Comments

WMBAA requested that the Commission establish a common format for

audit trail data to ensure consistency among all SEFs and to make the

information easier for the Commission to use and review when

investigating customer and market abuses.\532\

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

\532\ WMBAA Comment Letter at 22-23 (Mar. 8, 2011).

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

(ii) Commission Determination

The Commission is adopting Sec. 37.205(a) as proposed, subject to

the

[[Page 33518]]

modifications described below.\533\ The Commission believes that the

requirement that SEFs capture and retain all audit trial data is

essential to ensuring that SEFs can capture information to establish

whether rule violations have occurred, as required by Core Principle

2.\534\ Additionally, the creation and retention of a comprehensive

audit trail will enable SEFs to properly reconstruct any and all market

and trading events and to conduct a thorough forensic review of all

market information. The Commission believes that the ability to

reconstruct markets in such a manner is a fundamental element of a

SEF's surveillance and rule enforcement programs. Consistent with these

principles, the Commission is modifying Sec. 37.205(a) to clarify that

the audit trail data must be sufficient to reconstruct trades and

sufficient to reconstruct indications of interest, requests for quotes,

and orders within a reasonable period of time.

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

\533\ The Commission is making certain non-substantive

clarifications to Sec. 37.205(a).

\534\ CEA section 5h(f)(2)(B)(ii); 7 U.S.C. 7b-3(f)(2)(B)(ii).

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

Both the proposed and final rules in Sec. 37.205(a) require that a

SEF ``capture and retain all audit trail data necessary to detect,

investigate, and prevent customer and market abuses'' (emphasis added).

The Commission notes that information required to detect abuses may in

some cases include all communications between market participants and a

SEF's trading system or platform. The Commission also notes that a

SEF's obligation to capture in its audit trail all data necessary to

detect, investigate, and prevent customer and market abuses is not

altered by the nature of the trading system or platform that a SEF may

choose to utilize, including a system or platform that, for example,

utilizes the telephone. For example, an acceptable audit trail for a

SEF with a telephone component should include communications between

the SEF's employees and their customers, as well as any communications

between employees as they work customer indications of interest,

requests for quotes, orders, and trades. An acceptable audit trail must

capture the totality of communications (including, but not limited to,

telephone, instant messaging, email, written records, and electronic

communications within a trading system or platform) that could be

necessary to detect, investigate, and prevent customer and market

abuses, as required by both proposed and final Sec. 37.205(a).

The Commission believes that WMBAA's suggestion to establish a

common format for audit trail data may provide some value for SEFs that

wish to coordinate and establish such a standard. However, the intent

of the final rules is to require that a SEF establish and maintain an

effective audit trail program, not to dictate the method or form for

maintaining such information. Importantly, the rule, by not being

prescriptive, provides SEFs with flexibility to determine the manner

and the technology necessary and appropriate to meet the requirements.

The Commission notes, nevertheless, that staff from the Commission's

Office of Data and Technology will coordinate with SEFs to establish

standards for the submission of audit trail data to the Commission.

(2) Sec. 37.205(b)--Elements of an Acceptable Audit Trail Program

Proposed Sec. 37.205(b)(1) required a SEF's audit trail to include

original source documents, on which trade execution information was

originally recorded, as well as records for customer orders, whether or

not they were filled. The proposed rule also required that a SEF that

permits intermediation must require all executable orders or RFQs

received over the telephone to be immediately entered into the trading

system or platform. Proposed Sec. 37.205(b)(2) required that a SEF's

audit trail program include a transaction history database and

specified the trade information required to be included in the

database. Proposed Sec. 37.205(b)(3) required the audit trail program

to also have electronic analysis capability for the transaction history

database. Proposed Sec. 37.205(b)(4) required the audit trail program

to include the ability to safely store all audit trail data and to

retain it in accordance with the recordkeeping requirements of SEF Core

Principle 10 and its associated regulations.

(i) Summary of Comments

WMBAA commented that the requirement for records to be retained for

customer orders should not apply to indications of interest because it

would extend beyond the Commission's statutory authority and the audit

trail requirements currently in place in other financial markets, and

would be unnecessarily costly and burdensome.\535\ WMBAA also commented

that the audit trail requirements must permit the retention of relevant

information through various modes because SEFs may operate trade

execution platforms ``through any means of interstate commerce.'' \536\

Better Markets commented that audit trail records, such as records of

customers' orders and their disposition, must be time-stamped at

intervals that are consistent with the capabilities of high-frequency

traders that use SEFs.\537\

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

\535\ WMBAA Comment Letter at 23 (Mar. 8, 2011).

\536\ Id.

\537\ Better Markets Comment Letter at 18 (Mar. 8, 2011).

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

(ii) Commission Determination

The Commission is adopting proposed Sec. 37.205(b), subject to the

modifications discussed below. The Commission is clarifying that ``time

of trade execution'' must be included in the data points of an

acceptable audit trail, and is noting this clarification in final Sec.

37.205(b)(1). The Commission is also revising proposed Sec.

37.205(b)(2) to specify that a transaction history database must

include a history of ``all indications of interest, requests for

quotes, orders, and trades entered into a [SEF's] trading system or

platform, including all order modifications and cancellations.''

Further, the Commission is revising proposed Sec. 37.205(b)(3) to

specifically state that a SEF's electronic analysis capability must

provide it with the ``ability to reconstruct indications of interest,

requests for quotes, orders, and trades, and identify possible trading

violations.'' The revisions to Sec. 37.205(b)(2) and (b)(3), subject

to the additions of the indications of interest and requests for quotes

language, reflect regulatory requirements previously proposed as part

of Sec. 37.203(d), but, as noted above, the Commission is moving these

requirements to final Sec. 37.205(b). Additionally, the Commission is

revising proposed Sec. 37.205(b)(2) by replacing the customer type

indicators listed in the proposed rule with the term ``customer type

indicator code.''

In response to WMBAA's comment regarding indications of interest,

the Commission believes that retaining information about indications of

interest provides another important detail of an audit trail, just as

information of filled, unfilled, or cancelled orders provides important

information for the SEF. This information enables a SEF to fulfill its

statutory duty under Core Principle 2, which requires a SEF to capture

information that may be used in establishing whether rule violations

have occurred.\538\ Absent this information, SEFs would be limited in

their ability to monitor their markets and to detect, investigate, and

prevent customer and market abuses and trading

[[Page 33519]]

rule violations. However, as discussed above, the Commission has

removed the requirement for SEFs to offer indicative quote

functionality, which should reduce the costs of complying with the

audit trail requirements.\539\

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

\538\ CEA section 5h(f)(2)(B)(ii); 7 U.S.C. 7b-3(f)(2)(B)(ii).

\539\ See discussion above regarding Minimum Trading

Functionality under Sec. 37.3--Requirements for Registration in the

preamble.

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

In response to WMBAA's comment about the flexibility of audit trail

requirements to accommodate various methods of execution, the

Commission notes that proposed Sec. 37.205(b) did not discriminate

based on the method of execution. Given the Commission's clarification

that a SEF may utilize any means of interstate commerce in providing

the execution methods in Sec. 37.9(a)(2)(i)(A) or (B), the Commission

emphasizes that no matter how an indication of interest, request for

quote, or order is communicated or a trade is executed, an audit trail

that satisfies the requirements set forth in Sec. 37.205 must be

created.

The Commission is also making certain conforming changes to Sec.

37.205(b)(1) to harmonize its provisions with the Commission's

determination that a SEF may utilize any means of interstate commerce

in providing the execution methods in Sec. 37.9(a)(2)(i)(A) or (B).

First, the Commission is adding ``indications of interest'' to the

items that must be immediately captured in the audit trail pursuant to

Sec. 37.205(b)(1). Second, while proposed Sec. 37.205(b)(1) required

that all executable orders or requests for quotes ``be immediately

entered into the trading system or platform,'' Sec. 37.205(b)(1) as

adopted requires that such information be immediately ``captured in the

audit trail.'' This approach more accurately reflects the intent of

Sec. 37.205, whose purpose is to ensure an adequate audit trail,

rather than to address the operation of a SEF's trading system or

platform.

Accordingly, the final rules in Sec. 37.205(b)(1) include

conforming changes that remove the reference in proposed Sec.

37.205(b)(1) to orders or requests for quotes ``that are executable,''

and also remove the qualification that a SEF's obligation to capture

information in the audit trail is dependent on whether the SEF permits

intermediation. Finally, the final rules remove the additional audit

trail requirement in proposed Sec. 37.205(b)(1) for orders and

requests for quotes that cannot be immediately entered into the trading

system or platform. These clarifications are consistent with the

Commission's intention in Sec. 37.205(a) that a SEF's audit trail

``capture and retain all audit trail data necessary to detect,

investigate, and prevent customer and market abuses.'' It is the

Commission's intent throughout Sec. 37.205 to ensure that all SEFs'

audit trails are equally comprehensive and effective regardless of the

means of interstate commerce that a SEF may provide to meet the

execution methods in Sec. 37.9(a)(2)(i)(A) or (B).

Although Sec. 37.205 sets forth a unified set of audit trail

requirements for all methods of execution, the Commission notes that a

SEF, for example, that utilizes the telephone as a means of interstate

commerce in providing the execution methods in Sec. 37.9(a)(2)(i)(A)

or (B) may comply with the audit trail requirements by utilizing

different technologies than a SEF that does not utilize the telephone.

For example, the Commission believes that a SEF that utilizes the

telephone may comply with the audit trail requirements in Sec.

37.205(a) for oral communications by recording all such communications

that relate to swap transactions, and all communications that may

subsequently result in swap transactions. Such recordings must allow

for reconstruction of communications between the SEF and its customers;

reconstruction of internal and external communications involving SEF

employees who are ascertaining or providing indications of interest,

requests for quotes, or orders; reconstruction of executed

transactions; provide evidence of any rule violations; track a

customer's order; and capture order and trade data as required under

Sec. 37.205(a).

The Commission also believes that a SEF that utilizes the telephone

may comply with the original source document requirement in Sec.

37.205(b)(1) for oral communications by retaining each recording's

original media. By storing the recordings in a digital database and

supplementing it with additional data as necessary, the Commission

believes that a SEF that utilizes the telephone may comply with the

transaction history database requirement in Sec. 37.205(b)(2) for oral

communications. Additionally, the Commission believes that a SEF that

utilizes the telephone may comply with the electronic analysis

capability in Sec. 37.205(b)(3) for oral communications by ensuring

that its digital database of recordings is capable of being searched

and analyzed. The Commission notes, however, that Sec. 37.205(b) does

not establish an affirmative requirement to create recordings of oral

communications if the audit trail requirements are met through other

methods. The discussion above regarding the applicability of audit

trail requirements to SEFs that utilize the telephone in providing the

execution methods in Sec. 37.9(a)(2) applies equally to SEFs that use

non-telephonic means of communication (e.g., instant messaging or

email). In all cases, the operative requirement is to capture in the

audit trail and the transaction history database the totality of

communications that could be necessary to detect, investigate, and

prevent customer and market abuses.

The Commission acknowledges the comment by Better Markets regarding

time-stamping audit trail records at intervals that are consistent with

the capabilities of high-frequency traders. While the audit trail rules

do not specify the granularity of time-stamped data, the Commission

believes that the audit trail rules adopted herein, particularly the

requirements that a SEF retain and maintain all data necessary to

permit it to reconstruct trading, will help to ensure that audit trail

records are time-stamped with the granularity necessary to reconstruct

trades and investigate possible trading violations, including for high-

frequency trading.\540\

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

\540\ The Commission notes, as stated above under Sec.

37.203(d)--Automated Trade Surveillance System in the preamble, that

the accurate time stamping of data is particularly important for

SEFs that use an RFQ System, including an RFQ System with a voice

component. For such SEFs, the accurate time stamping of both their

Order Book and RFQ System activity is critical for ensuring both

that the SEF itself has a robust audit trail system and that the

Commission is able to monitor the SEF's adherence to part 37's Order

Book-RFQ System integration requirements.

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

(3) Sec. 37.205(c)--Enforcement of Audit Trail Requirements

Proposed Sec. 37.205(c)(1) required that a SEF conduct reviews, at

least annually, of its members and market participants to verify their

compliance with the SEF's audit trail and recordkeeping requirements.

Proposed Sec. 37.205(c)(1) also set forth minimum review criteria.

Proposed Sec. 37.205(c)(2) required that a SEF develop a program for

effective enforcement of its audit trail and recordkeeping

requirements, including a requirement that a SEF levy meaningful

sanctions when deficiencies are found. Proposed Sec. 37.205(c)(2) also

stated that sanctions may not include more than one warning letter for

the same violation within a rolling twelve-month period.

(i) Summary of Comments

Some commenters stated that annual audits are unnecessary and

unduly

[[Page 33520]]

burdensome.\541\ CME commented that annual audits of all SEF market

participants would be costly and unproductive, and should instead apply

at the clearing firm level.\542\ MarketAxess recommended that the

Commission require a single entity or self-regulatory organization,

such as FINRA or NFA, to conduct the audit of each SEF market

participant.\543\ Tradeweb commented that the proposed annual audit

review requirement is not required of DCMs and, as such, should not be

required of SEFs.\544\

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

\541\ Tradeweb Comment Letter at 6 (Jun. 3, 2011); MarketAxess

Comment Letter at 22 (Mar. 8, 2011); CME Comment Letter at 33 (Feb.

22, 2011).

\542\ CME Comment Letter at 33 (Feb. 22, 2011).

\543\ MarketAxess Comment Letter at 22 (Mar. 8, 2011).

\544\ Tradeweb Comment Letter at 6 (Jun. 3, 2011).

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

(ii) Commission Determination

The Commission is adopting Sec. 37.205(c) as proposed, subject to

certain modifications as discussed below. The Commission disagrees with

commenters who assert that the annual audit review requirement is

unnecessary, unduly burdensome, costly, and unproductive. Through its

experience with DCMs and DCOs, the Commission has learned that

sampling-based reviews of audit trail and recordkeeping requirements

are inadequate to ensure compliance with audit trail rules. The

Commission believes that the requirements under Sec. 37.205(c) are

necessary to ensure that SEFs have accurate and consistent access to

all data needed to reconstruct all transactions in their markets and to

provide evidence of customer and market abuses. Absent reliable audit

trail data, a SEF's ability to detect or investigate customer or market

abuses may be severely diminished.

However, in response to commenters' concerns that the rule is

burdensome, the Commission is narrowing the scope of the proposed rule

by removing the reference to ``market participants'' and instead

stating that the annual audit review requirement only applies to

members and those persons and firms that are subject to the SEF's

recordkeeping rules. As a result of this revision, the Commission

declines to adopt CME's recommendation to require annual audit trail

reviews only at the clearing firm level.

The Commission is maintaining proposed Sec. 37.205(c)(2) as a rule

to ensure that SEFs impose meaningful sanctions for violations of audit

trail and recordkeeping rules. However, the Commission is revising the

rule to clarify that the limit on warning letters only applies where a

SEF's compliance staff finds an actual rule violation, rather than just

the suspicion of a violation. This change is consistent with the

revisions in other sections discussing warning letters.\545\

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

\545\ See, e.g., discussion above under Sec. 37.203(f)(5)--

Warning Letters in the preamble.

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

In response to MarketAxess's recommendation that a single entity

conduct the audit of each SEF market participant, the Commission

believes that a SEF can monitor market participants on its own platform

without relying upon a single cross-market self-regulatory

organization. However, a SEF may use a regulatory service provider

pursuant to Sec. 37.204 to assist it in complying with the

requirements under Sec. 37.205(c).

In response to Tradeweb's comment that the annual audit review

requirement is not required of DCMs, the Commission notes that it

adopted a similar requirement for DCMs under Sec. 38.553 of the

Commission's regulations, to apply to all members and persons and firms

subject to the DCM's recordkeeping rules.\546\ The Commission believes

that similar requirements are appropriate because, as noted above,

SEFs, like DCMs, must have accurate and consistent access to all data

needed to reconstruct all transactions in their markets, including

indications of interest, requests for quotes, orders, and trades, and

to detect, investigate, and prevent customer and market abuses.

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

\546\ Core Principles and Other Requirements for Designated

Contract Markets, 77 FR at 36704.

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

(g) Sec. 37.206--Disciplinary Procedures and Sanctions

(1) Sec. 37.206--Disciplinary Procedures and Sanctions

Proposed Sec. 37.206 addressed SEF Core Principle 2's requirement

that SEFs establish and enforce trading, trade processing, and

participation rules to deter abuse, and have the capacity to

investigate and enforce such abuses.\547\ Proposed Sec. 37.206

provided that SEFs must establish trading, trade processing, and

participation rules that will deter abuses and have the capacity to

enforce such rules through prompt and effective disciplinary action.

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

\547\ CEA section 5h(f)(2)(B); 7 U.S.C. 7b-3(f)(2)(B).

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

(i) Summary of Comments

Some commenters generally stated that the proposed disciplinary

procedures go beyond the statute and intent of Congress.\548\ In this

regard, FXall stated that, unlike DCMs, retail customers will not be

participants on SEFs; therefore, the same level of protection afforded

to DCM participants is not required for SEFs.\549\ Some commenters

recommended that the proposed disciplinary procedures should be

streamlined through the use of a staff summary fine program.\550\ Some

commenters also requested that SEFs be granted greater flexibility to

establish their own disciplinary procedures.\551\ Tradeweb stated that

the proposed disciplinary procedures would impose significant costs on

SEFs and should be contracted to a central, third-party self-regulatory

organization.\552\

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

\548\ MarketAxess Comment Letter at 23 (Mar. 8, 2011); ABC/CIEBA

Comment Letter at 11 (Mar. 8, 2011); FXall Comment Letter at 12

(Mar. 8, 2011); ICAP Comment Letter at 5-6 (Mar. 8, 2011); State

Street Comment Letter at 5 (Mar. 8, 2011).

\549\ FXall Comment Letter at 12 (Mar. 8, 2011).

\550\ MarketAxess Comment Letter at 23 (Mar. 8, 2011), WMBAA

Comment Letter at 24 (Mar. 8, 2011); FXall Comment Letter at 12

(Mar. 8, 2011).

\551\ FXall Comment Letter at 12 (Mar. 8, 2011); ICAP Comment

Letter at 6 (Mar. 8, 2011); Reuters Comment Letter at 4 (Mar. 8,

2011); WMBAA Comment Letter at 23 (Mar. 8, 2011); State Street

Comment Letter at 5 (Mar. 8, 2011).

\552\ Tradeweb Comment Letter at 10 (Mar. 8, 2011). Parity

Energy also commented that the proposed disciplinary rules will

impose unnecessary costs and create unnecessary duplication and the

possibility of conflicting rules. Parity Energy Comment Letter at 4

(Mar. 25, 2011).

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

(ii) Commission Determination

The Commission's evaluation of public comments with respect to

proposed Sec. 37.206 is based on its understanding that a SEF's

obligation to establish adequate disciplinary rules is implicit in the

statutory language of Core Principle 2, which requires, in part, that a

SEF establish and enforce trading, trade processing, and participation

rules to deter abuse and have the capacity to investigate and enforce

such rules.\553\ The Commission also takes note of public comments

requesting greater flexibility in the application of SEF disciplinary

rules. Accordingly, consistent with both its statutory mandate and its

evaluation of the public comments received, the Commission is adopting

elements of Sec. 37.206 as proposed, while also moving to guidance or

eliminating other parts of the proposed rules.\554\

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

\553\ CEA section 5h(f)(2)(B); 7 U.S.C. 7b-3(f)(2)(B).

\554\ The Commission is also revising Sec. 37.206 to include

the term ``member'' in addition to the term ``market participant''

in order to provide greater detail and clarity. The Commission

notes, as described above in Sec. 37.200, that the term ``market

participant'' encompasses SEF ``members.''

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

The Commission believes that the specific disciplinary rules

retained in the final rules are those that are essential to the

promotion of market integrity by ensuring that SEF markets are free of

fraud or abuse, and also helping to provide basic procedural fairness

for SEF disciplinary

[[Page 33521]]

respondents. While the SEF NPRM noted that the SEF disciplinary

procedures parallel those for DCMs,\555\ the Commission has determined

that the level of protection offered by the proposed rules was more

appropriate for markets that include retail participants, in contrast

to SEFs, whose participants are limited to ECPs.\556\ Consequently, the

Commission is moving to guidance numerous procedural protections set

forth in the proposed rules that are more tailored to retail

participants, including the requirements relating to the issuance of a

notice of charges, and a respondent's right to representation, right to

answer charges, and right to request a hearing.

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

\555\ Core Principles and Other Requirements for Swap Execution

Facilities, 76 FR at 1225 n. 73.

\556\ The Commission also believes that guidance is more

appropriate for the SEF disciplinary procedures because the SEF core

principles do not have a parallel to DCM Core Principle 13, which

specifically discusses disciplinary procedures.

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

The remaining final rules provide an essential framework that the

Commission believes adequately ensures the effectiveness of a SEF's

disciplinary program. Accordingly, the Commission is maintaining the

proposed disciplinary rules that represent the most critical components

of a disciplinary program, including the requirements that a SEF: (1)

Establish disciplinary panels that meet certain composition

requirements; (2) levy meaningful disciplinary sanctions to deter

recidivism; and (3) issue no more than one warning letter per rolling

12-month period for the same violation by the same respondent. The

Commission believes that with these modifications, Sec. 37.206 strikes

the appropriate balance between providing the flexibility requested by

the commenters and ensuring that SEFs comply with their statutory

obligation under Core Principle 2.

Some commenters recommended that the proposed disciplinary

procedures should be streamlined through the use of a summary fine

program. The Commission believes that, while summary fines may be

appropriate for some disciplinary matters, such as recordkeeping

violations, many disciplinary matters are dynamic and require the

balancing of multiple unique facts and circumstances, which cannot be

addressed through a summary fine program. Therefore, the Commission

declines to adopt a summary fine program in lieu of disciplinary

procedures.

In response to Tradeweb's comment about contracting out certain

aspects of a SEF's disciplinary functions to a central third-party, the

Commission notes that it views SEFs as SROs,\557\ with all the

attendant self-regulatory responsibilities to establish and enforce

rules necessary to promote market integrity and the protection of

market participants. Such responsibilities include the adherence to,

and maintenance of, disciplinary procedures. The Commission notes that

a SEF may utilize the services of a third-party regulatory service

provider for assistance in performing its self-regulatory functions, as

provided for in Sec. 37.204.

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

\557\ See Adaptation of Regulations to Incorporate Swaps, 77 FR

66288 (Nov. 2, 2012). Section 1.3(ee) states that a self-regulatory

organization ``means a contract market (as defined in Sec. 1.3(h)),

a swap execution facility (as defined in Sec. 1.3(rrrr)), or a

registered futures association under section 17 of the Act.'' Id. at

66318.

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

(2) Sec. 37.206(a)--Enforcement Staff

Proposed Sec. 37.206(a) required that a SEF establish and maintain

sufficient enforcement staff and resources to effectively and promptly

prosecute possible rule violations within the SEF's jurisdiction.

Proposed Sec. 37.206(a) also required a SEF to monitor the size and

workload of its enforcement staff annually. In addition, proposed Sec.

37.206(a) included provisions to ensure the independence of the

enforcement staff and to help promote disciplinary procedures that are

free of potential conflicts of interest.

(i) Commission Determination

In response to the general comments requesting greater flexibility

regarding disciplinary procedures, the Commission is moving all of the

requirements of proposed Sec. 37.206(a) to guidance, except for the

critical requirement that a SEF maintain sufficient enforcement staff

and resources. The Commission believes that sufficient enforcement

staff and resources are essential to the effective performance of a

SEF's disciplinary program and are necessary to comply with Core

Principle 2. Without a sufficient enforcement staff and resources, a

SEF would be unable to promptly investigate and adjudicate potential

rule violations and deter future violations. To maintain consistency

with the revisions to proposed Sec. 37.203(c)(2), the Commission is

deleting from the rule the reference that a SEF monitor the size and

workload of its enforcement staff annually to provide greater

flexibility to SEFs in determining their approach to monitoring their

enforcement resources. Nonetheless, the Commission believes that a

SEF's obligation to monitor its enforcement staff and resources is

implicit in the requirement to maintain adequate enforcement staff and

resources.

(3) Sec. 37.206(b)--Disciplinary Panels

Proposed Sec. 37.206(b)(1) required a SEF to establish one or more

Review Panels and one or more Hearing Panels. The composition of both

panels was required to meet the composition requirements of proposed

Sec. 40.9(c)(3)(ii) \558\ and could not include any members of the

SEF's compliance staff or any person involved in adjudicating any other

stage of the same proceeding. Proposed Sec. 37.206(b)(2) provided that

a Review Panel must be responsible for determining whether a reasonable

basis exists for finding a violation of SEF rules and for authorizing

the issuance of a notice of charges. If a notice of charges is issued,

proposed Sec. 37.206(b)(3) provided that a Hearing Panel must be

responsible for adjudicating the matter and issuing sanctions.

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

\558\ Section 40.9(c)(3)(ii), as proposed, in the separate

release titled Requirements for Derivatives Clearing Organizations,

Designated Contract Markets, and Swap Execution Facilities Regarding

the Mitigation of Conflicts of Interest, provided that ``Each

Disciplinary Panel shall include at least one person who would not

be disqualified from serving as a Public Director by Sec.

1.3(ccc)(1)(i)-(vi) and (2) of this chapter (a ``Public

Participant''). Such Public Participant shall chair each

Disciplinary Panel. In addition, any registered entity specified in

paragraph (c)(3)(i) of this section shall adopt rules that would, at

a minimum: (A) Further preclude any group or class of participants

from dominating or exercising disproportionate influence on a

Disciplinary Panel and (B) Prohibit any member of a Disciplinary

Panel from participating in deliberations or voting on any matter in

which the member has a financial interest.'' 75 FR 63732, 63752

(proposed Oct. 18, 2010).

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

(i) Summary of Comments

MetLife supported the proposed rule and agreed that SEFs should

maintain a clear separation between disciplinary bodies that recommend

the issuance of charges and those responsible for adjudicating

matters.\559\ CME stated that the Commission should not require a

prescriptive approach to disciplinary panels, as SEFs may develop

structures that clearly satisfy the objective of the core principle,

but that may not precisely comply with the rule text.\560\ CME

illustrated two practices it believed may be precluded by the text of

proposed Sec. 37.206(b): (1) CME's Market Regulation staff determines

whether certain non-egregious rule violations merit referral to a

Review Panel and they issue warning letters on an administrative basis;

and (2) CME's hearing panel adjudicates a disciplinary case prior to

the issuance of charges

[[Page 33522]]

pursuant to a supported settlement agreement.\561\

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

\559\ MetLife Comment Letter at 6 (Mar. 8, 2011).

\560\ CME Comment Letter at 35 (Feb. 22, 2011).

\561\ Id.

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

(ii) Commission Determination

The Commission is adopting Sec. 37.206(b) as proposed, subject to

certain modifications described below. The Commission considered

commenters' views and believes that the proposed rule can be modified

to provide additional flexibility without diminishing its purpose.

Accordingly, final Sec. 37.206(b) will require SEFs to have one or

more disciplinary panels, without imposing a specific requirement for

SEFs to maintain a Review Panel and a Hearing Panel.\562\ However, even

under this single-panel approach, individuals who determine to issue

charges in a particular disciplinary matter may not also adjudicate the

matter. Therefore, final Sec. 37.206(b) permits flexibility in the

structure of SEFs' disciplinary bodies, but not in the basic

prohibition, supported by MetLife, against vesting the same individuals

with the authority to both issue and adjudicate charges in the same

matter.

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

\562\ The Commission notes that it is replacing specific panel

names (i.e., Review Panel and Hearing Panel) with a generic

reference to the ``disciplinary panel'' throughout part 37.

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

The modifications reflected in final Sec. 37.206(b), together with

the revisions made to the text of proposed Sec. 37.206(d) that will

now be included as guidance, as discussed below, provide additional

flexibility by permitting SEFs to rely on their authorized compliance

staff, rather than on a disciplinary panel, to issue disciplinary

charges. However, the Commission notes that the adjudication of charges

must still be performed by a disciplinary panel.

Finally, the Commission is adopting the composition and conflicts

requirements for disciplinary panels with one modification, by

replacing the reference to Sec. 40.9(c)(3)(ii) with a reference to the

more general ``part 40 of this chapter'' to accommodate any re-

enumeration that may occur with respect to proposed Sec.

40.9(c)(3)(ii).

(4) Sec. 37.206(c)--Review of Investigation Report

Proposed Sec. 37.206(c) required a Review Panel to promptly review

an investigation report received pursuant to proposed Sec.

37.203(f)(3), and to take one of the following actions within 30 days

of receipt: (1) Promptly direct compliance staff to conduct further

investigation if the Review Panel determined that additional

investigation or evidence was needed, (2) direct that no further action

be taken if the Review Panel determined that no reasonable basis

existed for finding a violation or that prosecution was unwarranted, or

(3) direct that the person or entity alleged to have committed a

violation be served with a notice of charges if the Review Panel

determined that a reasonable basis existed for finding a violation and

adjudication was warranted.

(i) Summary of Comments

CME agreed that an investigation report should include the

subject's disciplinary history; however, CME disagreed with the

requirement in proposed Sec. 37.203(f) that the disciplinary history

be included in the version of the investigation report sent to the

Review Panel.\563\ CME believed that the disciplinary history should

not be considered by the Review Panel at all when determining whether

to issue formal charges, arguing that a participant's disciplinary

history is not relevant to the consideration of whether it committed a

further violation of SEF rules.\564\

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

\563\ CME Comment Letter at 35 (Feb. 22, 2011).

\564\ Id. While the Commission largely agrees with CME's

comment, the Commission directs interested parties to Sec.

37.203(f) for a further discussion of the required components of

investigation reports.

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

(ii) Commission Determination

In response to the general comments requesting greater flexibility,

the Commission is eliminating all of proposed Sec. 37.206(c) except

for paragraph (3) of the proposed rule. In addition, the Commission is

adding language to paragraph (3) to provide SEFs with the flexibility

to allow authorized compliance staff to review an investigation report

and determine whether a notice of charges should be issued in a

particular matter. The Commission is also revising the text of

paragraph (3) to follow the single-panel approach provided for in Sec.

37.206(b). Proposed Sec. 37.206(c)(3), with the revisions described

above, is being incorporated into proposed Sec. 37.206(d). As

described below, all of proposed Sec. 37.206(d) is being moved to the

guidance in appendix B to part 37.

(5) Sec. 37.206(d)--Notice of Charges

Proposed Sec. 37.206(d) described the minimally acceptable

contents of a notice of charges issued by a Review Panel. Specifically,

proposed Sec. 37.206(d) provided that a notice of charges must

adequately state the acts, conduct, or practices in which the

respondent is alleged to have engaged; state the rule(s) alleged to

have been violated; advise the respondent that he is entitled, upon

request, to a hearing on the charges; and prescribe the period within

which a hearing may be requested. Paragraphs (1) and (2) of the

proposed rule permitted a SEF to adopt rules providing that: (1) The

failure to request a hearing within the time prescribed in the notice,

except for good cause, may be deemed a waiver of the right to a

hearing; and (2) the failure to answer or expressly deny a charge may

be deemed to be an admission of such charge.

(i) Commission Determination

Although no comments were received on proposed Sec. 37.206(d), the

Commission believes that it can provide SEFs with additional

flexibility by moving the entire rule to the guidance in appendix B to

part 37.\565\ Moreover, since paragraphs (1) and (2) of proposed Sec.

37.206(d) allowed, but did not require, a SEF to issue rules regarding

failures to request a hearing and expressly answer or deny a charge,

the Commission believes that the language in these paragraphs is better

suited as guidance rather than a rule.

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

\565\ As mentioned above, the Commission is moving paragraph (3)

of proposed Sec. 37.206(c) to the text of proposed Sec. 37.206(d)

that will now be included as guidance.

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

(6) Sec. 37.206(e)--Right to Representation

Proposed Sec. 37.206(e) provided for a respondent's right, upon

receiving a notice of charges, to be represented by legal counsel or

any other representative of its choosing in all succeeding stages of

the disciplinary process.

(i) Summary of Comments

CME commented that this rule should be limited to avoid conflicts

of interest in representation and, accordingly, requested that the rule

be revised to clarify that a respondent may not be represented by: (1)

A member of the SEF's disciplinary committees; (2) a member of the

SEF's Board of Directors; (3) an employee of the SEF; or (4) a person

substantially related to the underlying investigation, such as a

material witness or other respondent.\566\

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

\566\ CME Comment Letter at 35 (Feb. 22, 2011).

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

(ii) Commission Determination

The Commission is moving proposed Sec. 37.206(e) in its entirety

to the guidance in appendix B to part 37, subject to the following

modification. The Commission is amending the language to incorporate

CME's recommendation. The guidance states that upon being served with a

notice of charges, a respondent should have the right to be represented

by legal counsel or any other representative of its choosing in all

succeeding stages of the disciplinary process, except by any

[[Page 33523]]

member of the SEF's board of directors or disciplinary panel, any

employee of the SEF, or any person substantially related to the

underlying investigations, such as a material witness or respondent.

The Commission believes that this revision appropriately addresses the

conflicts of interest noted by CME.

(7) Sec. 37.206(f)--Answer to Charges

Proposed Sec. 37.206(f) required that a respondent be given a

reasonable period of time to file an answer to a notice of charges. The

proposed rule also provided that the rules of a SEF may prescribe

certain aspects of the answer, which were enumerated in paragraphs (1)

through (3).\567\

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

\567\ These aspects were that: (1) The answer must be in writing

and include a statement that the respondent admits, denies, or does

not have and is unable to obtain sufficient information to admit or

deny each allegation; (2) failure to file an answer on a timely

basis shall be deemed an admission of all allegations in the notice

of charges; and (3) failure in an answer to deny expressly a charge

shall be deemed to be an admission of such charge.

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

(i) Commission Determination

Although no comments were received on proposed Sec. 37.206(f), the

Commission is moving the entire rule to the guidance in appendix B to

part 37, with certain modifications, in order to provide SEFs with

greater flexibility to adopt their own disciplinary procedures. The

Commission is also condensing the guidance by replacing paragraphs (1)

through (3) with language making clear that any rules adopted by a SEF

governing the requirements and timeliness of a respondent's answer to a

notice of charges should be ``fair, equitable, and publicly

available.''

(8) Sec. 37.206(g)--Admission or Failure To Deny Charges

Proposed Sec. 37.206(g) provided that a SEF may adopt rules

whereby a respondent who admits or fails to deny any of the charges

alleged in the notice of charges may be found by the Hearing Panel to

have committed the violations charged. If a SEF adopted such rules,

paragraphs (1) through (3) of the proposed rule provided that: (1) The

Hearing Panel must impose a sanction for each violation found to have

been committed; (2) the Hearing Panel must promptly notify the

respondent in writing of any sanction to be imposed and advise the

respondent that it may request a hearing on such sanction within a

specified period of time; and (3) the rules of the SEF may provide that

if the respondent fails to request a hearing within the period of time

specified in the notice, then the respondent will be deemed to have

accepted the sanction.

(i) Commission Determination

Although the Commission did not receive comments on proposed Sec.

37.206(g), the Commission is moving the entire rule, with certain

modifications, to the guidance in appendix B to part 37.\568\ Given

that proposed Sec. 37.206(g) allowed, but did not require, a SEF to

issue rules regarding a respondent's admission or failure to deny

charges, the Commission believes that the proposed rule is better

suited as guidance rather than a rule. The Commission also believes

that adopting the proposed rule as guidance, rather than a rule, will

provide SEFs greater flexibility in administering their obligations,

consistent with the general comments seeking the same. Furthermore, the

Commission is modifying the text of proposed Sec. 37.206(g)(2) that

will now be included as guidance to clarify that a respondent may

request a hearing ``within the period of time, which should be stated

in the notice.''

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

\568\ The Commission notes that the text that will now be

included as guidance is being modified to reflect the single-panel

approach adopted in Sec. 37.206(b), replacing specific panel names

with a generic reference to the ``disciplinary panel.''

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

(9) Sec. 37.206(h)--Denial of Charges and Right to Hearing

Proposed Sec. 37.206(h) required that in every instance where a

respondent has requested a hearing on a charge that is denied, or on a

sanction set by the Hearing Panel pursuant to proposed Sec. 37.206(g),

the respondent must be given the opportunity for a hearing in

accordance with the requirements of proposed Sec. 37.206(j). Proposed

Sec. 37.206(h) also gave SEFs the option to adopt rules that provided,

except for good cause, the hearing must be concerned only with those

charges denied and/or sanctions set by the Hearing Panel under proposed

Sec. 37.206(g) for which a hearing has been requested.

(i) Commission Determination

The Commission received no comments on proposed Sec. 37.206(h),

but is moving the entire rule, with certain modifications, to the

guidance in appendix B to part 37.\569\ In order to provide SEFs with

further flexibility, even within the guidance, the Commission is also

removing the proposed rule's reference to a SEF's ability to limit

hearings to only those charges denied and/or sanctions set by the

Hearing Panel under proposed Sec. 37.206(g) for which a hearing has

been requested.

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

\569\ The Commission is revising the proposed rule to reflect

the single-panel approach adopted in Sec. 37.206(b), replacing

specific panel names with a generic reference to the ``disciplinary

panel.'' The Commission is also removing the references to proposed

Sec. Sec. 37.206(g) and (j) given that the Commission is moving

proposed Sec. 37.206(g) to guidance, and either eliminating or

moving certain provisions of proposed Sec. 37.206(j) to guidance.

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

(10) Sec. 37.206(i)--Settlement Offers

Proposed Sec. 37.206(i) provided the procedures that a SEF must

follow if it permits the use of settlements to resolve disciplinary

cases. Paragraph (1) of the proposed rule stated that the rules of a

SEF may permit a respondent to submit a written offer of settlement any

time after the investigation report is completed. The proposed rule

also permitted the disciplinary panel presiding over the matter to

accept the offer of settlement, but prohibited the panel from altering

the terms of the offer unless the respondent agreed. In addition,

paragraph (2) of the proposed rule provided that the rules of the SEF

may allow a disciplinary panel to permit the respondent to accept a

sanction without admitting or denying the rule violations upon which

the sanction is based.

Paragraph (3) of the proposed rule stated that a disciplinary panel

accepting a settlement offer must issue a written decision specifying

the rule violations it has reason to believe were committed, and any

sanction imposed, including any order of restitution where customer

harm has been demonstrated. Paragraph (3) also provided that if an

offer of settlement is accepted without the agreement of a SEF's

enforcement staff, then the decision must adequately support the

Hearing Panel's acceptance of the settlement. Finally, paragraph (4) of

the proposed rule allowed a respondent to withdraw his or her offer of

settlement at any time before final acceptance by a disciplinary panel.

If an offer is withdrawn after submission, or is rejected by a

disciplinary panel, the respondent must not be deemed to have made any

admissions by reason of the offer of settlement and must not be

otherwise prejudiced by having submitted the offer of settlement.

(i) Commission Determination

Although the Commission received no comments on proposed Sec.

37.206(i), the Commission is moving the entire rule, with certain

modifications, to the guidance in appendix B to part 37.\570\

[[Page 33524]]

The Commission believes that adopting the proposed rule as guidance,

rather than a rule, will provide SEFs greater flexibility in

administering their obligations, consistent with the general comments

seeking the same. Furthermore, the Commission is revising the guidance

text to make it consistent with its modifications to the customer

restitution provisions adopted below with respect to proposed Sec.

37.206(n).

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

\570\ The Commission notes that the text that will now be

included as guidance is being modified to reflect the single-panel

approach adopted in Sec. 37.206(b), replacing specific panel names

with a generic reference to the ``disciplinary panel.''

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

(11) Sec. 37.206(j)--Hearings

Proposed Sec. 37.206(j) required a SEF to adopt rules that provide

certain minimum procedural safeguards for any hearing conducted

pursuant to a notice of charges. In general, proposed Sec. Sec.

37.206(j)(1)(i) through (j)(1)(vii) required the following: (i) A fair

hearing; (ii) authority for a respondent to examine evidence relied on

by enforcement staff in presenting the charges; (iii) the SEF's

enforcement and compliance staffs to be parties to the hearing and the

enforcement staff to present its case on the charges and sanctions;

(iv) the respondent to be entitled to appear personally at the hearing,

to cross-examine and call witnesses, and to present evidence; (v) the

SEF to require persons within its jurisdiction who are called as

witnesses to participate in the hearing and produce evidence; (vi) a

copy of the hearing be made and be a part of the record of the

proceeding if the respondent requested the hearing; and (vii) the rules

of the SEF may provide that the cost of transcribing the record be

borne by the respondent in certain circumstances. Additionally,

proposed Sec. 37.206(j)(2) specified that the rules of the SEF may

provide that a sanction be summarily imposed upon any person within its

jurisdiction whose actions impede the progress of a hearing.

(i) Summary of Comments

CME recommended that proposed Sec. 37.206(j)(1)(ii) be revised so

that a respondent may not access protected attorney work product,

attorney-client communications, and investigative work product (e.g.,

investigation and exception reports).\571\

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

\571\ CME Comment Letter at 36 (Feb. 22, 2011).

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

(ii) Commission Determination

The Commission is partially adopting proposed Sec. 37.206(j), and

is either eliminating or moving to guidance the remaining portion of

the rule. The Commission is maintaining as a rule the provisions

requiring the following: (1) Hearings must be fair; and (2) if a

respondent requested a hearing, a copy of the hearing be made and be a

part of the record of the proceeding.\572\ The Commission is

eliminating proposed Sec. 37.206(j)(1)(vii), a discretionary rule that

in certain cases allowed for the cost of transcribing the record of the

hearing to be borne by the respondent. The Commission is moving the

remainder of proposed Sec. 37.206(j) to the guidance in appendix B to

part 37. The Commission believes that these revisions are appropriate

given commenters' requests for greater flexibility to establish their

own disciplinary procedures.

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

\572\ The Commission is renumbering proposed Sec. 37.206(j) to

Sec. 37.206(c). The Commission is also revising the proposed rule

to reflect the single-panel approach adopted in Sec. 37.206(b),

replacing specific panel names with a generic reference to the

``disciplinary panel.'' The Commission is also revising the

reference to Sec. 37.206(l) in proposed Sec. 37.206(j)(1)(vi)

given that it is moving proposed Sec. 37.206(l) to guidance.

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

The Commission agrees with CME's comment that a SEF should be

permitted to withhold certain documents from a respondent in certain

circumstances. Therefore, the Commission is revising the text of

proposed Sec. 37.206(j)(1)(ii), which will now be included in

guidance, to provide that a SEF may withhold documents that: (i) Are

privileged or constitute attorney work product; (ii) were prepared by

an employee of the SEF but will not be offered in evidence in the

disciplinary proceedings; (iii) may disclose a technique or guideline

used in examinations, investigations, or enforcement proceedings; or

(iv) disclose the identity of a confidential source.

(12) Sec. 37.206(k)--Decisions

Proposed Sec. 37.206(k) required a Hearing Panel, promptly

following a hearing conducted in accordance with proposed Sec.

37.206(j), to render a written decision based upon the weight of the

evidence and to provide a copy to the respondent. Paragraphs (1)

through (6) detailed the items to be included in the decision.

(i) Commission Determination

The Commission received no comments on proposed Sec. 37.206(k) and

is adopting the rule as proposed with certain non-substantive

clarifications.\573\

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

\573\ The Commission is renumbering proposed Sec. 37.206(k) to

Sec. 37.206(d). The Commission is also revising the reference to

Sec. 37.206(j) in proposed Sec. 37.206(k) given that the

Commission has either eliminated or moved to guidance many of the

provisions of proposed Sec. 37.206(j). The Commission is also

revising the proposed rule to reflect the single-panel approach

adopted in Sec. 37.206(b), replacing specific panel names with a

generic reference to the ``disciplinary panel.''

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

(13) Sec. 37.206(l)--Right to Appeal

Proposed Sec. 37.206(l) provided the procedures that a SEF must

follow in the event that the SEF's rules permit an appeal. For SEFs

that permit appeals, the language in paragraphs (1) through (4) of

proposed Sec. 37.206(l) generally required the SEF to: (1) Establish

an appellate panel; (2) ensure that the appellate panel composition is

consistent with Sec. 40.9(c)(iv) and not include any members of the

SEF's compliance staff or any person involved in adjudicating any other

stage of the same proceeding; (3) conduct the appeal solely on the

record before the Hearing Panel, except for good cause shown; and (4)

issue a written decision of the board of appeals and provide a copy to

the respondent.

(i) Commission Determination

Although the Commission received no comments on proposed Sec.

37.206(l), the Commission is moving the entire rule to the guidance in

appendix B to part 37.\574\ Given that proposed Sec. 37.206(l)

allowed, but did not require, a SEF to issue rules regarding a

respondent's right to appeal, the Commission believes that the proposed

rule is better suited as guidance rather than a rule. The Commission

also believes that adopting the proposed rule as guidance, rather than

a rule, will provide SEFs greater flexibility in administering their

obligations, consistent with the general comments seeking the same.

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

\574\ The Commission notes that the reference to Sec.

40.9(c)(iv) in the proposed rule was a technical error. Instead,

proposed Sec. 37.206(l) should have referenced the composition

requirements of an appellate panel outlined in proposed Sec.

40.9(c)(3)(iii). However, to accommodate any re-enumeration that may

occur with respect to proposed Sec. 40.9(c)(3)(iii), the Commission

is replacing the mistaken reference to Sec. 40.9(c)(iv) with a more

general reference to part 40 in the guidance text. See Requirements

for Derivatives Clearing Organizations, Designated Contract Markets,

and Swap Execution Facilities Regarding the Mitigation of Conflicts

of Interest, 75 FR 63732, 63752 (proposed Oct. 18, 2010). The

Commission is also revising the reference to Sec. 37.206(k) in

proposed Sec. 37.206(l)(4) to Sec. 37.206(d) given the renumbering

in Sec. 37.206. Finally, the Commission is revising the proposed

rule to reflect the single-panel approach adopted in Sec.

37.206(b), replacing specific panel names with a generic reference

to the ``disciplinary panel.''

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

(14) Sec. 37.206(m)--Final Decisions

Proposed Sec. 37.206(m) required that each SEF establish rules

setting forth when a decision rendered under Sec. 37.206 will become

the final decision of the SEF.

(i) Commission Determination

Although the Commission received no comments on proposed Sec.

37.206(m), the Commission is moving the entire rule to

[[Page 33525]]

the guidance in appendix B to part 37. The Commission believes that

adopting the proposed rule as guidance rather than a rule provides a

SEF with additional flexibility to establish disciplinary procedures to

meet its obligations pursuant to Core Principle 2.

(15) Sec. 37.206(n)--Disciplinary Sanctions

Proposed Sec. 37.206(n) required that disciplinary sanctions

imposed by a SEF must be commensurate with the violations committed and

must be clearly sufficient to deter recidivism or similar violations by

other market participants. In addition, the proposed rule required that

a SEF take into account a respondent's disciplinary history when

evaluating appropriate sanctions. The proposed rule further required

that in the event of demonstrated customer harm, any disciplinary

sanction must include full customer restitution.

(i) Summary of Comments

WMBAA recommended that any limitation of a market participant's

access to a SEF imposed in response to a rule violation should be

recognized and enforced consistently among all SEFs.\575\ WMBAA also

recommended that any disciplinary sanction imposed by a SEF should be

published and made available to market participants.\576\ Such

requirements, WMBAA argued, are necessary in order to prevent market

participants from gaming the system and maintaining access to markets

after violations.\577\

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

\575\ WMBAA Comment Letter at 23 (Mar. 8, 2011).

\576\ Id.

\577\ Id. at 24.

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

(ii) Commission Determination

The Commission is adopting proposed Sec. 37.206(n), subject to

certain modifications.\578\ The Commission is revising proposed Sec.

37.206(n) to clarify that a respondent's disciplinary history should be

taken into account in all sanction determinations, including sanctions

imposed pursuant to an accepted settlement offer. Furthermore, the

Commission is revising proposed Sec. 37.206(n) so that it does not

require customer restitution if the amount of restitution or the

recipient cannot be reasonably determined.\579\

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

\578\ The Commission is renumbering proposed Sec. 37.206(n) to

Sec. 37.206(e).

\579\ The Commission notes that commenters to the DCM rulemaking

requested this change and, after considering the comments, the

Commission believes that this revision should also be applicable to

SEFs. Core Principles and Other Requirements for Designated Contract

Markets, 77 FR at 36654-55.

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

The Commission acknowledges WMBAA's comment that disciplinary

sanctions may not be recognized and enforced consistently across SEFs.

However, each SEF is a distinct entity with its own rulebook and set of

disciplinary procedures. Therefore, each SEF must determine the

sanctions that are appropriate for its own market and thus the same

conduct may result in different sanctions at different SEFs. The

Commission does not believe that such sanction variation supports the

mandatory recognition of sanctions across SEFs. However, if a SEF

believes that it is important to recognize and enforce sanctions

against market participants imposed by other SEFs or DCMs, then the SEF

may implement appropriate rules.

The Commission agrees with WMBAA that any disciplinary sanction

imposed by a SEF should be published and made available to market

participants. Commission Regulation 9.11(a) requires that ``[w]henever

an exchange decision pursuant to which a disciplinary action or access

denial action is to be imposed has become final, the exchange must,

within thirty days thereafter, provide written notice of such action to

. . . the Commission . . . .'' \580\ The Commission has issued guidance

that an exchange may comply with Sec. 9.11(a) by transmitting or

delivering the notice to NFA to be included in NFA's Background

Affiliation Status Information Center database, which is available to

the public online.\581\ The Commission also notes that a SEF may adopt

rules regarding the publishing of disciplinary sanctions imposed by the

SEF.

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

\580\ Section 37.2 states that a SEF shall comply with part 9 of

the Commission's regulations.

\581\ NFA's Background Affiliation Status Information Center

database is available at http://www.nfa.futures.org/basicnet/.

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

(16) Sec. 37.206(o)--Summary Fines for Violations of Rules Regarding

Timely Submission of Records

Proposed Sec. 37.206(o) permitted a SEF to adopt a summary fine

schedule for violations of rules relating to the timely submission of

accurate records required for clearing or verifying each day's

transactions. Under the proposed rule, a SEF may permit its compliance

staff to summarily impose minor sanctions against persons within the

SEF's jurisdiction for violating such rules. The proposed rule made

clear that a SEF's summary fine schedule must not permit more than one

warning letter in a rolling 12-month period for the same violation

before sanctions are imposed and must provide for progressively larger

fines for recurring violations.

(i) Summary of Comments

CME objected to the restriction of one warning letter per rolling

12-month period.\582\ MarketAxess also requested that the Commission

adopt a uniform approach with respect to warning letters, either

permitting warning letters as a sanction or an indication of a finding

of a violation in all SEF contexts.\583\

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

\582\ CME Comment Letter at 36 (Feb. 22, 2011).

\583\ MarketAxess Comment Letter at 36 (Mar. 8, 2011).

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

(ii) Commission Determination

The Commission is partially adopting proposed Sec. 37.206(o) and

is converting the remaining portion of the rule to guidance in appendix

B to part 37.\584\ The Commission is maintaining as a rule the

provision in the proposed rule that prohibits a SEF from issuing more

than one warning letter per rolling 12-month period for the same

violation. As discussed above, the Commission believes that in order to

ensure that warning letters serve as effective deterrents, and to

preserve the value of disciplinary sanctions, no more than one warning

letter may be issued to the same person or entity found to have

committed the same rule violation within a rolling 12-month

period.\585\ While a warning letter may be appropriate for a first-time

violation, the Commission does not believe that more than one warning

letter in a rolling 12-month period for the same violation is ever

appropriate.\586\

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

\584\ The Commission is renumbering proposed Sec. 37.206(o) to

Sec. 37.206(f). The Commission is also retitling this section as

``Warning letters.''

\585\ For purposes of this rule, the Commission does not

consider a ``reminder letter'' or such other similar letter to be

any different than a warning letter.

\586\ See Core Principles and Other Requirements for Swap

Execution Facilities, 76 FR at 1224.

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

However, in response to MarketAxess's comment, the Commission is

narrowing the application of this rule to warning letters that contain

an affirmative finding that a rule violation has occurred.

Additionally, in order to provide flexibility, the compliance date of

this rule will be one year from the effective date of the final SEF

rules so that persons and entities may adapt to the new SEF regime. The

Commission is converting the remainder of proposed Sec. 37.206(o) to

guidance in appendix B to part 37 because the proposed rule allowed,

but did not require, a SEF to adopt a summary fine schedule.

(17) Sec. 37.206(p)--Emergency Disciplinary Actions

Proposed Sec. 37.206(p) provided that a SEF may impose a sanction,

including

[[Page 33526]]

a suspension, or take other summary action against a person or entity

subject to its jurisdiction upon a reasonable belief that such

immediate action is necessary to protect the best interest of the

marketplace. The proposed rule also provided that any emergency action

taken by the SEF must be in accordance with certain procedural

safeguards as enumerated in the proposed rule.\587\

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

\587\ The Commission notes that, pursuant to Sec. 9.11 and

Sec. 37.2, SEFs must provide the Commission with notice of any

disciplinary actions that they take, including emergency

disciplinary actions.

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

(i) Commission Determination

Although the Commission received no comments on proposed Sec.

37.206(p), the Commission is moving the entire rule to the guidance in

appendix B to part 37 because it is a discretionary rule.\588\ The

Commission also believes that adopting the proposed rule as guidance,

rather than a rule, will provide SEFs greater flexibility in

administering their obligations, consistent with the general comments

seeking the same.

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

\588\ The Commission is also revising the reference to Sec.

37.206(j) in proposed Sec. 37.206(p)(ii) given that the Commission

has either eliminated or moved to guidance many of the provisions of

proposed Sec. 37.206(j).

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

The Commission is also codifying new Sec. 37.206(g) \589\ (titled

``Additional sources for compliance'') that permits SEFs to refer to

the guidance and/or acceptable practices in appendix B to part 37 to

demonstrate to the Commission compliance with the requirements of Sec.

37.206.

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

\589\ The Commission notes that this paragraph's numbering is

due to the renumbering of Sec. 37.206.

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

(h) Sec. 37.207--Swaps Subject to Mandatory Clearing

Proposed Sec. 37.207 required that a SEF provide rules that when a

swap dealer or major swap participant enters into or facilitates a swap

transaction subject to the mandatory clearing requirement under section

2(h) of the Act, the swap dealer or major swap participant shall be

responsible for complying with the mandatory trading requirement under

section 2(h)(8) of the Act.

(1) Summary of Comments

FXall stated that proposed Sec. 37.207 could be read to require a

SEF to be responsible for policing the conduct of swap dealers and

major swap participants generally, and not only with respect to their

trading on such SEF.\590\ In this regard, MarketAxess stated that a

SEF's obligation to require swap dealers and major swap participants to

comply with the mandatory trading requirement should only extend to

swaps that are executed pursuant to its own rules.\591\ MarketAxess

also noted that proposed Sec. 37.207 is identical to proposed Sec.

37.200(d) and therefore is unnecessary.\592\ WMBAA commented that there

is no statutory basis to impose the requirement in proposed Sec.

37.207.\593\

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

\590\ FXall Comment Letter at 11 (Mar. 8, 2011).

\591\ MarketAxess Comment Letter at 34 (Mar. 8, 2011).

\592\ Id.

\593\ WMBAA Comment Letter at 24 (Mar. 8, 2011).

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

(2) Commission Determination

The Commission agrees with MarketAxess that proposed Sec. 37.207

is identical to Sec. 37.200(d) and is therefore eliminating proposed

Sec. 37.207. In response to WMBAA's comment, the Commission notes that

Sec. 37.200(d) recites the statutory text of Core Principle 2 and thus

provides the statutory basis for codification of the statutory text as

a regulation.\594\ To address FXall's and MarketAxess's concerns, the

Commission clarifies that a SEF's rules pursuant to Sec. 37.200(d)

need only apply to swaps executed on or pursuant to the rules of that

SEF.

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

\594\ CEA section 5h(f)(2)(D); 7 U.S.C. 7b-3(f)(2)(D).

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

3. Subpart D--Core Principle 3 (Swaps Not Readily Susceptible to

Manipulation)

Core Principle 3 requires that a SEF permit trading only in swaps

that are not readily susceptible to manipulation.\595\ In the SEF NPRM,

the Commission proposed to codify the statutory text of Core Principle

3 in proposed Sec. 37.300, and adopts that rule as proposed.

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

\595\ CEA section 5h(f)(3); 7 U.S.C. 7b-3(f)(3).

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

To demonstrate to the Commission compliance with Core Principle 3,

proposed Sec. 37.301 required a SEF to submit new swap contracts in

advance to the Commission pursuant to part 40 of the Commission's

regulations, and provide to the Commission the information required

under appendix C to part 38. The Commission also proposed guidance for

compliance with Core Principle 3 under appendix B to part 37, which

noted the importance of the reference price for a swap contract. The

guidance also stated that Core Principle 3 requires that the reference

price used by a swap not be readily susceptible to manipulation.

(a) Summary of Comments \596\

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

\596\ The Commission notes that in Argus's joint DCM and SEF

rulemaking comment letter dated Feb. 22, 2011, it commented on Core

Principle 3 and specifically, the Commission's guidance in appendix

C to part 38--Demonstration of Compliance That a Contract is Not

Readily Susceptible to Manipulation. The Commission has addressed

Argus's comments in the DCM final rulemaking, Core Principles and

Other Requirements for Designated Contract Markets, 77 FR at 36633-

34. The Commission also notes that in CME's SEF rulemaking comment

letter dated Mar. 8, 2011 and DCM rulemaking comment letter dated

Feb. 22, 2011, it commented on the Commission's guidance in appendix

C to part 38. The Commission has also addressed CME's comments in

the DCM final rulemaking, Core Principles and Other Requirements for

Designated Contract Markets, 77 FR at 36632-34.

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

Reuters generally supported Core Principle 3, and the requirement

that SEFs should have in place appropriate systems and controls to

identify and manage situations where the market or individual swap

contract may be susceptible to manipulation or fraud.\597\ GFI

commented that once the Commission has declared a swap subject to

mandatory clearing, a SEF should not be required to ensure that the

contract is not readily susceptible to manipulation since such activity

would be redundant.\598\ According to GFI, the Commission would not

make a swap subject to mandatory clearing unless it believed that the

swap is not subject to manipulation.\599\

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

\597\ Reuters Comment Letter at 5 (Mar. 8, 2011).

\598\ GFI Comment Letter at 4-5 (Mar. 8, 2011).

\599\ Id. at 5.

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

(b) Commission Determination

The Commission is adopting Sec. 37.301 as proposed, subject to

certain modifications for clarity. The Commission is deleting from the

rule the references to prior approval or self-certification for new

product submissions under part 40 of the Commission's regulations

because those details are covered under Sec. 37.4 and part 40. The

Commission is also adding to the rule a reference to the guidance and/

or acceptable practices in appendix B to part 37. This reference was

inadvertently omitted from the SEF NPRM.

In response to GFI's comments, the Commission notes that section 5h

of the Act requires that a SEF permit trading only in swaps that are

not readily susceptible to manipulation.\600\ The Commission notes that

this is a separate and distinct requirement for a SEF to comply with,

as opposed to the Commission determination as to whether a swap is

subject to mandatory clearing. The Commission does not have the

authority under CEA section 4(c)(1) to exempt SEFs from complying with

the core principles.

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

\600\ CEA section 5h(f)(3); 7 U.S.C. 7b-3(f)(3).

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

The Commission notes that the requirement that a SEF permit trading

in swaps that are not readily susceptible to manipulation requires a

SEF to be responsible for the terms and conditions of the swap

contracts which trade on its facility. To meet this requirement, the

[[Page 33527]]

guidance includes items that a SEF should consider in developing swap

contract terms and conditions for both physical delivery and cash-

settled contracts. The Commission recognizes that a SEF may permit

trading in a wide range of swaps, some standardized and others

customized and complex. The Commission staff is available to consult

with SEFs should questions arise regarding the information that SEFs

should submit to the Commission to satisfy the requirements of Core

Principle 3, especially for the SEF's more customized and complex swap

contracts. The Commission will take into account these considerations

when determining whether a SEF satisfies the requirements of Core

Principle 3.

4. Subpart E--Core Principle 4 (Monitoring of Trading and Trade

Processing)

Under Core Principle 4, a SEF must establish and enforce rules or

terms and conditions defining, or specifications detailing trading

procedures to be used in entering and executing orders traded on or

through the facilities of the SEF and procedures for trade processing

of swaps on or through the facilities of the SEF.\601\ Core Principle 4

also requires a SEF to monitor trading in swaps to prevent

manipulation, price distortion, and disruptions of the delivery or cash

settlement process through surveillance, compliance, and disciplinary

practices and procedures, including methods for conducting real-time

monitoring of trading and comprehensive and accurate trade

reconstructions.\602\ In the SEF NPRM, the Commission proposed to

codify the statutory text of Core Principle 4 in proposed Sec. 37.400,

and adopts that rule as proposed.

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

\601\ CEA section 5h(f)(4); 7 U.S.C. 7b-3(f)(4).

\602\ Id.

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

As discussed above under Core Principle 3, the Commission

recognizes that a SEF may permit trading in a wide range of swaps, some

standardized and others customized and complex. The Commission staff is

available to consult with SEFs should questions arise regarding how to

satisfy the requirements of Core Principle 4, especially for the SEF's

more customized and complex swap contracts. The Commission will take

into account these considerations when determining whether a SEF

satisfies the requirements of Core Principle 4.

(a) Sec. 37.401--General Requirements

Proposed Sec. 37.401(a) required a SEF to collect and evaluate

data on individual traders' market activity on an ongoing basis in

order to detect and prevent manipulation, price distortions and, where

possible, disruptions of the delivery or cash-settlement process.

Proposed Sec. 37.401(b) required a SEF to monitor and evaluate general

market data in order to detect and prevent manipulative activity that

would result in the failure of the market price to reflect the normal

forces of supply and demand. Proposed Sec. 37.401(c) required a SEF to

have the capacity to conduct real-time monitoring of trading and

comprehensive and accurate trade reconstruction. Further, the proposed

rule required that intraday trade monitoring must include the capacity

to detect abnormal price movements, unusual trading volumes,

impairments to market liquidity, and position-limit violations.

Finally, proposed Sec. 37.401(d) required a SEF to have either manual

processes or automated alerts that are effective in detecting and

preventing trading abuses. The Commission noted in the SEF NPRM

preamble that it would be difficult, if not impossible, for a SEF to

monitor for market disruptions in markets with high transaction volume

and a large number of trades unless the SEF installed automated trading

alerts.\603\

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

\603\ Core Principles and Other Requirements for Swap Execution

Facilities, 76 FR at 1227.

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

(1) Summary of Comments

Several commenters sought clarification that proposed Sec. 37.401

limits a SEF's oversight of market participant activity to its own

SEF.\604\ Tradeweb, for example, commented that a SEF cannot ensure

that a marketplace other than its own has not been manipulated to

affect the SEF's swaps because the SEF will not have enough information

about the other marketplaces.\605\

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

\604\ Bloomberg Comment Letter 3-4 (Jun. 3, 2011); Parity Energy

Comment Letter at 4 (Mar. 25, 2011); Tradeweb Comment Letter at 11

(Mar. 8, 2011); MarketAxess Comment Letter at 22 (Mar. 8, 2011);

WMBAA Comment Letter at 25 (Mar. 8, 2011).

\605\ Tradeweb Comment Letter at 11 (Mar. 8, 2011).

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

WMBAA requested that the Commission clarify what it means by

``individual traders'' and ``market activity'' in proposed Sec.

37.401(a).\606\ WMBAA also sought clarification regarding what

constitutes ``general market data'' in proposed Sec. 37.401(b).\607\

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

\606\ WMBAA Comment Letter at 25 (Mar. 8, 2011).

\607\ Id.

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

CME commented that the Commission's requirements for real-time

monitoring in proposed Sec. 37.401(c) are overly broad, and stated

that requiring real-time monitoring capabilities across every

instrument for vague terms such as ``abnormal price movements,''

``unusual trading volumes,'' and ``impairments to market liquidity''

does not provide a SEF with sufficient clarity with respect to what

specific capabilities satisfy the standard.\608\ Similarly, ICE

requested that the Commission delete the phrase ``impairments to market

liquidity'' from the rule, arguing that the wording is vague and has no

foundation in the core principle.\609\

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

\608\ CME Comment Letter at 24 (Feb. 22, 2011).

\609\ ICE Comment Letter at 4 (Mar. 8, 2011).

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

ICE and CME also expressed concern regarding the real-time

monitoring of position limits.\610\ ICE stated that real-time

monitoring of position limits may be flawed given that option deltas

change throughout the day, the destination of allocated and give-up

transactions are not immediately known, and off-exchange transactions

may not be reported in real-time.\611\ CME stated that effective real-

time monitoring of position limits is challenging given that the

identical contract will frequently trade in multiple competitive

venues.\612\

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

\610\ ICE Comment Letter at 4 (Mar. 8, 2011); CME Comment Letter

at 24 (Feb. 22, 2011).

\611\ ICE Comment Letter at 4 (Mar. 8, 2011).

\612\ CME Comment Letter at 24 (Feb. 22, 2011).

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

In response to the Commission's questions in the SEF NPRM regarding

high frequency trading, CME raised concerns over the absence of a

definition for high frequency trading, which CME claimed can include

many different trading strategies.\613\ CME questioned whether the

Commission had unique concerns about high frequency traders, and

further remarked that the Commission has not articulated what purpose

would be served by singling out high frequency trading for special

monitoring.\614\ CME stated, however, that it has the capability to

monitor the messaging frequency of participants in their markets and

can quickly and easily identify which participants generate high

messaging traffic.\615\ With respect to the ability of automated

trading systems to detect and flag high frequency trading anomalies,

CME commented that it is unclear what specific types of anomalies would

be uniquely of concern in the context of a high frequency trader as

opposed to any other type of trader.\616\ CME noted that its systems

were designed to identify anomalies or transaction patterns that

violate their rules or might otherwise be

[[Page 33528]]

indicative of some other risk to the orderly functioning of the

markets.\617\

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

\613\ Id. at 25.

\614\ Id.

\615\ Id.

\616\ Id.

\617\ Id.

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

(2) Commission Determination

The Commission is adopting Sec. 37.401 as proposed, subject to

certain modifications, including converting portions of the rule to

guidance in appendix B to part 37.\618\

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

\618\ The Commission is moving proposed Sec. 37.401(d) to the

guidance in appendix B to part 37 and moving the ``trade

reconstruction'' language in proposed Sec. 37.401(c) to final Sec.

37.401(d).

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

To address commenters' concerns whether Sec. 37.401 requires a SEF

to monitor market activity beyond its own market, the Commission notes

that the Act requires a SEF to monitor trading in swaps to prevent

manipulation, price distortion, and disruptions of the delivery or cash

settlement process.\619\ Given this statutory requirement, there are

certain instances where a SEF must monitor market activity beyond its

own market.\620\ As noted below, a SEF must assess whether trading in a

third-party index or instrument used as a reference price or the

underlying commodity for its listed swaps is being used to affect

prices on its market.\621\ The Commission, however, provides

flexibility to SEFs by not prescribing in the regulations the specific

methods for monitoring. To provide additional flexibility, in instances

where a SEF can demonstrate to the Commission that trading activity off

the SEF's facility is not relevant to threats of manipulation,

distortion, or disruption for trading conducted on its own facility,

then the SEF may limit monitoring to trading activity on its own

facility.

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

\619\ CEA section 5h(f)(4)(B); 7 U.S.C. 7b-3(f)(4)(B).

\620\ Refer to the guidance under Core Principle 4 in appendix B

to part 37 for examples of methods for monitoring market activity

beyond a SEF's own market.

\621\ See discussion below under Sec. 37.403--Additional

Requirements for Cash-Settled Swaps and Sec. 37.404--Ability To

Obtain Information in the preamble.

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

In response to WMBAA's concerns regarding the clarification of

certain terms in Sec. 37.401(a), the Commission is revising the rule

text to change the term ``individual traders'' to ``market

participants'' as ``individual traders'' was meant to apply to a SEF's

market participants. The Commission also clarifies that ``market

activity'' means its market participants' ``trading'' activity. In

Sec. 37.401(b), ``general market data'' means that a SEF shall monitor

and evaluate general market conditions related to its swaps. For

example, a SEF must monitor the pricing of the underlying commodity or

a third-party index or instrument used as a reference price for its

swaps as compared to the prices on its markets.

The Commission is also revising the rule to clarify that: (a) Real-

time monitoring is to detect and, when necessary, resolve

abnormalities; and (b) reconstructing trading activity is to detect

instances or threats of manipulation, price distortion, and

disruptions.

In the guidance, the Commission is clarifying that monitoring of

trading activity in listed swaps should be designed to prevent

manipulation, price distortion, and disruptions. The Commission

believes that SEFs should have rules in place that allow it to

intervene to prevent or reduce market disruptions given such

requirement in Core Principle 4. The Commission also notes that once a

threatened or actual disruption is detected, the SEF should take steps

to prevent the disruption or reduce its severity.

In the guidance, the Commission is also clarifying what activities

should be included in real-time monitoring as compared to what

activities may be done on a T+1 basis. The Commission believes that

monitoring of price movements and trading volumes in order to detect,

and when necessary, resolve abnormalities should be accomplished in

real time in order to achieve, as much as possible, the statute's

emphasis on preventive actions. It is acceptable, however, to have a

program that detects instances or threats of manipulation, price

distortion, and disruptions on at least a T+1 basis, incorporating any

additional data that is available on such T+1 basis, including trade

reconstruction data. The Commission notes that it dropped the

requirements for a SEF to monitor for ``impairments to market

liquidity'' and ``position limit violations'' given commenters'

concerns about the difficulty of such monitoring.

The Commission is moving to guidance the requirement to have

automated alerts in proposed Sec. 37.401(d). The Commission believes

that automated trading alerts, preferably in real time, are the most

effective means of detecting market anomalies. However, a SEF may

demonstrate that its manual processes are effective.

As for the Commission's inquiry in the SEF NPRM about requiring

additional monitoring of high frequency trading, the Commission

believes that a SEF should be capable of monitoring all types of

trading that may occur on its facility, including trading that may be

characterized as ``high frequency.'' The Commission has decided not to

implement, at this time, further rules pertaining to the monitoring of

high frequency trading. The Commission is encouraged that there are

efforts underway both within and outside of the Commission, to define

and develop approaches for better monitoring of high-frequency and

algorithmic trading. This is particularly evident from recent work done

at the request of the Commission's Technology Advisory Committee

(``TAC'').\622\ Further, the United Kingdom government's Foresight

Project also commissioned a recently released report on the future of

computer trading in financial markets, which aims to assess the risks

and benefits of automated buying and selling.\623\ These efforts may

assist the Commission's further development of a regulatory framework

for high frequency trading activities.

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

\622\ See, e.g., ``Recommendations on Pre-Trade Practices for

Trading Firms, Clearing Firms and Exchanges involved in Direct

Market Access,'' Pre-Trade Functionality Subcommittee of the CFTC's

Technology Advisory Committee (Mar. 1, 2011) (``TAC Subcommittee

Recommendations''), available at http://www.cftc.gov/idc/groups/public/@swaps/documents/dfsubmission/tacpresentation030111_ptfs2.pdf. The Commission notes that the subcommittee report was

submitted to the TAC and made available for public comment, but no

final action has been taken by the full committee.

\623\ See UK Government Office for Science, Foresight Project,

The Future of Computer Trading in Financial Markets (working paper),

available at http://www.bis.gov.uk/foresight/our-work/projects/current-projects/computer-trading/working-paper.

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

(b) Sec. 37.402--Additional Requirements for Physical-Delivery Swaps

Proposed Sec. 37.402 required, for physical-delivery swaps, that a

SEF monitor each swap's terms and conditions, monitor the adequacy of

deliverable supplies, assess whether supplies are available to those

making physical delivery and saleable by those taking delivery, and

monitor the ownership of deliverable supplies. Proposed Sec. 37.402

also required that a SEF address any conditions that are causing price

distortions or market disruptions.

(1) Summary of Comments

CME commented that proposed Sec. 37.402 should be an acceptable

practice instead of a prescriptive rule.\624\ Parity Energy commented

that in a market where numerous SEFs permit trading in identical swaps,

requiring each SEF to monitor the adequacy, size, and ownership of

deliverable supply as well as the delivery locations and commodity

characteristics is duplicative, unmanageable, and creates the risk of

conflicting conclusions.\625\

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

\624\ CME Comment Letter at 25 (Feb. 22, 2011).

\625\ Parity Energy Comment Letter at 4 (Mar. 25, 2011).

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

[[Page 33529]]

(2) Commission Determination

The Commission is adopting Sec. 37.402 as proposed, subject to

certain modifications, including converting portions of the rule to

guidance in appendix B to part 37.\626\ In response to comments and to

provide SEFs with greater flexibility, the Commission is revising the

requirement in proposed Sec. 37.402(a)(2) \627\ so that SEFs only have

to monitor the ``availability'' of the commodity supply instead of

monitoring whether the supply is ``adequate.'' The Commission is also

removing from proposed Sec. 37.402 the requirements that SEFs monitor

specific details of the supply, marketing, and ownership of the

commodity to be physically delivered. Instead, appendix B to part 37

lists guidance for monitoring conditions that may cause a physical-

delivery swap to become susceptible to price manipulation or

distortion, including monitoring the general availability of the

commodity specified by the swap, the commodity's general

characteristics, the delivery locations, and, if available, information

on the size and ownership of deliverable supplies. Moving these

specific details to guidance will provide SEFs with additional

flexibility in meeting their monitoring obligations associated with

physical-delivery swaps.

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

\626\ The Commission is renumbering proposed Sec. 37.402(a)(1)

and (a)(2) to Sec. 37.402(a) and (b), respectively. The Commission

is deleting or moving to guidance proposed Sec. 37.402(a)(3),

(a)(4), and (b).

\627\ Proposed Sec. 37.402(a)(2) is now final Sec. 37.402(b).

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

(c) Sec. 37.403--Additional Requirements for Cash-Settled Swaps

Proposed Sec. 37.403(a) required, for cash-settled swaps, that a

SEF monitor: (a) The availability and pricing of the commodity making

up the index to which the swap is settled and; (b) the continued

appropriateness of the methodology for deriving the index for SEFs that

compute their own indices. Where a swap is settled by reference to the

price of an instrument traded in another venue, proposed Sec.

37.403(b) required that the SEF either have an information sharing

agreement with the other venue or be able to independently determine

that positions or trading in the reference instrument are not being

manipulated to affect positions or trading in its swap.

(1) Summary of Comments

Argus expressed concern regarding the requirement in proposed Sec.

37.403(a)(1) for a SEF to monitor the availability and pricing of the

commodity making up the index to which the swap will be settled,

particularly where an index price is published based upon transactions

that are executed off the SEF.\628\ Argus noted that if a SEF is

required to perform this monitoring function, a SEF may choose not to

list the swap and market participants would not have a hedging

instrument.\629\ Argus also commented that the cost to monitor

transactions that are executed off of the SEF could be

prohibitive.\630\

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

\628\ Argus Comment Letter at 6 (Feb. 22, 2011).

\629\ Id.

\630\ Id. at 7.

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

Several commenters expressed concern about the requirement in

proposed Sec. 37.403(b) that a SEF have an information sharing

agreement with, or monitor positions or trading in, another venue when

a swap listed on the SEF is settled by reference to the price of an

instrument traded on another venue.\631\ ICE stated that the proposal

places an undue burden on SEFs to monitor positions held at other

trading venues, and that this requirement would be more efficiently

facilitated by a central regulatory body such as the Commission.\632\

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

\631\ Parity Energy Comment Letter at 5 (Mar. 25, 2011); ICE

Comment Letter at 4-5 (Mar. 8, 2011); Nodal Comment Letter at 5

(Mar. 8, 2011); CME Comment Letter at 11 (Mar. 8, 2011).

\632\ ICE Comment Letter at 4-5 (Mar. 8, 2011).

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

Similarly, CME stated that the Commission is uniquely situated to

add regulatory value to the industry by reviewing for potential cross-

venue rule violations because the Commission is the central repository

for position information delivered to it on a daily basis in a common

format across all venues.\633\ CME asserted that the SEF NPRM's

proposed alternative of requiring SEFs and their customers to report

information that the Commission already receives or will be receiving

is an onerous burden.\634\ CME further asserted that the SEF NPRM's

other proposed alternative, that the SEF enter into an information-

sharing agreement with the other venue, will result in additional costs

to both entities and that it may not be practical or prudent for a SEF

to enter into such an agreement with the other venue.\635\

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

\633\ CME Comment Letter at 11 (Mar. 8, 2011).

\634\ Id.

\635\ Id.

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

Finally, Nodal stated that a SEF that is a party to an industry

agreement such as the International Information Sharing Memorandum of

Understanding and Agreement should satisfy the information sharing

requirement in the proposed rule by virtue of such agreement.\636\

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

\636\ Nodal Comment Letter at 5 (Mar. 8, 2011).

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

(2) Commission Determination

The Commission is adopting Sec. 37.403 as proposed, subject to

certain modifications, including converting portions of the rule to

guidance in appendix B to part 37.\637\ The Act requires SEFs to

monitor trading in swaps to prevent disruptions of the cash settlement

process.\638\ However, in response to Argus's comment about the costs

of proposed Sec. 37.403(a)(1), the Commission has removed from the

rule the requirement that a SEF monitor the availability and pricing of

the commodity making up the index to which the swap will be settled.

Section 37.403(a) \639\ now requires that a SEF monitor the pricing of

the reference price used to determine cash flows or settlement. The

Commission believes that SEFs must monitor the pricing of the reference

price in order to comply with Core Principle 4's requirement to prevent

manipulation, price distortion, and disruptions of the cash settlement

process. As noted in the SEF NPRM, market participants may have

incentives to disrupt or manipulate reference prices for cash-settled

swaps.\640\

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

\637\ The Commission is renumbering proposed Sec. 37.403(a)(1)

and (a)(2) to Sec. 37.403(a), (b), and (c). The Commission is

moving proposed Sec. 37.403(b) to Sec. 37.404(a).

\638\ CEA section 5h(f)(4)(B); 7 U.S.C. 7b-3(f)(4)(B).

\639\ Final Sec. 37.403(a) was proposed Sec. 37.403(a)(1).

\640\ Core Principles and Other Requirements for Swap Execution

Facilities, 76 FR at 1228.

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

Although no comments were received on proposed Sec.

37.403(a)(2),\641\ the Commission is revising the rule so that the

requirement for monitoring the continued appropriateness of the

methodology for deriving the reference price only applies when the

reference price is formulated and computed by the SEF. In order to

reduce the burden on SEFs, the Commission is clarifying in new Sec.

37.403(c) that when the reference price relies on a third-party index

or instrument, including an index or instrument traded on another

venue, the SEF must only monitor the ``continued appropriateness'' of

the index or instrument as opposed to specifically monitoring the

``continued appropriateness of the methodology'' for deriving the

index. To provide SEFs with greater flexibility, the Commission is

moving the other requirements for monitoring in proposed Sec.

37.403(a)(2) to the guidance in appendix B to part 37. Specifically,

the guidance notes that if a SEF computes its own reference price, it

should promptly amend any methodologies or impose new methodologies as

necessary to resolve threats of disruption or distortions. For

[[Page 33530]]

reference prices that rely upon a third-party index or instrument, the

Commission notes in the guidance that the SEF should conduct due

diligence to ensure that the reference price is not susceptible to

manipulation.

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

\641\ The Commission is renumbering proposed Sec. 37.403(a)(2)

to Sec. 37.403(b).

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

With respect to commenters' concerns about the requirement in

proposed Sec. 37.403(b) for a SEF to have an information-sharing

agreement with, or monitor positions or trading in, another venue when

a swap listed on the SEF is settled by reference to the price of an

instrument traded on another venue, the Commission notes that the Act

requires SEFs to monitor trading in swaps to prevent disruptions of the

cash settlement process.\642\ Given this statutory requirement, the

Commission believes that a SEF must have access to sufficient

information to determine whether trading in the instrument or index

used as a reference price for its listed swaps is being used to affect

prices on its market. The Commission is adopting this general

requirement, but is moving it to Sec. 37.404 where it more logically

belongs.

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

\642\ CEA section 5h(f)(4)(B); 7 U.S.C. 7b-3(f)(4)(B).

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

Although, as CME noted, the Commission does obtain certain position

information in the large-trader reporting systems for swaps, the

Commission may not routinely obtain such position information,

including where a SEF's swap settles to the price of a non-U.S. index

or instrument. However, in response to ICE's and CME's concerns and to

reduce the burden on SEFs, the Commission is removing from the rule

text the requirement for SEFs to assess ``positions'' and is moving it

to the guidance in appendix B to part 37. The Commission is also moving

to the guidance the specific methods for a SEF to obtain information to

assess whether trading in the reference market is being used to affect

prices on its market. The guidance also allows SEFs to limit such

information gathering to market participants that conduct substantial

trading on its facility.

(d) Sec. 37.404--Ability To Obtain Information

Proposed Sec. 37.404(a) provided that a SEF must have rules that

require traders in its swaps to keep and make available records of

their activity in underlying commodities and related derivatives

markets and swaps. Proposed Sec. 37.404(b) required that a SEF with

customers trading through intermediaries have a large-trader reporting

system or other means to obtain position information.

(1) Summary of Comments

CME commented that the Commission should specify in acceptable

practices the types of records that traders are required to keep under

proposed Sec. 37.404(a).\643\ WMBAA commented that the requirement for

a SEF to force traders to maintain trading and financial records is not

required under the CEA.\644\

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

\643\ CME Comment Letter at 26 (Feb. 22, 2011).

\644\ WMBAA Comment Letter at 26 (Mar. 8, 2011).

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

(2) Commission Determination

The Commission is adopting Sec. 37.404 as proposed, subject to

certain modifications, including providing guidance in appendix B to

part 37.\645\ As noted above in the discussion of Sec. 37.403, the

Commission is moving to Sec. 37.404 the requirement for a SEF to

assess whether trading in swaps listed on its market, in the index or

instrument used as a reference price, or in the underlying commodity

for its swaps is being used to affect prices in its market.\646\

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

\645\ The Commission is changing the phrase ``traders in its

swaps'' to ``its market participants'' to provide clarity.

\646\ The Commission notes that this requirement is now in Sec.

37.404(a).

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

With respect to CME's and WMBAA's comments on proposed Sec.

37.404(a),\647\ the Commission disagrees that this rule is unnecessary

or that the requirements should instead be codified as acceptable

practices. Core Principle 4 requires a SEF to monitor trading in swaps

to prevent manipulation, price distortion, and disruptions.\648\ In its

experience regulating the futures market, the Commission has found

market participants' records to be an invaluable tool in its

surveillance efforts, and believes that a SEF should have direct access

to such information in order to discharge its obligations under the SEF

core principles, including Core Principle 4. However, the Commission

notes that in the guidance for this rule, a SEF may limit the

application of this requirement to those market participants who

conduct substantial trading activity on its facility, which is

consistent with the Commission's similar requirements that large

traders keep records for futures trading under Sec. 18.05 and for

swaps trading under Sec. 20.6 of the Commission's regulations. The

Commission also notes that the requirement for market participants to

keep such records is sound commercial practice, and that market

participants are likely already maintaining such trading records. In

response to CME's comment, the Commission notes that the nature of

records covered varies with the type of market and a market

participant's involvement, but would generally include purchases,

sales, ownership, production, processing, and use of swaps, the

underlying commodity, and other derivatives that have some relationship

to, or effect on, the market participant's trading in the listed swap.

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

\647\ The Commission notes that this requirement is now in Sec.

37.404(b).

\648\ CEA section 5h(f)(4)(B); 7 U.S.C. 7b-3(f)(4)(B).

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

The Commission is also deleting the requirements under proposed

Sec. 37.404(b) and replacing it, in the guidance, with a more general

requirement for a SEF to demonstrate that it can obtain position and

trading information directly from market participants or, if not

available from them, through information-sharing agreements. Moreover,

the guidance for this rule allows a SEF to limit the acquisition of

such information to those market participants who conduct substantial

trading on its facility. The Commission is making this change in

response to commenters' concerns, as noted in other sections, about

obtaining position information because a SEF will not have the

capability to monitor trading activities conducted on other trading

venues.\649\

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

\649\ See, e.g., comments below under Core Principle 6--Position

Limits or Accountability in the preamble.

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

(e) Sec. 37.405--Risk Controls for Trading

Proposed Sec. 37.405 required that a SEF have risk controls to

reduce the potential risk of market disruptions, including, but not

limited to, market restrictions that pause or halt trading in market

conditions prescribed by the SEF. Additionally, the rule provided that

where a SEF's swap is linked to, or a substitute for, other swaps on

the SEF or on other trading venues, including where a swap is based on

the level of an equity index, such risk controls must be coordinated

with those on the similar markets or trading venues, to the extent

possible.

The preamble of the SEF NPRM recognized that pauses and halts are

only one category of risk controls, and that additional controls may be

necessary to further reduce the potential for market disruptions.\650\

The SEF NPRM preamble specifically listed several risk controls that

the Commission believed may be appropriate, including price collars or

bands, maximum order size limits, stop loss order protections, kill

buttons, and any others that may be suggested by commenters.\651\

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

\650\ Core Principles and Other Requirements for Swap Execution

Facilities, 76 FR at 1228.

\651\ Id.

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

[[Page 33531]]

(1) Summary of Comments

Several commenters asserted that a SEF should have some discretion

to determine the specific risk controls that are implemented within its

markets.\652\ CME commented that the marketplace would benefit from

some standardization of the types of pre-trade risk controls employed

by SEFs and other trading venues, and expressed support for an

acceptable practices framework that includes pre-trade quantity limits,

price banding, and messaging throttles, but argued that the specific

parameters of such controls should be determined by each SEF.\653\ ICE

recommended that the Commission take a flexible approach to risk

controls so as not to hinder innovation in developing new mechanisms to

prevent market disruptions.\654\ ICE did, however, recommend that the

Commission expressly require a SEF to have pre-trade risk controls or

checks, which are especially important in thinly traded markets where

RFQs are more common.\655\

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

\652\ ICE Comment Letter at 5 (Mar. 8, 2011); Tradeweb Comment

Letter at 11 (Mar. 8, 2011); CME Comment Letter at 27 (Feb. 22,

2011).

\653\ CME Comment Letter at 27 (Feb. 22, 2011).

\654\ ICE Comment Letter at 5 (Mar. 8, 2011).

\655\ Id.

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

SDMA supported the requirement in proposed Sec. 37.405, but noted

that the rule should include pre-trade and post-trade risk control

requirements that are uniform across the market.\656\ SDMA noted that a

uniform approach would create a much needed single regulatory approach

to risk management across the derivatives market, enhance market

integrity, and decrease systemic risk.\657\ SDMA agreed with the best

practices for pre-trade and post-trade risk controls as noted in the

Pre-Trade Functionality Subcommittee of the CFTC TAC's Recommendations

on Pre-Trade Practices for Trading Firms, Clearing Firms and Exchanges

involved in Direct Market Access.\658\

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

\656\ SDMA Comment Letter at 5 (Mar. 8, 2011).

\657\ Id. at 6.

\658\ Id. See TAC Subcommittee Recommendations (Mar. 1, 2011).

The report recommended several pre-trade risk controls for

implementation at the exchange level, which were largely consistent

with the pre-trade controls listed in the preamble to the SEF NPRM.

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

Finally, CME objected to the requirement to coordinate risk

controls.\659\ CME stated that a SEF should retain the flexibility to

determine and implement risk controls that it believes are necessary to

protect the integrity of its markets.\660\ CME recommended that the

Commission work constructively with registered entities to facilitate

coordination.\661\

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

\659\ CME Comment Letter at 26 (Feb. 22, 2011).

\660\ Id.

\661\ Id.

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

(2) Commission Determination

The Commission is adopting proposed Sec. 37.405, subject to

certain modifications, including converting a portion of the rule to

the guidance in appendix B to part 37. As stated in the SEF NPRM, the

Commission believes that pauses and halts are effective risk management

tools that must be implemented by a SEF to facilitate orderly

markets.\662\ Automated risk control mechanisms, including pauses and

halts, have proven to be effective and necessary in preventing market

disruptions in the futures market and, therefore, will remain as part

of the rule.

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

\662\ Core Principles and Other Requirements for Swap Execution

Facilities, 76 FR at 1228.

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

As noted by SDMA, the Pre-Trade Functionality Subcommittee of the

TAC issued a report that recommended the implementation of several

trade risk controls at the exchange level.\663\ The controls

recommended in the Subcommittee report were consistent, in large part,

with the trade controls referenced in the preamble to the SEF NPRM, and

which are being adopted in the guidance in appendix B to part 37.\664\

The TAC accepted the Subcommittee report, which specifically

recommended that exchanges implement pre-trade limits on order size,

price collars around the current price, intraday position limits (of a

type that represent financial risk to the clearing member), message

throttles, and clear error-trade and order-cancellation policies.\665\

The Subcommittee report also noted that ``[s]ome measure of

standardization of pre-trade risk controls at the exchange level is the

cheapest, most effective and most robust path to addressing the

Commission's concern [for preserving market integrity].'' \666\

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

\663\ TAC Subcommittee Recommendations (Mar. 1, 2011).

\664\ The preamble to the SEF NPRM specifically mentioned daily

price limits, order size limits, trading pauses, stop logic

functionality, among others. Core Principles and Other Requirements

for Swap Execution Facilities, 76 FR at 1228.

\665\ TAC Subcommittee Recommendations at 4-5 (Mar. 1, 2011).

The TAC discussed this report's findings at its meeting on March 1,

2011. See Transcript of Third Meeting of Technology Advisory

Committee (Mar. 1, 2011) available at http://www.cftc.gov/idc/groups/public/@newsroom/documents/file/tac_030111_transcript.pdf.

\666\ TAC Subcommittee Recommendations at 4 (Mar. 1, 2011).

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

The Commission believes that the implementation of specific types

of other risk controls is generally desirable, but also recognizes that

such risk controls should be adapted to the unique characteristics of

the markets to which they apply. A SEF implementing any such additional

risk controls should consider the balance between avoiding a market

disruption while not impeding a market's price discovery function.

Controls that unduly restrict a market's ability to respond to

legitimate market events will interfere with price discovery.

Accordingly, consistent with many of the comments on this subject, the

Commission is enumerating specific types of risk controls, in addition

to pauses and halts, that a SEF may implement in the guidance rather

than in the rule, in order to provide a SEF with greater discretion to

select among the enumerated risk controls, or to create new risk

controls that meet the unique characteristics of its markets. A SEF

will also have discretion in determining the parameters for the

selected controls.

Additionally, in response to CME's concern about the requirement to

coordinate risk controls, the Commission is moving this language from

proposed Sec. 37.405 to the guidance. Specifically, a SEF with a swap

that is fungible with, linked to, or a substitute for other swaps on

the SEF or on other trading venues, should, to the extent practicable,

coordinate its risk controls with any similar controls placed on those

other swaps. The guidance also states that if a SEF's swap is based on

the level of an equity index, such risk controls should, to the extent

practicable, be coordinated with any similar controls placed on

national security exchanges.

(f) Sec. 37.406--Trade Reconstruction

Under Core Principle 4, Congress required that a SEF have the

ability to comprehensively and accurately reconstruct all trading on

its facility.\667\ Proposed Sec. 37.406 set forth this requirement,

including the requirement that audit-trail data and reconstructions be

made available to the Commission in a form, manner, and time as

determined by the Commission.

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

\667\ CEA section 5h(f)(4)(B); 7 U.S.C. 7b-3(f)(4)(B).

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

(1) Summary of Comments

CME commented that audit trail data is extremely detailed and

voluminous and that SEFs should be given adequate time to prepare the

trading data before it is supplied to the Commission.\668\ In this

regard, CME recommended that the wording ``in a form, manner, and time

as determined by the Commission'' be

[[Page 33532]]

replaced with ``such reasonable time as determined by the Commission.''

\669\

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

\668\ CME Comment Letter at 27 (Feb. 22, 2011).

\669\ Id.

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

(2) Commission Determination

The Commission is revising the rule so that a SEF shall be required

to make audit trail data and reconstructions available to the

Commission ``in a form, manner, and time that is acceptable to the

Commission.'' The Commission notes that it will work with SEFs to

provide them with adequate time to supply such information to the

Commission.

(g) Sec. 37.407--Additional Rules Required

Proposed Sec. 37.407 required a SEF to adopt and enforce any

additional rules that it believes are necessary to comply with the

requirements of subpart E of part 37.

(1) Commission Determination

Although the Commission did not receive any comments on the

proposed rule, the Commission is revising the rule to state that

applicants and SEFs may refer to the guidance and/or acceptable

practices in appendix B to part 37 to demonstrate to the Commission

compliance with the requirements of section 37.400. The Commission is

also moving proposed Sec. 37.407 to new Sec. 37.408, titled

``Additional sources for compliance.''

In new Sec. 37.407, titled ``Regulatory service provider,'' the

Commission is clarifying that a SEF can comply with the regulations in

subpart E through a dedicated regulatory department or by contracting

with a regulatory service provider pursuant to Sec. 37.204.

5. Subpart F--Core Principle 5 (Ability To Obtain Information)

Core Principle 5 requires a SEF to: (a) Establish and enforce rules

that will allow the facility to obtain any necessary information to

perform any of the functions described in section 5h of the Act, (b)

provide the information to the Commission on request, and (c) have the

capacity to carry out international information-sharing agreements as

the Commission may require.\670\ In the SEF NPRM, the Commission

proposed to codify the statutory text of Core Principle 5 in proposed

Sec. 37.500, and adopts that rule as proposed.

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

\670\ CEA section 5h(f)(5); 7 U.S.C. 7b-3(f)(5).

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

(a) Sec. 37.501--Establish and Enforce Rules

Proposed Sec. 37.501 required a SEF to establish and enforce rules

that will allow the SEF to have the ability and authority to obtain

sufficient information to allow it to fully perform its operational,

risk management, governance, and regulatory functions and any

requirements under part 37, including the capacity to carry out

international information-sharing agreements as the Commission may

require.

(1) Commission Determination

The Commission received no comments on proposed Sec. 37.501 and is

adopting the rule as proposed. The Commission believes that Sec.

37.501 appropriately implements the requirement in Core Principle 5 for

a SEF to establish and enforce rules that will allow the SEF to obtain

any necessary information to perform any of its functions described in

section 5h of the Act.\671\

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

\671\ CEA section 5h(f)(5)(A); 7 U.S.C. 7b-3(f)(5)(A).

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

(b) Sec. 37.502--Collection of Information

Proposed Sec. 37.502 required a SEF to have rules that allow it to

collect information on a routine basis, allow for the collection of

non-routine data from its participants, and allow for its examination

of books and records kept by the traders on its facility.

(1) Summary of Comments

WMBAA commented that aside from participants who contractually

agree to provide information, a SEF does not possess the legal

authority to obtain such information.\672\ Additionally, WMBAA stated

that the burden to collect information should be placed upon

counterparties.\673\ In the alternative, WMBAA stated that the

Commission should require a SEF and its participants to enter into

third party service provider agreements for the collection of the

required information.\674\ MarketAxess commented that it is not clear

what is meant by ``non-routine data'' in proposed Sec. 37.502 and that

the rule should make clear that a SEF is only required to collect and

maintain participant information that is directly related to such

participants' activity conducted pursuant to the SEF's rules.\675\

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

\672\ WMBAA Comment Letter at 26 (Mar. 8, 2011).

\673\ Id.

\674\ Id.

\675\ MarketAxess Comment Letter at 37 (Mar. 8, 2011).

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

(2) Commission Determination

The Commission is adopting Sec. 37.502 as proposed.\676\ In

response to WMBAA's and MarketAxess's comments, the Commission notes

that Core Principle 5 requires a SEF to establish and enforce rules

that will allow it to obtain any necessary information to perform any

of its functions described in section 5h of the Act. The Act and the

Commission's regulations provide a SEF with the legal authority to

collect such information. As mentioned in Sec. 37.204 above, a SEF may

contract with a regulatory service provider to perform regulatory

services on behalf of a SEF. Thus, a SEF may enter into a third party

regulatory service provider agreement for the collection of information

under Sec. 37.502. Additionally, as mentioned in Sec. 37.404 above,

the Act requires SEFs to monitor trading in swaps to prevent

manipulation, price distortion, and disruptions through surveillance,

compliance, and disciplinary practices and procedures.\677\ The

Commission believes that market participant records are a valuable tool

in conducting an effective surveillance program; thus, a SEF should

have direct access to such information in order to discharge its

obligations under the core principles. The Commission notes that market

participants are likely maintaining trading records as part of sound

business practices so requiring SEFs to have rules that allow them to

access such information should not present a burden. To address

MarketAxess's comment about ``non-routine data,'' the Commission

clarifies that ``non-routine data'' means the collection of data on an

ad-hoc basis, such as data that may be collected during an

investigation.

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

\676\ The Commission is changing the terms ``participants'' and

``traders'' to ``market participants'' to provide clarity.

\677\ CEA section 5h(f)(4)(B); 7 U.S.C. 7b-3(f)(4)(B).

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

(c) Sec. 37.503--Provide Information to the Commission

Proposed Sec. 37.503 required a SEF to provide information in its

possession to the Commission upon request, in a form and manner that

the Commission approves.

(1) Commission Determination

The Commission received no comments on proposed Sec. 37.503 and is

adopting the rule as proposed. The Commission believes that Sec.

37.503 appropriately implements the requirement in Core Principle 5 for

a SEF to provide information to the Commission on request.\678\

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

\678\ CEA section 5h(f)(5)(B); 7 U.S.C. 7b-3(f)(5)(B).

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

(d) Sec. 37.504--Information-Sharing Agreements

Proposed Sec. 37.504 required a SEF to share information with

other regulatory organizations, data repositories, and reporting

services as required by the

[[Page 33533]]

Commission or as otherwise necessary and appropriate to fulfill its

self-regulatory and reporting responsibilities. The proposed rule also

stated that appropriate information-sharing agreements can be

established with such entities or the Commission can act in conjunction

with the SEF to carry out such information sharing.

(1) Summary of Comments

WMBAA commented that the proposed rule could be interpreted to

require a SEF to share information with its competitors, unless the

information is disseminated by a neutral third party pursuant to a

services agreement.\679\ WMBAA also requested clarification regarding

the circumstances in which the Commission would determine to carry out

information sharing itself, as opposed to a SEF entering into

information-sharing agreements with the relevant entity.\680\

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

\679\ WMBAA Comment Letter at 27 (Mar. 8, 2011).

\680\ Id.

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

(2) Commission Determination

The Commission is adopting Sec. 37.504 as proposed, subject to one

modification. The Commission is revising the rule to change the term

``reporting services'' to ``third party data reporting services.'' The

Commission clarifies that the term ``reporting services'' was meant to

refer to independent third parties that would provide trading data on a

public basis and was not meant to include competitor SEFs. To address

WMBAA's comment about information sharing, the Commission clarifies

that a SEF may work with the Commission to fulfill its information

sharing requirements in the absence of agreements with SDRs, regulatory

bodies, or third party data reporting services. Given that each SEF is

unique, a particular SEF would need to contact the Commission to

discuss how the information sharing requirements could be fulfilled.

6. Subpart G--Core Principle 6 (Position Limits or Accountability)

Core Principle 6 requires that a SEF adopt for each swap, as is

necessary and appropriate, position limits or position accountability

to reduce the potential threat of market manipulation or

congestion.\681\ In addition, Core Principle 6 requires that for any

contract that is subject to a federal position limit under CEA section

4a(a), the SEF set its position limits at a level no higher than the

position limitation established by the Commission and monitor positions

established on or through the SEF for compliance with the limit set by

the Commission and the limit, if any, set by the SEF.\682\ In the SEF

NPRM, the Commission proposed to codify the statutory text of Core

Principle 6 in proposed Sec. 37.600, and adopts that rule as proposed.

Proposed Sec. 37.601 repeated the requirements in Sec. 37.600 and

required that SEFs establish position limits in accordance with the

requirements set forth in part 151 of the Commission's regulations.

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

\681\ CEA section 5h(f)(6); 7 U.S.C. 7b-3(f)(6).

\682\ Id.

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

(a) Summary of Comments

Several commenters stated that SEFs will have difficulty enforcing

position limitations.\683\ Many of these commenters noted that SEFs

will lack knowledge of a market participant's activity on other venues,

and that will prevent a SEF from being able to calculate the true

position of a market participant.\684\ In this regard, Phoenix stated

that market participants will be allowed to trade on multiple SEFs so

any one SEF's information concerning a market participant's position

will be virtually meaningless, as the market participant may sell a

large position on one SEF and simultaneously buy the same amount of the

instrument on another SEF.\685\ WMBAA recommended that a common

regulatory organization or third party regulatory service provider

monitor position limits because they will have the capability to ensure

coordinated oversight of the trading activity on multiple SEFs and the

ability to implement disciplinary action if needed.\686\ Reuters and

Phoenix recommended that the Commission or its designee monitor

position limits.\687\ Alice recommended that, for cleared swaps, DCOs

maintain position limits, and when a swap is cleared by multiple DCOs,

one DCO would be the primary for a given participant and the other DCOs

would report positions to that DCO.\688\

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

\683\ Bloomberg Comment Letter at 3-4 (Jun. 3, 2011); Alice

Comment Letter at 5 (May 31, 2011); Rosen et al. Comment Letter at

22 (Apr. 5, 2011); WMBAA Comment Letter at 27 (Mar. 8, 2011);

Tradeweb Comment Letter at 11 (Mar. 8, 2011); Reuters Comment Letter

at 6 (Mar. 8, 2011); Phoenix Comment Letter at 3 (Mar. 7, 2011).

\684\ WMBAA Comment Letter at 2 (Apr. 11, 2013); Bloomberg

Comment Letter at 3-4 (Jun. 3, 2011); Rosen et al. Comment Letter at

22 (Apr. 5, 2011); WMBAA Comment Letter at 27 (Mar. 8, 2011);

Tradeweb Comment Letter at 11 (Mar. 8, 2011); Phoenix Comment Letter

at 3 (Mar. 7, 2011).

\685\ Phoenix Comment Letter at 3-4 (Mar. 7, 2011).

\686\ WMBAA Comment Letter at 27 (Mar. 8, 2011).

\687\ Reuters Comment Letter at 6 (Mar. 8, 2011); Phoenix

Comment Letter at 4 (Mar. 7, 2011).

\688\ Alice Comment Letter at 5 (May 31, 2011).

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

Despite the concerns raised by other commenters, Phoenix noted

that, if required, a SEF can monitor position limits of market

participants based upon the trading activity that takes place only on

the SEF's platform.\689\ Tradeweb also requested confirmation from the

Commission that a SEF must only monitor its market participants'

position limits or positions in particular instruments with respect to

positions entered into on its own platforms.\690\

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

\689\ Phoenix Comment Letter at 4 (Mar. 7, 2011).

\690\ Tradeweb Comment Letter at 11 (Mar. 8, 2011).

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

(b) Commission Determination

In response to commenters concerns about monitoring position

limits, the Commission is removing the requirements in Sec. 37.601.

Instead, final Sec. 37.601 states that until such time that compliance

is required under part 151 of this chapter,\691\ a SEF may refer to the

guidance and/or acceptable practices in appendix B to part 37 to

demonstrate to the Commission compliance with the requirements of Sec.

37.600.

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

\691\ See Position Limits for Derivatives, 76 FR 4752 (proposed

Jan. 26, 2011).

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

The guidance provides a SEF with reasonable discretion to comply

with Sec. 37.600, including considering part 150 of the Commission's

regulations.\692\ The guidance also states that for Required

Transactions as defined in Sec. 37.9, a SEF may demonstrate compliance

with Sec. 37.600 by setting and enforcing position limitations or

position accountability levels only with respect to trading on the

SEF's own market. For example, a SEF could satisfy the position

accountability requirement by setting up a compliance program that

continuously monitors the trading activity of its market participants

and has procedures in place for remedying any violations of position

levels. For Permitted Transactions as defined in Sec. 37.9, a SEF may

demonstrate compliance with Sec. 37.600 by setting and enforcing

position accountability levels or sending the Commission a list of

Permitted Transactions traded on the SEF. Therefore, a SEF is not

required to monitor its market participants' activity on other venues

with respect to monitoring position limits.

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

\692\ Part 150 of the Commission's regulations contains the

current position limits regime.

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

In response to comments that a common regulatory organization or

the Commission should monitor position limits, the Commission notes

that Core Principle 6 places the responsibility on a SEF to adopt and

monitor position limits. The Dodd-Frank Act does not mandate that a

common regulatory organization or the Commission monitor position

limits. The Dodd-Frank Act also does not provide the Commission with

the authority to exempt a SEF from

[[Page 33534]]

certain core principles. Therefore, the Commission is providing a SEF

with flexibility to adopt and monitor position limits as described

above.

7. Subpart H--Core Principle 7 (Financial Integrity of Transactions)

Core Principle 7 requires a SEF to establish and enforce rules and

procedures for ensuring the financial integrity of swaps entered on or

through the facilities of the SEF, including the clearance and

settlement of the swaps pursuant to section 2(h)(1) of the Act.\693\ In

the SEF NPRM, the Commission proposed to codify the statutory text of

Core Principle 7 in proposed Sec. 37.700, and adopts that rule as

proposed.

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

\693\ CEA section 5h(f)(7); 7 U.S.C. 7b-3(f)(7).

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

(a) Sec. 37.701--Mandatory Clearing \694\

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

\694\ The Commission is renaming the title of this section from

``Mandatory Clearing'' to ``Required Clearing'' to be consistent

with terminology used in the CEA and the Commission's regulations.

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

Proposed Sec. 37.701 required transactions executed on or through

a SEF to be cleared through a Commission registered DCO unless the

transaction is excepted from clearing under section 2(h)(7) of the Act

or the swap is not subject to the clearing requirement under section

2(h)(1) of the Act.

(1) Summary of Comments

ISDA/SIFMA commented that section 2(h)(1) of the CEA provides that

swaps subject to the clearing requirement must be submitted for

clearing to a registered DCO or a DCO that is exempt from registration;

however, proposed Sec. 37.701 requires that transactions executed

through a SEF be cleared only through a Commission-registered DCO.\695\

ISDA/SIFMA recommended that the rule be amended to permit the use of

exempt DCOs.\696\ MarketAxess recommended that proposed Sec. 37.701 be

revised to permit a SEF to rely on a representation from an end-user

that it qualifies for the section 2(h)(7) exemption.\697\

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

\695\ ISDA/SIFMA Comment Letter at 13 (Mar. 8, 2011).

\696\ Id.

\697\ MarketAxess Comment Letter at 38 (Mar. 8, 2011).

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

(2) Commission Determination

The Commission is adopting Sec. 37.701 as proposed, subject to

certain revisions. The Commission is modifying Sec. 37.701 to state

that ``[t]ransactions executed on or through the swap execution

facility that are required to be cleared under section 2(h)(1)(A) of

the Act or are voluntarily cleared by the counterparties shall be

cleared through a Commission-registered derivatives clearing

organization, or a derivatives clearing organization that the

Commission has determined is exempt from registration.'' The Commission

is deleting proposed Sec. 37.701(a), which referred to the end-user

exception under CEA section 2(h)(7) because, as modified, the final

rule text clarifies that any swaps that are required to be cleared or

that are voluntarily cleared must be cleared through a registered DCO,

or a DCO that the Commission has determined is exempt from

registration. The Commission notes that swaps that are subject to the

clearing requirement must be submitted for clearing, except where the

swap may be eligible for an exception or exemption from the clearing

requirement pursuant to either the exception provided under section

2(h)(7) of the Act and Sec. 50.50 of the Commission's regulations, or

an exemption provided under part 50 of the Commission's regulations.

The rule also provides that counterparties that elect to clear a swap

that is not required to be cleared may do so voluntarily through a

Commission-registered DCO, or a DCO that the Commission has determined

is exempt from registration.

In response to ISDA/SIFMA's recommendation that the rule be amended

to permit the use of exempt DCOs, the Commission is mindful that CEA

section 2(h)(1) provides that swaps subject to the clearing requirement

must be submitted for clearing to a registered DCO or a DCO that is

exempt from registration under the Act. The Commission further notes

that under CEA section 5b(h), the Commission has discretionary

authority to exempt DCOs, conditionally or unconditionally, from the

applicable DCO registration requirements.\698\ Specifically, section

5b(h) of the Act provides that ``[t]he Commission may exempt,

conditionally or unconditionally, a derivatives clearing organization

from registration under this section for the clearing of swaps if the

Commission determines that the [DCO] is subject to comparable,

comprehensive supervision and regulation by the Securities and Exchange

Commission or the appropriate government authorities in the home

country of the organization.'' \699\ Thus, the Commission has

discretion to exempt from registration DCOs that, at a minimum, are

subject to comparable and comprehensive supervision by another

regulator.

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

\698\ CEA section 5b(h); 7 U.S.C. 7a-1(h).

\699\ Id.

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

The Commission notes that it has not yet exercised its

discretionary authority to exempt DCOs from registration.

Notwithstanding that there are no exempt DCOs at this time, the

Commission has determined to revise the rule text as suggested by ISDA/

SIFMA. If the Commission determines to exercise its authority to exempt

DCOs from applicable registration requirements, the Commission would

likely address, among other things, the conditions and limitations

applicable to clearing swaps for customers subject to section 4d(f) of

the Act.\700\

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

\700\ The Commission will address any necessary revisions to

part 37 at such time as it determines to exercise its discretionary

authority to exempt DCOs from certain DCO registration requirements.

For example, if exempt DCOs are limited to clearing for only certain

types of market participants, then the Commission will take action

to ensure that SEF market participants have impartial access to swap

clearing through registered DCOs.

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

Until such time as the Commission determines to exercise its

authority to exempt DCOs from the applicable registration requirement,

SEFs must route all swaps through registered DCOs, which are the

appropriate entities to perform the clearing functions under CEA

section 2(h)(1) at this time. Registered DCOs are subject to the CEA,

the Commission's regulations, and its regulatory programs. Among other

things, registered DCOs are supervised for compliance with the

Commission's regulations, and subjected to ongoing risk surveillance

and regular examinations.

In consideration of MarketAxess's comment that a SEF should be able

to rely on a representation from an end-user that it qualifies for the

CEA section 2(h)(7) exception, the Commission clarifies that a SEF is

not obligated to make any determinations with respect to applicability

of the exceptions to the clearing requirement.

(b) Sec. 37.702--General Financial Integrity

Proposed Sec. 37.702(a) required a SEF to provide for the

financial integrity of its transactions by establishing minimum

financial standards for its members. At a minimum, a SEF would have to

ensure that its members meet the definition of ``eligible contract

participant'' under CEA section 1(a)(18). Proposed Sec. 37.702(b)

required a SEF, for transactions cleared by a DCO, to have the capacity

to route transactions to the DCO in a manner acceptable to the DCO for

purposes of ongoing risk management. In proposed Sec. 37.702(c), for

transactions that are not cleared by a DCO, a SEF must require members

to demonstrate that they: (1) Have entered into credit arrangement

documentation for the transaction, (2) have the ability to exchange

collateral, and (3) meet any credit filters that the SEF may adopt.

Proposed Sec. 37.702(d) required a SEF to implement any additional

safeguards

[[Page 33535]]

that may be required by Commission regulations.

(1) Summary of Comments

Bloomberg commented, with respect to proposed Sec. 37.702(a), that

a SEF should be able to determine a market participant's ability to

meet any minimum financial standards by virtue of confirming that the

participant has access to a DCO either as a member or through an

intermediary.\701\ According to Bloomberg, it is not necessary to set

separate, duplicative financial requirements at the SEF level that are

redundant to the exhaustive financial requirements that will be

associated with access to a DCO.\702\

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

\701\ Bloomberg Comment Letter at 5 (Mar. 8, 2011).

\702\ Id.

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

With respect to proposed Sec. 37.702(b), Reuters agreed that SEFs

should assure the secure and prompt routing to a DCO for swap

transactions subject to the clearing requirement.\703\ MarketAxess

commented that SEFs should be able to send a trade to the DCO via an

affirmation hub.\704\ Use of affirmation hubs, according to

MarketAxess, would allow SEFs to enjoy lower costs and is preferred by

its clients.\705\

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

\703\ Reuters Comment Letter at 6 (Mar. 8, 2011).

\704\ MarketAxess Comment Letter at 35 (Mar. 8, 2011).

\705\ Id.

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

The Commission received several comments with regard to proposed

Sec. 37.702(c). The Energy Working Group noted that proposed Sec.

37.702(c) should be narrower in scope and that a SEF should be able to

fulfill its obligation by ensuring that the counterparties have entered

into bilateral credit support arrangements.\706\ MarketAxess wrote that

a SEF is not in a position to determine whether members' credit filters

or exchanges of collateral are sufficient.\707\ Reuters noted that the

existence of credit and/or collateral arrangements should be primarily

a matter between the counterparties.\708\ ISDA/SIFMA commented that the

Commission should not create new collateral requirements for end-users

transacting through a SEF.\709\ ABC/CIEBA commented that proposed Sec.

37.702(c) would impose costly burdens on SEFs.\710\

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

\706\ Energy Working Group Comment Letter at 5 (Mar. 8, 2011).

\707\ MarketAxess Comment Letter at 37 (Mar. 8, 2011).

\708\ Reuters Comment Letter at 6 (Mar. 8, 2011).

\709\ ISDA/SIFMA Comment Letter at 13 (Mar. 8, 2011).

\710\ ABC/CEIBA Comment Letter at 11 (Mar. 8, 2011).

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

Goldman noted that there are circumstances where a swap that is

subject to the clearing requirement may not be accepted for clearing

for credit or other reasons.\711\ In such cases and depending on the

SEF's rules under Core Principle 7, parties that execute through the

SEF either would face one another in an uncleared, bilateral

transaction or would potentially owe amounts arising from the trade not

being accepted for clearing.\712\ Therefore, Goldman recommended that

parties should be able to learn the identities of their counterparty

when transacting in cleared and uncleared swaps.\713\

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

\711\ Goldman Comment Letter at 5 (Mar. 8, 2011).

\712\ Id.

\713\ Id.

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

(2) Commission Determination

The Commission has considered the comments received and is adopting

Sec. 37.702(a) as proposed. In response to Bloomberg's comment about

setting financial requirements at the SEF level, the Commission

disagrees that a SEF should be able to determine a member's ability to

meet any minimum financial standards by virtue of confirming that the

member has access to a DCO. The Commission notes that a DCO only

screens clearing members, and not customers, according to financial

standards. Therefore, unless a SEF member is also a clearing member,

the SEF will not be able to determine the member's ability to meet any

minimum financial standards by virtue of confirming that the member has

access to a DCO. The Commission also notes that there is no affirmative

obligation for a DCO to ensure that its members, customers, or

counterparties are ECPs. Therefore, a SEF must ensure that its members

qualify as ECPs and may rely on representations from its members to

fulfill this requirement.\714\

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

\714\ The Commission notes that under Sec. 37.202(a)(2), a SEF

that permits intermediation must also obtain signed representations

from intermediaries that their customers are ECPs.

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

Last year, the Commission adopted rules regarding the processing of

cleared trades.\715\ In that rulemaking, the Commission proposed a new

Sec. 37.702(b) \716\ and adopted a revised Sec. 37.702(b) \717\

regarding cleared swaps traded through a SEF. That final rule required

a SEF to provide for the financial integrity of its transactions that

are cleared by a DCO: (a) By ensuring that it has the capacity to route

transactions to the DCO in a manner acceptable to the DCO for purposes

of clearing; and (b) by coordinating with each DCO to which it submits

transactions for clearing, in the development of rules and procedures

to facilitate prompt and efficient transaction processing in accordance

with the requirements of Sec. 39.12(b)(7) of the Commission's

regulations.\718\

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

\715\ Customer Clearing Documentation, Timing of Acceptance for

Clearing, and Clearing Member Risk Management, 77 FR 21278 (Apr. 9,

2012).

\716\ Requirements for Processing, Clearing, and Transfer of

Customer Positions, 76 FR 13101, 13109-10 (proposed Mar. 10, 2011).

\717\ Customer Clearing Documentation, Timing of Acceptance for

Clearing, and Clearing Member Risk Management, 77 FR at 21309.

\718\ Id.

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

In response to MarketAxess's comment about affirmation hubs, the

Commission notes that Sec. 37.702(b), as adopted in April 2012,

requires a SEF to route a swap to a DCO in a manner acceptable to the

DCO.\719\ If the DCO views the use of an affirmation hub as an

acceptable means for routing the swap, the routing otherwise complies

with Sec. 37.702(b), and the trade is processed in accordance with the

standards set forth in Sec. Sec. 1.74, 39.12, 23.506, and 23.610 of

the Commission's regulations, then the use of an affirmation hub for

routing a swap to a DCO for clearing would be permissible.

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

\719\ Id.

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

In consideration of the comments with respect to uncleared swaps,

the Commission is eliminating proposed Sec. 37.702(c). The Commission

agrees with commenters that requiring SEFs to monitor the credit and

collateral arrangements of parties transacting uncleared swaps goes

beyond the scope of what should be expected of a SEF. To address

Goldman's comments requesting that the Commission mandate that a SEF's

rules require identification of the counterparties prior to a swap

transaction, the Commission believes that a SEF should retain

discretion in this regard. Finally, the Commission is deleting proposed

Sec. 37.702(d) as it is unnecessary because a SEF must already

implement safeguards as required by Commission regulations.

(c) Sec. 37.703--Monitoring for Financial Soundness

Proposed Sec. 37.703 required a SEF to monitor its members'

compliance with the SEF's minimum financial standards and routinely

receive and promptly review financial and related information from its

members.

(1) Summary of Comments

ABC/CIEBA commented that this requirement would create significant

barriers to entry, stifle competition, and lead to higher transaction

costs.\720\ FXall commented that like DCMs, SEFs should be permitted to

delegate their financial surveillance functions to the

[[Page 33536]]

Joint Audit Committee to the extent that its members are registered

with NFA.\721\ For non-NFA members, FXall recommended that SEFs be

permitted to delegate financial surveillance obligations to the

members' primary financial regulator or otherwise outsource such duties

to a third party service provider.\722\

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

\720\ ABC/CEIBA Comment Letter at 11 (Mar. 8, 2011).

\721\ FXall Comment Letter at 13 (Mar. 8, 2011).

\722\ Id.

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

(2) Commission Determination

The Commission agrees with the commenters that burdensome financial

surveillance obligations may lead to higher transaction costs.

Therefore, in consideration of the comments, the Commission is revising

Sec. 37.703 to state that a SEF must monitor its members to ensure

that they continue to qualify as ECPs. With regard to the comment

requesting delegation of the proposed Sec. 37.703 responsibilities to

the Joint Audit Committee, the Commission notes that final Sec.

37.703, as revised, obviates the need for any such delegation. Under

final Sec. 37.703, a SEF need only ensure that its members remain ECPs

and may rely on representations from its members.

8. Subpart I--Core Principle 8 (Emergency Authority)

Core Principle 8 requires a SEF to adopt rules to provide for the

exercise of emergency authority, in consultation or cooperation with

the Commission, as is necessary and appropriate, including the

authority to liquidate or transfer open positions in any swap or to

suspend or curtail trading in a swap.\723\ In the SEF NPRM, the

Commission proposed to codify the statutory text of Core Principle 8 in

proposed Sec. 37.800, and adopts that rule as proposed.\724\

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

\723\ CEA section 5h(f)(8); 7 U.S.C. 7b-3(f)(8).

\724\ The Commission notes that Commission regulation

40.6(a)(6)(i) provides that any SEF rule that establishes general

standards or guidelines for taking emergency actions must be

submitted to the Commission pursuant to regulation 40.6(a).

Relatedly, Commission regulation 40.6(a)(6)(ii) provides particular

emergency actions shall be filed with the Commission ``prior to

[its] implementation, or, if not practicable, . . . at the earlier

possible time after implementation, but in no event more than

twenty-four hours after implementation.''

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

(a) Sec. 37.801--Additional Sources for Compliance

Proposed Sec. 37.801 referred applicants and SEFs to the guidance

and/or acceptable practices in appendix B to part 37 to demonstrate

compliance with Core Principle 8. The guidance reflected the

Commission's belief that the need for emergency action may also arise

from related markets traded on other platforms and that there should be

an increased emphasis on cross-market coordination of emergency

actions. In that regard, the proposed guidance provided that, in

consultation and cooperation with the Commission, a SEF should have the

authority to intervene as necessary to maintain markets with fair and

orderly trading and to prevent or address manipulation or disruptive

trading practices, whether the need for intervention arises exclusively

from the SEF's market or as part of a coordinated, cross-market

intervention. The proposed guidance also provided that in situations

where a swap is traded on more than one platform, emergency action to

liquidate or transfer open interest must be as directed, or agreed to,

by the Commission or the Commission's staff. The proposed guidance also

clarified that the SEF should have rules that allow it to take market

actions as may be directed by the Commission.

In addition to providing for rules, procedures, and guidelines for

emergency intervention, the guidance noted that SEFs should provide

prompt notification and explanation to the Commission of the exercise

of emergency authority, and that information on all regulatory actions

carried out pursuant to a SEF's emergency authority should be included

in a timely submission of a certified rule.

(1) Summary of Comments

Several commenters expressed concern about a SEFs ability to

liquidate or transfer open positions.\725\ Bloomberg stated that,

because a SEF will not hold a participant's swap positions, the

Commission should only require that a SEF adopt rules requiring it to

coordinate with a DCO to facilitate the liquidation or transfer of

positions during an emergency.\726\ Similarly, WMBAA noted that a SEF

will not maintain counterparty positions and thus it may not possess

the ability to liquidate or transfer those positions.\727\ Reuters

stated that liquidating open positions does not fall within a trading

platform's traditional role in the market.\728\

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

\725\ Bloomberg Comment Letter at 4 (Jun. 3, 2011); Bloomberg

Comment Letter at 5-6 (Mar. 8, 2011); WMBAA Comment Letter at 28

(Mar. 8, 2011); Reuters Comment Letter at 7 (Mar.8, 2011).

\726\ Bloomberg Comment Letter at 4 (Jun. 3, 2011); Bloomberg

Comment Letter at 5-6 (Mar. 8, 2011).

\727\ WMBAA Comment Letter at 28 (Mar. 8, 2011).

\728\ Reuters Comment Letter at 7 (Mar. 8, 2011).

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

CME stated that SEFs must have the flexibility and independence

necessary to address market emergencies.\729\ Alternatively, ISDA/SIFMA

commented that the Core Principle 8 rules should adopt uniform

standards and that those standards must consider the interaction

between SEFs, DCMs, clearing organizations, swap data repositories, and

other market-wide institutions.\730\

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

\729\ CME Comment Letter at 28 (Feb. 22, 2011).

\730\ ISDA/SIFMA Comment Letter at 13 (Mar. 8, 2011).

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

(2) Commission Determination

The Commission is adopting Sec. 37.801 as proposed, with certain

modifications to the guidance in appendix B to part 37. The Commission

acknowledges commenters concerns regarding a SEF's ability to liquidate

or transfer open positions; however, the statute requires a SEF to have

the authority to liquidate or transfer open positions.\731\ The

Commission expects that SEFs would establish such authority over open

positions through their rules and/or participant agreements and that

the exercise of any such authority would, consistent with the statute,

be done in coordination with the Commission and relevant DCOs.

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

\731\ CEA section 5h(f)(8); 7 U.S.C. 7b-3(f)(8).

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

The Commission is making slight revisions to the guidance to

clarify that SEFs retain the authority to independently respond to

emergencies in an effective and timely manner consistent with the

nature of the emergency, as long as all such actions taken by the SEF

are made in good faith to protect the integrity of the markets. The

Commission believes that market emergencies can vary with the type of

market and any number of unusual circumstances so SEFs need flexibility

to carry out emergency actions. The Commission believes that the

guidance strikes a reasonable balance between the need for flexibility

and the need for standards in the case of coordinated cross-market

intervention.

9. Subpart J--Core Principle 9 (Timely Publication of Trading

Information)

Core Principle 9 requires a SEF to make public timely information

on price, trading volume, and other trading data on swaps to the extent

prescribed by the Commission.\732\ It also requires a SEF to have the

capacity to electronically capture and transmit trade information for

those transactions that occur on its facility.\733\ In the SEF NPRM,

the Commission proposed to codify the statutory text of Core Principle

9 in proposed Sec. 37.900. Proposed Sec. 37.901 required that, for

swaps traded on or through a SEF, the SEF report specified swap data as

[[Page 33537]]

provided under part 43 \734\ and part 45 \735\ of the Commission's

regulations and meet the requirements of part 16 of the Commission's

regulations. Proposed Sec. 37.902 required a SEF to have the capacity

to electronically capture trade information with respect to

transactions executed on the facility.

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

\732\ CEA section 5h(f)(9); 7 U.S.C. 7b-3(f)(9).

\733\ Id.

\734\ 17 CFR part 43; Real-Time Reporting of Swap Transaction

Data, 77 FR 1182 (Jan. 9, 2012).

\735\ 17 CFR part 45; Swap Data Recordkeeping and Reporting

Requirements, 77 FR 2136 (Jan. 13, 2012).

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

(a) Summary of Comments

In response to the Commission's questions in the SEF NPRM about

end-of-day price reporting for interest rate swaps and the Commission's

proposed revisions to Sec. 16.01,\736\ Eris stated the following: (1)

It is reasonable to require a market to report publicly each trade

(including instrument, price, and volume) intra-day, as soon as the

trade occurs; (2) daily open interest should be published publicly in a

summary fashion and should be grouped in maturity buckets based on the

remaining tenor of each instrument; (3) as to end-of-day pricing, a

clearing house will settle contracts based upon a market-driven curve,

and the methodology, as well as the inputs and components, of the curve

should be made transparent to the full trading community; and (4) the

clearing house should publish the specific settlement value applied to

each cleared swap in the daily mark-to-market process.\737\ Eris also

stated that SEFs and DCMs should be held to the same reporting standard

in this respect.\738\

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

\736\ The Commission proposed certain revisions to Sec. 16.01

in the DCM NPRM. See Core Principles and Other Requirements for

Designated Contract Markets, 75 FR 80572 (proposed Dec. 22, 2010)

for further details.

\737\ Eris Comment Letter at 5 (Mar. 8, 2011).

\738\ Id.

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

MarketAxess commented that proposed Sec. 37.900(b) and Sec.

37.902 are duplicative and that proposed Sec. 37.902 should be

withdrawn.\739\

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

\739\ MarketAxess Comment Letter at 39 (Mar. 8, 2011).

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

(b) Commission Determination

The Commission is adopting Sec. 37.900 and Sec. 37.901 as

proposed. The Commission acknowledges MarketAxess's comment that Sec.

37.902 is duplicative to Sec. 37.900(b) and thus is withdrawing Sec.

37.902. In response to Eris's comment about the same reporting

standards for SEFs and DCMs that list swaps, the Commission notes that

a SEF, similar to a DCM, must meet the same requirements under part 16

of the Commission's regulations for swaps reporting.\740\ The

Commission also notes that it codified Sec. 16.01 in the final DCM

rulemaking, and in that rulemaking, the Commission states that it

considered the proposed reporting standard put forth by Eris, but the

Commission believes that the more detailed reporting obligations under

Sec. 16.01 are warranted at this time in light of the novelty of swaps

trading on regulated exchanges.\741\

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

\740\ The Commission notes that Sec. 16.00 is applicable to a

SEF only to the extent that such SEF has clearing members and lists

options on physicals for trading. Section 16.01 is applicable to a

SEF for all swaps and options traded thereon. Section 16.02 is

applicable to a SEF only to the extent that such SEF lists options

for trading.

\741\ Core Principles and Other Requirements for Designated

Contract Markets, 77 FR 36612, 36642 (Jun. 19, 2012).

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

10. Subpart K--Core Principle 10 (Recordkeeping and Reporting)

Core Principle 10 establishes recordkeeping and reporting

requirements for SEFs.\742\ In the SEF NPRM, the Commission proposed to

codify the statutory text of Core Principle 10 in proposed Sec.

37.1000, and adopts that rule as proposed.

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

\742\ CEA section 5h(f)(10); 7 U.S.C. 7b-3(f)(10).

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

Proposed Sec. 37.1001 required a SEF to maintain records of all

business activities, including a complete audit trail, investigatory

files, and disciplinary files, in a form and manner acceptable to the

Commission for at least five years in accordance with the requirements

of section 1.31 and part 45 of this chapter. Proposed Sec. 37.1002

required a SEF to report to the Commission such information that the

Commission determines to be necessary or appropriate for it to perform

its duties. Proposed Sec. 37.1003 required a SEF to keep records

relating to swaps defined in section 1a(47)(A)(v) of the CEA open to

inspection and examination by the SEC.

(a) Summary of Comments

MarketAxess stated that a SEF should be permitted to use a

regulatory service provider with respect to its recordkeeping and

reporting requirements.\743\ CME commented that proposed Sec. 37.1003

does not provide any guidance as to what records will need to be

retained and for how long they must be retained.\744\

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

\743\ MarketAxess Comment Letter at 39 (Mar. 8, 2011).

\744\ CME Comment Letter at 38 (Feb. 22, 2011).

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

(b) Commission Determination

The Commission is adopting Sec. 37.1001 as proposed. The

Commission is also withdrawing proposed Sec. 37.1002 and Sec. 37.1003

because they are repetitive of paragraphs (a)(2) and (a)(3) of Sec.

37.1000. In response to MarketAxess's comment, the Commission notes

that a SEF may utilize the services of a regulatory service provider

pursuant to Sec. 37.204 to assist the SEF in complying with its

responsibilities under Core Principle 10. In response to CME's comment,

the Commission notes that in accordance with Core Principle 10 and

Sec. 1.31 of the Commission's regulations, a SEF should retain ``any''

records relevant to swaps defined in section 1a(47)(A)(v) of the Act

and that the SEF should leave such records open to inspection and

examination for a period of five years. The Commission staff also

consulted with representatives from the SEC, who confirmed that the

SEC's relevant recordkeeping requirements typically extend for a period

of five years.\745\

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

\745\ See Registration and Regulation of Security-Based Swap

Execution Facilities, 76 FR at 10982, 11063 (Proposed Rule 818(b)

requires SB-SEFs to keep books and records ``for a period of not

less than five years, the first two years in an easily accessible

place). Rule 17a-1(b) (240.17a-1(b) requires national securities

exchanges, among others, to keep books and records for a period of

not less than five years, the first two years in an easily

accessible place, subject to a destruction and disposition

provisions, which allows exchanges to destroy physical documents

pursuant to an effective and approved plan regarding such

destruction and transferring/indexing of such documents onto some

recording medium.). 17 CFR 240.17a-1(b).

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

11. Subpart L--Core Principle 11 (Antitrust Considerations)

Core Principle 11 governs the antitrust obligations of SEFs.\746\

In the SEF NPRM, the Commission proposed to codify the statutory text

of Core Principle 11 in proposed Sec. 37.1100, and adopts that rule as

proposed. Additionally, proposed Sec. 37.1101 referred applicants and

SEFs to the guidance in appendix B to part 37 for purposes of

demonstrating compliance with proposed Sec. 37.1100.

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

\746\ CEA section 5h(f)(11); 7 U.S.C. 7b-3(f)(11).

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

(a) Summary of Comments

NGSA commented that if SEFs are allowed to select the SDR to which

SEF-executed swaps are reported, there is a threat of anticompetitive

tying of swap data reporting services from a particular SDR to the

SEF's services, which may harm competition among SDRs.\747\

Accordingly, NGSA recommended that the Commission amend the proposed

rules to explicitly prohibit a SEF from tying the swap data reporting

services of a particular SDR to the swap execution services provided by

such SEF and from entering into an exclusive agreement

[[Page 33538]]

with any SDR to report all swaps to such SDR.\748\

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

\747\ NGSA Comment Letter at 2 (Jun. 8, 2012). DTCC also raised

this concern in its comment letter. DTCC Comment Letter at 3 (Jun.

10, 2011).

\748\ NGSA Comment Letter at 5 (Jun. 8, 2012).

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

(b) Commission Determination

The Commission is adopting Sec. 37.1101 and the corresponding

guidance in appendix B to part 37 as proposed and declines to revise

the proposed rules as NGSA recommends. The Commission notes that under

Core Principle 11, SEFs may not adopt any rule or take any action that

results in any unreasonable restraint of trade or impose any material

anticompetitive burden on trading or clearing. The Commission believes

that Core Principle 11 adequately addresses NGSA's concern. The

Commission also notes that it has not limited a SEF's choice of DCOs.

The Commission believes that SDRs and DCOs should be able to compete

for a SEF's business subject to the anticompetitive considerations

under Core Principle 11. Additionally, the Commission notes that

multiple SEFs are likely to trade the same swap contracts so market

participants will be able to choose the appropriate SEF to trade swaps

based on SDR and other considerations.

12. Subpart M--Core Principle 12 (Conflicts of Interest)

Core Principle 12 governs conflicts of interest.\749\ In the SEF

NPRM, the Commission proposed to codify the statutory text of Core

Principle 12 in proposed Sec. 37.1200, and adopts that rule as

proposed. As noted in the SEF NPRM, the substantive regulations

implementing Core Principle 12 were proposed in a separate release

titled ``Requirements for Derivatives Clearing Organizations,

Designated Contract Markets, and Swap Execution Facilities Regarding

the Mitigation of Conflicts of Interest.'' \750\ Until such time as the

Commission may adopt the substantive rules implementing Core Principle

12, SEFs have reasonable discretion to comply with this core principle

as stated in Sec. 37.100.

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

\749\ CEA section 5h(f)(12); 7 U.S.C. 7b-3(f)(12).

\750\ Requirements for Derivatives Clearing Organizations,

Designated Contract Markets, and Swap Execution Facilities Regarding

the Mitigation of Conflicts of Interest, 75 FR 63732 (proposed Oct.

18, 2010).

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

13. Subpart N--Core Principle 13 (Financial Resources)

Core Principle 13 requires a SEF to have adequate financial,

operational, and managerial resources to discharge each of its

responsibilities.\751\ In particular, Core Principle 13 states that a

SEF's financial resources are considered to be adequate if the value of

such resources exceeds the total amount that would enable the SEF to

cover its operating costs for a period of at least one year, calculated

on a rolling basis.\752\ In the SEF NPRM, the Commission proposed to

codify the statutory text of Core Principle 13 in proposed Sec.

37.1300, and adopts that rule as proposed.

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

\751\ CEA section 5h(f)(13); 7 U.S.C. 7b-3(f)(13).

\752\ Id.

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

(a) Sec. 37.1301--General Requirements

Proposed Sec. 37.1301 set forth the financial resources

requirements for SEFs in order to implement Core Principle 13. Proposed

Sec. 37.1301(a) required a SEF to maintain financial resources

sufficient to enable it to perform its functions in compliance with the

SEF core principles. Proposed Sec. 37.1301(b) required an entity

operating as both a SEF and a DCO to comply with both the SEF financial

resources requirements and the DCO financial resources requirements in

Sec. 39.11.\753\ Proposed Sec. 37.1301(c) stated that financial

resources would be considered sufficient if their value is at least

equal to a total amount that would enable the SEF, or applicant for

designation as such, to cover its operating costs for a period of at

least one year, calculated on a rolling basis.

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

\753\ See Derivatives Clearing Organization General Provisions

and Core Principles, 76 FR 69334 (Nov. 8, 2011). Commission

regulation Sec. 39.11 establishes requirements that a DCO will have

to meet in order to comply with DCO Core Principle B (Financial

Resources), as amended by the Dodd-Frank Act. Amended Core Principle

B requires a DCO to possess financial resources that, at a minimum,

exceed the total amount that would enable the DCO to meet its

financial obligations to its clearing members notwithstanding a

default by the clearing member creating the largest financial

exposure for the DCO in extreme but plausible conditions; and enable

the DCO to cover its operating costs for a period of one year, as

calculated on a rolling basis.

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

(1) Summary of Comments

Several commenters raised concerns about the financial resources

requirement to cover one year of operating costs. Parity Energy

recommended that the Commission interpret ``operating costs of a swap

execution facility for a 1-year period'' to be the cost to the SEF of

an orderly wind-down of operations, where the SEF is one of many

execution avenues for standardized, cleared swaps and its failure would

have minimal impact on market risk or stability.\754\ Phoenix

recommended that because a SEF does not take or hold positions in any

of the products traded on it, an orderly wind-down of a SEF should take

six months so SEFs should be required to maintain financial resources

to cover six months of its operating costs.\755\ Similarly, TruMarx

contended that SEFs should not have such stringent financial resources

standards because a SEF is a trading platform and, therefore, will not

carry on its books the risks of positions and trades executed on

it.\756\ Rather, TruMarx stated that risk will be borne by the

principals entering into the transactions, their clearing brokers, and

clearing houses.\757\

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

\754\ Parity Energy Comment Letter at 6 (Mar. 25, 2011).

\755\ Phoenix Comment Letter at 4 (Mar. 7, 2011).

\756\ TruMarx Comment Letter at 7 (Mar. 8, 2011).

\757\ Id.

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

Alternatively, SDMA noted that it would be disruptive to the market

if a SEF went into bankruptcy.\758\ Therefore, it contended that 12

months of working capital is the absolute minimum amount of financial

resources that SEFs should have, and recommend that the Commission

require that SEFs have 18 months of working capital.\759\

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

\758\ SDMA Comment Letter at 12 (Mar. 8, 2011).

\759\ Id.

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

(2) Commission Determination

The Commission is adopting Sec. 37.1301 as proposed.\760\ To

address the concerns about the financial resources requirement, the

Commission notes that Core Principle 13 requires each SEF to maintain

adequate financial resources to discharge its responsibilities.\761\ In

order to fulfill this responsibility, the core principle states that

the financial resources of a SEF shall be considered to be adequate if

the value of the financial resources exceeds the total amount that

would enable the SEF to cover its operating costs for a period of one

year, calculated on a rolling basis.\762\

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

\760\ The Commission is making a technical change due to the

fact that the cross reference in Sec. 37.1301(b) should include

``of this chapter'' at the end of the reference in order to comply

with federal regulatory guidelines. Accordingly, the Commission is

revising Sec. 37.1301(b) to read: ``An entity that operates as both

a swap execution facility and a derivatives clearing organization

shall also comply with the financial resources requirements of

section 39.11 of this chapter.'' The Commission is also removing the

phrase ``or applicant for designation as such'' from Sec.

37.1301(c) because it is unnecessary. Section 37.3 and Form SEF read

together make clear that an applicant must comply with the financial

resources requirement.

\761\ CEA section 5h(f)(13)(A); 7 U.S.C. 7b-3(f)(13)(A).

\762\ CEA section 5h(f)(13)(B); 7 U.S.C. 7b-3(f)(13)(B).

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

In response to comments that Core Principle 13 should be

interpreted to mean the cost to wind-down a SEF's operations, the

Commission notes that such an interpretation would require SEFs to have

significantly less financial resources. The Commission believes that a

SEF's financial strength is vital to ensure that the SEF can discharge

its

[[Page 33539]]

core principle responsibilities in accordance with the CEA and that

those costs are greater than the cost to wind-down operations. Based on

its experience regulating DCMs and DCOs, the Commission has learned

that financial strength is vital to market continuity and the ability

of an entity to withstand unpredictable market events, and believes

that one year of operating expenses on a rolling basis is appropriate.

For these reasons, the Commission also disagrees with TruMarx's

argument that SEFs should not have such stringent financial resources

standards because they will not hold the risks of positions and trades.

(b) Sec. 37.1302--Types of Financial Resources

Proposed Sec. 37.1302 set forth the type of financial resources

available to satisfy the requirements of proposed Sec. 37.1301. The

proposed rule stated that financial resources may include: (a) The

SEF's own capital; and (b) Any other financial resource deemed

acceptable by the Commission. The Commission invited comment regarding

particular financial resources to be included in the final

regulation.\763\

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

\763\ Core Principles and Other Requirements for Swap Execution

Facilities, 76 FR at 1230.

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

(1) Summary of Comments

Several commenters recommended that the Commission include specific

examples of financial resources that might satisfy the requirement.

Phoenix recommended that the Commission include in final Sec. 37.1302

the following financial resources: assets of a parent company that

wholly owns the SEF, and, subject to Sec. 37.1304 (Valuation of

financial resources), the SEF's accounts receivable from SEF

members.\764\ Phoenix contended that as long as the parent company has

committed to guarantee the financial resource obligations of the SEF,

those assets should be available to the SEF, and that amounts owed to a

SEF by its customers are easily obtainable by a SEF.\765\ CME believed

that Congress intended the term ``financial resources'' to be construed

broadly and include anything of value at the SEF's disposal, including

operating revenues.\766\ Reuters recommended that assets of affiliated

entities within a corporate group should be acceptable types of

financial resources.\767\

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

\764\ Phoenix Comment Letter at 5 (Mar. 7, 2011).

\765\ Id.

\766\ CME Comment Letter at 37 (Feb. 22, 2011).

\767\ Reuters Comment Letter at 8 (Mar. 8, 2011).

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

(2) Commission Determination

The Commission is revising proposed Sec. 37.1302(a) to state that

a SEF's own capital means its assets minus its liabilities calculated

in accordance with U.S. Generally Accepted Accounting Principles

(``GAAP''). The Commission believes that if a particular financial

resource is an asset under GAAP, then it is appropriate for inclusion

in the calculation for this rule. If a particular financial resource is

not an asset under GAAP, but based upon the facts and circumstances a

SEF believes that the particular financial resource should be

acceptable, the Commission staff will work with the SEF to determine

whether such resource is acceptable. In this regard, the Commission is

clarifying that the language in final Sec. 37.1302(b) is intended to

provide flexibility to both SEFs and the Commission in determining

other acceptable types of financial resources on a case-by-case basis.

Finally, the Commission notes that it may not have jurisdiction

over a SEF's parent company or its affiliates; therefore, the

Commission cannot consider the parent company's or affiliates'

financial resources in determining whether the SEF possesses adequate

financial resources.

(c) Sec. 37.1303--Computation of Financial Resource Requirement \768\

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

\768\ The Commission is renaming the title of this section from

``Computation of Financial Resource Requirement'' to ``Computation

of Projected Operating Costs to Meet Financial Resource

Requirement'' to provide greater clarity.

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

Proposed Sec. 37.1303 required a SEF, each fiscal quarter, to make

a reasonable calculation of its projected operating costs over a

twelve-month period to determine the amount needed to meet the

requirements of proposed Sec. 37.1301. Proposed Sec. 37.1303 provided

SEFs with reasonable discretion to determine the methodology used to

compute such projected operating costs. The proposed rule authorized

the Commission to review the methodology and require changes as

appropriate.

(1) Summary of Comments

MarketAxess noted that the proposed regulations do not prescribe

specific methodologies for computing projected operating costs and

recommended that the Commission provide a safe harbor for specific

methodologies.\769\

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

\769\ MarketAxess Comment Letter at 39 (Mar. 8, 2011).

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

(2) Commission Determination

The Commission is adopting Sec. 37.1303 as proposed because it

provides flexibility to both SEFs and the Commission regarding the

calculation of projected operating costs.\770\ This flexibility would

be limited if the Commission prescribed specific methodologies for

computing projected operating costs in the rule text. In response to

MarketAxess's comment, the Commission notes that SEFs may work with the

Commission staff to create an appropriate methodology for computing

such operating costs.

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

\770\ The Commission is revising the language of Sec. 37.1303

for clarity.

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

(d) Sec. 37.1304--Valuation of Financial Resources

Proposed Sec. 37.1304 required a SEF, not less than quarterly, to

compute the current market value of each financial resource used to

meet its obligations under proposed Sec. 37.1301. The proposed rule

required SEFs to perform the valuation at other times as appropriate.

As stated in the SEF NPRM, the rule is designed to address the need to

update valuations in circumstances where there may have been material

fluctuations in market value that could impact a SEF's ability to meet

its obligations under proposed Sec. 37.1301.\771\ The proposed rule

required that, when valuing a financial resource, the SEF reduce the

value, as appropriate, to reflect any market or credit risk specific to

that particular resource (i.e., apply a haircut).\772\ The SEF NPRM

stated that the Commission would permit SEFs to exercise discretion to

determine applicable haircuts, which would be subject to Commission

review and acceptance.\773\

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

\771\ Core Principles and Other Requirements for Swap Execution

Facilities, 76 FR at 1231.

\772\ A ``haircut'' is a deduction taken from the value of an

asset to reserve for potential future adverse price movements in

such asset.

\773\ Core Principles and Other Requirements for Swap Execution

Facilities, 76 FR at 1231 n. 102.

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

(1) Summary of Comments

MarketAxess commented that proposed Sec. 37.1304 did not prescribe

specific methodologies for valuing financial resources and recommended

that the Commission provide a safe harbor for specific

methodologies.\774\

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

\774\ MarketAxess Comment Letter at 39 (Mar. 8, 2011).

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

(2) Commission Determination

The Commission is adopting Sec. 37.1304 as proposed.\775\ As with

[[Page 33540]]

Sec. 37.1303, Sec. 37.1304 provides flexibility to both SEFs and the

Commission regarding the valuation of financial resources. This

flexibility would be limited if the Commission prescribed specific

methodologies for valuing financial resources in the rule text. In

response to MarketAxess's comment, the Commission notes that SEFs may

work with the Commission staff to create an appropriate methodology for

valuing such financial resources.

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

\775\ MarketAxess noted that Sec. 37.1304 contains a

typographical error as it mistakenly cross-references proposed Sec.

37.701, which relates to the mandatory clearing requirement, instead

of proposed Sec. 37.1301. The Commission has made this technical

change in the final rule. Additionally, the Commission is revising

the language of Sec. 37.1304 for clarity.

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

(e) Sec. 37.1305--Liquidity of Financial Resources

Proposed Sec. 37.1305 required a SEF's financial resources to

include unencumbered, liquid financial assets (i.e., cash and/or highly

liquid securities) equal to at least six months' operating costs. As

noted in the SEF NPRM, the Commission believes that the requirement to

have six months' worth of unencumbered, liquid financial assets would

provide a SEF time to liquidate the remaining financial assets it would

need to continue operating for the last six months of the required one-

year period.\776\ The proposed rule stated that if any portion of such

financial resources is not sufficiently liquid, the SEF may take into

account a committed line of credit or similar facility to satisfy this

requirement. As stated in the SEF NPRM, a SEF may only use a committed

line of credit or similar facility to meet the liquidity requirements

set forth in Sec. 37.1305.\777\ Accordingly, the SEF NPRM stated that

a committed line of credit or similar facility is not available to a

SEF to satisfy the financial resources requirements of Sec.

37.1301.\778\

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

\776\ Core Principles and Other Requirements for Swap Execution

Facilities, 76 FR at 1231.

\777\ Id.

\778\ Id.

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

(1) Summary of Comments

Several commenters recommended alternate liquidity requirements to

the six months of operating costs. CME commented that the liquidity

measurement is only relevant in the context of winding-down operations,

and claimed that a three-month period, rather than a six-month period,

is a more accurate assessment of how long it would take for a SEF to

wind down.\779\ Similarly, Phoenix recommended that a SEF be required

to maintain liquid assets equal to three months of operating

expenses.\780\ Parity Energy commented that the Commission should

tailor financial requirements to a SEF's size and market impact and

recommended limiting the six month liquid asset requirement to only

those SEFs whose failure could impact market stability.\781\ SDMA,

however, recommended that the Commission require SEFs to have at least

12 months of unencumbered capital.\782\

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

\779\ CME Comment Letter at 37 (Feb. 22, 2011).

\780\ Phoenix Comment Letter at 4 (Mar. 7, 2011).

\781\ Parity Energy Comment Letter at 6 (Mar. 25, 2011).

\782\ SDMA Comment Letter at 12 (Mar. 8, 2011).

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

(2) Commission Determination

The Commission is adopting Sec. 37.1305 as proposed. The

Commission views a six month period as appropriate for a wind down

period and notes that commenters did not provide any support for

alternative time frames. In response to Parity Energy's comment, the

Commission notes that the purpose of the liquidity requirement is so

that all SEFs have liquid financial assets to allow them to continue to

operate and to wind down in an orderly fashion. Therefore, the

Commission is not limiting the liquidity requirement to only those SEFs

whose failure could impact market stability. In this regard, the

Commission notes that the statutory financial resources requirements

apply to all SEFs and are necessary to ensure core principle

compliance. The statute does not distinguish SEFs' financial resources

based on their market impact.

The Commission also notes that it is using the term

``unencumbered'' in Sec. 37.1305 in the normal commercial sense to

refer to assets that are not subject to a security interest or other

adverse claims. By ``committed line of credit or similar facility,''

the Commission means a committed, irrevocable contractual obligation to

provide funds on demand with preconditions limited to the execution of

appropriate agreements. For example, a facility with a material adverse

financial condition restriction would not be acceptable. The purpose of

this requirement is for a SEF to have no impediments to accessing its

line of credit at the time it needs liquidity. Further, SEFs are

encouraged to periodically check their line of credit arrangements to

confirm that no operational difficulties are present.

(f) Sec. 37.1306--Reporting Requirements \783\

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

\783\ The Commission is renaming the title of this section from

``Reporting Requirements'' to ``Reporting to the Commission'' to

provide greater clarity.

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

Proposed Sec. 37.1306(a)(1) required that, at the end of each

fiscal quarter, or at any time upon Commission request, a SEF report to

the Commission: (i) The amount of financial resources necessary to meet

the requirements of Sec. 37.1301; and (ii) the value of each financial

resource available to meet those requirements. Proposed Sec.

37.1306(a)(2) required a SEF to provide the Commission with a financial

statement, including balance sheet, income statement, and statement of

cash flows of the SEF or of its parent company. Proposed Sec.

37.1306(b) required calculations to be made on the last business day of

the SEF's fiscal quarter.

Proposed Sec. 37.1306(c) required a SEF to provide the Commission

with sufficient documentation explaining the methodology it used to

calculate its financial requirements and the basis for its valuation

and liquidity determinations. The proposed rule also required the SEF

to provide copies of any agreements establishing or amending a credit

facility, insurance coverage, or any similar arrangement that evidences

or otherwise supports its conclusions.

Finally, proposed Sec. 37.1306(d) required SEFs to file the report

no later than 17 business days \784\ from the end of its fiscal quarter

but allowed SEFs to request an extension of time from the Commission.

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

\784\ This filing deadline is consistent with the deadline

imposed on FCMs for the filing of monthly financial reports. See 17

CFR 1.10(b) for further details.

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

(1) Summary of Comments

CME wrote that it would not be feasible for SEFs to comply with the

proposed filing deadline of 17 business days from the end of a SEF's

fiscal quarter.\785\ CME recommended a reporting deadline of 40

calendar days after the end of each fiscal quarter and 60 calendar days

after the end of the fiscal year, which it noted is consistent with the

SEC's reporting requirements.\786\ CME also sought clarification that

consolidated financial statements covering multiple registered entities

satisfy the reporting requirements.\787\

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

\785\ CME Comment Letter at 38 (Feb. 22, 2011).

\786\ Id.

\787\ Id.

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

MarketAxess stated that the proposed reporting requirements are

unnecessary and burdensome, and recommended that the Commission allow a

senior officer of the SEF to represent to the Commission that the SEF

satisfies the financial resources requirements.\788\

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

\788\ MarketAxess Comment Letter at 40 (Mar. 8, 2011).

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

Two commenters discussed disclosure of the reports. CME recommended

that the Commission clarify that filings made in compliance with the

proposed financial resources regulations are confidential.\789\

[[Page 33541]]

However, SIFMA AMG commented that SEFs should submit to the Commission

and make available for public comment evidence demonstrating sufficient

resources.\790\

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

\789\ CME Comment Letter at 38 (Feb. 22, 2011).

\790\ SIMFA AMG Comment Letter at 13 (Mar. 8, 2011).

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

(2) Commission Determination

The Commission is adopting Sec. 37.1306 as proposed, subject to

certain amendments to the filing deadlines.\791\ The Commission agrees

with CME that the proposed 17 business day filing deadline may be

burdensome. In the final rule, the Commission is extending the 17

business day proposed filing deadline to 40 calendar days for the

fiscal quarter reports and to 60 calendar days for the fiscal year-end

report, which will also harmonize the filing deadlines with the SEC's

requirements for its Form 10-Q and Form 10-K. The Commission also

clarifies that consolidated financial statements must disclose all

relevant and appropriate figures such that a determination of the

sufficiency of financial resources of a SEF can be made without

additional requests for information from the entity. In such case,

consolidated financial statements would comply with the reporting

requirements.

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

\791\ The Commission is also making certain non-substantive

clarifications to Sec. 37.1306.

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

In response to MarketAxess's comment that the reporting

requirements are unnecessary and burdensome, the Commission believes

that prudent financial management requires SEFs to prepare and review

financial reports on a regular basis and expects that SEFs would

regularly review their finances. In this regard, the Commission notes

that because of the importance of this requirement, a mere

representation by a senior officer is insufficient for verification

that the SEF meets its financial obligations. The quarterly reporting

required by Sec. 37.1306 will adequately provide the Commission with

assurance that a SEF satisfies its financial resources requirements.

The Commission notes that DCMs and DCOs have similar financial

resources reporting obligations and does not believe that SEFs should

be treated differently. The Commission also believes that much of the

information required by the reports should be readily available to a

sophisticated organization, which the Commission expects would

regularly account for its financial resources. As such, the Commission

notes that the cost of submitting these reports to the Commission would

be de minimis.

The Commission further clarifies that it does not intend to make

financial resources reports public. However, where such information is,

in fact, confidential, the Commission encourages SEFs to submit a

written request for confidential treatment of such filings under the

Freedom of Information Act (``FOIA''), pursuant to the procedures

established in section 145.9 of the Commission's regulations.\792\ The

determination of whether to disclose or exempt such information in the

context of a FOIA proceeding would be governed by the provisions of

part 145 and any other relevant provision.

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

\792\ 17 CFR 145.9.

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

Finally, the Commission is adding new Sec. 37.1307 titled

``Delegation of Authority'' to the final SEF rules to delegate

authority to the Director of DMO to perform certain functions that are

reserved to the Commission under subpart N.

14. Subpart O--Core Principle 14 (System Safeguards)

Core Principle 14 pertains to the establishment of system

safeguards and requires SEFs to: (1) Establish and maintain a program

of risk analysis and oversight to identify and minimize sources of

operational risk through the development of appropriate controls and

procedures and the development of automated systems that are reliable,

secure, and have adequate scalable capacity; (2) establish and maintain

emergency procedures, backup facilities, and a plan for disaster

recovery that allow for the timely recovery and resumption of

operations and the fulfillment of the responsibilities and obligations

of the SEF; and (3) periodically conduct tests to verify that backup

resources are sufficient to ensure continued order processing and trade

matching, price reporting, market surveillance, and maintenance of a

comprehensive and accurate audit trail.\793\ In the SEF NPRM, the

Commission proposed to codify the statutory text of Core Principle 14

in proposed Sec. 37.1400, and adopts that rule as proposed.

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

\793\ CEA section 5h(f)(14); 7 U.S.C. 7b-3(f)(14).

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

(a) Sec. 37.1401--Requirements

Proposed Sec. 37.1401(a) required a SEF to: Establish and maintain

a program of risk analysis and oversight; establish and maintain

emergency procedures, backup facilities, and a plan for disaster

recovery; and periodically conduct tests to verify that backup

resources are sufficient. Proposed Sec. 37.1401(b) required that a

SEF's program of risk analysis and oversight address six categories of

risk analysis and oversight, including: Information security; business

continuity-disaster recovery (``BC-DR'') planning and resources;

capacity and performance planning; systems operations; systems

development and quality assurance; and physical security and

environmental controls. Proposed Sec. 37.1401(c) suggested that a SEF

follow generally accepted standards and best practices when addressing

the categories of risk analysis and oversight.

Proposed Sec. 37.1401(d) and (e) also required each SEF to

maintain a BC-DR plan, BC-DR resources, emergency procedures, and

backup facilities sufficient to enable timely recovery and resumption

of its operations and ongoing fulfillment of its responsibilities and

obligations as a SEF following any disruption, either through

sufficient infrastructure and personnel resources of its own or through

sufficient contractual arrangements with other SEFs or disaster

recovery service providers. If the Commission determines that a SEF is

a critical financial market, then that SEF would be subject to more

stringent requirements, set forth in Sec. 40.9 of the Commission's

regulations.

The proposed rule also required each SEF to notify the Commission

staff of various system security-related events, including prompt

notice of all electronic trading halts and systems malfunctions

(proposed Sec. 37.1401(f)(1)), cyber-security incidents (proposed

Sec. 37.1401(f)(2)), and any activation of the SEF's BC-DR plan

(proposed Sec. 37.1401(f)(3)). In addition, the proposed rule required

each SEF to provide the Commission staff with timely advance notice of

all planned changes to automated systems that may impact the

reliability, security, or adequate scalable capacity of such systems

(proposed Sec. 37.1401(g)(1)) and planned changes to programs of risk

analysis and oversight (proposed Sec. 37.1401(g)(2)).

The proposed rule also required each SEF to provide relevant

documents to the Commission (proposed Sec. 37.1401(h)) and to conduct

regular, periodic, objective testing and review of its automated

systems (proposed Sec. 37.1401(i)). Moreover, proposed Sec.

37.1401(j) required each SEF, to the extent practicable, to coordinate

its BC-DR plan with those of the market participants upon whom it

depends to provide liquidity, to initiate coordinated testing of such

plans, and to ensure that its BC-DR plan takes into account the BC-DR

plans of relevant telecommunications, power, water, and

[[Page 33542]]

other essential service providers. Finally, proposed Sec. 37.1401(k)

stated that part 46 of the Commission's regulations governs the

obligations of entities determined to be critical financial markets,

with respect to maintenance and geographical dispersal of disaster

recovery resources.

(1) Summary of Comments

CME objected to what it considers to be an overly broad requirement

in proposed Sec. 37.1401(f)(1) to notify the Commission staff promptly

of all electronic trading halts and systems malfunctions.\794\ CME

stated that the required reporting should be limited only to material

system failures.\795\ CME also objected to proposed Sec.

37.1401(g)(1), stating that the requirement that SEFs provide the

Commission with timely advance notice of all planned changes to

automated systems that may impact the reliability, security, or

adequate scalable capacity of such systems is overly burdensome, and

not cost effective.\796\ Additionally, CME stated that the proposed

Sec. 37.1401(g)(2) requirement that SEFs provide timely advance notice

of all planned changes to their program of risk analysis and oversight

is too broad and generally unnecessary.\797\ Finally, CME noted that it

does not control, or generally have access to, the details of the

disaster recovery plans of its major vendors.\798\

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

\794\ CME Comment Letter at 36 (Feb. 22, 2011).

\795\ Id.

\796\ Id. at 37.

\797\ Id.

\798\ Id.

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

MarketAxess and WMBAA sought clarification of the criteria used to

determine which SEFs are ``critical financial markets,'' as referenced

in proposed Sec. 37.1401(d).\799\

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

\799\ MarketAxess Comment Letter at 40 (Mar. 8, 2011); WMBAA

Comment Letter at 28 (Mar. 8, 2011).

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

(2) Commission Determination

As noted in the SEF NPRM, automated systems play a central and

critical role in today's electronic financial market environment, and

the oversight of core principle compliance by SEFs with respect to

automated systems is an essential part of effective oversight of swaps

market.\800\ Advanced computer systems are fundamental to a SEF's

ability to meet its obligations and responsibilities under the core

principles.\801\ Accordingly, the Commission is adopting Sec. 37.1401

as proposed, subject to the modifications described below.

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

\800\ Core Principles and Other Requirements for Swap Execution

Facilities, 76 FR at 1231.

\801\ Id.

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

Although the Commission did not receive related comments, the

Commission is eliminating proposed Sec. 37.1401(a) because this

paragraph is repetitious of proposed rule Sec. 37.1400. The Commission

is also moving the following portions of proposed Sec. 37.1401 to the

guidance in appendix B to part 37 because the rules as proposed

provided SEFs with a degree of discretion: (1) Proposed Sec.

37.1401(c) suggesting that a SEF follow generally accepted standards

and best practices in addressing the categories of its risk analysis

and oversight program; (2) the portion of proposed Sec. 37.1401(i)

suggesting that a SEF's testing of its automated systems and BC-DR

capabilities be conducted by qualified, independent professionals; and

(3) proposed Sec. 37.1401(j) suggesting that a SEF coordinate its BC-

DR plan with those of others.\802\ Given that these proposed provisions

provided SEFs with a degree of discretion, the Commission believes that

they are better suited as guidance rather than rules, and as guidance,

SEFs will have greater flexibility in administering their obligations.

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

\802\ As a result of these changes, proposed section (b) is

adopted as section (a), proposed section (d) is adopted as section

(b), proposed section (e) is adopted as section (c), proposed

section (f) is adopted as section (d), proposed section (g) is

adopted as section (e), proposed section (h) is adopted as section

(f), proposed section (i) is adopted as section (g), and proposed

section (k) is adopted as section (h).

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

In response to CME's comments, the Commission is revising proposed

Sec. 37.1401(f)(1) to provide that SEFs only need to promptly notify

the Commission staff of all material system malfunctions. With respect

to planned changes to automated systems or programs of risk analysis

and oversight, the Commission is revising proposed Sec. 37.1401(g) to

require timely advance notification of all material changes to

automated systems and to programs of risk analysis and oversight. The

Commission believes that these revisions are appropriate because the

scope of the proposed rules may have been too broad as CME noted. The

Commission notes that proposed Sec. 37.1401(j) does not require SEFs

to control or have access to the details of the disaster recovery plans

of its major vendors. Rather, the requirement in the proposed rule,

which is being adopted as guidance, suggests coordination to the extent

possible.

In response to comments from WMBAA and MarketAxess, the Commission

is revising proposed Sec. 37.1401(d) to include a reference to

appendix E to part 40 of the Commission's regulations, which describes

the Commission's criteria for determining whether a SEF is a critical

financial market.\803\ Appendix E to part 40 describes the evaluation

and notification process for SEFs once designated as a critical

financial market.\804\

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

\803\ Business Continuity and Disaster Recovery, 75 FR 42633

(proposed Jul. 22, 2010). The Commission notes that this rulemaking

is not yet final.

\804\ Id. at 42639.

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

With respect to the references to Sec. 40.9 regarding critical

financial markets in proposed Sec. 37.1401(d) and 37.1401(k), the

Commission notes that Sec. 40.9, which was proposed in a separate

rulemaking,\805\ is not yet final. However, SEFs deemed critical

financial markets will be subject to the requirements set forth in

Sec. 40.9 upon its effective date. The Commission further notes that

the reference to part 46 in proposed Sec. 37.1401(k) was a technical

error. Instead, the proposed rule should have referenced part 40.

Accordingly, the Commission is replacing the mistaken reference to part

46 with a reference to part 40.

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

\805\ Id. at 42638-39.

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

15. Subpart P--Core Principle 15 (Designation of Chief Compliance

Officer)

Core Principle 15 establishes the position and duties of chief

compliance officer (``CCO'').\806\ Core Principle 15 also requires the

CCO to design procedures to establish the handling, management

response, remediation, retesting, and closing of noncompliance

issues.\807\ The statute also requires a CCO to prepare and sign an

annual compliance report that is filed with the Commission.\808\ In

addition, Core Principle 15 requires the CCO to include in the report a

certification that, under penalty of law, the report is accurate and

complete.\809\ In the SEF NPRM, the Commission proposed to codify the

statutory text of Core Principle 15 in proposed Sec. 37.1500, and

adopts that rule as proposed.

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

\806\ CEA section 5h(f)(15); 7 U.S.C. 7b-3(f)(15).

\807\ Id.

\808\ Id.

\809\ Id.

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

(a) Sec. 37.1501--Chief Compliance Officer

Proposed Sec. 37.1501 implemented the statutory provisions of Core

Principle 15 and granted CCOs the authority necessary to fulfill their

responsibilities.

(1) Sec. 37.1501(a)--Definition of Board of Directors

Proposed Sec. 37.1501(a) defined ``board of directors'' as the

board of directors of

[[Page 33543]]

a swap execution facility or for those swap execution facilities whose

organizational structure does not include a board of directors, a body

performing a function similar to a board of directors.

(i) Commission Determination

The Commission received no comments on Sec. 37.1501(a) and is

adopting the rule as proposed.

(2) Sec. 37.1501(b)--Designation and Qualifications of Chief

Compliance Officer

Proposed Sec. 37.1501(b)(1) required a SEF to establish a CCO

position and to designate an individual to serve in that capacity.

Proposed Sec. 37.1501(b)(1)(i) required that a SEF provide its CCO

with the authority and resources to develop and enforce policies and

procedures necessary to fulfill its statutory and regulatory duties. In

addition, proposed Sec. 37.1501(b)(1)(ii) provided that CCOs must have

supervisory authority over all staff acting in furtherance of the CCO's

statutory, regulatory, and self-regulatory obligations.

Proposed Sec. 37.1501(b)(2) required that a CCO have the

appropriate background and skills to fulfill the responsibilities of

the position. Proposed Sec. 37.1501(b)(2)(i) prohibited anyone who

would be disqualified from registration under CEA sections 8a(2) or

8a(3) from serving as a CCO.\810\ Proposed Sec. 37.1501(b)(2)(ii)

prohibited a CCO from being a member of the SEF's legal department or

its general counsel.\811\

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

\810\ See Core Principles and Other Requirements for Swap

Execution Facilities, 76 FR at 1232 (discussing the reasons for this

requirement).

\811\ Id.

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

(i) Summary of Comments

Some commenters stated that by mandating that the CCO have the

authority and resources to ``enforce'' a SEF's policies and procedures,

the proposed rules change the traditional role of a CCO and give the

CCO authority that should be reserved for senior management.\812\ These

commenters stated that the traditional and proper role of a CCO is to

advise management on compliance issues and that management has the

authority to enforce compliance policies and procedures.\813\ The

commenters recommended that the Commission revise the proposed rules to

give effect to the well-established and critical distinction between a

CCO and management.\814\

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

\812\ WMBAA Comment Letter II at 2-6 (Mar. 8, 2011); FXall

Comment Letter at 14-15 (Mar. 8, 2011); CME Comment Letter at 5-6

(Feb. 7, 2011). WMBAA submitted two comment letters to the SEF

rulemaking comment file on Mar. 8, 2011. The second comment letter

referred to herein as ``WMBAA Comment Letter II'' only pertains to

the SEF NPRM's proposed CCO provisions. Additionally, rather than

repeat its comments regarding the CCO provisions that pertain to

both the DCO and SEF NPRMs, CME incorporated its entire DCO

rulemaking comment letter regarding CCOs dated Feb. 7, 2011 as

Exhibit B to its SEF comment letter dated Mar. 8, 2011. The

Commission notes these comments by referencing the Feb. 7, 2011 date

of CME's DCO comment letter regarding CCOs. The Commission is also

changing CME's reference to ``DCO'' to ``SEF'' for these comments.

\813\ WMBAA Comment Letter II at 2-6 (Mar. 8, 2011); FXall

Comment Letter at 14-15 (Mar. 8, 2011); CME Comment Letter at 5-6

(Feb. 7, 2011).

\814\ WMBAA Comment Letter II at 6 (Mar. 8, 2011); FXall Comment

Letter at 14-15 (Mar. 8, 2011); CME Comment Letter at 6 (Feb. 7,

2011).

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

Some commenters stated that the proposed rules should not prohibit

a CCO from serving as the SEF's general counsel or as a member of the

SEF's legal department.\815\ WMBAA noted that it is not uncommon for a

company's CCO to be its general counsel.\816\ Similarly, CME noted that

many CCOs have certain other job responsibilities, most typically in

related ``control areas'' such as the Legal Department or Internal

Audit.\817\ Additionally, MarketAxess stated that this prohibition

could prevent a smaller SEF from structuring its internal management in

the most efficient manner.\818\ Parity Energy recommended that this

requirement only apply to SEFs that could have a substantial impact on

market risk and stability if they were to fail.\819\ However, Tradeweb

and Better Markets expressed support for a dedicated CCO position

independent of a SEF's legal department.\820\ Better Markets also

commented that in situations where there are a number of affiliated

organizations, a single senior CCO should have overall responsibility

for each affiliated and controlled entity, even if the individual

entities have CCOs.\821\

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

\815\ WMBAA Comment Letter II at 6-7 (Mar. 8, 2011); MarketAxess

Comment Letter at 27 (Mar. 8, 2011); ICE Comment Letter at 6-7 (Mar.

8, 2011); CME Comment Letter at 3 (Feb. 7, 2011).

\816\ WMBAA Comment Letter II at 6 (Mar. 8, 2011).

\817\ CME Comment Letter at 3 (Feb. 7, 2011).

\818\ MarketAxess Comment Letter at 27 n. 31 (Mar. 8, 2011).

\819\ Parity Energy Comment Letter at 6 (Mar. 25, 2011).

\820\ Tradeweb Comment Letter at 12 (Mar. 8, 2011); Better

Markets Comment Letter at 19 (Mar. 8, 2011).

\821\ Better Markets Comment Letter at 19 (Mar. 8, 2011).

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

(ii) Commission Determination

The Commission is adopting Sec. 37.1501(b) as proposed, subject to

two modifications described below. In general, the Commission disagrees

with the commenters who believe that a CCO's function is solely to

monitor and advise on compliance issues. These commenters do not

provide any statutory support for this view and their position appears

to conflict with the statutory responsibilities of a CCO as set forth

in the Act. In particular, CEA section 5h(f)(15)(B) requires a CCO to

``resolve any conflicts of interest that may arise'' and to ``ensure

compliance with this Act.'' \822\ These duties suggest that a CCO is

intended to be more than just an advisor, and must have the appropriate

authority to enforce policies and procedures related to his or her

areas of responsibility. The Commission believes that such authority is

particularly important for a SEF CCO, given the CCO's responsibility in

overseeing a SEF's self-regulatory programs.

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

\822\ CEA sections 5h(f)(15)(B)(iii) and (v); 7 U.S.C. 7b-

3(f)(15)(B)(iii) and (v).

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

However, to clarify the CCO's supervisory authority, the Commission

is amending proposed Sec. 37.1501(b)(1)(ii) to state that ``[t]he

chief compliance officer shall have supervisory authority over all

staff acting at the direction of the chief compliance officer''

(emphasis added). This modification provides greater clarity as to the

SEF staff that must be under the managerial oversight of a CCO by

emphasizing that such staff includes persons necessary for SEFs to

fulfill their self-regulatory obligations, including compliance staff

(e.g., trade practice and market surveillance staff and enforcement

staff). The Commission notes that other SEF staff are not captured by

the requirements of Sec. 37.1501(b)(1).

The Commission is withdrawing proposed Sec. 37.1501(b)(2)(ii),

which prohibits the CCO from serving as a SEF's general counsel or as a

member of its legal department. In the SEF NPRM, the Commission noted

that there is potentially a conflict of interest present if a CCO

serves as a SEF's general counsel or as a member of its legal

department.\823\ However, the Commission has determined that the

potential costs of hiring additional staff to satisfy the requirement

in proposed Sec. 37.1501(b)(2)(ii) may impose an excessive burden on

SEFs, particularly smaller SEFs.

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

\823\ Core Principles and Other Requirements for Swap Execution

Facilities, 76 FR at 1232, n. 103.

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

Although the Commission is eliminating proposed Sec.

37.1501(b)(2)(ii) from the final SEF rules, the Commission notes that a

conflict of interest may compromise a CCO's

[[Page 33544]]

ability to effectively fulfill his or her responsibilities as a CCO,

and that such conflicts may be more likely to arise when a CCO is also

employed as the SEF's general counsel or within its legal department.

Therefore, the Commission expects that as soon as any conflict of

interest becomes apparent, a SEF will immediately implement contingency

measures. For example, a SEF may reassign the conflicted matter to an

alternate employee who does not report to the CCO and who does not

possess a conflict of interest. The Commission believes that a SEF's

Regulatory Oversight Committee (``ROC'') \824\ should regularly monitor

for potential conflicts of interest in its oversight of the CCO, and

should be particularly involved in the oversight of any matter in which

a CCO was recused.

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

\824\ See Requirements for Derivatives Clearing Organizations,

Designated Contract Markets, and Swap Execution Facilities Regarding

the Mitigation of Conflicts of Interest, 75 FR 63732, 63747-48

(proposed Oct. 18, 2010). Proposed Sec. 37.19(b) describes the role

of the ROC. The Commission notes that this rule is not yet final.

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

The Commission disagrees with the recommendation by Better Markets

to require a single senior CCO to have responsibility over multiple

affiliated registered entities, some of which would be required by the

CEA and Commission regulations to have their own CCOs. Such a situation

might cause unnecessary confusion and dilute CCO accountability at the

individual entity level. Additionally, the Commission believes that the

proposed rule is sufficient to manage instances where there are a

number of affiliated organizations within a corporate family. In these

instances, each SEF would be required to appoint its own CCO.

(3) Sec. 37.1501(c)--Appointment, Supervision, and Removal of Chief

Compliance Officer

Proposed Sec. 37.1501(c)(1) required that a CCO's appointment and

compensation be approved by a majority of the SEF's board of directors

or its senior officer. Proposed Sec. 37.1501(c)(1) also required a CCO

to meet with the SEF's board of directors at least annually and the ROC

at least quarterly, and to provide any information requested regarding

the SEF's regulatory program. In addition, proposed Sec. 37.1501(c)(1)

required a SEF to notify the Commission of the appointment of a new CCO

within two business days of such appointment. Proposed Sec.

37.1501(c)(2) required a CCO to report directly to the board of

directors or to the senior officer of the SEF, at the SEF's discretion.

Proposed Sec. 37.1501(c)(3) required approval of a majority of a SEF's

board of directors to remove a CCO. If a SEF does not have a board of

directors, the proposed rule provided that the CCO may be removed by

its senior officer. Proposed Sec. 37.1501(c)(3) also required a SEF to

notify the Commission of, and explain the reasons for, the departure of

the CCO within two business days. In addition, proposed Sec.

37.1501(c)(3) required a SEF to immediately appoint an interim CCO, to

appoint a permanent CCO as soon as reasonably practicable, and to

notify the Commission within two business days of appointing any new

interim or permanent CCO.

(i) Summary of Comments

Some commenters requested that the Commission define the term

``senior officer'' and provided recommendations.\825\ FXall recommended

that the Commission define the term ``senior officer'' to include the

SEF's president, chief executive officer, chief legal officer, or other

officer with ultimate supervisory authority for the SEF entity.\826\

CME recommended that the term ``senior officer'' be defined to include

the senior officer of a division that is engaged in SEF activities

rather than the senior officer of a larger corporation.\827\

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

\825\ FXall Comment Letter at 14 (Mar. 8, 2011); Tradeweb

Comment Letter at 12 n.8 (Mar. 8, 2011); CME Comment Letter at 2-3

(Feb. 7, 2011).

\826\ FXall Comment Letter at 14 (Mar. 8, 2011).

\827\ CME Comment Letter at 2-3 (Feb. 7, 2011).

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

Commenters also requested that the Commission grant a SEF greater

flexibility in determining how a CCO is appointed, compensated,

supervised, and removed.\828\ In this regard, WMBAA stated that a CCO

should be permitted to satisfy the statutory requirement of reporting

to the board of directors or a senior officer by reporting to a

ROC.\829\ MarketAxess commented that the proposed requirements for a

majority of the board of directors to approve the appointment,

compensation, and removal of the CCO go beyond the statutory mandate

and would effectively place the CCO at the same level as the SEF's

senior officer.\830\ CME argued that each SEF should be given the

flexibility to take additional steps beyond those required in the

proposed rule, based on the SEF's particular corporate structure, size,

and complexity, to ensure an appropriate level of independence for its

CCO.\831\

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

\828\ Tradeweb Comment Letter at 6 (Jun. 3, 2011); MarketAxess

Comment Letter at 26 (Mar. 8, 2011); WMBAA Comment Letter II at 7

(Mar. 8, 2011); Tradeweb Comment Letter at 12 (Mar. 8, 2011).

\829\ WMBAA Comment Letter II at 7 (Mar. 8, 2011).

\830\ MarketAxess Comment Letter at 26 (Mar. 8, 2011).

\831\ CME Comment Letter at 9 (Feb. 7, 2011).

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

AFR and Better Markets recommended, however, that the rules for

CCO's appointment, compensation, supervision, and removal be

strengthened.\832\ AFR recommended that CCOs be responsible only to a

SEF's ROC.\833\ It argued that CCO independence may only be ensured by

vesting oversight of the position exclusively in public directors.\834\

Similarly, Better Markets recommended that decisions relating to a

CCO's designation, compensation, and termination should be the sole

responsibility of the independent members of the board of

directors.\835\

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

\832\ AFR Comment Letter at 6 (Mar. 8, 2011); Better Markets

Comment Letter at 19-20 (Mar. 8, 2011).

\833\ AFR Comment Letter at 6 (Mar. 8, 2011).

\834\ Id.

\835\ Better Markets Comment Letter at 19-20 (Mar. 8, 2011).

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

(ii) Commission Determination

The Commission is adopting Sec. 37.1501(c) as proposed, subject to

several modifications described below.\836\ In response to commenters'

requests to define the term ``senior officer,'' the Commission

believes, based on the statutory language that requires a CCO to report

directly to the ``board or to the senior officer,'' that ``senior

officer'' would only include the most senior executive officer of the

legal entity that is registered as a SEF.

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

\836\ The Commission is making certain non-substantive revisions

to Sec. 37.1501(c) for clarity.

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

In response to the commenters' requests for greater flexibility,

the Commission believes that proposed Sec. 37.1501(c) generally

strikes the appropriate balance between flexibility and ensuring that a

SEF's CCO is insulated from day-to-day commercial pressures. The

proposed rules provide a degree of flexibility by allowing a SEF's

board of directors or senior officer to appoint, set the compensation

of, and supervise the CCO. The proposed rules also protect the CCO from

undue influence by requiring that the board of directors or the senior

officer (if the SEF does not have a board of directors) be responsible

for removing the CCO and that the CCO meet with the board of directors

at least annually and with the ROC at least quarterly. In response to

CME's comment about additional flexibility beyond the rules, the

Commission notes that Sec. 37.1501(c) sets forth minimum standards so

a SEF may implement additional measures if it deems doing so necessary

to insulate the CCO from undue influence. The Commission encourages

SEFs to review and enact conflict mitigation procedures as appropriate

for their specific

[[Page 33545]]

corporate and/or organizational structure.

However, the Commission is revising proposed Sec. 37.1501(c) in

six respects. First, the Commission is modifying proposed Sec.

37.1501(c)(1) to more clearly state that the CCO is obligated to meet

with the board of directors at least annually and with the ROC at least

quarterly, even if the CCO was appointed by, or is supervised by, the

senior officer of the facility. Second, to clarify a CCO's duty to

provide information to a SEF's board of directors or ROC, the

Commission is modifying proposed Sec. 37.1501(c)(1) to state that

``[t]he chief compliance officer shall provide any information

regarding the swap execution facility's self-regulatory program that is

requested by the board of directors or the regulatory oversight

committee'' (emphasis added). Third, the Commission is eliminating the

requirement in proposed Sec. 37.1501(c)(1) that a CCO's appointment

and compensation require the approval of a majority of a SEF's board of

directors. The Commission believes that board of director approval is a

sufficient requirement for appointment, and that a SEF should have

appropriate discretion to determine the voting percentage necessary to

appoint a CCO or determine salary. Fourth, the Commission is

eliminating the requirement in proposed Sec. 37.1501(c)(3) that a SEF

explain the reason for the departure of a CCO within two business days.

The Commission believes that the specific reason for the departure may

be unnecessary in most instances. However, the Commission will have the

opportunity to investigate the reason for the departure if it so

desires because a SEF must notify the Commission of a CCO's departure

within two business days. Fifth, the Commission is eliminating the

requirement in proposed Sec. 37.1501(c)(3) that a SEF immediately

appoint an interim CCO, and appoint a new permanent CCO as soon as

reasonably practicable, upon the removal of a CCO. The Commission

believes that the requirement to appoint a new CCO is implicit in Sec.

37.1501(b)(1), which requires that a SEF designate an individual to

serve as CCO. Finally, the Commission is eliminating the requirement in

proposed Sec. 37.1501(c)(3) that a SEF notify the Commission within

two business days of appointing a new CCO because this requirement is

already included in Sec. 37.1501(c)(1).

(4) Sec. 37.1501(d)--Duties of Chief Compliance Officer

Proposed Sec. 37.1501(d) generally listed the following CCO

duties: (1) Overseeing and reviewing compliance with section 5h of the

CEA and related Commission regulations; (2) in consultation with the

board of directors or the senior officer, resolving any conflicts of

interest that may arise; (3) establishing and administering written

policies and procedures reasonably designed to prevent violations of

the CEA and Commission regulations; (4) ensuring compliance with the

CEA and Commission regulations relating to agreements, contracts, or

transactions, and with Commission regulations issued under section 5h

of the CEA; (5) establishing procedures for the remediation of

noncompliance issues identified by the CCO; (6) establishing and

following appropriate procedures for noncompliance issues; (7)

establishing a compliance manual and administering a code of ethics;

(8) supervising a SEF's self-regulatory program; and (9) supervising

the effectiveness and sufficiency of any regulatory services provided

to the SEF.

(i) Summary of Comments

Better Markets and CME commented on proposed Sec. 37.1501(d)(2)

regarding conflicts of interest.\837\ Better Markets recommended that

the Commission revise proposed Sec. 37.1501(d)(2) to require a CCO to

consult with both the independent members of the board of directors and

the senior officer when resolving conflicts of interest, which are

particularly contentious.\838\ CME requested that the Commission revise

proposed Sec. 37.1501(d)(2) to require a CCO to establish policies and

procedures reasonably designed to resolve any conflicts of interest

that may arise.\839\ Although CME conceded that the language in

proposed Sec. 37.1501(d)(2) mirrors the language in the Act, it

believes that Congress did not intend for the CCO to resolve conflicts

in the executive or managerial sense.\840\

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

\837\ Better Markets Comment Letter at 20 (Mar. 8, 2011); CME

Comment Letter at 6 (Feb. 7, 2011).

\838\ Better Markets Comment Letter at 19, 20 (Mar. 8, 2011).

\839\ CME Comment Letter at 6 (Feb. 7, 2011).

\840\ Id.

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

Several commenters argued that proposed Sec. 37.1501(d)(4),

requiring a CCO to ``ensure'' compliance with the Act and Commission

regulations, is an impracticable standard.\841\ Instead, many of these

commenters recommended alternative language, which generally stated

that the CCO put in place policies and procedures that reasonably

ensure compliance with the Act and Commission regulations.\842\

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

\841\ Tradeweb Comment Letter at 6-7 (Jun. 3, 2011); WMBAA

Comment Letter II at 5-6 (Mar. 8, 2011); MarketAxess Comment Letter

at 26 (Mar. 8, 2011); Tradeweb Comment Letter at 12 (Mar. 8, 2011);

CME Comment Letter at 4 (Feb. 7, 2011).

\842\ Tradeweb Comment Letter at 6-7 (Jun. 3, 2011); Tradeweb

Comment Letter at 12 (Mar. 8, 2011); CME Comment Letter at 4 (Feb.

7, 2011).

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

CME also took issue with the requirement in proposed Sec.

37.1501(d)(6), which requires a CCO to ``follow'' appropriate

procedures for the handling, management response, remediation,

retesting, and closing of noncompliance issues.\843\ CME requested that

the Commission eliminate this requirement, which it believes is a

function of senior management.\844\ Additionally, WMBAA recommended

that the Commission delete proposed Sec. 37.1501(d)(8) and (d)(9),

regarding the supervision of a SEF's self-regulatory program and any

regulatory service provider, because these functions should be the

responsibility of management.\845\

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

\843\ CME Comment Letter at 6 (Feb. 7, 2011).

\844\ Id.

\845\ WMBAA Comment Letter II at 6 (Mar. 8, 2011).

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

(ii) Commission Determination

The Commission is adopting Sec. 37.1501(d) as proposed, subject to

certain modifications described below. The Commission is revising

proposed Sec. 37.1501(d)(2) to clarify that the list of enumerated

conflicts of interest is not exhaustive.\846\ The Commission is not

adopting the recommendation by Better Markets to require the CCO to

consult with both the independent members of the board of directors and

the senior officer when resolving conflicts of interest. Considering

the statutory provisions of CEA section 5h, the Commission believes

that it is unnecessary to require the CCO to do so. However, the

Commission notes that Sec. 37.1501(d)(2) sets forth minimum standards

so a SEF may institute higher standards, such as requiring its CCO to

consult with both the independent members of the board of directors and

the senior officer when resolving conflicts of interest. The Commission

also declines to adopt CME's recommendation regarding conflicts of

interest. As CME acknowledged, the Commission is following the

statutory language in its implementation of Sec. 37.1501(d)(2).

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

\846\ The Commission notes that the preamble to the SEF NPRM

already clarified this point. To provide additional clarity, the

Commission is clarifying this point in the final rule by adding the

word ``including'' before the list of enumerated conflicts of

interest. See Core Principles and Other Requirements for Swap

Execution Facilities, 76 FR at 1233.

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

In response to commenters' concerns about the requirement to

``ensure'' compliance in proposed Sec. 37.1501(d)(4),

[[Page 33546]]

the Commission is modifying the rule to state that the CCO shall take

``reasonable steps to ensure compliance with the Act and the rules of

the Commission.'' The Commission understands that a single individual

cannot guarantee compliance with the CEA and Commission regulations.

The Commission believes that this modification is responsive to

commenters' concerns and is consistent with the final rules for other

registered entities.\847\ The Commission is also removing the reference

to ``agreements, contracts, or transactions'' in proposed Sec.

37.1501(d)(4) to more closely follow the language in the Act. In making

this modification, the Commission does not intend to modify any

substantive obligations of the CCO with regard to agreements,

contracts, or transactions to the extent that these documents implicate

the Act or Commission regulations under the Act.

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

\847\ See, e.g., Swap Data Repositories: Registration Standards,

Duties and Core Principles, 76 FR 54538, 54584 (Sept. 1, 2011)

(stating that the duties of an SDR's CCO include ``[t]aking

reasonable steps to ensure compliance with the Act and Commission

regulations . . .''); Derivatives Clearing Organization General

Provisions and Core Principles, 76 FR 69334, 69434 (Nov. 8, 2011)

(stating that the duties of a DCO's CCO include ``[t]aking

reasonable steps to ensure compliance with the Act and Commission

regulations . . .'').

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

In order to clarify differences between the SEF NPRM's preamble and

rule text regarding proposed Sec. 37.1501(d)(7), the Commission is

revising the rule to state that the CCO's duties include

``[e]stablishing and administering a compliance manual designed to

promote compliance with the applicable laws, rules, and regulations . .

.'' (emphasis added). The Commission also disagrees with CME and WMBAA

that the requirements in proposed Sec. 37.1501(d)(6), (d)(8), and

(d)(9) are functions of management. These provisions, as discussed

above, require a CCO to establish and follow appropriate procedures

regarding noncompliance issues, supervise the SEF's self-regulatory

program, and supervise the effectiveness and sufficiency of any

regulatory service provider. As noted above, the Commission disagrees

with the commenters who believe that a CCO's function is solely to

monitor and advise on compliance issues. Finally, the Commission is

revising proposed Sec. 37.1501(d)(9) to remove the references to

``registered futures association'' and ``other registered entity'' and,

instead, adding a reference to ``regulatory service provider'' given

the inclusion of FINRA as a regulatory service provider under Sec.

37.204.

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

\848\ The Commission is renaming the title of this section from

``Annual Compliance Report Prepared by Chief Compliance Officer'' to

``Preparation of Annual Compliance Report.''

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

(5) Sec. 37.1501(e)--Annual Compliance Report Prepared by Chief

Compliance Officer \848\

Proposed Sec. 37.1501(e) generally enumerated the following

information that must be included in the annual compliance report: (1)

A description of the SEF's written policies and procedures, including

the code of ethics and conflicts of interest policies; (2) a detailed

review of the SEF's compliance with CEA section 5h and Commission

regulations, which, among other requirements, identifies the policies

and procedures that ensure compliance with the core principles; (3) a

list of any material changes to the compliance policies and procedures

since the last annual compliance report; (4) a description of staffing

and resources set aside for the SEF's compliance program; (5) a

description of any material compliance matters, including instances of

noncompliance; (6) any objections to the annual compliance report by

those persons who have oversight responsibility for the CCO; and (7) a

certification by the CCO that, to the best of his or her knowledge and

reasonable belief, and under penalty of law, the annual compliance

report is accurate and complete.

(i) Summary of Comments

FXall and CME asserted that the information required to be included

in the annual compliance report is too detailed.\849\ FXall, for

example, commented that the requirements for the annual compliance

report go beyond those set forth in the Dodd-Frank Act and that

producing the report will consume considerable resources.\850\ FXall

proposed alternative requirements, which it believes would be more in-

line with the requirements in the Dodd-Frank Act.\851\

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

\849\ FXall Comment Letter at 16-17 (Mar. 8, 2011); CME Comment

Letter at 7-8 (Feb. 7, 2011).

\850\ FXall Comment Letter at 16 (Mar. 8, 2011).

\851\ See id. for details regarding FXall's proposed

alternatives.

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

With respect to the requirement in proposed Sec. 37.1501(e)(2)(i)

to identify policies and procedures that ``ensure'' compliance with the

core principles, FXall and CME stated that policies and procedures

cannot ``ensure'' or guaranty compliance, but can only be reasonably

designed to result in compliance.\852\ CME also recommended that the

requirement in proposed Sec. 37.1501(e)(5) to describe any material

compliance matters be revised to require the report to identify ``any

material non-compliance issues that were not properly addressed.''

\853\ MarketAxess recommended that the Commission remove proposed Sec.

37.1501(e)(6) because in its opinion other persons should be able to

correct the CCO's annual report.\854\

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

\852\ FXall Comment Letter at 17 (Mar. 8, 2011); CME Comment

Letter at 7 (Feb. 7, 2011).

\853\ CME Comment Letter at 7-8 (Feb. 7, 2011).

\854\ MarketAxess Comment Letter at 26 (Mar. 8, 2011).

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

MarketAxess and FSR expressed their concern that the CCO's

certification of the annual compliance report in proposed Sec.

37.1501(e)(7) may impose strict liability on a CCO where the report

contains even a minor and insignificant error.\855\ These commenters

recommended adding a materiality qualifier to the certification.\856\

Additionally, both FXall and CME recommended that the SEF's senior

officer, not the CCO, certify the accuracy of the annual compliance

report.\857\

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

\855\ MarketAxess Comment Letter at 26 (Mar. 8, 2011); FSR

Comment Letter at 10 (Mar. 8, 2011).

\856\ Id.

\857\ FXall Comment Letter at 15 (Mar. 8, 2011); CME Comment

Letter at 8 (Feb. 7, 2011).

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

(ii) Commission Determination

The Commission is adopting Sec. 37.1501(e) as proposed, subject to

certain modifications described below. The Commission disagrees with

the comments from FXall and CME regarding the complexity and the burden

of the annual compliance report. The annual compliance report is meant

to provide the Commission with a detailed account of a SEF's compliance

with the CEA and Commission regulations, as well as a detailed account

of a SEF's self-regulatory program. The Commission believes that the

level of detail the proposed rules require, including the requirement

that the annual report include a description of all noncompliance

issues identified, is necessary to ensure that the Commission can

determine the effectiveness of a SEF's compliance and self-regulatory

programs.\858\

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

\858\ In this regard, the Commission disagrees with CME's

recommendation regarding proposed Sec. 37.1501(e)(5).

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

However, in response to comments, the Commission is revising

proposed Sec. 37.1501(e)(2)(i) to require that the annual compliance

report identify ``the policies and procedures that are designed to

ensure compliance with each subsection and core principle, including

each duty specified in section 5h(f)(15)(B) of the Act . . .''

(emphasis added). The Commission is also removing proposed Sec.

37.1501(e)(6), which requires the annual compliance report to include

any objections by

[[Page 33547]]

those persons who oversee the CCO.\859\ The Commission believes that

the board of directors \860\ may append its own comments if desired,

but the statutory text and the Commission's implementing regulations do

not require it.

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

\859\ As a result of this deletion, the Commission is adopting

proposed Sec. 37.1501(e)(7) as Sec. 37.1501(e)(6).

\860\ If a SEF does not have a board of directors, then the

senior officer of the SEF may append his or her own comments if

desired.

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

The Commission disagrees with the comments from MarketAxess and FSR

regarding the inclusion of a materiality qualifier to the certification

requirement. The Commission believes that the current certification

sufficiently protects the CCO from being held strictly liable for any

minor inaccuracies because it includes a ``knowledge'' and ``reasonable

belief'' qualifier. The Commission also disagrees with CME's and

FXall's comments to have the SEF's CEO, instead of the CCO, certify the

accuracy of the annual compliance report. While the CEA does not

explicitly require that the CCO certify the report, it does require

that the CCO ``annually prepare and sign'' the report, and that the

report ``include a certification that, under penalty of law, the

compliance report is accurate and complete.'' \861\ The Commission

believes that these two requirements read together provide sufficient

basis for the CCO to certify that the report is accurate and complete.

However, the Commission is modifying Sec. 37.1501(e) to explicitly

state that the CCO ``sign'' the annual compliance report in order to

follow the statutory text more closely.

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

\861\ CEA section 5h(f)(15)(D); 7 U.S.C. 7b-3(f)15)(D).

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

(6) Sec. 37.1501(f)--Submission of Annual Compliance Report by Chief

Compliance Officer to the Commission \862\

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

\862\ The Commission is renaming the title of this section from

``Submission of Annual Compliance Report by Chief Compliance Officer

to the Commission'' to ``Submission of Annual Compliance Report.''

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

Proposed Sec. 37.1501(f)(1) required, among other items, that the

CCO provide the annual compliance report to the board of directors or

the senior officer for review, prior to submission to the Commission.

The proposed rule also stated that the board of directors or the senior

officer may not require the CCO to make any changes to the report.

Proposed Sec. 37.1501(f)(2) required that the annual compliance report

be electronically provided to the Commission not more than 60 days

after the end of the SEF's fiscal year. Proposed Sec. 37.1501(f)(3)

required the CCO to promptly file an amendment to an annual compliance

report upon discovery of any material error or omission. Proposed Sec.

37.1501(f)(4) allowed a SEF to request an extension of time to file its

compliance report based on substantial, undue hardship. Finally,

proposed Sec. 37.1501(f)(5) stated that annual compliance reports will

be treated as exempt from mandatory public disclosure for purposes of

FOIA \863\ and the Sunshine Act \864\ and parts 145 and 147 of the

Commission's regulations.

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

\863\ 5 U.S.C. 552.

\864\ 5 U.S.C. 552b(b).

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

(i) Summary of Comments

Some commenters stated that proposed Sec. 37.1501(f)(1) should be

modified to allow the board of directors or the senior officer to make

changes to the annual compliance report.\865\ These commenters

generally argued that the CCO should be accountable to management and,

by not permitting the board of directors or the senior officer to

revise the report, the proposed rule undermines the authority of the

board of directors.\866\ Better Markets recommended that the CCO should

be required to present his or her finalized report to the board of

directors and executive management prior to its submission.\867\ Better

Markets further recommended that the independent directors and/or the

Audit Committee, as well as the entire board of directors, review and

approve the report or detail where and why it disagrees with any

provision before submission to the Commission.\868\

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

\865\ FXall Comment Letter at 17-18 (Mar. 8, 2011); WMBAA

Comment Letter II at 7 (Mar. 8, 2011); MarketAxess Comment Letter at

26 (Mar. 8, 2011).

\866\ Id.

\867\ Better Markets Comment Letter at 20 (Mar. 8, 2011).

\868\ Id.

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

With respect to proposed Sec. 37.1501(f)(5), CME recommended that

the Commission expressly state that annual compliance reports are

confidential documents that are not subject to public disclosure by

listing such reports as a specifically exempt item in Commission

regulation 145.5.\869\

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

\869\ CME Comment Letter at 9 (Feb. 7, 2011).

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

(ii) Commission Determination

The Commission is adopting Sec. 37.1501(f) as proposed, subject to

two modifications described below. The Commission has determined not to

adopt the commenters' recommendation to allow the board of directors or

the senior officer to make changes to the annual compliance report. The

Commission believes that allowing the board of directors or the senior

officer to make changes to the report would prevent the CCO from making

a complete and accurate assessment of a SEF's compliance program. The

Commission has determined not to adopt the recommendation by Better

Markets that the board of directors approve the annual compliance

report or detail any disagreement. The Commission believes that

requiring the board of directors to approve the report increases the

risk that the CCO would be subject to undue influence by the board or

by management. The Commission notes that the board of directors may

include its own opinion of the annual compliance report if it disagrees

with the CCO's assessment. The Commission believes that the rule

strikes the appropriate balance between ensuring that the board of

directors cannot adversely influence the content of the annual

compliance report and granting the board the opportunity to express its

opinion of the report to the Commission.

The Commission is revising proposed Sec. 37.1501(f)(2) to clarify

that a SEF shall submit its annual compliance report to the Commission

concurrently with the SEF's filing of its fourth fiscal quarter

financial report pursuant to Sec. 37.1306. The Commission is making

this technical correction because CEA section 5h(f)(15)(D)(ii) sets

forth such a requirement, which was inadvertently omitted from the

proposed rules.\870\

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

\870\ CEA section 5h(f)(15)(D)(ii); 7 U.S.C. 7b-3(f)(15)(D)(ii).

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

Additionally, the Commission is withdrawing proposed Sec.

37.1501(f)(5). The Commission acknowledges CME's concern regarding the

public release of annual compliance reports and clarifies that the

Commission does not intend to make annual compliance reports public.

However, where such information is, in fact, confidential, the

Commission encourages SEFs to submit a written request for confidential

treatment of such filings under FOIA, pursuant to the procedures

established in section 145.9 of the Commission's regulations.\871\ The

determination of whether to disclose or exempt such information in the

context of a FOIA proceeding would be governed by the provisions of

part 145 and any other relevant provision.

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

\871\ 17 CFR 145.9.

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

(7) Sec. 37.1501(g)--Recordkeeping

Proposed Sec. 37.1501(g)(1) generally stated that a SEF must

maintain the following records: (i) A copy of written policies and

procedures adopted in furtherance of compliance with the Act and

Commission regulations; (ii) copies

[[Page 33548]]

of all materials created in furtherance of the CCO's duties listed in

paragraphs (d)(6) and (d)(7) of proposed Sec. 37.1501; (iii) copies of

all materials in connection with the review and submission of the

annual compliance report; and (iv) any records relevant to a SEF's

annual report. Proposed Sec. 37.1501(g)(2) required a SEF to maintain

these records in accordance with Sec. 1.31 and part 45 of the

Commission's regulations.

(i) Summary of Comments

MarketAxess commented that the final rule should provide an

exception for legally privileged materials.\872\ MarketAxess argued

that it is unreasonable for the Commission to take the position that a

CCO should not be able to receive privileged advice from counsel in an

effort to comply with these new, complex, and uncertain rules.\873\

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

\872\ MarketAxess Comment Letter at 27 (Mar. 8, 2011).

\873\ Id.

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

(ii) Commission Determination

The Commission is adopting Sec. 37.1501(g) as proposed.\874\ The

Commission does not believe that Sec. 37.1501(g) changes existing

Commission policies regarding the assertion of attorney-client

privilege by registrants. As stated in the SEF NPRM, the Commission

designed Sec. 37.1501(g) to ensure that the Commission staff would be

able to obtain the necessary information to determine whether a SEF has

complied with the CEA and applicable regulations.\875\ The Commission

believes that proposed Sec. 37.1501(g) properly accomplishes this

goal.

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

\874\ The Commission is making certain non-substantive

clarifications to Sec. 37.1501(g). In addition, the Commission is

revising the citation to paragraphs ``(d)(6) and (d)(7)'' in

proposed Sec. 37.1501(g)(1)(ii) to cite to paragraphs ``(d)(8) and

(d)(9).'' The Commission notes that this was a drafting error.

\875\ Core Principles and Other Requirements for Swap Execution

Facilities, 76 FR at 1235.

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

Finally, the Commission is adding new Sec. 37.1501(h) titled

``Delegation of authority'' to the final SEF rules to delegate

authority to the Director of DMO to grant or deny a swap execution

facility's request for an extension of time to file its annual

compliance report under paragraph (f)(4) of Sec. 37.1501.

III. Related Matters

A. Regulatory Flexibility Act

The Regulatory Flexibility Act (``RFA'') \876\ requires federal

agencies, in promulgating regulations, to consider the impact of those

regulations on small entities. The regulations adopted herein will

affect SEFs. The Commission has previously established certain

definitions of ``small entities'' to be used by the Commission in

evaluating the impact of its regulations on small entities in

accordance with the RFA.\877\ In addition, the Commission has

previously determined that DCMs, derivatives transaction execution

facilities (``DTEFs''), exempt commercial markets (``ECMs''), exempt

boards of trade (``EBOTs''), and DCOs are not small entities for the

purpose of the RFA.\878\

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

\876\ 5 U.S.C. 601 et seq.

\877\ See 47 FR 18618-21 (Apr. 30, 1982).

\878\ See 47 FR 18618, 18619 (Apr. 30, 1982) discussing DCMs; 66

FR 42256, 42268 (Aug. 10, 2001) discussing DTEFs, ECMs, and EBOTs;

and 66 FR 45604, 45609 (Aug. 29, 2001) discussing DCOs.

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

While SEFs are new entities to be regulated by the Commission

pursuant to the Dodd-Frank Act,\879\ in the SEF NPRM the Commission

proposed that SEFs should not be considered as small entities for the

purpose of the RFA for essentially the same reasons that DCMs and DCOs

have previously been determined not to be small entities.\880\ The

Commission received no comments on the impact of the rules contained

herein on small entities. Therefore, the Chairman, on behalf of the

Commission, hereby certifies, pursuant to 5 U.S.C. 605(b), that the

regulations will not have a significant economic impact on a

substantial number of small entities.

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

\879\ Dodd Frank Wall Street Reform and Consumer Protection Act,

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

\880\ Core Principles and Other Requirements for Swap Execution

Facilities, 76 FR at 1235.

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

B. Paperwork Reduction Act

The Paperwork Reduction Act (``PRA'') \881\ 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''). This final rulemaking contains new collection of information

requirements within the meaning of the PRA. Accordingly, in connection

with the SEF NPRM, the Commission submitted an information collection

request, titled ``Core Principles and Other Requirements for Swap

Execution Facilities,'' to OMB for its review and approval in

accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11. Additionally,

pursuant to 44 U.S.C. 3506(c)(2)(B), the Commission, in the SEF NPRM,

requested comments from the public on the proposed information

collection requirements in order to, among other items, evaluate the

necessity of the proposed collections of information and minimize the

burden of the information collection requirements on respondents.\882\

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

\881\ 44 U.S.C. 3501 et seq.

\882\ Core Principles and Other Requirements for Swap Execution

Facilities, 76 FR at 1236.

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

On April 28, 2011, OMB assigned control number 3038-0074 to this

collection of information, but withheld final approval pending the

Commission's resubmission of the information collection, which includes

a description of the comments received on the collection and the

Commission's responses thereto. The Commission has revised some of its

proposed estimates of the number of mandatory responses in order to

clarify the Commission's original intent; otherwise, the proposed

burden hour estimates are being adopted as discussed herein. The

Commission has submitted the revised information collection request to

OMB for its review, which will be made available by OMB at http://www.reginfo.gov/public/do/PRAMain.

As noted in the SEF NPRM, 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.'' \883\ The Commission is also required to protect certain

information contained in a government system of records according to

the Privacy Act of 1974.\884\

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

\883\ 7 U.S.C. 12(a)(1).

\884\ 5 U.S.C. 552a.

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

1. Proposed Collection of Information

In the SEF NPRM, the Commission estimated that each SEF respondent

would have an average annual reporting burden of 308 hours.\885\ In

deriving this estimate, the Commission compared the reporting

requirements for other entities that fall under the Commission's

regulatory oversight, such as an Exempt Commercial Market with a

significant price discovery contract (``SPDC ECM''), a DTEF, and a

DCM.\886\ Specifically, the Commission estimated that a SEF will have

more reporting requirements than a SPDC ECM and a DTEF, but fewer

[[Page 33549]]

reporting requirements than a DCM (as most recently calculated).\887\

The Commission employed an average of its most recent hourly burdens

for DCMs, DTEFs, and SPDC ECMs.\888\ Those hourly burdens provided in

the SEF NPRM are noted below:

---------------------------------------------------------------------------

\885\ Core Principles and Other Requirements for Swap Execution

Facilities, 76 FR at 1236.

\886\ Id.

\887\ Id. SPDC ECMs were subject to 9 core principles, DTEFs

were subject to 9 core principles, and DCMs are subject to 23 core

principles. SEFs will be subject to 15 core principles. Id. at 1236

n. 124.

\888\ Id. at 1236.

---------------------------------------------------------------------------

Current estimate of DCM's annual burden: 440 hours per DCM 889

---------------------------------------------------------------------------

\889\ After passage of the Commodity Futures Modernization Act

of 2000 and a switch to the core principles framework for DCMs, the

Commission estimated that the recordkeeping and reporting

obligations imposed by part 38 would total 300 burden hours per DCM.

See A New Regulatory Framework for Trading Facilities,

Intermediaries and Clearing Organizations, 66 FR 42256, 42268 (Aug.

10, 2001); 66 FR 14262, 14268 (proposed Mar. 9, 2001). In 2007, the

Commission amended the acceptable practices in part 38 for

minimizing conflicts of interest, estimating that the amendments

would increase the information collection and reporting burden by an

additional 70 hours per DCM. See Conflicts of Interest in Self-

Regulation and Self-Regulatory Organizations (``SROs''), 72 FR 6936,

6957 (Feb. 14, 2007); 71 FR 38740, 38748 (proposed Jul. 7, 2006).

Most recently, the Commission adopted revisions to part 38 to

implement the Dodd-Frank Act, estimating that the revisions would

increase the information collection and reporting burden by an

additional 70 hours per DCM. See Core Principles and Other

Requirements for Designated Contract Markets, 77 FR 36612, 36662

(Jun. 19, 2012). The average for purposes of the initial burden hour

estimate for SEFs averages both initial estimates for DCMs with the

other most recent estimates.

---------------------------------------------------------------------------

Initial estimate of DTEF's annual burden: 200 hours per DTEF 890

---------------------------------------------------------------------------

\890\ A New Regulatory Framework for Trading Facilities,

Intermediaries and Clearing Organizations, 66 FR at 42268; 66 FR at

14268.

---------------------------------------------------------------------------

Initial estimate of SPDC ECM's annual burden: 233 hours per ECM 891

---------------------------------------------------------------------------

\891\ Significant Price Discovery Contracts on Exempt Commercial

Markets, 74 FR 12178, 12187 (Mar. 23, 2009); 73 FR 75888, 75902

(proposed Dec. 12, 2008).

In the SEF NPRM, the Commission estimated that 30 to 40 SEFs will

register with the Commission as a result of the Dodd-Frank Act.\892\

Therefore, the Commission estimated the annual aggregate hour burden

for all respondents to be 10,780 hours.\893\ Based on an hourly rate of

$52,\894\ the Commission estimated that respondents may expend up to

$16,016 annually to comply with the proposed regulations.\895\ This

would result in an aggregate cost across all SEF respondents of

$560,560 per annum (35 respondents x $16,016).\896\ The SEF NPRM also

provided the following summary of estimates:

---------------------------------------------------------------------------

\892\ Core Principles and Other Requirements for Swap Execution

Facilities, 76 FR at 1236. For hourly reporting requirements, an

average of 35 SEFs was used for calculation purposes. Id. at 1236 n.

125.

\893\ Id. at 1236.

\894\ In arriving at a wage rate for the hourly costs imposed,

the Commission consulted the Management and Professional Earnings in

the Securities Industry Report, published in 2010 by the Securities

Industry and Financial Markets Association (SIFMA Report). The wage

rate is a composite (blended) wage rate arrived at by averaging the

mean annual salaries of an Assistant/Associate General Counsel, an

Assistant Compliance Director, a Senior Programmer, and a Senior

Treasury/Cash Management Manager as published in the SIFMA Report

and dividing that figure by 2,000 annual work hours to arrive at the

hourly rate of $52.

\895\ Core Principles and Other Requirements for Swap Execution

Facilities, 76 FR at 1236.

\896\ Id.

Estimated number of respondents: 35

Annual responses by each respondent: 1

Total annual responses: 35

Quarterly responses by each respondent: 4

Total quarterly responses: 140

Estimated average hours per response: 308

Aggregate annual reporting hours burden: 10,780 897

---------------------------------------------------------------------------

\897\ 308 average hours per respondent x 35 respondents = 10,780

total hours/year. Id.

---------------------------------------------------------------------------

2. Summary of Comments and Commission Response

While no commenter directly addressed the proposed aggregate burden

hour estimate, the Commission did receive comments related to the costs

of various recordkeeping and reporting requirements in the proposed

rules.

(a) Sec. 37.3--Requirements and Procedures for Registration

WMBAA commented that the Commission could reduce the regulatory

burden of the registration procedures by reconciling its Form SEF with

the SEC's registration form such that a potential SEF will have to fill

out only one form.\898\ Similarly, MarketAxess stated that it is costly

and inefficient for a SEF that is required to be registered by both the

Commission and SEC to go through two full registration processes, and

that the Commission instead should permit ``notice'' or ``passport''

registration of an SB-SEF already registered with the SEC.\899\ While

the Commission acknowledges notice registration under section 5h(g) of

the Act, it notes that the registration requirements for SEFs may

differ from the registration requirements for SB-SEFs and thus the

Commission must conduct an independent review of a SEF applicant's

registration application to ensure that the potential SEF's proposed

trading models and operations comply with the Commission's

requirements. Given such differing requirements, the Commission also

notes that Form SEF may differ from the SEC's registration form.

---------------------------------------------------------------------------

\898\ WMBAA Comment Letter at 14 (Mar. 8, 2011).

\899\ MarketAxess Comment Letter at 20-21 (Mar. 8, 2011).

---------------------------------------------------------------------------

With respect to temporary registration, the Commission has

eliminated the requirement from the SEF NPRM that an applicant provide

transaction data that substantiates that the execution or trading of

swaps has occurred and continues to occur on the applicant's trading

system or platform at the time the applicant submits its temporary

registration request. The Commission has also eliminated the

certification requirement that an applicant believes that when it

operates under temporary registration it will meet the requirements of

part 37 of the Commission's regulations. Instead, the Commission has

revised the temporary registration provisions to require a SEF

applicant that is already operating a swaps-trading platform, in

reliance upon either an exemption granted by the Commission or some

form of no-action relief granted by the Commission staff, to include in

the temporary registration notice a certification that it is operating

pursuant to such exemption or no-action relief. The Commission believes

that these revisions will not materially affect the proposed part 37

information collection estimate.

(b) Sec. 37.4--Procedures for Listing Products and Implementing Rules

CME commented that the proposed product and rule certification

process substantially increased the documentation burden, which in turn

would increase the cost and amount of time it takes to list new

products and implement new rules, with no corresponding benefit to the

public.\900\ While CME cited the 8,300 additional aggregate hours that

product and rule submissions were estimated to impose on all registered

entities,\901\ the Commission notes that this figure was already

accounted for in the Commission's information collection estimate in

the part 40 rulemaking titled ``Provisions Common to Registered

Entities.'' \902\ Therefore, the burden

[[Page 33550]]

associated with that information collection is not duplicated here.

---------------------------------------------------------------------------

\900\ CME Comment Letter at 10, 13 (Feb. 22, 2011).

\901\ Id. at 10.

\902\ Provisions Common to Registered Entities, 76 FR 44776,

44789 (Jul. 27, 2011). The Commission also notes that the annual

burden hour estimate for DCMs that was used to calculate the annual

burden hour estimate for SEFs in this part 37 rulemaking did not

include the recordkeeping and reporting hours accounted for in the

part 40 rulemaking's information collection estimate. Therefore,

there is no double counting of hours for product and rule

submissions. Furthermore, the Commission notes that, similar to the

DCM rulemaking, many of the collection burdens associated with this

part 37 rulemaking are covered by other existing or pending

collections of information. Therefore, only those burdens that are

not covered elsewhere are included in this collection of

information.

---------------------------------------------------------------------------

(c) Sec. 37.5(c)--Equity Interest Transfers

CME commented that the ``level of immediacy'' contemplated by the

24-hour timeframe for submitting agreements with the notification to

the Commission of an equity interest transfer in proposed Sec. 37.5(c)

may be unrealistic.\903\ CME further commented that the representation

of compliance with the requirements of CEA section 5h and the

Commission's regulations adopted thereunder would be more appropriate

if required upon consummation of the equity interest transfer, rather

than with the initial notification.\904\ In this final rulemaking, the

Commission has revised proposed Sec. 37.5(c) to remove references to

specific documents that must be provided with the equity transfer

notification, and instead provided that the Commission may request

supporting documentation. The Commission has also revised the proposed

rule to increase the threshold of when a SEF must file an equity

interest transfer notification with the Commission from ten percent to

fifty percent and has extended the time period for a SEF to file the

notification to up to ten business days from one business day under the

proposed rule. In addition, the Commission has deleted the requirement

for a SEF to provide a representation of compliance with section 5h of

the Act and the Commission regulations thereunder with the equity

interest transfer notification, as requested by CME. The Commission

notes that these revisions should slightly reduce the burden of the

information collection requirements for those respondents who are not

requested to provide supporting documentation.

---------------------------------------------------------------------------

\903\ CME Comment Letter at 13 (Feb. 22, 2011).

\904\ Id.

---------------------------------------------------------------------------

(d) Sec. 37.202(b)--Jurisdiction

CME stated that it would be costly for a SEF to obtain every

customer's consent to its regulatory jurisdiction as required by

proposed Sec. 37.202(b).\905\ As noted in the preamble, the Commission

believes that jurisdiction must be established by a SEF prior to

granting members and market participants access to its markets in order

to effectuate the statutory mandate of Core Principle 2 that a SEF

shall have the capacity to detect, investigate, and enforce rules of

the SEF. The Commission notes that any information collection costs

associated with this rule is covered by the Commission's information

collection estimate.

---------------------------------------------------------------------------

\905\ Id. at 16.

---------------------------------------------------------------------------

(e) Sec. 37.203(f)--Investigations and Investigation Reports

CME stated that minor transgressions could be handled effectively

through the issuance of a warning letter rather than a formal

investigatory report.\906\ As explained in the preamble, the Commission

clarifies that warning letters may be issued for minor transgressions;

however, no more than one warning letter may be issued to the same

person or entity found to have committed the same rule violation more

than once within a rolling 12-month period. The Commission also

clarifies that the limit on the number of warning letters is not

applicable when a rule violation has not been found. The Commission

believes that these clarifications will not materially affect the

proposed part 37 information collection estimate.

---------------------------------------------------------------------------

\906\ Id. at 22.

---------------------------------------------------------------------------

(f) Sec. 37.205--Audit Trail

WMBAA commented that the proposed audit trail requirement in Sec.

37.205(b) to retain records of customer orders should not apply to

indicative quotes because it would be burdensome and costly.\907\ As

discussed in the preamble, the Commission believes that this

requirement is necessary so that a SEF has a complete picture of all

trading activity in order to carry out its statutory mandate to monitor

its markets to detect abusive trading practices and trading rule

violations. The Commission accounted for this recordkeeping requirement

in the proposed burden hour estimate; therefore, the estimate remains

unaffected.

---------------------------------------------------------------------------

\907\ WMBAA Comment Letter at 23 (Mar. 8, 2011).

---------------------------------------------------------------------------

(g) Sec. 37.404--Ability to Obtain Information

WMBAA commented that the requirement for SEFs to mandate that

traders maintain trading and financial records is not required under

the Act.\908\ The Commission notes that market participants' trading

records are an invaluable tool in its surveillance efforts and believes

that a SEF should have direct access to such information in order to

discharge its obligations under the SEF core principles. However, as

noted in the preamble, the Commission states in the guidance that SEFs

may limit the application of this requirement to those market

participants who conduct substantial trading on their facility. The

Commission notes that the requirement for market participants to keep

such records is sound commercial practice, and that market participants

are likely already maintaining such trading records; therefore, the

Commission believes that the revision above will not materially affect

the proposed part 37 information collection estimate.

---------------------------------------------------------------------------

\908\ Id. at 26.

---------------------------------------------------------------------------

(h) Sec. 37.703--Monitoring for Financial Soundness

FXall commented that SEFs would be burdened by the ``onerous

financial surveillance obligations'' of proposed Sec. 37.703, which

include the routine review of members' financial records.\909\ The

Commission agrees that burdensome financial surveillance obligations

may lead to higher transaction costs; therefore, as discussed in the

preamble, the Commission has revised the proposed rule to state that

SEFs must monitor their market participants to ensure that they

continue to qualify as ECPs. The Commission believes that this revision

will not materially affect the proposed part 37 information collection

estimate and is thus maintaining the estimate.

---------------------------------------------------------------------------

\909\ FXall Comment Letter at 3 (Mar. 8, 2011).

---------------------------------------------------------------------------

(i) Sec. 37.1306--Financial Resources Reporting to the Commission

MarketAxess commented that the financial resources reporting

requirements are unnecessary and burdensome and recommended that the

Commission allow a senior officer of the SEF to represent to the

Commission that it satisfies the financial resources requirements.\910\

The Commission disagrees with MarketAxess and, as discussed in the

preamble, believes that much of the information required by the reports

should be readily available to a SEF in the ordinary course of

business. The Commission's proposed burden hour estimate includes this

reporting requirement.

---------------------------------------------------------------------------

\910\ MarketAxess Comment Letter at 40 (Mar. 8, 2011).

---------------------------------------------------------------------------

(j) Sec. 37.1401--System Safeguards Requirements

CME commented that the requirements to notify the Commission staff

of all system security-related events and all planned changes to

automated systems that may impact the reliability, security, or

scalability of the systems are overly burdensome.\911\ As noted in the

preamble, the Commission has revised the rule to only require

notification of material system malfunctions and material planned

system changes. While

[[Page 33551]]

these revisions should decrease the regulatory burden imposed by the

rule, the Commission believes that, given the infrequent nature of the

information collection requirement as originally proposed, the effect

of the revisions should be de minimis and therefore not affect the

proposed burden hour estimate.

---------------------------------------------------------------------------

\911\ CME Comment Letter at 36-37 (Feb 22, 2011).

---------------------------------------------------------------------------

(k) Sec. 37.1501(e)--Preparation of Annual Compliance Report

FXall commented that the information required by the proposed

regulations to be included in the annual compliance report is too

detailed and will be too costly to compile.\912\ The Commission is not

persuaded by FXall's comment, and notes that the annual compliance

report is meant to be the primary tool by which the Commission can

evaluate the effectiveness of a SEF's compliance and self-regulatory

programs, thus requiring a high level of detail. The Commission's

proposed burden hour estimate includes the annual compliance report

requirement.

---------------------------------------------------------------------------

\912\ FXall Comment Letter at 16 (Mar. 8, 2011).

---------------------------------------------------------------------------

3. Final Burden Estimate

The final regulations require each respondent to file information

with the Commission. For instance, SEF applicants must file

registration applications with the Commission pursuant to Sec. 37.3.

SEFs must record, report, and disclose information related to prices,

trading volume, and other trading data for swaps pursuant to Core

Principles 9 and 10 (``Timely Publication of Trading Information'' and

``Recordkeeping and Reporting''). In general, the collections of

information are required to demonstrate a SEF's operational capability

and are a tool by which both the SEF and the Commission can evaluate

the effectiveness of a SEF's self-regulatory programs.

The mandatory information collections are contained in several of

the general provisions being adopted in subpart A, as well as in

certain regulations implementing Core Principles 2, 3, 4, 5, 7, 8, 9,

10, 13, 14, and 15. Generally, the information collections covered in

this final part 37 rulemaking are not covered in other existing

collections or collections that are being established in connection

with other Dodd-Frank rulemakings, and pertain to the following general

categories of recordkeeping and reporting: registration; submissions

related to material changes in the SEF's operations or business

structure; compliance; financial resources reports, and an annual

report by the CCO related to the SEF's performance of its self-

regulatory responsibilities.

As discussed above, the methodology used to formulate the proposed

estimate was an average of other registered entities. Due to the

relatively low magnitude of changes made to the mandatory information

collection provisions in this final part 37 rulemaking, the Commission

has determined not to alter its proposed estimate of 308 hours per SEF

respondent. By definition, averages are meant to serve as only a

reference point; the Commission understands that due to both

discretionary and mandatory requirements, some SEFs may go above the

final estimate of 308 hours to complete mandatory information

collection requirements, while others may stay below. The Commission

is, however, adjusting the proposed estimate of annual and quarterly

responses to clarify the Commission's original intent. In this regard,

the Commission is adding an estimated average hours per response number

below, which is based on 5 responses per year (1 annual response and 4

quarterly responses) per respondent.

Estimated number of respondents: 35

Annual responses by each respondent: 1 \913\

---------------------------------------------------------------------------

\913\ Under Sec. 37.1501, the SEF's CCO is required to submit

to the Commission annually a compliance report.

---------------------------------------------------------------------------

Total annual responses: 35

Quarterly responses by each respondent: 1 \914\

---------------------------------------------------------------------------

\914\ Under Sec. 37.1306, a SEF is required to submit to the

Commission each fiscal quarter a report of its financial resources

available to meet the financial resources requirements of Core

Principle 13.

---------------------------------------------------------------------------

Total quarterly responses: 140 \915\

---------------------------------------------------------------------------

\915\ 1 quarterly response x 4 quarters per year x 35

respondents.

---------------------------------------------------------------------------

Estimated average hours per response: 62 \916\

---------------------------------------------------------------------------

\916\ 308 average burden hours per respondent/5 responses total

per year (1 annual response and 4 quarterly responses) = 61.6

average hours per response.

---------------------------------------------------------------------------

Aggregate annual reporting hours burden: 10,780

Therefore, the Commission estimates that based on 35 registered

SEFs, this final part 37 rulemaking will result in 10,780 information

collection hours across all respondents.\917\

---------------------------------------------------------------------------

\917\ 5 responses total per year x 61.6 average hours per

response x 35 respondents.

---------------------------------------------------------------------------

4. Aggregate Information Burden

The Commission concludes that new information collection 3038-0074

will result in each SEF respondent expending, on average, $16,632

annually based on an hourly wage rate of $54 to comply with the

recordkeeping and reporting requirements of this final part 37

rulemaking.\918\ In aggregate, this will result in a cost to all SEF

respondents of $582,120 per annum based on 35 expected respondents.

This aggregate cost estimate has been adjusted from the estimate in the

SEF NPRM to account for updated wage rate data.\919\

---------------------------------------------------------------------------

\918\ See supra footnote 894 for a discussion of the wage rate.

The Commission has revised the wage rate to $54 per hour based on

data from the 2011 SIFMA Report.

\919\ While the Commission recognizes that some estimates cited

in the following cost-benefit consideration section suggest that

reporting and recordkeeping requirements may result in a much higher

aggregate cost to SEFs and market participants, it notes that all of

the estimates provided therein account for more than pure

recordkeeping and reporting costs subject to the PRA. Therefore, the

Commission has not considered those estimates for purposes of

reaching its final burden hour estimate and aggregate cost

projection.

---------------------------------------------------------------------------

C. Cost Benefit Considerations

1. Introduction

Section 15(a) of the Commodity Exchange Act (``CEA'' or ``Act'')

mandates that the Commodity Futures Trading Commission (``Commission''

or ``CFTC'') consider the costs and benefits of the regulations that it

is adopting in this rulemaking to implement the statutory requirements

for the registration and operation of swap execution facilities

(``SEFs''), a new type of regulated marketplace for the trading and

execution of financial derivative contracts known as swaps.\920\ In

considering the costs and benefits of the final SEF regulations, the

Commission has grouped the same into the following categories--SEF

Market Structure, Registration, Recordkeeping and Reporting,

Compliance, Monitoring and Surveillance, Financial Resources and

Integrity, and Emergency Operations and System Safeguards.

---------------------------------------------------------------------------

\920\ CEA section 15(a); 7 U.S.C. 19(a). A more complete

explanation of this statutory requirement is provided below. See

infra section 1(b) of this Cost Benefit Considerations section.

Swaps, futures, and options are collectively referred to as

derivatives--contracts used by market participants to hedge against

the risk of a future change in prices, such as commodity prices,

interest rates, and exchange rates.

---------------------------------------------------------------------------

Several preliminary matters, however, provide background for the

Commission's consideration of the costs and benefits of the rules

adopted in this release. Discussed in this Introduction section, these

preliminary matters are: (a) The circumstances and events that form the

backdrop for the statutory requirements that this rulemaking

implements; (b) the Commission's statutory mandate to consider costs

and benefits and its methodology for doing so; and (c) the estimated

aggregate costs of forming and operating a SEF.

[[Page 33552]]

(a) Background

An appreciation of certain background elements is helpful to

understand the costs and benefits of this rulemaking. These are: (i)

The definition of the derivative financial transactions (i.e., swaps)

that will be executed on SEFs; (ii) the execution and regulation of

swaps prior to the Dodd-Frank Act; (iii) the 2008 financial crisis and

the role of the over-the-counter (``OTC'') swaps market; (iv) the new

regulatory regime to reform the swaps market in Title VII of the Dodd-

Frank Act; and, more specifically, (v) the role and purpose of SEFs

within the Title VII regulatory regime. Each of these background

elements is discussed below.

(1) The Definition of a Swap

Congress defined the term ``swap'' in the Dodd-Frank Act.\921\ The

statutory definition of the term ``swap'' includes, in part, any

agreement, contract, or transaction ``that provides for any purchase,

sale, payment, or delivery (other than a dividend on an equity

security) that is dependent on the occurrence, nonoccurrence, or the

extent of the occurrence of an event or contingency associated with a

potential financial, economic, or commercial consequence.'' \922\ The

statutory definition, among other things, generally includes options

(other than options on futures) as well as transactions that now or in

the future are commonly known to the trade as swaps.\923\ The

definition also articulates a broad range of underlying interests upon

which a swap may be based: ``1 or more interest or other rates,

currencies, commodities, securities, instruments of indebtedness,

indices, quantitative measures, or other financial or economic

interests or property of any kind . . .'' \924\ or ``the occurrence,

nonoccurrence, or the extent of the occurrence of any event or

contingency associated with a potential financial, economic, or

commercial consequence.'' \925\ In a joint rulemaking with the

Securities and Exchange Commission (``SEC''), the Commission also

adopted rules further defining the term ``swap.'' \926\

---------------------------------------------------------------------------

\921\ See Dodd-Frank Act section 721(a)(21), adding CEA section

1a(47). 7 U.S.C. 1a(47).

\922\ CEA section 1a(47)(A)(ii); 7 U.S.C. 1a(47)(A)(ii).

\923\ CEA section 1a(47)(A)(i) & (iv); 7 U.S.C. 1a(47)(A)(i) &

(iv). Futures are not within the definition of swap and remain

separately subject to requirements of the CEA. See CEA section

1a(47)(B)(i); 7 U.S.C. 1a(47)(B)(i).

\924\ CEA section 1a(47)(A)(i) & (iii); 7 U.S.C. 1a(47)(A)(i) &

(iii).

\925\ CEA section 1a(47)(A)(ii); 7 U.S.C. 1a(47)(A)(ii).

\926\ See Further Definition of ``Swap,'' ``Security-Based

Swap,'' and ``Security-Based Swap Agreement''; Mixed Swaps;

Security-Based Swap Agreement Recordkeeping, 77 FR 48208 (Aug. 13,

2012).

---------------------------------------------------------------------------

(2) The Execution and Regulation of Swaps Prior to the Dodd-Frank Act

Unlike futures contracts which are regulated by the Commission and

are listed for trading on exchanges called designated contract markets

(``DCMs''), swap transactions (excluding some exchange-traded options

encompassed by the post-Dodd-Frank Act definition) evolved off-

exchange--largely to provide customized solutions for unique risk

management needs that exchange-traded products addressed less

effectively--lending themselves to the often used label of ``OTC

derivatives.'' Accordingly, many swap transactions prior to the Dodd-

Frank Act were negotiated privately OTC between counterparties.\927\ In

these situations, only the counterparties knew that the swap

transaction was taking place, and regulators and other market

participants lacked access to pricing information during the

negotiation phase (pre-trade) and after the agreement was consummated

(post-trade). While centralized exchanges permit multiple market

participants to compare, assess, accept, or reject bids (offers to buy)

and asks (offers to sell), the privately negotiated OTC market provided

little, if any, pre- or post-trade transparency.\928\

---------------------------------------------------------------------------

\927\ The Commission notes that privately negotiated swap

transactions between counterparties is only one method to execute or

trade a swap transaction in the OTC market. Counterparties in the

OTC market may execute or trade swap transactions through many

trading methods such as order books, RFQ systems, or systems that

incorporate electronic and voice components.

\928\ Absent a centralized trading mechanism such as a limit

order book, buyers and sellers ``negotiated terms privately, often

in ignorance of prices currently available from other potential

counterparties and with limited knowledge of trades recently

negotiated elsewhere in the market. OTC markets are thus said to be

relatively opaque; investors are somewhat in the dark about the most

attractive available terms and conditions and about whom to contact

for attractive terms.'' Darrell Duffie, Dark Markets: Asset Pricing

and Information Transmission in Over-the-Counter Markets 1

(Princeton University Press) (2012).

---------------------------------------------------------------------------

In a typical privately negotiated OTC swap transaction, a customer

for a swap is likely to obtain a private quote from, and bilaterally

negotiate contract terms with, one of a small number of market-making

dealers. These dealers, often large financial institutions, may stand

ready to take either a long position (if they want to buy) or a short

position (if they want to sell), profiting from spreads (the difference

between the bid and the offer price) and fees. Relative to their non-

dealer (usually ``buy-side'') counterparties, these dealers enjoy

asymmetric information advantages.\929\ The Commodity Futures

Modernization Act of 2000 (``CFMA'')--which largely excluded swaps

transacted between ``eligible contract participants'' \930\ from

regulation under the CEA--reinforced this outcome.\931\ Swaps remained

largely insulated from regulation prior to the enactment of the Dodd-

Frank Act.\932\

---------------------------------------------------------------------------

\929\ Asymmetric information exists when one party to a

transaction has more or better information than the other. In the

context of the swaps market, as dealers are always on one side of a

large fraction of trades, it is highly likely that they will have

better information on prevailing market conditions and valuations

compared to their non-dealer counterparties. See Michael Fleming,

John Jackson, Ada Li, Asani Sarkar & Patricia Zobel, ``An Analysis

of OTC Interest Rate Derivatives Transactions: Implications for

Public Reporting,'' Federal Reserve Bank of New York Staff Reports,

No. 557, at 6 n. 14 (Mar. 2012), available at http://www.newyorkfed.org/research/staff_reports/sr557.pdf. Major

derivatives dealer activity accounts for 89% of the total interest

rate swap activity in notional terms. Id.

\930\ CEA section 1a(18); 7 U.S.C. 1a(18).

\931\ Under the CFMA, prior to the adoption of Title VII of the

Dodd-Frank Act, swaps based on exempt commodities--including energy

and metals--could be traded among eligible contract participants

without CFTC regulation, but certain CEA provisions against fraud

and manipulation continued to apply to these markets. No statutory

exclusions were provided for swaps on agricultural commodities by

the CFMA, although they could be traded under certain regulatory

exemptions provided by the CFTC prior to its enactment. Swaps based

on securities were subject to certain SEC enforcement authorities,

but the SEC was prohibited from prophylactic regulation of such

swaps. See Commodity Futures Modernization Act of 2000, Pub. L. 106-

554, 114 Stat. 2763 (2000). The Financial Crisis Inquiry Commission

majority found that the CFMA ``effectively shielded OTC derivatives

from virtually all regulation or oversight,'' and ``OTC derivatives

markets boomed'' in the law's wake, increasing ``more than

sevenfold'' after the CFMA was enacted. See The Financial Crisis

Inquiry Commission, The Financial Crisis Inquiry Report: Final

Report of the National Commission on the Causes of the Financial and

Economic Crisis in the United States (Official Government Edition),

at 48, 364 (2011) (hereinafter the ``FCIC Report''), available at

http://www.gpo.gov/fdsys/pkg/GPO-FCIC/pdf/GPO-FCIC.pdf.

\932\ Legislative history indicates that in enacting the Dodd-

Frank Act, Congress recognized that OTC market opacity, combined

with the availability of superior price information primarily to

dealers, limited the ability of swaps customers ``to shop for the

best price or rate.'' See Mark Jickling & Kathleen Ann Ruane, ``The

Dodd-Frank Wall Street Reform and Consumer Protection Act: Title

VII, Derivatives,'' Cong. Research Serv., R41398, at 7 (Aug. 30,

2010). See also S. Rep. No. 111-176, at 30 (2010) (``Information on

[OTC derivative contract] prices and quantities is opaque. . . .

This can lead to inefficient pricing and risk assessment for

derivatives users and leave regulators ill-informed about risks

building up throughout the financial system''). Ben Bernanke,

Chairman of the Board of Governors of the Federal Reserve System,

stated, ``[a]t times [during the crisis], the complexity and

diversity of derivatives instruments also posed problems. Financial

firms sometimes found it quite difficult to fully assess their own

net derivatives exposures or to communicate to counterparties and

regulators the nature and extent of those exposures. The associated

uncertainties helped fuel losses of confidence that contributed

importantly to the liquidity problems I mentioned earlier. The

recent legislation addresses these issues by requiring that

derivatives contracts be traded on exchanges or other regulated

trading facilities when possible and that they be centrally

cleared.'' ``Too Big To Fail: Expectations and Impact of

Extraordinary Government Intervention and the Role of Systemic Risk

in the Financial Crisis: Hearing Before the Financial Crisis Inquiry

Commission,'' 11 (Sep. 2, 2010) (statement of Ben Bernanke,

Chairman, Board of Governors of the Federal Reserve System),

available at http://fcic-static.law.stanford.edu/cdn_media/fcic-testimony/2010-0902-Bernanke.pdf.

---------------------------------------------------------------------------

[[Page 33553]]

From these beginnings, the unregulated swaps market has expanded

exponentially over the last thirty years. According to the Bank for

International Settlements (``BIS''), the global OTC derivatives market

measures at over $647 trillion in notional size.\933\

---------------------------------------------------------------------------

\933\ The Bank for International Settlements, Quarterly Review,

at A 131 (Sep. 2012), available at http://www.bis.org/statistics/otcder/dt1920a.pdf.

---------------------------------------------------------------------------

(3) The 2008 Financial Crisis and the Role of the OTC Swaps Market

In the fall of 2008, the United States experienced a financial

crisis that led to millions of Americans losing their jobs, millions of

families losing their homes, and thousands of small businesses closing

their doors. The BIS characterized 2008 as a year that escalated for

``what many had hoped would be merely . . . manageable market turmoil

[to] a full-fledged global crisis.'' \934\ Faced with what policy

makers at the time perceived as a grave threat that without immediate

and unprecedented government action U.S. and global credit markets

would freeze, the federal government mounted an extraordinary

intervention at great cost to the American taxpayer to buttress the

stability of the U.S. financial system.

---------------------------------------------------------------------------

\934\ The Bank for International Settlements, 79th Annual

Report, at 23 (2009), available at http://www.bis.org/publ/arpdf/ar2009e2.pdf, for a broader discussion of the development of the

crisis.

---------------------------------------------------------------------------

While there were multiple causes of the financial crisis,

unregulated swaps played an important role. Swaps contributed

significantly to the interconnectedness between banks, investment

banks, hedge funds, and other financial entities. As the swaps market

grew, additional participation added risk to the already highly-

leveraged and interconnected market. Accordingly, swaps concentrated

and heightened risks in the financial system and to the public.

The crisis elevated concern among regulators that the opaque

structure of the OTC swaps market and the consequent lack of

information about swap prices and quantities would hinder efficient

pricing, and that the lack of information about outstanding positions

and exposures could ``leave regulators ill-informed about the risks

building up in the financial system. . . . Lack of transparency in the

massive OTC market intensified systemic fears during the crisis about

interrelated derivatives exposures from counterparty risk.'' \935\ As

regulators did not have a clear view into how OTC derivatives were

being used, they also feared that ``the complexity and limited

transparency of the market reinforced the potential for excessive risk-

taking. . . .'' \936\

---------------------------------------------------------------------------

\935\ S. Rep. No. 111-176, at 30 (2010).

\936\ See Darrell Duffie, Ada Li & Theo Lubke, ``Policy

Perspectives on OTC Derivatives Market Infrastructure,'' Federal

Reserve Bank of New York Staff Reports, No. 424, at 1 (Mar. 2010),

available at http://www.newyorkfed.org/research/staff_reports/sr424.pdf.

---------------------------------------------------------------------------

(4) The New Regulatory Regime To Reform the Swaps Market in Title VII

of the Dodd-Frank Act

On July 21, 2010, President Obama signed the Dodd-Frank Act into

law. Title VII of the Dodd-Frank Act established a comprehensive new

regulatory framework for swaps and charged the Commission and the SEC

with oversight of the more than $300 trillion domestic swaps

market.\937\ The legislation was enacted, among other reasons, to

promote market integrity within the financial system, reduce risk, and

increase transparency, including by: (i) Providing for the registration

and comprehensive regulation of swap dealers and major swap

participants; (ii) imposing clearing and trade execution requirements

on swaps; (iii) creating a rigorous recordkeeping and real-time

reporting regime; and (iv) enhancing the rulemaking and enforcement

authority of the Commission with respect to, among others, all

registered entities, including SEFs. These various elements work in

concert to provide the Commission with a comprehensive view of the

entire swaps market, furthering the Commission's ability to monitor the

market. Consistent with the view that the vulnerability of the OTC

derivatives market during the financial crisis was not attributable to

a single weakness, but a combination of several,\938\ Title VII does

not provide for a single-dimensional fix. Rather, it weaves together a

multidimensional regulatory construct designed to ``mitigate costs and

risks to taxpayers and the financial system.'' \939\

---------------------------------------------------------------------------

\937\ See Section 733 of the Dodd-Frank Act, which adopted CEA

section 5h regarding registration, operation, and compliance

requirements for SEFs. 7 U.S.C. 7b-3. See also Section 723(a)(3) of

the Dodd-Frank Act, which amended CEA section 2(h) to add CEA

section 2(h)(8) setting forth a trade execution requirement. 7

U.S.C. 2(h)(8). Similarly, the Dodd-Frank Act authorized the SEC to

regulate security-based swaps. See Section 763 of the Dodd-Frank

Act, which amended the Securities and Exchange Act of 1934 to add

section 3D of the Exchange Act, among other provisions.

\938\ See FCIC Report at xxiv (listing uncontrolled leverage;

lack of transparency, capital and collateral requirements;

speculation; interconnection among firms; and concentrations of risk

in the market as contributing factors).

\939\ S. Rep. No. 111-176, at 92 (2010).

---------------------------------------------------------------------------

(5) The Role and Purpose of SEFs Within the Title VII Regulatory Regime

One of the most important goals of the Dodd-Frank Act is to bring

transparency to the opaque OTC swaps market. It is generally accepted

that when markets are open and transparent, prices are more competitive

and markets are more efficient.\940\ The legislative history of the

Dodd-Frank Act indicates that Congress viewed exchange trading as a

mechanism to ``provide pre- and post-trade transparency for end users,

market participants, and regulators.'' \941\ As such, exchange trading

was intended as ``a price transparency mechanism'' that complements

Title VII's separate central clearing requirement to mitigate

counterparty risk.\942\ Additionally, legislative history reveals a

Congressional expectation that, over time, exchange trading of swaps

would reduce transaction costs, enhance market efficiency, and counter

the ability of dealers to extract economic rents from higher bid/ask

spreads at the expense of other market participants.\943\

---------------------------------------------------------------------------

\940\ See academic research discussed below.

\941\ S. Rep. No. 111-176, at 34 (2010).

\942\ Id. at 33-34 (quoting former CFTC Chair Brooksley Born,

the report states `` `[w]hile central clearing would mitigate

counterparty risk, central clearing alone is not enough. . . .

[e]xchange trading is also essential in order to provide price

discovery, transparency, and meaningful regulatory oversight of

trading and intermediaries.' '').

\943\ Id. at 34 (quoting Stanford University Professor Darrel

Duffie, `` `[t]he relative opaqueness of the OTC market implies that

bid/ask spreads are in many cases not being set as competitively as

they would be on exchanges. . . . [t]his entails a loss in market

efficiency.' '').

---------------------------------------------------------------------------

Consistent with this purpose, the Dodd-Frank Act amended the CEA to

create SEFs, a new type of regulated marketplace, and promotes swap

trading and execution on them. The statutory requirements for SEFs are

similar to the requirements for the existing Commission-regulated

futures market, which incorporates pre-trade and post-trade

transparency aspects not present in the OTC swaps market. SEFs will

allow buyers and sellers to meet in an open, centralized marketplace,

where prices are publicly available. As statutorily defined, a SEF is

``a trading

[[Page 33554]]

system or platform in which multiple participants have the ability to

execute or trade swaps by accepting bids and offers made by multiple

participants in the facility or system, through any means of interstate

commerce, including any trading facility, that (A) facilitates the

execution of swaps between persons; and (B) is not a designated

contract market.'' \944\

---------------------------------------------------------------------------

\944\ CEA section 1a(50), as amended by section 721 of the Dodd-

Frank Act. 7 U.S.C. 1a(50). ``Trading facility'' is also a

statutorily defined term. See CEA section 1a(51); 7 U.S.C. 1a(51).

---------------------------------------------------------------------------

With this rulemaking, in conjunction with the separate made

available to trade rulemaking \945\ and the swaps block

rulemaking,\946\ the Commission is implementing the Dodd-Frank Act's

trade execution mandate.\947\ Pursuant to this trade execution

requirement, transactions involving swaps subject to the clearing

requirement in CEA section 2(h)(1) \948\ must be executed on a SEF or a

DCM, unless no SEF or DCM ``makes the swap available to trade'' or the

related transaction is subject to the clearing exception under CEA

section 2(h)(7).\949\ Further, no facility may be operated for the

trading or processing of swaps unless first registered as a SEF or

DCM.\950\ SEFs are required to comply with 15 statutorily enumerated

core principles,\951\ as well as any other requirements that the

Commission prescribes by rule or regulation.\952\

---------------------------------------------------------------------------

\945\ The Commission separately proposed rules to determine

whether a swap is ``made available to trade'' for purposes of the

trade execution requirement in CEA section 2(h)(8). Process for a

Designated Contract Market or Swap Execution Facility To Make a Swap

Available To Trade, 76 FR 77728 (proposed Dec. 14, 2011).

\946\ The Commission separately proposed rules to determine

minimum block trade sizes for swaps. Since the execution methods for

Required Transactions excludes block trades, this rulemaking affects

the scope of the trade execution mandate. See Procedures to

Establish Appropriate Minimum Block Sizes for Large Notional Off-

Facility Swaps and Block Trades, 77 FR 15460 (proposed Mar. 15,

2012).

\947\ See Section 723(a)(3) of the Dodd-Frank Act, which amended

the CEA to add section 2(h)(8). 7 U.S.C. 2(h)(8).

\948\ See Section 723(a)(3) of the Dodd-Frank Act, which amended

the CEA to add section 2(h)(1). 7 U.S.C. 2(h)(1).

\949\ See Section 723(a)(3) of the Dodd-Frank Act, which amended

the CEA to add section 2(h)(7). 7 U.S.C. 2(h)(7). The Commission

separately proposed rules to determine whether a swap is ``made

available to trade'' for purposes of the trade execution requirement

in CEA section 2(h)(8). Process for a Designated Contract Market or

Swap Execution Facility To Make a Swap Available To Trade, 76 FR

77728 (proposed Dec. 14, 2011).

\950\ CEA section 5h(a)(1); 7 U.S.C. 7b-3(a)(1).

\951\ CEA section 5h(f); 7 U.S.C. 7b-3(f).

\952\ CEA section 5h(f)(1)(A); 7 U.S.C. 7b-3(f)(1)(A). Further,

CEA section 5h(h) mandates that the Commission prescribe rules

governing SEF regulation. 7 U.S.C. 7b-3(h).

---------------------------------------------------------------------------

Taken together, these statutory provisions provide the framework

that transforms the swaps market from one in which prices for

bilaterally-negotiated contracts are privately quoted--often by dealers

with an informational advantage--to one in which bid/offer prices for

swap contracts are accessible to multiple market participants to

compare, assess, accept, or reject. By improving price transparency,

the new provisions should reduce information asymmetry and, in turn,

the informational advantage enjoyed by a small number of dealers to the

detriment of other market participants.\953\ These provisions benefit

the financial system as a whole by creating more efficient market

places, where market participants will take into account the price at

which recent transactions have occurred when determining at what price

to display quotes or orders.

---------------------------------------------------------------------------

\953\ While the SEF rules focus on measures to promote pre-trade

price transparency and trade execution, they complement other

Commission rules pertaining to real-time reporting (part 43 of the

Commission's regulations) and swap data recordkeeping and reporting

(part 45 of the Commission's regulations). The addition of the CEA

section 5h rules for registration, operation, and compliance of SEFs

to this mix results in a suite of rules covering all critical

aspects of the trading process--pre-trade, trade, and post-trade.

---------------------------------------------------------------------------

As discussed, this rulemaking furthers Congress' goal of promoting

transparency in the swaps market.\954\ The goal of pre-trade

transparency on SEFs is statutorily mandated in the Dodd-Frank

Act.\955\ Notwithstanding the fact that Congress directed the

Commission to construe the statute in light of this goal, some

commenters have questioned the benefits of the Commission's proposals

in furtherance of that goal.\956\

---------------------------------------------------------------------------

\954\ Pre-trade transparency is defined as ``the dissemination

of current bid and ask quotations, depths, and information about

limit orders away from the best prices. Post-trade transparency

refers to the public and timely transmission of information on past

trades, including execution time, volume and price.'' See Ananth

Madhavan, David Porter & Daniel Weaver, ``Should securities markets

be transparent?,'' 8 Journal of Financial Markets 265, 268 (Aug.

2005). See also Larry Harris, Trading and Exchanges--Market

Microstructure for Practitioners 102 (Oxford University Press)

(2003) (hereinafter Harris, ``Trading and Exchanges'').

\955\ See section 733 of the Dodd-Frank Act, adding CEA section

5h. 7 U.S.C. 7b-3. Under section 5h, Congress provided an explicit

rule of construction, stating that ``[t]he goal of this section is

to promote the trading of swaps on swap execution facilities and to

promote pre-trade price transparency in the swaps market.'' CEA

section 5h(e); 7 U.S.C. 7b-3(e).

\956\ See, e.g., ISDA Research Staff & NERA Economic Consulting,

Costs and Benefits of Mandatory Electronic Execution Requirements

for Interest Rate Products, ISDA Discussion Papers Series, Number

Two, at 1, 4 (Nov. 2011) (added to the public comment file for the

SEF rulemaking on Nov. 10, 2011) (hereinafter ``ISDA Discussion

Paper''); ISDA/SIFMA Comment Letter at 5-6 (Mar. 8, 2011); MetLife

Comment Letter at 2-3 (Mar. 8, 2011).

---------------------------------------------------------------------------

In response to commenters who question the Congressionally-directed

goal of pre-trade price transparency and the Commission's

implementation of that goal, the Commission notes that there is a body

of research that tends to be generally supportive, albeit based on

experience in other markets, as discussed below. Although this research

was not critical to or relied upon by the Commission in its decision-

making of how to best implement Congress' goal of promoting pre-trade

price transparency, it does provide a useful counterpoint to many of

the general comments raised by commenters and therefore merits brief

mention.

While there are no studies on the effect of pre-trade transparency

in the swaps market, empirical research on the likely effects of

transparency on market participants exists in other markets, including

the equity market, which has pre-trade transparency, and the corporate

bond market, which has a similar market structure to the OTC swaps

market and has post-trade transparency.\957\ While academics have a

range of perspectives on market structure and transparency issues,\958\

the empirical research discussed below and throughout this document

supports the general proposition that a lack of pre- and post-trade

transparency, which are characteristics of any dark, opaque market,

generally increases search and transaction costs, and negatively

impacts price discovery.

---------------------------------------------------------------------------

\957\ The corporate bond markets are generally comparable to the

OTC swap markets in terms of the large number of instruments traded,

with potentially a large overlap of market participants.

Additionally, any single issuer will have multiple bonds

outstanding, with different maturity dates and coupons. Some

potential SEF registrants will likely be firms operating trading

platforms for corporate bonds.

\958\ For example, Larry Harris notes that market participants

might be ``ambivalent about transparency,'' and explains that

traders ``favor transparency when it allows them to see more of what

other traders are doing, but they oppose it when it requires that

they reveal more of what they are doing. Generally, those who know

the least about market conditions most favor transparency. Those who

know the most oppose transparency because they do not want to give

up their informational advantages.'' The Commission also recognizes

that there is a continuum of markets occupying ``various points

between high and low transparency.'' See Harris, ``Trading and

Exchanges,'' at 101. See also ISDA Research Notes, ``Transparency

and over-the-counter derivatives: The role of transaction

transparency,'' No. 1, at 2-3 (2009), available at http://www2.isda.org/attachment/MTY4NA==/ISDA-Research-Notes1.pdf.

---------------------------------------------------------------------------

While some commenters contend that pre-trade price transparency

requirements would increase costs for market participants, there is

academic support for the general proposition that increased

transparency will actually

[[Page 33555]]

lower costs for market participants,\959\ ``help them predict future

price changes, to predict when their orders will execute, and to

evaluate their brokers' performance,'' \960\ and will improve the

quality of execution they receive from the marketplace.\961\ Greater

transparency in general can increase market liquidity by reducing

information asymmetry between informed and less informed market

participants, and greater pre-trade transparency also helps improve

price discovery by promoting competition among liquidity

providers.\962\

---------------------------------------------------------------------------

\959\ Discussing the trade-off between higher costs to liquidity

providers and the lower costs to institutional investors from

greater post-trade transparency in the corporate bond markets,

Bessembinder & Maxell conclude that while ``[T]raders employed by

insurance companies and investment management firms bear costs

associated with decreases in service provided by bond dealers . . .

these higher costs are offset by lower trade execution costs that .

. . benefit the investors who ultimately own the bonds transacted. .

.'' See Hendrik Bessembinder & William Maxwell, ``Markets:

Transparency and the Corporate Bond Market,'' 22 Journal of Economic

Perspectives 217, 232-33 (Spring 2008) (hereinafter Bessembinder &

Maxwell, ``Transparency'').

\960\ Harris, ``Trading and Exchanges,'' at 101.

\961\ It is instructive to note the view that transparency is

``not an objective per se but rather a means for ensuring the proper

functioning of the market.'' See Marco Avellaneda & Rama Cont,

``Transparency in Credit Default Swap Markets,'' Finance Concepts,

at 3 (Jul. 2010), available at http://www.finance-concepts.com/images/fc/CDSMarketTransparency.pdf.

\962\ Pagano & R[ouml]ell explain the regulatory policy support

for pre-trade transparency as a means ``to enable ordinary traders

to check for themselves whether they have gotten a fair price.''

Comparing the price formation in auction and dealer markets, they

find that greater transparency generates lower trading costs for

uninformed traders on average, although not necessarily for every

trade size. See Marco Pagano & Ailsa R[ouml]ell, ``Transparency and

Liquidity: A Comparison of Auction and Dealer Markets with Informed

Trading,'' 51 Journal of Finance 579 (Jun. 1996). Research

referenced later in the release has found that such competition can

reduce revenues and increase costs and risks for liquidity

providers, thus causing them to reduce their participation in the

markets.

---------------------------------------------------------------------------

Academic research supports the view that a lack of pre-trade

transparency affects trading costs because it contributes to frictions

in the search process, which in turn can translate into higher

transaction costs and impact equilibrium prices and allocations. Given

the lack of pre-trade transparency and the absence of centralized

markets (i.e., exchanges) in the OTC swaps market, market participants

will likely contact multiple dealers sequentially by phone or by some

other electronic means of communication.\963\ Bessembinder and Maxwell

explain that the take-it-or-leave-it aspect of the negotiation process

in the bond markets (which is also present in the OTC swaps market)

``limits one's ability to obtain multiple quotations before committing

to trade.'' \964\

---------------------------------------------------------------------------

\963\ Many of the existing electronic trading platforms for

bonds and for swaps display indicative quotes, but the Commission is

not aware of research on the quality of these indicative quotes, and

of their likely impact on price discovery and market quality in

terms of transaction costs.

\964\ See Bessembinder & Maxwell, ``Transparency,'' at 223

(explaining that in addition to the cost of conducting the search,

market participants are exposed to the additional cost from the fact

that a dealer's quote is only good ``as long as the breath is

warm''). Comparing execution cost in the equity and corporate bond

markets, Edwards, Harris & Piwowar theorize that despite the fact

that corporate bonds are less risky than equity (in the same

company), differences in pre- and post-trade transparency between

the two markets contribute to higher transaction costs in the bond

markets. See Amy Edwards, Lawrence Harris & Michael Piwowar,

``Corporate Bond Market Transactions Costs and Transparency,'' 62

Journal of Finance 1421, 1438 (Jun. 2007) (hereinafter Edwards et

al., ``Transaction Costs and Transparency'').

---------------------------------------------------------------------------

More generally, this area of research, also called search and

matching theory, ``offers a framework for studying frictions in real-

world transactions and has led to new insights into the working of

markets.'' \965\ This research shows that ``even with very minor search

costs and with a large number of sellers, a search and matching

environment would deliver a rather large departure from the outcome

under perfect competition (which would prevail if the search costs were

zero).'' \966\ This ``Diamond paradox'' \967\ is of relevance to this

rulemaking because given search costs, no matter how small, the

presence of multiple dealers can result in trades being transacted at

the single monopoly price.\968\ This highlights the importance of

reducing the costs that exist when a market is dominated by a small

number of dealers--in other words, an oligopoly.\969\

---------------------------------------------------------------------------

\965\ See ``Markets with Search Frictions,'' The Royal Swedish

Academy of Sciences, at 1 (Oct. 11, 2010), available at http://www.nobelprize.org/nobel_prizes/economics/laureates/2010/advanced-economicsciences2010.pdf.

\966\ Id. at 5.

\967\ See Peter Diamond, ``A Model of Price Adjustment,'' 3

Journal of Economic Theory 156 (Jun. 1971).

\968\ See Darrell Duffie, Nicolae G[acirc]rleanu & Lasse Heje

Pedersen, ``Valuation in Over-the-Counter Markets,'' 20 The Review

of Financial Studies 1865, 1888-89 (Nov. 2007) (hereinafter Duffie

et al., ``Valuation in OTC Markets'') for a series of examples of

markets where search costs impact price discovery, adversely

resulting in prices diverging from competitive market outcomes.

\969\ An oligopoly is a market form in which a market or

industry is dominated by a small number of sellers (oligopolists)--

dealers or market makers in the context of the OTC swaps markets.

While the traditional research into oligopolistic behavior has

focused on attempts by firms to collude, which could potentially

result in non-competitive or monopoly pricing for the rest of the

market, the search literature explains that the monopoly pricing is

due to the presence of search costs. Indicative of the potential

impact of such oligopolistic behavior by dealers in an environment

with low pre-trade transparency, Hendershott & Madhavan reference

research comparing transactions costs between equity and corporate

and municipal bond markets. See Terrence Hendershott & Ananth

Madhavan, ``Click or Call? Auction versus Search in the Over-the-

Counter Market,'' Working Paper, at 2 (Mar. 19, 2012) (hereinafter

Hendershott & Madhavan, ``Click or Call''). They explain that

despite improvements in the post-trade transparency in both

corporate and municipal bond markets, transaction costs are higher

compared to equivalent-sized equity trades due to ``the lack of pre-

trade transparency that confers rents to dealers.'' Id.

---------------------------------------------------------------------------

Academic research into the impact of pre-trade transparency on

market quality in the context of the equity markets is an active area

of research. As buy and sell interest at the best bid and offer price

is widely available to all market participants in these markets, they

are not necessarily analogous to the OTC swap markets, where such

information is simply not available. Nevertheless, research in this

area is notable because the equity markets have pre-trade transparency,

and Congress has mandated pre-trade transparency on SEFs. Various

research papers examine the impact of changes in relative levels of

pre-trade transparency within a specific trading venue or exchange, and

depending on the specific circumstances of each such event, market

participants' behavior can be influenced, which in turn can impact

liquidity and costs.\970\

---------------------------------------------------------------------------

\970\ Empirical research evaluating the impact of transparency

on market quality are typically in the context of natural

experiments when there is a change in the set of trading rules in a

particular market. Madhavan, Porter & Weaver examined the outcomes

when the Toronto Stock Exchange increased transparency levels for

stocks traded on the floor and on the screen, and found that it

reduced the earnings of specialists (or liquidity providers); lower

order flows from them in turn reduced market depth and caused the

market to exhibit increased price volatility and higher transaction

costs. See Ananth Madhavan, David Porter & Daniel Weaver, ``Should

securities markets be transparent?,'' 8 Journal of Financial Markets

265 (Aug. 2005). Eom, Ok & Park focus on the impact of changes in

the display in the level of depth of the limit order book in the

Korean equity market and find evidence of positive effects on market

quality measured in terms of depth, volume and quoted spreads, but

beyond a point, these effects taper-off, and can even become

negative. See Kyong Shik Eom, Jinho Ok & Jong Ho Park, ``Pre-trade

transparency and market quality,'' 10 Journal of Financial Markets

319 (Nov. 2007). In another paper, Boehmer, Saar & Yu present

evidence that when the New York Stock Exchange took specific steps

to display limit-order book information to traders off the exchange

floor, ``an increase in pre-trade transparency affects investors'

trading strategies and can improve certain dimensions of market

quality.'' See Ekkehart Boehmer, Gideon Saar & Lei Yu, ``Lifting the

Veil: An Analysis of Pre-trade Transparency at the NYSE,'' 60 The

Journal of Finance 783 (Apr. 2005). Additionally, in a paper

highlighting the impact of pre-trade transparency on price

discovery, and highlighting the risks of driving trading activity to

competing markets, Hendershott & Jones found that when the Island

electronic communications network stopped displaying its limit order

book in certain exchange-traded funds (``ETFs''), ETF prices

adjusted more slowly, and there was ``substantial price discovery

movement from ETFs to the futures market.'' See Terrence Hendershott

& Charles M. Jones, ``Island Goes Dark: Transparency, Fragmentation,

and Regulation,'' 18 The Review of Financial Studies 743 (Fall

2005).

---------------------------------------------------------------------------

[[Page 33556]]

While the literature from the equity markets referenced above

focuses on changes in relative levels of pre-trade transparency,

research from the corporate bond markets also directly addresses the

benefits from bringing post-trade transparency into dark markets.

Edwards, Harris, and Piwowar examine trading costs in the corporate

bond market using a record of every corporate bond trade reported on

the TRACE \971\ system between January 2003 and January 2005.\972\ In

their paper, they find evidence that post-trade transparency through

TRACE has lowered transaction costs in the corporate bond market and

that higher post-transparency has helped improve liquidity in this

market.\973\ Summarizing findings from studies by other researchers on

the impact of TRACE on market participants, Bessembinder and Maxwell

confirm that it has helped provide a level playing field--in the

context of information regarding current prices at which various

corporate bonds are being traded.\974\

---------------------------------------------------------------------------

\971\ The Trade Reporting and Compliance Engine (``TRACE'') is

operated by the Financial Industry Regulatory Authority (``FINRA''),

and facilitates the mandatory reporting of OTC secondary market

transactions in eligible fixed income securities. All broker/dealers

who are FINRA member firms have an obligation to report transactions

in corporate bonds to TRACE under an SEC-approved set of rules. See

http://www.finra.org/Industry/Compliance/MarketTransparency/TRACE/for further details.

\972\ See Edwards et al., ``Transaction Costs and

Transparency,'' at 1426. As with OTC swaps, given that there is no

pre-trade transparency in the corporate bond markets, bid-ask

spreads, a key determinant of transaction costs, have to be

estimated using specialized econometric techniques. In this paper,

they assume that there has been no change in the market structure

(in terms of execution methods) before and after TRACE.

\973\ In a related paper on the impact of higher transparency on

liquidity, research examining the impact of higher post-trade

transparency on the liquidity of the BBB-rated corporate bond market

shows that ``overall, adding transparency has either a neutral or a

positive effect on liquidity.'' Id. at 1438.

\974\ Bessembinder & Maxwell point out that prior to the

introduction of TRACE, ``customers found it difficult to know

whether their trade price reflected market conditions . . . . With

transaction reporting, customers are able to assess the

competitiveness of their own trade price by comparing it to recent

and subsequent transactions in the same and similar issues.''

Bessembinder & Maxwell, ``Transparency,'' at 226.

---------------------------------------------------------------------------

(b) The Statutory Mandate To Consider the Costs and Benefits of the

Commission's Action: Section 15(a) of the CEA

Section 15(a) of the CEA requires the Commission to consider the

costs and benefits of its actions before promulgating a regulation

under the CEA or issuing certain orders.\975\ CEA section 15(a) further

specifies that the costs and benefits shall be evaluated in light of

the following 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.\976\ The Commission considers below the costs

and benefits resulting from its discretionary determinations with

respect to the section 15(a) factors.

---------------------------------------------------------------------------

\975\ CEA section 15(a); 7 U.S.C. 19(a).

\976\ Id.

---------------------------------------------------------------------------

To aid the Commission in its consideration of the costs and

benefits resulting from its regulations, the Commission requested in

the SEF NPRM that commenters provide data and supporting information

which quantify or qualify the costs and benefits of the proposed

rules.\977\ While a number of industry commenters expressed the general

view that implementing and complying with the proposed rules would come

at considerable cost and that the proposed rules would be

burdensome,\978\ the Commission only received one comment quantifying

the costs that may result from the proposed regulations.\979\ In

meetings requested by potential SEF registrants during the comment

period, the Commission staff invited those entities to provide specific

data to support general assertions that the proposed regulations would

be costly. Again, no such information was provided. In another effort

to gather such data, the Commission staff initiated follow-up contacts

with certain potential SEFs regarding their projected expenses in light

of the Commission's proposed regulations. The product of these

conversations is reflected in the cost estimates included in this

release.

---------------------------------------------------------------------------

\977\ See Core Principles and Other Requirements for Swap

Execution Facilities, 76 FR 1214, 1237 (proposed Jan. 7, 2011).

\978\ See, e.g., FXall Comment Letter at 2-4 (Mar. 8, 2011); CME

Comment Letter at 2 (Mar. 8, 2011).

\979\ See ISDA Discussion Paper (Nov. 2011).

---------------------------------------------------------------------------

While certain costs are amenable to quantification, other costs are

not easily monetized, such as the costs to the public of another

financial crisis. The Commission's final regulations are intended to

mitigate that risk, and, therefore, serve an important if

unquantifiable public benefit. While the benefits of effective

regulation are difficult to value in dollar terms, the Commission

believes that they are no less important to consider given the

Commission's mission to protect both market users and the public.

Additionally, where appropriate, in response to the cost concerns

of some commenters, the Commission, as discussed below, adopted cost-

mitigating alternatives presented by commenters where doing so would

still achieve the goals of the Dodd-Frank Act.

The discussion of costs and benefits that follows begins with an

informational discussion of the aggregate estimated costs of forming

and operating a SEF. Although these costs are mostly attributable to

Congress' mandate that there be SEFs, they provide useful context for

the costs and benefits attributable to the Commission's action of

implementing that mandate in this rulemaking. Relatedly, the Commission

believes that many of the costs that arise from the application of the

final rules are a consequence of the Congressional trade execution

mandate of section 2(h)(8) of the CEA, as well as the Congressional

goals to promote the trading of swaps on SEFs and to promote pre-trade

price transparency in the swaps market in section 5h(e) of the CEA. For

example, those market participants who are not eligible for the CEA

section 2(h)(7) end user exception will no longer have the option to

execute Required Transactions bilaterally even when they consider it

more costly or less convenient to execute trades on a SEF (or a DCM).

As described more fully below, the Commission has considered these

costs in adopting these final rules, and has, where appropriate,

attempted to mitigate the costs while observing the express direction

of Congress in CEA sections 2(h)(8) and 5h(e).

After the discussion of the aggregate costs of forming and

operating a SEF, the Commission's consideration of costs and benefits

is organized into seven categories: (1) SEF Market Structure; (2)

Registration; (3) Recordkeeping and Reporting; (4) Compliance; (5)

Monitoring and Surveillance; (6) Financial Resources and Integrity; and

(7) Emergency Operations and System Safeguards. For each category,\980\

the

[[Page 33557]]

Commission summarizes the final regulations; describes and responds to

comments discussing the costs and benefits; \981\ assesses

alternatives, including those raised by commenters; and considers the

costs and benefits in light of the five factors set out in CEA section

15(a), which expressly requires the Commission to consider the costs

and benefits of ``the action of the Commission.'' \982\ In this regard,

as with the aggregate costs of forming and operating a SEF attributable

to Congress, where the Commission merely codifies a statutory

requirement, the Commission believes that there is no act of discretion

for consideration under CEA section 15(a). For example, for each core

principle, the first section of the Commission's regulations is a

codification of the statutory language of the core principle as a rule

and, accordingly, there is no Commission act of discretion and thus no

costs and benefits for the Commission to consider under section 15(a).

In other cases, such as Core Principle 1, the rule simply codifies the

text of the core principle, and thus will not be discussed as it is

outside the scope of section 15(a).

---------------------------------------------------------------------------

\980\ The costs and benefits of Core Principle 12 are discussed

in connection with a separate proposed rulemaking entitled

Requirements for Derivatives Clearing Organizations, Designated

Contract Markets, and Swap Execution Facilities Regarding the

Mitigation of Conflicts of Interest, 75 FR 63732 (proposed Oct. 18,

2010).

\981\ The Commission notes that a number of these regulations

also refer to requirements that are contained in other rulemakings,

some that have been finalized and others that have not. The costs

and benefits of these regulations have been, or will be, discussed

in those other rulemakings.

\982\ CEA section 15(a); 7 U.S.C. 19(a).

---------------------------------------------------------------------------

The Commission expects that the costs and benefits will vary based

on the specific circumstances of the individual entity seeking

registration as a SEF. For example, some SEF-like execution platforms

that currently operate in the OTC marketplace may generally already

have the infrastructure to comply with the Commission's regulations

without the need for sizeable additional expenditures. For these

potential SEF registrants, the regulations may occasion minimal

incremental costs above their existing cost structure. In contrast,

potential SEF registrants that are not currently operating in the OTC

marketplace, registered as a DCM, or operating as an exempt board of

trade will likely lack existing infrastructure and may incur costs, at

times significant, in both physical and human capital to meet the

requirements of the regulations.\983\ Accordingly, where appropriate

and possible to account for these differences, the Commission has

attempted to express costs and benefits as a range, sometimes one that

is wide.

---------------------------------------------------------------------------

\983\ The Commission notes that these registrants will also

incur costs to meet the statutory requirements.

---------------------------------------------------------------------------

Finally, in some instances, quantification of costs to certain

market participants is not reasonably feasible because costs will

depend on the size, structure, and product offering of a SEF, which are

likely to have considerable variation, or because required information

or data will not exist until after a SEF commences operation as a

registrant. In other instances--for example with respect to protection

of market participants and the public--suitable metrics to quantify

costs and benefits simply do not exist. Notwithstanding the above-

mentioned limitations, the Commission identifies and considers the

costs and benefits of these rules in qualitative terms.

(c) Estimated Aggregate Costs of Forming and Operating a SEF

In its discussion paper, ISDA estimated the cost of establishing a

new SEF to be $7.4 million,\984\ and estimated ongoing operating costs

to be nearly $12 million per year.\985\ ISDA based its cost estimates

on a survey of groups which included a ``small number of (large) Buy-

Side firms and the 16 largest dealers.'' \986\ ISDA's estimate is based

on a trading architecture that includes an order matching engine, and a

Request for Quote system or other means of interstate commerce that

will allow members to show (and see) bids and offers.\987\ In addition,

ISDA's estimate includes costs associated with: systems to capture and

retain data necessary to create an audit trail for at least 5 years; an

electronic analysis capability and the ability to collect and evaluate

market data on a daily basis; a real-time electronic monitoring system

to detect and deter manipulation, distortion, and market disruption;

reporting transaction information to the Commission and data

repositories using unique product identifiers; a Chief Compliance

Officer; and disaster recovery.\988\ ISDA also identified major

operating costs to include the cost of compensation and benefits for

staff, leasing office space, maintaining and upgrading operational

infrastructure and systems, maintaining sufficient financial resources

to cover operating costs for at least one year, maintaining an

independent board of governors, and maintaining emergency backup

facilities.\989\

---------------------------------------------------------------------------

\984\ ISDA Discussion Paper at 30-31 (Nov. 2011). While the ISDA

discussion paper is largely concerned with the costs and benefits

resulting from the statute and regulations implemented by other

rulemakings, relevant portions are discussed in this release. ISDA's

estimate includes the costs of: registering with the Commission;

developing an electronic system capable of providing market

participants with the ability to make bids and offers to multiple

participants and capable of maintaining safe storage capacity;

developing and maintaining electronic analysis, reporting, and

monitoring software; developing new products; drafting contractual

arrangements with SEF users and vendors; drafting market rules and

policies; and developing emergency backup procedures and systems.

\985\ Id. at 31-32. This estimate includes the cost of

compensation and benefits for staff, leasing office space,

maintaining and upgrading operational infrastructure and systems,

maintaining sufficient financial resources to cover operating costs

for at least one year, maintaining an independent board of

governors, and maintaining emergency backup facilities.

\986\ Id. at 31, 34.

\987\ Id. at 29.

\988\ Id. at 30.

\989\ Id. at 31.

---------------------------------------------------------------------------

In another comment letter, MarketAxess stated that the SEC's cost

estimates in its proposed rulemaking for security-based SEFs (``SB-

SEFs''), were ``generally realistic and accurate estimates of the costs

of establishing and operating a SB-SEF'' and that these estimates would

be ``comparable to, and thus relevant for, calculation of costs for a

SEF.'' \990\

---------------------------------------------------------------------------

\990\ MarketAxess Comment Letter at 5 (Jun. 3, 2011).

---------------------------------------------------------------------------

The SEC estimated that the cost of forming an SB-SEF is

approximately $15-20 million, including the first year of

operation.\991\ These costs included a software and product development

estimate of $6.5-10 million for the first year and ongoing technology

and maintenance costs of $2-4 million.\992\ The SEC also estimated that

it would cost approximately $50,000-$3 million for an operator of an

existing platform to modify its platform to conform to the statute and

the SEC's proposed rules, depending on the enhancements that would be

required by the final regulations.\993\

---------------------------------------------------------------------------

\991\ Registration and Regulation of Security-Based Swap

Execution Facilities, 76 FR 10948, 11041 (proposed Feb. 28, 2011).

\992\ Id.

\993\ Id.

---------------------------------------------------------------------------

In the Commission staff's follow-up conversations, potential SEFs

stated that the costs associated with the SEF NPRM may differ from the

SEC's cost estimates in various areas. For example, one commenter

estimated first-year software and product development costs of $4

million rather than the $6.5-10 million estimated by the SEC. Another

commenter stated that existing entities will be able to leverage

existing technology at minimal cost, and that there is no real cost

associated with the rulemaking from a technology perspective if an

entity is not a startup. As stated above, ISDA's estimates also

differed from those of the SEC, including estimated initial software

development costs of $1 million and

[[Page 33558]]

initial product development costs of $1.25 million.\994\

---------------------------------------------------------------------------

\994\ ISDA Discussion Paper at 32 (Nov. 2011). ISDA's paper also

contained a discussion of the costs likely to be faced by dealers

and buy-side users of interest rate swaps that must be executed on

regulated exchanges. Some of these costs result from statutory

requirements that were not the product of Commission discretion,

while other costs are likely to derive from regulations being

implemented in other rulemakings. Other costs simply reflect the

cost of doing business and are not directly imposed by Commission

regulations. Accordingly, these costs are beyond the scope of this

rulemaking and will not be discussed in this release.

---------------------------------------------------------------------------

In the Commission staff's follow-up conversations, potential SEFs

stated that total ongoing costs would range from $3.5 million to $5

million per year. These potential SEFs also told the Commission staff

that it would cost them approximately $2 million to conform to the

statute and the Commission's proposed rules, including contracting with

the National Futures Association (``NFA'') to perform regulatory

services.

While the Commission believes that the various cost estimates

(including those for SB-SEFs and those reflecting costs imposed by

statute) can be used as a rough guide to the costs that would be

incurred to establish and operate a SEF, the Commission notes that the

majority of these costs are necessary to establish and operate any

platform for the trading of swaps, as a number of firms had already

done prior to the enactment of the Dodd-Frank Act. The Commission

believes that the additional costs of modifying a platform to comply

with the Commission's regulations to implement the statute represent a

relatively modest proportion of these costs.

(1) Regulatory Costs

Pursuant to final Sec. 37.204 adopted in this release, SEFs may

utilize a regulatory service provider for assistance in performing

certain self-regulatory functions, including, among others, trade

practice surveillance, market surveillance, real-time market

monitoring, investigations of possible rule violations, and

disciplinary actions.\995\ The costs described in this cost benefit

consideration section reflect the costs that a SEF is likely to face if

it does not choose to utilize the services of a regulatory service

provider. To the extent that utilizing a regulatory service provider is

more cost-effective for a SEF than performing the functions

independently, the quantitative and qualitative cost discussions in

this release may overstate the costs of complying with the rules. Based

on the Commission staff's follow-up discussions with potential SEFs, it

appears that most SEFs will be entering into agreements with regulatory

service providers for the provision of these functions. In fact, the

Commission understands that many potential SEFs have already entered

into formal agreements with a regulatory service provider. The

Commission notes that competition among regulatory service providers,

including NFA and the Financial Industry Regulatory Authority, may

result in additional cost savings for SEFs that choose to outsource

compliance obligations.

---------------------------------------------------------------------------

\995\ Rule 37.204 permits SEFs to contract with a regulatory

service provider for the provision of services to assist in

compliance with the core principles, as approved by the Commission.

---------------------------------------------------------------------------

2. SEF Market Structure

(a) Background

(1) Minimum Trading Functionality (Order Book)

Final Sec. 37.3(a)(2) requires that each SEF provide its market

participants with a minimum trading functionality referred to as an

Order Book,\996\ which the Commission believes is consistent with the

SEF definition and promotes the goals provided in section 733 of the

Dodd-Frank Act.\997\ As noted in the preamble, the Commission is

withdrawing the proposed requirement that SEFs offer indicative quote

functionality because the Commission believes that, at this time, such

a requirement is unnecessary.\998\

---------------------------------------------------------------------------

\996\ An Order Book means: (i) An electronic trading facility,

as that term is defined in section 1a(16) of the Act; (ii) a trading

facility, as that term is defined in section 1a(51) of the Act; or

(iii) a trading system or platform in which all market participants

in the trading system or platform have the ability to enter multiple

bids and offers, observe or receive bids and offers entered by other

market participants, and transact on such bids and offers. See Final

Sec. 37.3(a)(3) of the Commission's regulations.

\997\ CEA section 1a(50) defines a SEF as ``a trading system or

platform in which multiple participants have the ability to execute

or trade swaps by accepting bids and offers made by multiple

participants in the facility or system, through any means of

interstate commerce . . .'' 7 U.S.C. 1a(50). In section 5h(e) of the

Act, Congress provided a ``rule of construction'' to guide the

Commission's interpretation of certain SEF provisions (stating that

the goals of section 5h of the Act are to ``promote the trading of

swaps on [SEFs] and to promote pre-trade price transparency in the

swaps market''). 7 U.S.C. 7b-3(e).

\998\ See Minimum Trading Functionality discussion above under

Sec. 37.3--Requirements for Registration in the preamble.

---------------------------------------------------------------------------

(2) Methods of Execution on a SEF

Final Sec. 37.9 governs the execution methods that are available

on a SEF and classifies transactions executed on a SEF as either

Required Transactions (i.e., any transaction involving a swap that is

subject to the trade execution requirement in section 2(h)(8) of the

Act \999\) or Permitted Transactions (i.e., any transaction not

involving a swap that is subject to the trade execution requirement in

section 2(h)(8) of the Act).

---------------------------------------------------------------------------

\999\ Transactions that are subject to the trade execution

requirement of CEA section 2(h)(8) are subject to the clearing

requirement of CEA section 2(h)(1) and are ``available to trade'' on

a SEF or DCM. See Process for a Designated Contract Market or Swap

Execution Facility To Make a Swap Available To Trade, 76 FR 77728

(proposed Dec. 14, 2011).

---------------------------------------------------------------------------

Pursuant to final Sec. 37.9(a)(2), market participants may only

execute Required Transactions using either the SEF's Order Book or an

RFQ System that will transmit a request for a quote to at least three

market participants and that operates in conjunction with the Order

Book. In contrast, while SEFs must offer an Order Book for Permitted

Transactions, market participants may execute Permitted Transactions on

a SEF using any method of execution.\1000\

---------------------------------------------------------------------------

\1000\ The SEF NPRM provided that Permitted Transactions may be

executed by an Order Book, RFQ System, Voice-Based System, or any

such other system for trading as may be permitted by the Commission.

Core Principles and Other Requirements for Swap Execution

Facilities, 76 FR at 1241.

---------------------------------------------------------------------------

(3) Request for Quote (``RFQ'') System for Required Transactions

The RFQ System definition in final Sec. 37.9(a)(3) requires that

each market participant transmit a request for a quote to at least

three market participants, with each of these market participants being

given the opportunity to respond. As described in greater detail in the

preamble, permitting RFQ requesters to send RFQs to a single market

participant would undermine the multiple participant to multiple

participant requirement in the SEF definition and the goal of pre-trade

price transparency.\1001\ The three market participant requirement will

help the RFQ requester benefit from price competition among multiple

RFQ responders and thus promotes price discovery. In addition, final

Sec. 37.9(a)(3) requires that any firm bid or offer pertaining to the

same instrument resting on any of the SEF's Order Books must be

communicated to the RFQ requester at the same time the first responsive

bid or offer is received by such requester.

---------------------------------------------------------------------------

\1001\ See RFQ System Definition and Transmission to Five Market

Participants discussion above under Sec. 37.9(a)(1)(ii)--Request

for Quote System in the preamble.

---------------------------------------------------------------------------

(4) Time Delay Requirement

Final Sec. 37.9(b)(1) sets forth a time delay requirement for a

broker or dealer who has the ability to execute against its

[[Page 33559]]

customer's order or to execute two of its customers' orders against

each other. These orders (i.e., price, size, and other terms) are

subject to a 15-second time delay between the entry of the two orders,

such that one side of the potential transaction is disclosed and made

available to other market participants before the second side of the

potential transaction is submitted for execution. This time delay

requirement is similar to certain timing delays applicable to futures

transactions executed on DCMs, which are also designed to promote pre-

trade transparency by allowing other market participants the

opportunity to participate in the transaction and thus prevent any two

market participants from crossing a bilaterally (off-exchange)

negotiated trade. The Commission notes that the 15-second requirement

is a default time delay; the final rule also permits SEFs to adjust

this time delay requirement based upon a swap's liquidity or other

product-specific characteristics.

(b) Costs

(1) Costs to SEFs

(i) Minimum Trading Functionality (Order Book) and Methods of Execution

on a SEF

In the Commission staff's follow-up conversations with potential

SEFs, one commenter noted that it would cost approximately $250,000 to

upgrade its existing system to provide the required minimum trading

functionality, while another stated that there is no real cost

associated with the rulemaking from a technology perspective if an

entity is already operating a trading platform, and that an existing

platform could become compliant with the rule by leveraging existing

technology at minimal cost. The Commission believes that these

estimates are reasonable for existing platforms. Though the Commission

is not requiring that systems be upgraded once they have achieved

compliance with the rules, it expects that SEFs may have business

incentives to incur ongoing programming costs to upgrade their systems.

ISDA/SIFMA noted that the minimum trading functionality may limit

competition by increasing costs to applicants that would otherwise

prefer to offer solely RFQ functionality.\1002\ As discussed in the

preamble to this release,\1003\ the Commission believes that the

minimum trading functionality is consistent with the SEF definition and

promotes the statutory goals of pre-trade price transparency and

trading on SEFs provided in section 733 of Dodd-Frank.\1004\

Nevertheless, the Commission has adopted cost-mitigating alternatives

identified by commenters, including: (1) Deleting the requirement that

indicative bids and offers must be posted on a SEF's Order Book; (2)

allowing work-up sessions \1005\ where the original counterparties to a

trade and other market participants can trade additional quantities of

a swap at the previously executed price; and (3) allowing SEFs to use

any means of interstate commerce in providing the execution methods for

Required Transactions in Sec. 37.9(a)(2)(i)(A) or (B) of this final

rulemaking (i.e., Order Book or RFQ System that operates in conjunction

with an Order Book). Not having to display indicative quotes will

likely reduce the programming costs for SEFs, since they will not need

to program that functionality into the platform. The Commission

believes the requirement to communicate any firm bid or offer will

marginally add to the programming costs for SEFs and is included in the

$250,000 estimate provided above. As commenters have described, work-up

sessions are part of current OTC market practice, and the Commission

believes that this additional flexibility for market participants to

execute transactions in the SEF context will promote the trading of

swaps on SEFs consistent with CEA section 5h(e).

---------------------------------------------------------------------------

\1002\ ISDA/SIFMA Comment Letter at 5-6 (Mar. 8, 2011).

\1003\ See Minimum Trading Functionality discussion above under

Sec. 37.3--Requirements for Registration in the preamble.

\1004\ In section 5h(e) of the Act (as adopted by section 733 of

the Dodd-Frank Act), Congress provided a ``rule of construction'' to

guide the Commission's interpretation of certain SEF provisions

(stating that the goals of section 5h of the Act are to ``promote

the trading of swaps on [SEFs] and to promote pre-trade price

transparency in the swaps market''). 7 U.S.C. 7b-3(e).

\1005\ As described earlier, a work-up session refers to a

practice wherein once a trade has been executed, one of the

counterparties to the trade can express an interest in transacting

additional volume at the same price.

---------------------------------------------------------------------------

(ii) Time Delay Requirement

A SEF will incur some additional programming costs as a result of

the requirement that a SEF must provide for a 15-second time delay in

certain circumstances. The Commission did not receive any specific

estimates of these programming costs and notes that the rule permits a

SEF to adjust the minimum time delay requirement based upon a swap's

liquidity or other product-specific characteristics. For example, less

liquid contracts may need a longer time delay than more liquid

contracts.

(2) Costs to Market Participants

(i) General Costs

In its discussion paper, ISDA described what it asserted would be

the likely costs and benefits of what it labeled the ``electronic

execution mandate,'' that is, mandating the execution of interest rate

swaps on DCMs or on SEFs.\1006\ According to ISDA, ``[t]he study

indicates that the EE mandate [electronic execution mandate], in all

likelihood, will bring little benefit to the market while adding

significantly to the costs of using derivatives.''\1007\ ISDA stated

that the electronic execution mandate will result in higher bid/ask

spreads and significant operational, technological, and compliance

costs for those transacting in interest rate swaps.\1008\ ISDA further

stated that these costs will be borne by end users and may force some

participants to withdraw from the market with ``virtually no effect on

small end users.'' \1009\ ISDA stated that the electronic execution

mandate is both unnecessary and counterproductive as electronic trading

is already developing rapidly as users take advantage of the existing

choice in execution venues.\1010\

---------------------------------------------------------------------------

\1006\ ISDA Discussion Paper at 20-21 (Nov. 2011).

\1007\ Id. at 1.

\1008\ Id. at 4.

\1009\ Id.

\1010\ Id.

---------------------------------------------------------------------------

According to ISDA, the electronic execution mandate will take away

users' choice, create inefficiencies, and discourage innovation.\1011\

ISDA stated that the electronic execution mandate will impose new costs

because:

---------------------------------------------------------------------------

\1011\ Id.

SEFs themselves need to be established, licensed and operated.

Buy-Side users will face significant technology and operational

challenges as well as increased regulatory reporting requirements.

Dealers will have to upgrade infrastructure to deal with automated

trading and comply with increased regulatory reporting and record-

keeping. All participants will face increased reconciliations,

oversight and reporting requirements as well. Finally, regulators

will need additional staff to properly oversee the new

markets.\1012\

---------------------------------------------------------------------------

\1012\ Id. at 24.

According to ISDA, the aggregate market-wide ``set up costs are

estimated to exceed $750 million and annual costs may run to $250

million.''\1013\

---------------------------------------------------------------------------

\1013\ Id. at 4.

---------------------------------------------------------------------------

In terms of benefits, ISDA concluded that:

Transparency and market access may improve marginally for small

financial entities that use IRS [interest rate swaps] but any

benefit they receive will be very modest relative to the added costs

of execution.

[[Page 33560]]

Indeed, the imposition of clearing and the higher fees that will

result from the EE Mandate [electronic execution mandate] and other

provisions of DFA [Dodd-Frank Act] may cause these and other

participants to reduce their activity or even withdraw from the IRS

market.\1014\

---------------------------------------------------------------------------

\1014\ Id. at 36.

ISDA asserted that transaction costs for OTC trades in interest

rate swaps are already low with levels of transparency that market

participants consider sufficient, and that trading in a regulated

market or on an exchange does not guarantee a more efficient market

because traders often get better execution off-exchange.\1015\ ISDA

further asserted that liquidity in OTC interest rate swaps is at least

as good as liquidity in exchange-traded futures contracts, especially

outside of the most liquid futures contract months, and that market

participants predicted that bid-ask spreads in interest rate swaps

would increase after the execution mandate takes effect.\1016\

---------------------------------------------------------------------------

\1015\ Id. at 20-21.

\1016\ Id. at 2-4, 20-21.

---------------------------------------------------------------------------

ISDA also estimated that the market as a whole will need to absorb

at least an additional $400 million in annual expenses as a result of

the changes implemented in connection with the Dodd-Frank Act, and that

assuming SEFs will execute 1,000 trades a day (comparable to what ISDA

states is the current number of transactions in the OTC market), this

will amount to execution costs of $1,280 per trade.\1017\ As a result,

ISDA stated that dealer costs will be passed on to end users and will

cause participants to withdraw from the market, discouraging

innovation.\1018\

---------------------------------------------------------------------------

\1017\ Id. at 35.

\1018\ Id. at 4.

---------------------------------------------------------------------------

The Commission notes that a majority of the costs identified by

ISDA result from statutory requirements that were not the product of

Commission discretion. For example, the requirements that certain swaps

must be executed on a SEF or DCM,\1019\ and that no person may operate

a facility for the trading or processing of swaps unless the facility

is registered as a SEF or as a DCM,\1020\ are statutory requirements.

Additionally, CEA section 5h(e) contains a rule of construction that

states ``[t]he goal of this section is to promote the trading of swaps

on swap execution facilities and to promote pre-trade price

transparency in the swaps market.'' \1021\ The interest rate swaps

discussed by ISDA are included in these statutory requirements.

Moreover, notwithstanding ISDA's use of the term ``electronic execution

mandate,'' this rulemaking does not require that market participants

execute swaps in Required Transactions electronically, since SEFs will

be allowed to use any means of interstate commerce in providing the

execution methods for such transactions as described in Sec.

37.9(a)(2)(ii). Nevertheless, the Commission addresses below many of

ISDA's comments regarding the statutory trading mandate for interest

rate swaps.

---------------------------------------------------------------------------

\1019\ CEA section 2(h)(8); 7 U.S.C. 2(h)(8).

\1020\ CEA section 5h(a)(1); 7 U.S.C. 7b-3(a)(1).

\1021\ CEA section 5h(e); 7 U.S.C. 7b-3(e).

---------------------------------------------------------------------------

Further, while commenters did not submit any data to support or

refute ISDA's estimates, during follow-up calls with potential SEFs,

one commenter stated that the U.S. credit default swap market

experiences approximately 1,350 trades per day. If interest rate swaps

and other swaps are included, the total number of trades per day is

likely to be a much higher figure. In turn, this would imply that the

execution costs per trade are likely to be lower than ISDA's estimate,

which was based on only 1,000 trades per day.

The Commission notes that while SEFs are expected to list for

trading a wide variety of swaps, ISDA's comment addresses only the

costs and benefits applicable to the interest rate swap market. The

interest rate swap market is one of the most liquid swap markets and is

characterized by relatively tight bid-ask spreads, a high level of

notional principal, and relatively high volume compared to other swap

markets, including credit default swaps. Most other swap markets,

especially many of the instruments like credit derivatives which

contributed to the financial crisis, are less liquid than the interest

rate swap market and thus will benefit more from the enhanced pre-trade

and post-trade price transparency and centralized marketplaces that

will be available on SEFs.

While it may be true, as ISDA asserts, that some buy-side users

contend that current levels of price transparency in the interest rate

swap market are adequate, the Commission notes that an increase in pre-

trade transparency benefits the public because it will allow all market

participants (not just those with a strong business relationship with a

particular swap dealer) \1022\ to transact in the market on a level

playing field, and will likely enhance price discovery in the swaps

market. Moreover, as noted, section 5h(e) of the CEA states that a

purpose of SEFs is to promote pre-trade transparency in the swaps

market.\1023\

---------------------------------------------------------------------------

\1022\ The ISDA comment ignores the liquidity risk inherent in

the current bilateral interest rate swap market. It addresses the

cost of entering into a new position, but not of unwinding it. If a

buy-side firm wishes to unwind a swap in the OTC market, it will

typically have to complete the unwind trade with the original

counterparty or swap dealer. Given that the dealer is aware of the

true trading interest of the buy-side firm, the quote might be one-

sided favoring the dealer. Assuming sufficient liquidity, any

anonymous trading platform will pose a lower unwind risk/cost to

most non-dealer or buy-side firms.

\1023\ CEA section 5h(e); 7 U.S.C. 7b-3(e).

---------------------------------------------------------------------------

According to ISDA, market participants asserted that bid-ask

spreads in interest rate swaps will widen after SEFs begin

trading.\1024\ The Commission notes that such predictions are

speculative and are not based on data, which does not yet exist because

SEFs have yet to begin trading. Moreover, during the Commission staff's

follow-up conversations, other market participants (potential SEFs)

shared information illustrating that after the financial crisis,

participation by dealers or liquidity providers increased on their

trading platforms. These sources stated that in some instances, new

entrants now account for over a quarter of the total business

transacted on such platforms. The Commission believes that, holding all

else constant, increased participation and competition among liquidity

providers should result in tighter spreads and greater depth, both key

components of improved liquidity.\1025\

---------------------------------------------------------------------------

\1024\ ISDA Discussion Paper at 2-4 (Nov. 2011).

\1025\ See Hendershott & Madhavan, ``Click or Call,'' at 2;

Darrell Duffie, Nicolae G[acirc]rleanu & Lasse Heje Pedersen,

``Over-the-Counter Markets,'' 73 Econometrica 1815 (Nov. 2005)

(hereinafter Duffie et al., ``OTC Markets'').

---------------------------------------------------------------------------

However, to promote the trading of swaps on SEFs, the Commission's

final rules, as mentioned above, further increase the flexibility

regarding the trading platforms that a SEF may offer for Required

Transactions (which the Commission expects will include many interest

rate swap contracts).\1026\ In addition, as discussed above,\1027\

work-up sessions will allow market participants to continue using

certain existing market practices, which will help facilitate the

transition of swap markets to SEFs.

---------------------------------------------------------------------------

\1026\ See, e.g., Minimum Trading Functionality discussion above

under Sec. 37.3--Requirements for Registration in the preamble and

``Through Any Means of Interstate Commerce'' Language in the SEF

Definition discussion above under Sec. 37.9(b)(1) and (b)(4)--

Execution Methods for Required Transactions in the preamble.

\1027\ See ``Through Any Means of Interstate Commerce'' Language

in the SEF Definition discussion above under Sec. 37.9(b)(1) and

(b)(4)--Execution Methods for Required Transactions in the preamble.

---------------------------------------------------------------------------

To support its comments on the potentially adverse impact of moving

interest rate swaps to centralized execution platforms, ISDA provided

data on bid-offer spreads from both interest rate swap markets and

[[Page 33561]]

exchange-traded futures markets.\1028\ The Commission notes that

interest rate swap dealers use exchange-traded interest rate futures,

primarily the Eurodollar futures, to hedge the exposures that arise

from their interest rate swap dealing activity. A dealer seeking to

hedge an interest rate swap using Eurodollar futures will typically

trade a strip of Eurodollar futures.\1029\ In its comparisons of

typical bid-offer spreads in exchange-traded interest rate futures and

in OTC interest rate swaps, ISDA provided spreads in the front month

Treasury bond and Treasury note futures contracts and the relatively

illiquid interest rate swap futures contracts, but not the highly

liquid Eurodollar futures contract.\1030\ As noted, the Eurodollar

futures contract is the primary vehicle used by interest rate swap

dealers to hedge their residual interest rate exposure. Therefore, the

Commission believes that Eurodollar futures bid-offer spreads are a

more appropriate metric for comparison to interest rate swap bid-ask

spreads than the interest rate swap futures contracts bid-ask spreads

used by ISDA. Likewise, Eurodollar futures are more closely related to

the OTC interest rate swap market and more useful for hedging interest

rate swap positions than Treasury futures contracts. Thus, Eurodollar

futures are also a better metric for comparison to interest rate swaps

than Treasury futures.

---------------------------------------------------------------------------

\1028\ ISDA Discussion Paper at 12-20 (Nov. 2011).

\1029\ A strip of Eurodollar futures contracts is a position

consisting of a sequence of contract months, for example, a position

consisting of the March 2013, June 2013, September 2013, and

December 2013 Eurodollar futures contracts. This position is

economically equivalent to a one year interest rate swap with

quarterly payment dates on the futures expiration dates.

\1030\ According to the CME Group Web site, during the first

eight months of 2012, Eurodollar futures contracts had a total

volume of approximately 2300 million contracts. During that same

period, the combined volume of CME Group's interest rate swap

futures contracts was only about 312,000 contracts, approximately 1/

10 of one percent of the volume in Eurodollar futures contracts. See

http://www.cmegroup.com/wrappedpages/web_monthly_report/Web_Volume_Report_CMEG.pdf, updated monthly and viewed in September

2012.

---------------------------------------------------------------------------

Underlying ISDA's comment is an implicit assumption that moving

swaps to electronic trading platforms will not result in any major

changes to the number of transactions that occur. In computing its cost

estimates, ISDA assumes that the number of trades on SEFs will be

comparable to the number of trades that occur in the OTC market today.

As noted above, ISDA states that, assuming SEFs will execute 1,000

trades a day, total execution costs will amount to $1,280 per

trade.\1031\ However, transaction volume has increased dramatically in

securities markets and DCM futures markets that have migrated to

electronic trading platforms (such as order books) from open outcry and

other non-electronic trading environments. This volume increase is due

to a tendency for typical transaction sizes to be much smaller on

electronic order book markets and also because order books attract

participation from new and alternate sources of liquidity, including

participants using automated trading strategies.\1032\ Transactions

levels increased in the securities and futures markets when trading

moved to electronic platforms, and the Commission believes that it is

likely that the number of transactions in the swap markets will

increase as swap trading migrates to SEFs and DCMs. The Commission is

unaware of any comments or studies indicating that transaction sizes in

the swap markets will remain unchanged when they move to electronic

platforms.

---------------------------------------------------------------------------

\1031\ See ISDA Discussion Paper at 35 (Nov. 2011). A recent

paper by the New York Federal Reserve estimated 2,500 trades/day in

the interest rate swap market. See Michael Fleming, John Jackson,

Ada Li, Asani Sarkar, & Patricia Zobel, ``An Analysis of OTC

Interest Rate Derivatives Transactions: Implications for Public

Reporting,'' Federal Reserve Bank of New York Staff Reports, No.

557, at 2 (Mar. 2012), available at http://www.newyorkfed.org/research/staff_reports/sr557.pdf.

\1032\ See, e.g., George H. K. Wang & Aysegul Ates, ``When Size

Matters: The Case of Equity Index Futures,'' EFMA 2004 Basel

Meetings Paper (Dec. 2003); Samarth Shah & B. Wade Brorsen,

``Electronic vs. Open Outcry: Side-by-Side Trading of KCBT Wheat

Futures,'' 36 Journal of Agricultural and Resource Economics 48

(Apr. 2011).

---------------------------------------------------------------------------

(ii) RFQ-5 Market Participant Requirement

Several commenters stated that the five market participant

requirement in proposed Sec. 37.9(a)(1)(ii) is likely to increase

costs, but commenters did not provide any data to support this

assertion.\1033\ MetLife stated that disclosure of a large expected

trade by RFQ to five swap dealers would likely result in a material

widening of bid/ask spreads and increased hedging costs, as swap

dealers will pass on to their customers the cost of protecting

themselves against potential adverse price movements due to the

required pre-trade transparency.\1034\ Some commenters specifically

noted that these adverse price movements would be due to non-executing

market participants receiving the RFQ front-running the transaction in

anticipation of the executing market participant's forthcoming and

offsetting transactions.\1035\ Commenters additionally stated that the

risks associated with the five market participant requirement would be

most pronounced in illiquid swaps or large-sized trades (i.e.,

transactions approaching the block trade threshold).\1036\ Some

commenters also stated that the five market participant requirement

would negatively impact liquidity.\1037\

---------------------------------------------------------------------------

\1033\ See RFQ System Definition and Transmission to Five Market

Participants discussion above under Sec. 37.9(a)(1)(ii)--Request

for Quote System in the preamble.

\1034\ MetLife Comment Letter at 2-3 (Mar. 8, 2011).

\1035\ See RFQ System Definition and Transmission to Five Market

Participants discussion above under Sec. 37.9(a)(1)(ii)--Request

for Quote System in the preamble.

\1036\ Id.

\1037\ Id.; ISDA Discussion Paper at 2 (Nov. 2011).

---------------------------------------------------------------------------

While the Commission believes that the five market participant

requirement promotes the statutory goal of pre-trade transparency

because the RFQ requester will have access to quotes from a larger

group of potential responders, the Commission is sensitive to

commenters' concerns about this requirement, such as the potential for

increased trading costs and information leakage to the non-executing

market participants in the RFQ. To address these concerns, while still

complying with the statutory SEF definition and promoting the goals

provided in section 733 of the Dodd-Frank, the Commission is revising

final Sec. 37.9(a)(3) so that a market participant must transmit an

RFQ to no less than three market participants.

As noted in the preamble, the Commission believes that the three

market participant requirement is consistent with current market

practice where, in certain markets, many market participants already

choose to send an RFQ to multiple market participants, while still

complying with the statutory SEF definition and promoting the goal of

pre-trade transparency.

Additionally, the Commission believes that adopting a minimum

market participant requirement of fewer than three (e.g., a minimum of

two market participants) will expose market participants to a higher

risk of not receiving multiple responses to their RFQs. The receipt of

multiple responses increases the likelihood that the requestor will

execute at the best possible price. The Commission has learned that

business or technology reasons may prevent any given market participant

from responding to a specific RFQ. For example, DCM market maker

programs typically require participants to quote two-sided markets for

75 to 85 percent of the trading day. Therefore, if the Commission

established a minimum market

[[Page 33562]]

participant requirement of two, there could be instances where one

market participant does not respond to the RFQ, leaving the RFQ

requester with only a single response. While there is no guarantee that

even a minimum of three market participants will ensure that multiple

responses are available for all RFQs at all times, it increases the

probability that the goal of pre-trade price transparency is achieved

and that a competitive market is created for market participants.

In response to the concerns raised by commenters about increased

trading costs, the Commission also notes that research in the corporate

bond market supports the view that RFQ systems in general increase

search options for investors, and that the competition that ensues

among market participants results in lower bid-ask spreads.\1038\ One

paper by Hendershott and Madhavan provides evidence that by allowing a

market participant to negotiate simultaneously with multiple

participants, and thus not be constrained by the limitations of the

sequential search process as discussed above, RFQ systems contribute to

a statistically significant reduction in transaction costs for quote

requesters.\1039\

---------------------------------------------------------------------------

\1038\ See Hendershott & Madhavan, ``Click or Call,'' at 10-12.

\1039\ Id. at 10.

---------------------------------------------------------------------------

Specifically, the authors compare transaction costs across two

different market structures, one with an RFQ and one with a traditional

OTC structure, and find that investors are more likely to use RFQ

systems when their costs are high because increased RFQ participation

reduces their transaction costs.\1040\ This is so because competition

among dealers lowers costs.\1041\ While Hendershott and Madhavan's

estimates for transaction costs in the corporate bond market are

consistent with those reported by others,\1042\ access to RFQ market

data, plus their choice of econometric model, help them obtain deeper

insights into the reasons for differences in costs across different

types of bonds.\1043\ This research in the debt markets supports the

final rules' three market participant requirement because it

demonstrates that unless multiple market participants receive the RFQ,

the quote requester will not be able to generate a minimal level of

competition sufficient to reduce the quoted bid-ask spread.

---------------------------------------------------------------------------

\1040\ Id. at 14.

\1041\ Id. at 17.

\1042\ See, e.g., Edwards et al., ``Transaction Costs and

Transparency,'' 1421-51.

\1043\ Hendershott & Madhavan, ``Click or Call,'' at 1-4.

---------------------------------------------------------------------------

As stated by commenters, in a market with high levels of pre-trade

transparency, concerns about leakage of trading interest typically grow

with trade size; a market participant posting a bid or offer in the

order book, or sending a request for a quote to multiple dealers, will

typically be concerned that information about their trading interest

will adversely impact the market price. However, empirical research by

Hendershott and Madhavan demonstrates that standard-sized (as opposed

to large size) trades are more likely to be traded on an RFQ

system.\1044\ For these trade sizes, market participants believe that

the benefits from lowering search costs mitigate concerns about

information leakage.\1045\ On the other hand, for larger trades (i.e.,

block trades), leakage concerns could dominate any expected savings in

search costs from participating in the order book or RFQ system, and

larger trades are more likely to be executed though a bilateral

bargaining process. The Commission's understanding of this potential

trade-off between lower search costs and higher leakage risk is

generally consistent with the results from Hendershott and Madhavan

described above. These findings are relevant for the final rules'

exclusion of block-sized trades from the execution methods for Required

Transactions.

---------------------------------------------------------------------------

\1044\ Id. at 15, 18, 28.

\1045\ Id. A market participant sending an order to the market

is likely to be concerned about others in the market being able to

glean information through the order. In the context of a firm

sending a large size trade, one substantially bigger than the

typical trade size, there will always be concern that the size of

the order will be interpreted as containing information, and elicit

responses from other market participants. Firms will typically be

interested in ensuring that the size of the order does not have an

adverse impact on the order price, or the quotes from liquidity

providers. Accordingly, while looking to execute such orders, firms

will take steps to avoid leakage of the information of their trading

interest beyond a very small group of potential counterparties.

---------------------------------------------------------------------------

While some commenters stated that the five market participant

requirement would result in excessive and costly disclosure, other

commenters argued that the requirement would result in insufficient

transparency, comparing the proposed requirement to the current status

quo of private OTC markets, where large swap dealers can choose to only

interact with one another.\1046\ According to Mallers et al., because

the SEF NPRM would permit a market participant to interact with a

limited number of market participants (i.e., less than the entire

market), the proposal would allow ``semi-private side deals'' to take

place, and that in light of the 2008 financial crisis, the ``costs and

risks of permitting private RFQ markets [remained] high.'' \1047\

---------------------------------------------------------------------------

\1046\ Mallers et al. Comment Letter at 3-5 (Mar. 21, 2011).

\1047\ Id. at 5.

---------------------------------------------------------------------------

As noted above, the Commission agrees that a broader group of

potential responders will encourage price competition and provide a

fairer assessment of market value; however, the Commission is mindful

of concerns that the five RFQ recipient model may impose additional

costs, especially for illiquid and bespoke swaps. Following the

practice for futures on DCMs, the Commission could have required that

RFQs be disseminated to all market participants.\1048\ However, the

Commission recognizes that swaps tend to be less standardized than

futures; therefore, the rules pertaining to the execution methods for

SEFs should provide the requisite flexibility to market participants

trading swaps. As such, the Commission is implementing the minimum

three market participant requirement. The Commission also believes that

the three market participant requirement reflects the more flexible

statutory provisions for SEFs as compared to DCMs.

---------------------------------------------------------------------------

\1048\ The Commission notes that a SEF market participant may

send an RFQ to the entire market. Core Principles and Other

Requirements for Swap Execution Facilities, 76 FR at 1220. Based on

its experience with RFQ-to-all functionality offered by DCMs, the

Commission notes that there are two distinct differences between

these and the requirements finalized in this release. First, RFQs

submitted to DCMs are disseminated to all market participants.

Second, the responses to the RFQs take the form of executable bids

or offers that are entered into the DCM's order book or other

centralized market, such that orders from any market participant,

not just the one submitting the RFQ, can be matched against such

responsive bids or offers.

---------------------------------------------------------------------------

While commenters have not submitted any data on the potential

impact of the proposed five market participant requirement from the

potential information leakage and front-running risks, the Commission

believes that the three market participant requirement adopted in this

final release does not necessarily introduce a new source of risk for

market participants as these risks to the extent that they exist are

present in the current OTC market. The Commission also believes that

the prices of bids and offers made in response to RFQs will reflect any

subsequent hedging risks by the responders, and the potential winner's

curse to the extent one exists will, if at all, be realized only if the

market participant does not price this risk fully into its quote.

Nonetheless, the revision from five to three market participants should

help to mitigate this potential

[[Page 33563]]

risk, while still complying with the statutory SEF definition and

promoting pre-trade price transparency and price competition.

Furthermore, regarding comments concerns' about the potential

winner's curse for illiquid swaps, the Commission notes that the three

market participant requirement will only apply to transactions in swaps

that are subject to the CEA section 2(h)(8) trade execution mandate

(i.e., transactions in more liquid swaps, which are subject to the

clearing mandate and made available to trade, and not to illiquid and

bespoke swaps).\1049\ The Commission also notes that the interest rate

swaps and credit default swaps that the Commission has determined are

required to be cleared under CEA section 2(h)(1) (and are likely to be

subject to the trade execution mandate of CEA section 2(h)(8)) are some

of the most liquid swaps.\1050\ Additionally, 77 swap dealers have

registered with the Commission and nearly all of them make markets in

such swaps.\1051\ SEFs may offer RFQ systems without the three market

participant requirement for Permitted Transactions (i.e., transactions

not involving swaps that are subject to the trade execution mandate of

CEA section 2(h)(8)). In response to commenters' concerns about the

potential winner's curse for large-sized trades, the Commission notes

that block-sized transactions would not be subject to the execution

methods for Required Transactions, including the three market

participant requirement.\1052\ Therefore, excluding block-sized

transactions from the execution methods for Required Transactions will

address the potential risk of a winner's curse for large-sized trades.

---------------------------------------------------------------------------

\1049\ Clearing Requirement Determination Under Section 2(h) of

the CEA, 77 FR 74284 (Dec. 13, 2012); Process for a Designated

Contract Market or Swap Execution Facility To Make a Swap Available

To Trade, 76 FR 77728 (proposed Dec. 14, 2011).

\1050\ Clearing Requirement Determination Under Section 2(h) of

the CEA, 77 FR 74284. The Commission notes that these swaps already

went through a Commission determination process that included a five

factor review, including a liquidity review. Id. ISDA, in its letter

requesting interpretive relief regarding the obligation to provide a

pre-trade mid-market mark, recognized that many of the swaps that

the Commission has determined are required to be cleared under CEA

section 2(h)(1) are ``highly-liquid, exhibit narrow bid-ask spreads

and are widely quoted by SD/MSPs in the marketplace . . .'' ISDA

Comment Letter at 2 (Nov. 30, 2012).

\1051\ The Commission recognizes that not all swap dealers will

be active in all Required Transactions. The Commission also notes

that of the 77 swap dealers, 35 swap dealers are not affiliated with

any of the 77 swap dealers.

\1052\ See definition of block trade in Sec. 43.2 of the

Commission's regulations.

---------------------------------------------------------------------------

As noted in the preamble, the three market participants may not be

affiliated with or controlled by the RFQ requester and may not be

affiliated with or controlled by each other, and the Commission is

revising final Sec. 37.9(a)(3) to clarify this point. The Commission

believes that for an RFQ requester to send an RFQ to another entity who

is affiliated with or controlled by the RFQ requester would undermine

the benefits of the requirement.

The costs associated with the no-affiliate rule may include, for

example, the costs that a SEF would incur to upgrade its systems to

create filters that would prevent RFQs from being sent to affiliated

parties, but these costs could be mitigated or eliminated by, for

example, the SEF requiring market participants accepting RFQs to

disclose their affiliations to potential RFQ requestors before a

request is transmitted. Another possibility is for a SEF to monitor

RFQs and cancel trades that it determines are made pursuant to RFQs

between affiliated parties. Yet another possibility is for the SEF to

include in its rules a requirement that market participants must not

transmit RFQs to their affiliates or to market participants who are

affiliated with each other.

The primary benefit of this no-affiliate rule is to ensure that

RFQs are sent to three unaffiliated parties who can be expected to

provide truly independent quotes. If an RFQ requester were to transmit

an RFQ to one non-affiliate and two affiliates or if an RFQ requester

transmits an RFQ to three requestees who are affiliates of each other,

then the goal of pre-trade price transparency would be undermined

(since the quotes might be coordinated or otherwise not independent)

and the RFQ could effectively turn into an RFQ-to-one, which is

contrary to the statutory SEF definition. The Commission also notes

that such an outcome could disincentivize entities from responding to

an RFQ, which would reduce price competition and liquidity.\1053\

---------------------------------------------------------------------------

\1053\ As any trades emanating from an RFQ will be subject to

real time reporting, if a non-affiliated respondent to an RFQ

observes trades happening away from better or equal prices quoted by

it, such respondents might be discouraged from responding to future

RFQ requests, thus hurting market integrity.

---------------------------------------------------------------------------

The Commission clarifies that SEFs are not required to: (1) Display

RFQs to market participants not participating in the RFQ, (2) disclose

RFQ responses to all market participants, or (3) disclose the identity

of the RFQ requester. The Commission also clarifies that an acceptable

RFQ System may allow for a transaction to be consummated if the

original request to three potential counterparties receives fewer than

three responses. Moreover, Sec. 37.9(a)(2)(ii) clarifies that in

providing either one of the execution methods for Required Transactions

(i.e., an Order Book or an RFQ System that operates in conjunction with

an Order Book), a swap execution facility may for purposes of execution

and communication use any means of interstate commerce, including, but

not limited to, the mail, internet, email, and telephone, provided that

the chosen execution method satisfies the requirements provided in

Sec. 37.3(a)(3) for Order Books or in Sec. 37.9(a)(3) for Request for

Quote Systems. Finally, in order to provide market participants, SEFs,

and the swaps industry generally with additional time to adapt to the

new SEF regime, the Commission is phasing-in the three market

participant requirement so that from the effective date of the SEF rule

until one year after the compliance date for the SEF rule, RFQ

requesters may transmit RFQs to no less than two market participants

(rather than three). These provisions will likely significantly

mitigate the likelihood and magnitude of the potential costs noted by

commenters.

(iii) Time Delay Requirement

Some commenters stated that the rule requiring a 15-second time

delay before crossing a trade between two customers should be

eliminated because it may impact liquidity or result in increased

costs.\1054\ FHLB stated that this requirement would likely increase

the bid-ask spread, because ``by waiting for 15 seconds before entering

into an offsetting transaction, brokers will be exposed to risks

associated with market fluctuations and will have to pass the costs of

these risks along to its customer.'' \1055\ No commenter provided

dollar estimates or data regarding these costs.

---------------------------------------------------------------------------

\1054\ See Time Delay Requirement discussion above under Sec.

37.9--Permitted Execution Methods in the preamble.

\1055\ FHLB Comment Letter at 13 (Jun. 13, 2011).

---------------------------------------------------------------------------

The time delay requirement (which only applies to a SEF's Order

Book and not to its RFQ System) supports the Congressional goal of pre-

trade transparency on SEFs by allowing other market participants the

opportunity to participate in a trade where dealer internalization or a

dealer crossing customers' orders would otherwise reduce such pre-trade

price transparency.\1056\ The Commission

[[Page 33564]]

believes that this requirement will minimize the possibility of dealer

internalization and incentivize competition between market

participants. Absent this requirement, market participants would be

free to conduct pre-execution communications away from the centralized

market and then ensure that the orders from such private negotiations

are matched by coordinating their submission to the SEF.

---------------------------------------------------------------------------

\1056\ Dealer internalized or cross-trades are not open and

competitive and may result in inferior execution for one of the

parties compared to situations where the bid or offer is exposed to

the market. Accordingly, DCM rules typically require that an order

be exposed to an order book or trading pit before it can be crossed

with another order.

---------------------------------------------------------------------------

Further, the Commission notes that the costs outlined by commenters

are speculative, since SEFs have not yet begun operation. Moreover, the

time delay requirement is similar to certain timing delays adopted by

DCMs, and the Commission is not aware of evidence that those DCM rules

are imposing significant costs on participants in those markets.\1057\

Nevertheless, the Commission's final rules recognize that a one-size-

fits-all approach to the time delay requirement is not appropriate for

all swap products and markets on a SEF. Accordingly, the Commission is

revising the proposed rule to allow a SEF to adjust the duration of the

time delay requirement based upon a swap's liquidity or other product-

specific characteristics. SEFs therefore will have the ability to

reduce the costs described by the commenters, if they arise.

---------------------------------------------------------------------------

\1057\ See, e.g., NYMEX rule 533, which provides for a 5-second

delay for futures and a 15-second delay for options, available at

http://www.cmegroup.com/rulebook/NYMEX/1/5.pdf.

---------------------------------------------------------------------------

(c) Benefits

As a whole, the minimum trading functionality (i.e., Order Book)

and permissible execution methods established by Sec. Sec. 37.3 and

37.9 advance the Congressional goals of promoting pre-trade price

transparency in the swaps market and promoting trading of swaps on

SEFs.\1058\

---------------------------------------------------------------------------

\1058\ CEA section 5h(e); 7 U.S.C. 7b-3(e).

---------------------------------------------------------------------------

(1) Promotion of Pre-Trade Price Transparency

The order book requirement is designed to ensure a base level of

pre-trade transparency to all market participants by providing for live

executable bids and offers in Required Transactions. This requirement

gives all market participants (and potential market participants)

access to the same key information that swap dealers have, including

current information about the price of a particular swap, at the same

time. An order book with executable bids and offers will ensure that

prior to placing an order or executing a trade, a market participant

will be able to view other bids and offers submitted to the SEF,

including prices, quantities, and order book depth.\1059\ Access to

such information allows market participants to make informed trading

decisions involving variables such as price, size, and timing, and to

better assess the quality of execution effected by their

intermediaries.

---------------------------------------------------------------------------

\1059\ See Duffie et al., ``OTC Markets,'' at 1827 (presenting

results showing that bid-ask spreads are lower if investors can find

each other more easily).

---------------------------------------------------------------------------

Intermediaries will know that their market participants have

information to assess the quality of executions and can send their

business elsewhere if they are not satisfied with their executions.

Thus, intermediaries will have greater incentive to provide efficient

execution to their customers at competitive prices.

In addition, an order book is an efficient method of execution of

transactions for swaps that are subject to the CEA section 2(h)(8)

trade execution mandate because it provides prompt and fast executions

of marketable orders at market prices, while providing for a variety of

functionalities such as limit orders and stop-loss orders. The order

book functionality for such transactions will introduce core levels of

pre-trade transparency without hindering the ability of SEFs and market

participants to deploy other market structures depending on the needs

of the individual products and markets.

As discussed above, the benefits of pre-trade (and post-trade)

transparency generally flow from reducing information

asymmetries.\1060\ In transparent markets, all market participants (and

potential market participants) have timely access to the same public

pricing information that insiders or professionals have, reducing

potential negotiating advantages. Also, in a transparent market, market

participants can better assess the quality of executions effected by

their intermediaries by comparing execution prices against quotations

and other transactions. A potential entrant can view current price

quotations as well as prices of recent trades in an instrument, and can

thereby assess whether it can offer a better price. Market transparency

can thus provide incentives for new participants to enter the market,

increasing competition, reducing concentration, and narrowing spreads.

---------------------------------------------------------------------------

\1060\ See, e.g., Transparency of Structured Finance Products

(Final Report), Technical Committee of the International

Organization of Securities Commissions, at 17, 21 (Jul. 2010),

available at http://www.iosco.org/library/pubdocs/pdf/IOSCOPD326.pdf.

---------------------------------------------------------------------------

The 15-second time delay requirement is intended to limit dealer

internalization of trades (cross trades) and to incentivize competition

between market participants. This requirement will also promote pre-

trade price transparency of swaps executed on SEFs by allowing other

market participants the opportunity to participate in the trade. The

Commission's final rules also recognize that a one-size-fits-all

approach to the time delay requirement is not appropriate for all swap

products on a SEF. Therefore, the final rules provide SEFs with an

appropriate level of discretion to adjust the minimum time delay

requirement based upon a swap's liquidity or other product-specific

characteristics. Moreover, the Commission has clarified that the time

delay requirement does not apply to the RFQ System.

The Commission recognizes commenters' concerns, as discussed in

this section, that there may be certain circumstances in which pre-

trade price transparency may reduce overall market liquidity.

Therefore, the Commission has taken certain steps in the final

regulations to mitigate such benefit-reducing effects (such as

excluding block trades, tying the time-delay requirement to a swap's

liquidity, clarifying the subset of swaps that are Required

Transactions, and allowing SEFs to offer any method of execution for

Permitted Transactions).

(2) Promotion of Trading on SEFs

While the statutory goal of pre-trade price transparency is

reflected in the minimum trading functionality (i.e., Order Book)

requirement, the regulations also provide a SEF with additional

flexibility for offering the trading and execution of swaps by

providing additional execution methods (e.g., RFQ Systems along with

the discretion to offer any method of execution for Permitted

Transactions). The Commission believes that these additional

functionalities will provide flexibility in methods of execution that

will promote the trading of swaps on SEFs, which in turn will promote

price transparency.

For example, execution methods and market structures in general can

vary depending on the product--simple or complex, the state of

development of the market--established or new, market participants--

retail or institutional, and other related factors. The Commission

anticipates that the order book method will typically work well for

liquid Required Transactions (i.e., transactions involving swaps that

are subject to the trade execution requirement under CEA section

2(h)(8)), but for less liquid

[[Page 33565]]

Required Transactions, RFQ systems are expected to help facilitate

trading. RFQ systems are currently used by market participants in the

OTC swap market, many in conjunction with order book functionality. By

providing a SEF with the flexibility to offer alternate execution

methods to its market participants, the Commission is leveraging best

practices from current swap trading platforms. The additional

flexibility offered for the trading and execution of Permitted

Transactions will allow a SEF to offer new, innovative market

structures to facilitate trading in these swaps that are not subject to

the trade execution requirement under CEA section 2(h)(8), and thus may

help to promote the trading of these swaps on SEFs.

Additionally, the RFQ system communication requirement helps

promote the trading of swaps on SEFs and enhances price competition and

pre-trade price transparency by ensuring that RFQ requesters have

access to competitive prices, and that competitive resting bids and

offers left by market participants on the SEF will be transmitted to

the RFQ requester for possible execution.

(3) Facilitating Search

The Duffie, G[acirc]rleanu, and Pedersen (``DGP'') approach

reflects the typical search process, which involves approaching

intermediaries sequentially (similar to making phone calls to different

dealers asking for quotes); strategic bargaining then ensues--prices

negotiated reflect each investor's or the dealer's alternatives to

trade.\1061\ DGP's results show that both traded prices as well as

transaction costs depend on investors' search abilities, access to

market makers, and investors' bargaining powers.\1062\ DGP's results

show that bid-ask spreads are lower if investors can find each other

more easily, through market structures designed to allow them to

negotiate simultaneously, instead of sequentially, with multiple,

competing liquidity providers.\1063\ Contrary to what commenters have

stated, DGP reason that improvements in an investor's ability to search

for alternate counterparties forces dealers to improve on their quoted

prices and spreads.\1064\ Further, they demonstrate that those with

better access to market makers (or liquidity providers) receive tighter

bid-ask spreads.\1065\

---------------------------------------------------------------------------

\1061\ See Duffie et al., ``OTC Markets,'' at 1818-20.

\1062\ Id. at 1815.

\1063\ Id. at 1827.

\1064\ Id. at 1817.

\1065\ Id.

---------------------------------------------------------------------------

The final rules establishing a market structure for SEFs, including

the provisions governing Order Books and RFQ Systems are designed to

deliver improved search capabilities to investors and better access to

market makers. These provisions will facilitate the shifting of trading

to the centralized SEF market structure from the bilateral OTC market

structure where investors may have limited ability to find one another.

The importance of facilitating investors' ability to find each

other more easily is highlighted by evidence in the DGP paper of

another dealer-centric market--the one prevailing at Nasdaq until the

mid-1990s, where all trades had to be routed to a dealer.\1066\

Notwithstanding competition among the dealers, and the fact that there

was both pre- and post-trade transparency in the equity markets,

spreads at Nasdaq at that time were wider than at the New York Stock

Exchange.\1067\ Though the latter had ``a single specialist for each

stock, floor brokers can find and trade among themselves, and outside

brokers can find each other and trade `around' the specialist with

limit orders.'' \1068\ Along these lines, the final rules provide for

an anonymous but transparent order book that will facilitate trading

among market participants directly without having to route all trades

through dealers.

---------------------------------------------------------------------------

\1066\ Id. at 1834-35.

\1067\ Id.; see also Hendrik Bessembinder & Herbert M. Kaufman,

``A Comparison of Trade Execution Costs for NYSE and NASDAQ-Listed

Stocks,'' 32 The Journal of Financial and Quantitative Analysis 287

(Sep. 1997).

\1068\ Duffie et al., ``OTC Markets,'' at 1834-35.

---------------------------------------------------------------------------

(d) Consideration of Alternatives

Some commenters recommended that the Commission modify the proposed

five market participant requirement from no less than five market

participants to either ``one or more'' \1069\ or to all market

participants.\1070\ Other commenters recommended an alternative that

would include some level of order interaction between the SEF's order

book functionality and RFQ systems, including the order interaction

model proposed by the SEC for SB-SEFs.\1071\ MFA recommended that the

Commission expand the definition of Permitted Transaction to include

other transactions, such as exchanges of swaps for physicals, exchanges

of swaps for swaps, and linked or packaged transactions.\1072\ Each of

these alternatives is discussed below.

---------------------------------------------------------------------------

\1069\ See, e.g., Rosen et al. Comment Letter at 11 (Apr. 5,

2011).

\1070\ Mallers et al. Comment Letter at 4 (Mar. 21, 2011); AFR

Comment Letter at 4-5 (Mar. 8, 2011).

\1071\ Rosen et al. Comment Letter at 12-14 (Apr. 5, 2011); JP

Morgan Comment Letter at 5-6 (Mar. 8, 2011); FXall Comment Letter at

9-10 (Mar. 8, 2011); Tradeweb Comment Letter at 8 (Mar. 8, 2011);

FSR Comment Letter at 5 (Mar. 8, 2011); MetLife Comment Letter at 3

(Mar. 8, 2011); SIFMA AMG Comment Letter at 9 (Mar. 8, 2011);

MarketAxess Comment Letter at 32 (Mar. 8, 2011); Barclays Comment

Letter at 7 (Mar. 8, 2011); ABC/CIEBA Comment Letter at 6-7 (Mar. 8,

2011); ISDA/SIFMA Comment Letter at 3-4; Evolution Comment Letter at

5-6 (Mar. 8, 2011).

\1072\ MFA Comment Letter at 8 (Mar. 8, 2011).

---------------------------------------------------------------------------

(1) Modification to the Number of RFQ Requests

Numerous commenters recommended that the Commission adopt the SEC's

proposed approach for SB-SEFs by allowing RFQs to be sent to one or

more market participants (while not recommending that the Commission

adopt the SEC's proposed order interaction requirement), instead of

requiring that RFQs be sent to at least five market participants.\1073\

The benefit of this approach, cited favorably by some commenters, would

be to protect proprietary trading strategies and mitigate hedging

costs.\1074\

---------------------------------------------------------------------------

\1073\ See RFQ System Definition and Transmission to Five Market

Participants discussion above under Sec. 37.9(a)(1)(ii)--Request

for Quote System in the preamble. Under the SEC's interpretation of

the SB-SEF definition, such an RFQ system would provide multiple

participants with the ability, but not the obligation, to transact

with multiple other participants. Registration and Regulation of

Security-Based Swap Execution Facilities, 76 FR at 10953.

\1074\ See, e.g., Rosen et al. Comment Letter at 11 (Apr. 5,

2011).

---------------------------------------------------------------------------

Other commenters, however, stated that only requiring RFQs to be

sent to one or more market participants would preserve the single-

dealer status quo, would diminish the transparency and efficiency of

the regulated swaps markets, and would be inconsistent with the goals

of the Dodd-Frank Act.\1075\ These commenters supported another

alternative under which an RFQ must be transmitted to all participants

on the SEF.\1076\ In particular, one commenter stated that participants

would not be disadvantaged by disclosing an RFQ to the entire market

for transactions below the block trade threshold, which would not move

the market.\1077\ In this commenter's view, the proposed five market

participant requirement would still allow a participant to conduct

semi-private deals with a few favored participants to the exclusion of

other market participants, which would ultimately decrease liquidity

and create a

[[Page 33566]]

substantial barrier to entry into the swaps market.\1078\

---------------------------------------------------------------------------

\1075\ See, e.g., Mallers et al. Comment Letter at 3-5 (Mar. 21,

2011).

\1076\ Id.

\1077\ Id. at 4.

\1078\ Id.

---------------------------------------------------------------------------

The Commission considered the costs and benefits of the above

alternatives, but believes that neither alternative would satisfy the

objectives of the Dodd-Frank Act. As noted by one commenter, only

requiring that RFQs be sent to one market participant would preserve

the status quo,\1079\ while requiring that RFQs be sent to the entire

market may not be feasible for certain less liquid swaps. Nevertheless,

in light of the comments, the Commission is reducing the required

minimum number of recipients for RFQs in the final rule from five to

three. The Commission expects that this will mitigate the concerns of

commenters as discussed above, while continuing to satisfy the

objectives of the Dodd-Frank Act. As discussed above in connection with

the RFQ to three market participant requirement, the Commission views

three RFQ recipients as appropriately balancing between ensuring

liquidity in the swaps market and promoting pre-trade price

transparency. The Commission further notes that the three RFQ recipient

model will provide a more reliable indicator of market value than a

quote from a single RFQ responder.

---------------------------------------------------------------------------

\1079\ IECA Comment Letter at 3 (May 24, 2011).

---------------------------------------------------------------------------

(2) Order Interaction

Another alternative was to allow for one-to-one RFQs, but to

mandate full order interaction.\1080\ However, according to commenters,

an order interaction requirement across trading platforms would impose

significant architectural and operational costs on SEFs.\1081\ In

particular, potential SEFs were concerned that they would incur

significant expenses by having to create the technological capabilities

necessary to ensure that market participants execute against the best

price.

---------------------------------------------------------------------------

\1080\ Under the SEC's SB-SEF NPRM, an RFQ requester must

execute against the best-priced orders of any size within and across

an SB-SEF's modes of execution. See Registration and Regulation of

Security-Based Swap Execution Facilities, 76 FR at 10953-54, 10971-

74.

\1081\ See, e.g., Tradeweb Comment Letter at 6 (Mar. 8, 2011).

---------------------------------------------------------------------------

The Commission did not propose this type of order interaction and

has declined to impose such a requirement herein. Accordingly, the

final regulations respond to concerns regarding a transacting party's

ability to take into consideration factors other than price when

choosing a counterparty or clearing entity, by, for example, offsetting

an existing position cleared through the Derivatives Clearing

Organization (``DCO'') through which the position was entered into,

even though a slightly better price may exist for the same instrument

at a different DCO. This flexibility will allow market participants to

execute swap transactions in accordance with the unique execution

requirements of each transaction.

(3) Expand Definition of Permitted Transaction

Another alternative is to expand the definition of Permitted

Transaction to include other transactions, such as exchanges of swaps

for physicals, exchanges of swaps for swaps, and linked or packaged

transactions. The Commission interprets MFA's comment suggesting this

alternative to be a request that the Commission create through

rulemaking an exception to the CEA section 2(h)(8) trade execution

mandate similar to the centralized market trading exception established

by DCM Core Principle 9 for certain exchange of futures for related

positions (``EFRPs'').\1082\

---------------------------------------------------------------------------

\1082\ See CEA section 5(d)(9); 7 U.S.C. 7(d)(9). The Commission

notes that DCM Core Principle 9 does not explicitly permit DCMs to

offer exchange of swaps for physicals or exchange of swaps for

swaps.

---------------------------------------------------------------------------

The Commission has determined not to adopt this alternative,

because a broad exception for the off-exchange transactions described

by MFA could undermine the trade execution requirement by allowing

market participants to execute swaps subject to the trade execution

requirement bilaterally rather than on a SEF or DCM. The Commission

notes that market participants with a bona fide business purpose for

executing exchange of swaps for physicals in physical commodity swaps

(should such swaps become subject to the trade execution mandate) are

likely to be eligible for the end-user exception. The Commission is not

currently aware of any bona fide business purpose for executing such

transactions in financial swaps subject to the trade execution mandate.

In light of the end-user exception, the Commission expects that the

costs associated with the Commission's determination will be minimal.

The Commission is aware that the swaps market will evolve in ways that

it does not currently anticipate and is open to revisiting this issue

should a bona fide business purpose arise to execute swaps that are

subject to the trade execution mandate in a manner recommended by the

commenter.

(e) Section 15(a) Factors

(1) Protection of Market Participants and the Public

The final regulations, specifically the provisions requiring a

minimum trading functionality (i.e., Order Book) and the communication

of any firm bid or offer along with responses to the RFQ, promote the

protection of market participants and the public by promoting the

statutory goals of increased pre-trade transparency and trading on

SEFs. Taken together, these final rules should reduce the likelihood

that market participants and SEFs execute swaps at non-market prices,

thus protecting traders and members of the public that rely on the

prices of swaps facilitated or executed on SEFs. The rules should

benefit market participants by reducing the potential rents extracted

by dealers from customers in opaque markets, ``and more so from less

informed customers.'' \1083\

---------------------------------------------------------------------------

\1083\ Bessembinder & Maxwell, ``Transparency,'' at 226. Their

conclusions in the context of post-trade transparency introduced by

the TRACE system can be generalized to the improvement in pre-trade

transparency introduced through the minimum trading functionality

(i.e., Order Book) and the ability to negotiate simultaneously with

multiple market participants through the RFQ system.

---------------------------------------------------------------------------

The Commission mitigates the costs to market participants by

minimizing the risk of information leakage to other market participants

by clarifying that SEFs are not required to: (1) Display RFQs to market

participants not participating in the RFQ, (2) disclose RFQ responses

to all market participants, or (3) disclose the identity of the RFQ

requester.

As discussed above, the Commission anticipates that the

requirements in Sec. 37.9 will result in better pricing and liquidity

and increased participation on SEFs because market participants will be

able to trade on flexible platforms without compromising on pre- and

post-trade transparency. The final regulations also provide information

and pricing benefits to market participants using an RFQ System because

market participants seeking liquidity will have access to additional

pricing information after disseminating an RFQ. The final regulations

increase the likelihood that RFQ requesters will receive competing

quotes from a larger group of responders. The Commission notes that

competition between multiple quote providers should result in tighter

bid-offer spreads for the RFQ requesters.

The rules promoting trading on SEFs protect the public by

encouraging trading on regulated SEFs rather than on unregulated OTC

markets. Moreover,

[[Page 33567]]

some market participants may be end users that provide goods and

services to the public (e.g., airlines or electric utilities). To the

extent that these end users obtain better pricing due to these rules

and are able to pass those cost savings to their customers and

shareholders, the public would gain additional benefits from the pre-

trade transparency and promotion of trading on SEFs.

(2) Efficiency, Competitiveness, and Financial Integrity of the Markets

\1084\

---------------------------------------------------------------------------

\1084\ The Commission notes that CEA Sec. 15(a)(2)(B) requires

the Commission to consider the costs and benefits of its actions in

light of ``considerations of the efficiency, competitiveness, and

financial integrity of futures markets.'' The Commission is also

considering the costs and benefits of these rules in light of

considerations of the efficiency, competitiveness, and financial

integrity of ``swap markets.''

---------------------------------------------------------------------------

The final regulations will improve the efficiency, competitiveness,

and financial integrity of the swaps market by providing a SEF with the

flexibility to offer several execution methods for Required

Transactions to meet the needs of market participants, including RFQ

Systems, as well as the flexibility to offer any execution method for

Permitted Transactions. This flexibility reflects the fact that there

is a continuum of markets occupying ``various points between high and

low transparency'' \1085\ and will allow participants to efficiently

execute trades using various methods of execution depending on the

liquidity levels in particular products. For example, participants may

execute more liquid products on an Order Book, while executing less

liquid products using RFQ functionality. Final Sec. 37.9, specifically

the provisions related to RFQ Systems (including the minimum RFQ to

three requirement) and the 15 second time delay requirement for cross

trades, should also facilitate an increase in the number of market

participants that provide liquidity on SEFs by providing greater

opportunities for those market participants, which will contribute to

the competitiveness of the swaps market.

---------------------------------------------------------------------------

\1085\ See ISDA Research Notes, ``Transparency and over-the-

counter derivatives: The role of transaction transparency,'' No. 1,

at 2-3 (2009), available at http://www2.isda.org/attachment/MTY4NA==/ISDA-Research-Notes1.pdf.

---------------------------------------------------------------------------

Research by Hendershott and Madhavan supports the benefits of

increased competition facilitated by RFQ systems.\1086\ By enabling

market participants to meet each other directly (without being forced

to go through an intermediary as is the case in the current OTC market

structure), and by providing them a facility (via the RFQ system) to

simultaneously negotiate with multiple market participants, the rules

reduce the search costs inherent in the current OTC market structure as

described by Duffie, G[acirc]rleanu, and Pedersen,\1087\ and thus

promote a more efficient and competitive market structure for the swaps

markets. In another paper, Zhu addresses the requirement for a minimum

of five quote providers as a means to ``increase direct trading among

`end-users' and reduce the fraction of trading volume that is conducted

through intermediaries.'' \1088\ Similarly, Avellaneda and Cont

emphasize the importance of market transparency as ``not an objective

per se but rather a means for ensuring the proper functioning of the

market.'' \1089\

---------------------------------------------------------------------------

\1086\ See Hendershott & Madhavan, ``Click or Call,'' at 3

(stating that ``[T]he evolution of bilateral, sequential trading

into an auction type framework'' (their definition of the RFQ

system), ``offers a path from an over-the-counter market to

centralized, continuous trading'').

\1087\ Duffie et al., ``OTC Markets,'' at 1815.

\1088\ Haoxiang Zhu, ``Finding a Good Price in Opaque Over-the-

Counter Markets,'' 25 The Review of Financial Studies 1255, 1264

(Apr. 2012).

\1089\ Marco Avellaneda & Rama Cont, ``Transparency in Credit

Default Swap Markets,'' Finance Concepts, at 3 (Jul. 2010),

available at http://www.finance-concepts.com/images/fc/CDSMarketTransparency.pdf.

---------------------------------------------------------------------------

(3) Price Discovery

The final rules provide for pre-trade transparency and promote

trading on SEFs, both of which will enhance price discovery on a SEF.

The minimum trading functionality will allow non-dealer firms with

access to the SEF to compete with dealers by also placing bids and

offers on the SEF. The 15 second time delay requirement will ensure a

minimum level of pre-trade transparency by allowing other market

participants the opportunity to participate in a privately negotiated

trade before it is crossed. The broader participation and pre-trade

transparency could increase market depth and improve price discovery.

Research by Zhu shows that execution methods similar to the RFQ system

can help improve the dispersion of quote information across a broader

cross-section of market participants, the sensitivity of quoted prices

to information, and the ability of the market to aggregate information

distributed among multiple participants.\1090\ These conclusions

support findings from research by Duffie, G[acirc]rleanu, and Pedersen

that ``[s]earch frictions affect not only the average levels of asset

prices but also the asset market's resilience to aggregate shocks[,]''

both of which are critical elements of any efficient and effective

price discovery process.\1091\

---------------------------------------------------------------------------

\1090\ Haoxiang Zhu, ``Finding a Good Price in Opaque Over-the-

Counter Markets,'' 25 The Review of Financial Studies 1255, 1257-58

(Apr. 2012).

\1091\ Duffie et al., ``Valuation in OTC Markets,'' at 1881.

---------------------------------------------------------------------------

The differentiation in execution methods for Required and Permitted

Transactions, and the ability to use ``any means of interstate

commerce'' in providing the execution methods for Required Transactions

as described in Sec. 37.9(a)(2)(ii), will allow a SEF to adjust its

market structures for emerging and less liquid markets by using a

variety of means of communication in providing the execution methods

for Required Transactions and using any execution method the SEF deems

appropriate for Permitted Transactions. This approach reflects the

Commission's belief that the price discovery process varies across

markets and products.

(4) Sound Risk Management Practices

Centralized trading platforms have multiple checks and balances

built into their systems designed to reduce operational risks (such as

human error) inherent in order submission, matching, and confirmation.

The Commission believes that adoption of centralized trading platforms

for swaps trading on a SEF will contribute to a system-wide reduction

in operational risks, and will help standardize risk management

practices in the marketplace. This in turn will reduce overall

transaction costs, and will, along with pre-trade transparency and the

prospects for improved price discovery discussed earlier, encourage

market participants to trade swaps on SEFs and thus aid in the

development of the swaps market. As markets are interlinked, the growth

of the swaps market will likely drive growth of the futures and other

derivatives markets through the liquidity externality mechanism, which

in turn will improve the ability of a broader range of market

participants to measure, hedge, and transfer their risks through such

contracts.\1092\

---------------------------------------------------------------------------

\1092\ See Yakov Amihud, Haim Mendelson, & Beni Lauterbach,

``Market microstructure and securities values: Evidence from the Tel

Aviv Stock Exchange,'' 45 Journal of Financial Economics 365, 378-80

(Sep. 1997) (discussing liquidity externalities in trading).

---------------------------------------------------------------------------

(5) Other Public Interest Considerations

The Commission has not identified any effects that these rules will

have on other public interest considerations other than those

enumerated above.

3. Registration

(a) Background

Section 5h(a)(1) of the Act provides that no person may operate a

facility for

[[Page 33568]]

the trading or processing of swaps unless the facility is registered as

a SEF or a DCM.\1093\ The SEF definition in CEA section 1a(50) defines

a SEF as ``a trading system or platform in which multiple participants

have the ability to execute or trade swaps by accepting bids and offers

made by multiple participants in the facility or system, through any

means of interstate commerce, including any trading facility, that--(A)

Facilitates the execution of swaps between persons; and (B) is not a

designated contract market.'' \1094\ In accordance with these

provisions, the Commission has clarified that a facility would be

required to register as a SEF if it offers a trading system or platform

in which more than one market participant has the ability to execute or

trade swaps with more than one other market participant on the system

or platform.\1095\ In response to comments, the Commission also

provides examples of how it would interpret the registration

requirement for certain entities.

---------------------------------------------------------------------------

\1093\ CEA section 5h(a)(1); 7 U.S.C. 7b-3(a)(1).

\1094\ CEA section 1a(50); 7 U.S.C. 1a(50).

\1095\ See Requirements for Registration discussion above under

Sec. 37.3--Requirements for Registration in the preamble for

further details.

---------------------------------------------------------------------------

Section 37.3(a)(1) codifies this statutory registration requirement

and Sec. 37.3(b) requires, among other things, that applicants

requesting approval of registration as a SEF must file a complete Form

SEF, which consists of general questions and a list of exhibits that

will enable the Commission to determine whether the applicant complies

with the core principles and the Commission's regulations. Form SEF

standardizes the information that an applicant must provide to the

Commission and includes comprehensive instructions that will guide

applicants through the process.\1096\ Section 37.3(b)(5) requires the

Commission to review any application for registration as a SEF

submitted two years or later after the effective date of part 37

pursuant to the 180-day timeframe and procedures specified in CEA

section 6(a).

---------------------------------------------------------------------------

\1096\ Sections 37.3(d)-(g) provide procedures for other actions

involving registration, including reinstating a dormant

registration, requesting a transfer of registration, withdrawal of

an application for registration, and vacation of registration. These

procedures will further the ability of the Commission to efficiently

monitor SEFs' compliance with the core principles, and will result

in minimal administrative costs for SEFs.

---------------------------------------------------------------------------

Under Sec. 37.3(c), SEF applicants may submit a notice to the

Commission requesting temporary registration, allowing them to operate

during the pending application process once a notice granting temporary

registration from the Commission has been received. The SEF NPRM

required these applicants to submit transaction data substantiating

that they are trading swaps. In response to comments, the Commission is

eliminating this requirement from the final rule and is also extending

the termination date of the proposed temporary registration provision

by one year. In addition, the Commission is shortening the proposed

effective date of the regulations from 90 days to 60 days subsequent to

publication in the Federal Register. In connection with this change,

the Commission is also using its discretion to establish alternative

dates for the commencement of its enforcement of regulatory provisions

and is setting a general compliance date of 120 days subsequent to

Federal Register publication.

(b) Costs

In its discussion paper, ISDA estimated the average cost of

registration would be $333,000.\1097\ Based on the Commission staff's

follow-up discussions with commenters, the Commission estimates that

the total cost of completing and filing a registration application with

the Commission will be between $333,000 and $500,000. This range

accounts for the time that will be expended to prepare and file Form

SEF.\1098\

---------------------------------------------------------------------------

\1097\ ISDA Discussion Paper at 32 (Nov. 2011).

\1098\ The Commission notes that the SEC estimated that the one-

time registration burden to prepare and file Form SB-SEF will be

approximately 100 hours for each new and existing entity. See

Registration and Regulation of Security-Based Swap Execution

Facilities, 76 FR at 11024. The SEC based this estimate on its

experience with the registration process for national securities

exchanges, having last estimated the average time it should take to

fill out the securities exchange registration form (Form 1) to be 47

hours. Id. The SEC adjusted this figure upwards to account for the

greater resources that would be required initially in lieu of an

established framework and familiarity of the industry in order to

gather supporting documentation and complete Form SB-SEF.

---------------------------------------------------------------------------

As noted above, based on the statute as interpreted by the

Commission, a facility that meets the SEF definition would be required

to register as a SEF and would incur the costs of registration. These

facilities would also be required to meet the minimum trading

functionality and other requirements of Sec. 37.9. The costs and

benefits of those requirements are discussed above. The 180-day review

period for SEF applications submitted two years or later after the

effective date of part 37 is not expected to impose significant costs

on applicants who submit their applications sooner since they will be

eligible for two years of temporary registration and will not need to

await final Commission approval before commencing SEF operation.

(c) Benefits

As discussed above, based on the statute as interpreted by the

Commission, a facility that meets the SEF definition would be required

to register as a SEF. These facilities will, as registered SEFs, have

the benefit of being able to offer Required Transactions for execution,

while alternative entities that are not required to register as SEFs,

including one-to-many systems or platforms, will only be able to offer

Permitted Transactions for execution. This will ensure, consistent with

the statute, a level playing field, that all Required Transactions are

executed on registered SEFs. This will provide market participants in

Required Transactions with the benefits associated with the minimum

trading functionality, core principles, and other requirements set out

in this release.

Additionally, the Commission's interpretation of the registration

requirement through a set of examples helps to clarify which facilities

must register as a SEF. The Commission believes that providing examples

of how it would interpret the CEA section 5h(a)(1) registration

requirement will ensure that a consistent set of metrics is available

to market participants while evaluating the applicability of the

registration requirements. Providing specific examples will also

mitigate the costs potential registrants may incur in seeking advice on

issues pertaining to registration.

Form SEF is designed to ensure that only applicants that comply

with the Act and the Commission's regulations are registered as SEFs.

Form SEF is expected to minimize the amount of time the Commission

staff will need to review applications and reduce the need for the

Commission staff to request, and applicants to provide, supplementary

information, which, in turn, benefits potential SEFs by reducing the

time it takes to become fully registered. This standardized

registration process will provide applicants with legal certainty

regarding the type of information that is required and will ensure that

no applicant is given a competitive advantage in the application

process.

Further, granting temporary registration for up to two years will

improve market continuity by allowing the Commission ample time to

review applications without jeopardizing an applicant's ability to

operate pending Commission review. By withdrawing the existing trading

activity requirement in proposed Sec. 37.3(b)(1)(ii), all SEF

[[Page 33569]]

applicants, not only those operating existing platforms, may apply for

temporary registration. The withdrawal of the trading activity

requirement should promote competition between SEFs by providing

opportunities for new entities to establish trading operations that

compete with existing platforms. The 180-day review period for SEF

applications submitted two years or later after the effective date of

part 37 will provide any later SEF applicants with the same review

period as is applicable under the CEA to DCMs and will provide greater

certainty for SEF applicants regarding the time period for the

Commission's review of their applications.

(d) Consideration of Alternatives

Several commenters stated that the Commission should harmonize its

registration procedures with the SEC in order to avoid unnecessary cost

and duplication for SEFs.\1099\ In particular, Tradeweb stated that SEF

applicants should not have to file separate applications for each mode

of execution, and that where a SEF is offering both swaps and security-

based swaps, the SEF should only be required to file one application

for both agencies.\1100\

---------------------------------------------------------------------------

\1099\ See Application Procedures discussion above under Sec.

37.3--Requirements for Registration in the preamble.

\1100\ Tradeweb Comment Letter at 3-4 (Jun. 3, 2011).

---------------------------------------------------------------------------

The Commission recognizes that substantially similar registration

forms and procedures could facilitate compliance and reduce regulatory

costs for SEFs seeking dual registrations. The Commission notes,

however, that it must comprehensively review and understand a SEF's

proposed trading models and operations, which will facilitate trading

for a more diverse universe of financial instruments and underlying

commodities than SB-SEFs. Accordingly, the Commission is not permitting

notice registration to SEC-registered SB-SEFs. Additionally, in

response to comments raised, the Commission clarified in the preamble

that a SEF applicant does not need to file separate applications for

each mode of execution, but that its application must describe each

mode of execution offered. This should allay concerns that multiple

costly applications must be filed with the Commission.

(e) Section 15(a) Factors

(1) Protection of Market Participants and the Public

The interpretation of the registration provision to apply to

facilities that meet the SEF definition will ensure that market

participants transacting any swap on these platforms, whether or not

they are subject to the trade execution requirement, will benefit from

the core principles and other requirements for SEFs (including the pre-

trade transparency available on SEFs), especially those designed to

protect market participants and the public. Furthermore, given the

critical role that SEFs will play in the financial markets, it is

essential that the Commission conduct a comprehensive and thorough

review of all SEF applications for registration. Such a review is

important for the protection of market participants and the public

because it ensures that only qualified applicants who satisfy the

statutory requirements and the Commission's regulations thereunder can

operate as SEFs. Form SEF will enable the Commission to efficiently and

accurately determine whether an applicant meets such requirements.

(2) Efficiency, Competitiveness, and Financial Integrity of the Markets

The Commission's interpretation of the registration provision to

apply to facilities that meet the SEF definition, along with the

minimum trading functionality requirement, will promote competition in

the swaps market by providing a level playing field for entities that

meet the SEF definition.

The standardized registration procedures and Form SEF will create

an efficient process that will reduce the resources associated with

submitting and reviewing completed applications. The final rules

promote market competition by not discriminating between new and

existing platforms applying to register as SEFs. For example, the

elimination of the proposed existing trading activity requirement for

temporary registration will ensure that new entities wishing to qualify

for temporary registration will not be placed at a competitive

disadvantage to existing entities. The required information in Form SEF

(Exhibits I-K--Financial Information and M and T--Compliance) will

allow the Commission to evaluate each applicant's ability to operate a

financially-sound SEF and to appropriately manage the risks associated

with its role in the financial markets.

(3) Price Discovery

The Commission has not identified any effects that these procedures

will have on price discovery.

(4) Sound Risk Management Practices

The registration procedures will require SEF applicants to examine

their proposed risk management program through a series of detailed

exhibits and submissions. These risks include risks associated with the

SEF applicant's financial resources and operational and market risks

associated with trading on the SEF platform. The submission of exhibits

relating to risk management, including Exhibits I-K (Financial

Information) and M, O, and T (Compliance), will provide data and

information that will aid the Commission staff's analysis and

evaluation of an applicant's ability to comply with the core

principles.

(5) Other Public Interest Considerations

The Commission has not identified any effects that these procedures

will have on other public interest considerations other than those

enumerated above.

4. Recordkeeping and Reporting

(a) Background

This release finalizes a series of provisions governing the

recordkeeping and reporting responsibilities of SEFs and market

participants.\1101\ Among other requirements, these rules require each

SEF to: (1) Provide the Commission with information about its business

as a SEF (Sec. Sec. 37.5(a), 37.503), provide a written demonstration

of compliance with any core principle (Sec. 37.5(b)), and provide

notice of any transaction involving the transfer of at least fifty

percent of the equity interest in the SEF (Sec. 37.5(c)); (2) provide

each counterparty to a swap on the SEF with a written record of all of

the terms of the transaction (Sec. 37.6(b)); \1102\ and (3) maintain

records of all business activities, including a complete audit trail,

investigatory files, and disciplinary files, in a form and manner

acceptable to the Commission for at least 5 years (Sec. 37.1001).

---------------------------------------------------------------------------

\1101\ For example, section 37.901 states that SEFs must report

swap data as specified in parts 43 and 45 and meet the requirements

of part 16. This provision references other Commission regulations,

the costs and benefits of which are discussed in connection with

those rulemakings.

\1102\ The discretionary costs and benefits specific to the

confirmation process are discussed in the part 23 rulemaking for new

confirmation standards.

---------------------------------------------------------------------------

A SEF must also: (1) Have the ability to obtain the information

necessary to perform its self-regulatory responsibilities, including

the authority to examine books and records (Sec. Sec. 37.501, 37.502);

(2) share information with other regulatory organizations, data

repositories, and third-party data reporting services as required by

the Commission (Sec. 37.504); (3) demonstrate that it has access to

sufficient information to assess whether

[[Page 33570]]

trading is being used to affect prices in its market (Sec. 37.404(a));

and (4) require market participants to keep records of their trading

and make such records available to the SEF or the SEF's regulatory

service provider, and the Commission, upon request (Sec. 37.404(b)).

The final rules also govern a SEF's use of data and records

obtained from market participants, and prohibit a SEF from using for

business or marketing purposes proprietary or personal information that

it collects from any person unless the person clearly consents to the

use of its information in such a manner (Sec. 37.7).

(b) Costs

The costs associated with responding to requests for information or

demonstrations of compliance under recordkeeping rules in Sec. 37.5

will include the staff hours required to prepare exhibits, draft

responses, and submit materials. These costs will vary among SEFs

depending upon the nature and frequency of Commission inquiries.

The Commission is reducing the reporting burden associated with

final Sec. 37.5(c) (equity interest transfers) by raising the

threshold of when a SEF must file a notification with the Commission

from 10 percent to 50 percent, by increasing the time frame for

submitting such notification to 10 days rather than the next business

day, and by eliminating the proposed requirement that SEFs must provide

a series of documents and a representation along with the notification

of an equity transfer interest. Under the final rules, the Commission,

upon receiving a notification of an equity interest transfer, may

request appropriate documentation of the transfer, but all the

documentation should already be in the possession of the SEF.

Accordingly, a SEF that enters into agreements that could result in

equity interest transfers of 50 percent of more will incur one-time

costs associated with preparing and submitting the required

notification for each event.

Further, final Sec. 37.1001 (requirement to maintain business

records including audit trail, investigatory, and disciplinary files)

codifies the substantive requirements found in Core Principle 10.

Accordingly, most, if not all, of the costs associated with this rule

are attributable to statutory mandate. Commenters did not mention any

specific costs with respect to this rule. In addition, Sec. Sec.

37.501 and 37.503 (establish and enforce rules and provide information

to the Commission) codify requirements that appear in the statute and

impose no additional costs on SEFs or market participants beyond those

attributable to Congressional mandate.

Final Sec. 37.502 requires each SEF to have rules that allow it to

collect information or examine books and records of participants, but

imposes no affirmative obligations on SEFs to do so. Accordingly, the

only direct costs associated with Sec. 37.502 are the de minimis costs

associated with writing such rules.

Final Sec. 37.504 (information sharing agreements) codifies and

implements the Core Principle 5 requirement that a SEF have the

capacity to carry out international information-sharing agreements as

the Commission may require. Accordingly, SEFs will bear the cost of

responding to Commission requests to share information with other

regulatory organizations, data repositories, and third-party data

reporting services. The cost of responding to Commission requests to

share information will vary depending on the frequency and nature of

the requests. To the extent that it is necessary for a SEF to enter

into an information sharing agreement, the SEF may face additional

costs such as negotiating such agreement. However, these costs are

unlikely to be significant and will only be incurred should a SEF

determine that it is necessary to enter into an information sharing

agreement.

A market participant's cost to maintain records under Sec. 37.404

(ability to obtain information) should be minimal if, as expected, it

is part of its normal business practice. As a result, a market

participant's additional cost to provide records to the SEF, and the

SEF's cost to request and process the records, will be nominal if,

based upon the Commission's experience with DCMs, such requests are

infrequent and targeted to specific and significant market situations.

Additionally, the Commission has moved to guidance the requirement

from proposed Sec. 37.404(b) that a SEF require customers engaging in

intermediated trades to use a comprehensive large-trader reporting

system or be able to demonstrate that they can obtain position data

from other sources. This change should mitigate costs by providing SEFs

with greater flexibility to identify particular methods of compliance

that suit their markets and business structures.

The Commission is also amending Sec. 37.7 (use of proprietary or

personal information) to allow SEFs to use certain information for

business or marketing purposes if the person consents to the use of

such information. The costs imposed by this provision are limited to

the cost a SEF might incur in obtaining such person's consent to use

its information for the purposes described above. The Commission does

not prescribe the method by which a SEF must obtain such consent, which

provides flexibility to SEFs.

(c) Benefits

The Dodd-Frank Act created a robust recordkeeping regime in order

to reduce risks associated with swaps trading, increase transparency,

and promote market integrity. Taken as a whole, the recordkeeping and

reporting regulations adopted in this release will provide a SEF and

the Commission with access to information that will enhance a SEF's

ability to oversee its platforms and markets and enable the Commission

to determine whether a SEF is operating in compliance with the statute

and the Commission's regulations. The information-sharing requirement

in Sec. 37.504 will also provide cost-savings across market regulators

by allowing the SEF to serve as the focal point for collecting certain

data instead of each regulator duplicating efforts and collecting the

information independently.

The confirmation requirement in Sec. 37.6(b) will provide market

participants with the certainty that transactions entered into on or

pursuant to the rules of a SEF will be legally enforceable on all

parties to the transaction. The requirement that a SEF provide each

counterparty with a confirmation at the same time as execution will

support the policy goal of straight-through processing to ensure that

counterparties do not encounter gaps in their records as to their

exposure level with other counterparties. This will also reduce the

costs and risks involved in resolving disputes between counterparties

to a trade; given dependency across trades, for example, if a

participant has already unwound a position or taken a position via a

trade under dispute or hedged it, any delays or uncertainties in the

confirmation will result in higher costs from having to further unwind

such linked trades.

The prohibition on the use by a SEF of proprietary or personal

information for business purposes without consent (Sec. 37.7) will

ensure that information provided to a SEF for regulatory purposes will

not be used to advance the commercial interests of the SEF. The rule

does, however, afford market participants the flexibility to consent to

a SEF's use of their personal information for commercial purposes, if

they so desire.

[[Page 33571]]

(d) Section 15(a) Factors

(1) Protection of Market Participants and the Public

The recordkeeping and reporting rules will protect market

participants and the public by improving a SEF's and the Commission's

ability to detect manipulative or disruptive activity. This, in turn,

may deter SEFs and market participants from engaging in practices that

may harm other market participants and harm the public by placing the

larger economy at risk. Additionally, certification of continued

compliance with the core principles will enable the Commission to

ensure that performance of SEF functions is limited to only those

entities that have adequately demonstrated an ability to comply with

the Act and accompanying regulations. This will protect the public by

promoting trading on regulated SEFs rather than OTC markets. While SEFs

and the Commission may at times require access to market participants'

information for regulatory purposes, the rules also protect market

participants by stipulating that information they provide to SEFs for

regulatory purposes is not used inappropriately to advance the

commercial interests of the SEF without their consent.

(2) Efficiency, Competitiveness, and Financial Integrity of the Markets

The recordkeeping and reporting rules promote financial integrity

as they ensure that the Commission and SEFs will have access to

information to ensure that trading is conducted pursuant to the

regulatory requirements, and that SEFs have sufficient documentation to

detect, enforce, and deter potential rule violations.

(3) Price Discovery

The Commission has not identified any effects that these rules will

have on price discovery considerations.

(4) Sound Risk Management Practices

Requiring that SEFs maintain audit trail, investigatory files,

disciplinary, and other records will provide the Commission with access

to data that will allow it to assess whether market participants are

manipulating or otherwise disrupting trading in the swaps market. The

Commission and SEFs can then take action to mitigate these risks.

(5) Other Public Interest Considerations

The Commission has not identified any effects that these rules will

have on other public interest considerations other than those

enumerated above.

5. Compliance

(a) Rule Writing and Enforcement

Under Core Principle 2, a SEF must implement a number of rule-

writing and enforcement-related provisions. Among other requirements, a

SEF must: (1) Establish a rulebook that addresses critical areas of

market protection (Sec. 37.201), including rules prohibiting certain

abusive trading practices (Sec. 37.203(a)), rules ensuring impartial

access to the SEF's trading system (Sec. 37.202), and rules governing

internal disciplinary procedures (Sec. 37.206); and (2) have resources

for effective rule enforcement, including sufficient compliance staff

and resources (Sec. 37.203(c)), authority to collect information and

examine books and records (Sec. 37.203(b)), and procedures for

conducting investigations into possible rule violations (Sec.

37.203(f)). The Commission is also clarifying that a SEF must establish

and enforce rules for its employees that are reasonably designed to

prevent violations of the Act and the rules of the Commission.

Additionally, Sec. 37.204 provides SEFs with the option to choose

to contract with a regulatory service provider for the provision of

services to assist in complying with the CEA and Commission

regulations, provided that the SEF supervise the regulatory service

provider and retain exclusive authority with respect to all substantive

decisions made by the regulatory service provider on the SEF's behalf.

(1) Costs

The costs associated with the rule-writing and enforcement

provisions outlined above will consist mostly of one-time

administrative outlays such as wages paid to attorneys and other

compliance personnel for time spent drafting, reviewing, implementing,

and updating rules. While new entities seeking to become SEFs would

need to develop a rulebook, existing entities that already have written

rules would only incur the incremental expense of updating them.

SEFs will also incur the initial and recurring costs associated

with investing in the resources and staff necessary to provide

effective rule enforcement. A SEF must have sufficient staff and

resources, including resources to collect information and examine books

and records, as well as automated systems to assist the compliance

staff in carrying out the SEF's self-regulatory responsibilities. One

commenter stated that these requirements are overly burdensome, but did

not provide any data in support.\1103\

---------------------------------------------------------------------------

\1103\ State Street Comment Letter at 5 (Mar. 8, 2011).

---------------------------------------------------------------------------

The Commission believes that having a minimum level of resources in

place for rule enforcement purposes is a critical element of a

sufficient compliance program, and is necessary pursuant to the

statutory mandate of Core Principle 2, which requires SEFs to have the

capacity to detect, investigate, and enforce its rules.\1104\ SEFs may

be able to reduce these costs by contracting with a regulatory service

provider. In addition, the Commission reduced the costs of the final

rules by eliminating the requirement in proposed Sec. 37.203(c)(2)

that a SEF monitor the size and workload of its compliance staff on an

ongoing basis and, on at least an annual basis, formally evaluate the

need to increase its compliance resources and staff. The Commission

believes that the final rulemaking provides greater flexibility to SEFs

in determining their approach to monitoring their compliance resources.

---------------------------------------------------------------------------

\1104\ CEA section 5h(f)(2)(B); 7 U.S.C. 7b-3(f)(2)(B).

---------------------------------------------------------------------------

With respect to the use of a third-party regulatory service

provider as permitted under Sec. 37.204 (Regulatory services provided

by a third party), two commenters in follow-up conversations indicated

to the Commission staff that they each may contract (or have already

contracted) with a regulatory service provider to perform various

compliance functions at a cost of between $540,000 and $720,000 per

year. This estimate represents the total cost of contracting a SEF's

compliance functions to a regulatory service provider. Additionally,

ISDA estimates an assessment on SEFs of $45,000 per year to contract

with a regulatory service provider and $635,000 per year in dues for

membership to the regulatory service provider.\1105\ Section 37.204 is

intended to be a cost-saving provision that mitigates the burden placed

on SEFs by the rule enforcement program and, as stated by one

commenter, this rule may reduce a SEF's overall costs by at least

thirty percent.

---------------------------------------------------------------------------

\1105\ ISDA Discussion Paper at 28 (Nov. 2011).

---------------------------------------------------------------------------

SEFs that choose to contract with a regulatory service provider

will need to hire sufficient compliance staff to supervise the quality

and effectiveness of the services provided by the regulatory service

provider, including the cost of holding regular meetings with the

regulatory service provider to review and assess the adequacy of the

services provided. SEFs will also incur the cost of documenting any

instances

[[Page 33572]]

in which their decisions differ from those recommended by their

regulatory service provider.

(2) Benefits

Establishing a rulebook and an effective rule enforcement program

will ensure that SEFs have specific and transparent procedures for

addressing critical areas of market protection, and that SEFs will have

the resources needed to implement those procedures. In particular, the

requirements that a SEF offer impartial access, provide a fair and

competitive market free of abusive trading practices, have sufficient

resources to oversee and monitor the market, promptly investigate rule

violations, establish disciplinary procedures that will deter abuses,

and provide respondents with adequate safeguards will foster greater

confidence that SEFs will provide a fair and competitive market free of

trading abuses. This confidence is likely to result in increased

trading of swaps on SEFs, improving liquidity and resulting in more

competitive quotes.

According to conversations with commenters, SEFs that contract-out

certain regulatory functions to a regulatory service provider are

likely to realize significant cost savings from economies of scale--one

commenter stated that contracting with a regulatory service provider

would reduce a SEF's overall costs by at least thirty percent.

According to NFA's Web site, it appears that many potential SEFs have

already contracted with, or are in the process of contracting with, a

regulatory service provider.\1106\ Additionally, the rule governing the

use of regulatory service providers ensures that SEFs will have

sufficient staff to adequately supervise their regulatory service

providers. By requiring that SEFs oversee the services provided by the

regulatory service provider, the rule will likely result in cost

savings to the SEF, as the failure of a service provider to adequately

fulfill its duties may result in costs to SEFs for not meeting

compliance obligations.

---------------------------------------------------------------------------

\1106\ See, e.g., ``NFA Signs Agreement with ICAP to provide

Regulatory Services to ICAP's Swap Execution Facility'' (Mar. 20,

2012), available at http://www.nfa.futures.org/NFA-regulation/regulationNewsRel.asp?ArticleID=3996.

---------------------------------------------------------------------------

(3) Consideration of Alternatives

As referenced above, one of a SEF's rule-writing obligations is to

develop rules governing internal disciplinary procedures, including

rules governing disciplinary panels. CME stated that the Commission

should not provide a prescriptive approach to disciplinary panels in

proposed Sec. 37.206(b) by requiring a ``hearing panel'' to be

separate from a ``review panel.'' \1107\ In response, the Commission

removed the proposed requirement to establish separate hearing and

review panels, instead allowing a SEF to establish one or more

disciplinary panels, which will, among other things, issue notices of

charges, conduct hearings, render written decisions, and impose

disciplinary sanctions. The final rule will continue to achieve the

goals of the proposed regulations by deterring violations of SEF rules,

preventing recidivist behavior, and protecting respondents and

customers harmed by violations of exchange rules. The procedures will

achieve these goals while also providing SEFs with greater flexibility

to structure their disciplinary bodies in a manner that best suits

their business models and markets. The final rule is unlikely to impose

additional personnel expenditures on SEFs, as the Commission

anticipates that SEFs, like DCMs, will rely upon unpaid disciplinary

panel members. The Commission anticipates that any actual costs

associated with the disciplinary panel will be limited to de minimis

administrative expenses for convening hearings over which the panel

presides, such as postage, facility rentals, and printing.

---------------------------------------------------------------------------

\1107\ CME Comment Letter at 35 (Feb. 22, 2011).

---------------------------------------------------------------------------

The Commission notes that it has provided additional flexibility to

SEFs by delaying the effective date of proposed Sec. 37.206(o) to 1

year from the effective date of the SEF rules.\1108\ Where a rule

violation is found to have occurred, this provision limits the number

of warning letters to one per rolling twelve month period for the same

violation. The delay in the effective date of this provision is likely

to mitigate costs for persons and entities so that they may adapt to

the new SEF regime.

---------------------------------------------------------------------------

\1108\ The Commission is renumbering proposed Sec. 37.206(o) to

Sec. 37.206(f). The Commission is also retitling this section as

``Warning letters.''

---------------------------------------------------------------------------

As recommended by commenters, the Commission has also adopted cost-

mitigating alternatives that will provide SEFs with additional

flexibility and discretion to implement disciplinary and other

enforcement programs in the manner they find most suited to their

market. In particular, the Commission has: eliminated the requirement

that an investigation report include the member or market participant's

disciplinary history at the SEF; removed the requirement that SEFs

include a copy of a warning letter in an investigation report; amended

the standard for commencing an investigation from a ``possible basis''

to a ``reasonable basis'' that a violation may have occurred or will

occur; and deleted several provisions.\1109\

---------------------------------------------------------------------------

\1109\ Deleted provisions include proposed Sec. 37.203(c)(2)

(ongoing monitoring of compliance staff and resources), the second

sentence of proposed Sec. 37.206(a) (annual review of enforcement

staff), the majority of proposed Sec. 37.206(c) (timely review of

investigation reports), the last sentence of proposed Sec.

37.206(h) (denial of charges and right to a hearing), and proposed

Sec. 37.206(j)(1)(vii) (cost of transcribing the record to be borne

by the respondent).

---------------------------------------------------------------------------

The Commission has also moved part or all of several provisions to

guidance.\1110\ By moving these provisions to guidance, entities will

have the flexibility to tailor compliance programs to varying business

models and trading platforms as well as unanticipated technological

innovation or behavioral changes. While the Commission's pairing of

guidance and regulations provides for a broad and flexible regulatory

framework, it also promotes uniformity of safe and sound operation such

that market participants and the public receive comparable levels of

protection irrespective of the particular SEF on which they transact.

---------------------------------------------------------------------------

\1110\ See second part of proposed Sec. 37.206(a) (enforcement

staff), proposed Sec. 37.206(d) (notice of charges), proposed Sec.

37.206(e) (right to representation), proposed Sec. 37.206(f)

(answer to charges), proposed Sec. 37.206(g) (admission or failure

to deny charges), proposed Sec. 37.206(h) (denial of charges and

right to hearing), proposed Sec. 37.206(i) (settlement of offers),

the majority of proposed Sec. 37.206(j) (hearings), proposed Sec.

37.206(l) (right to appeal), proposed Sec. 37.206(m) (final

decisions), proposed Sec. 37.206(o) (summary fines for violations

of rules regarding timely submission of records), and proposed Sec.

37.206(p) (emergency disciplinary actions).

---------------------------------------------------------------------------

(4) Section 15(a) Factors (Rule Writing and Enforcement)

(i) Protection of Market Participants and the Public

Together, the rule-writing and enforcement provisions described

above ensure that SEFs adopt and enforce operational rules that protect

market participants and the public through orderly SEF-traded markets

that are better protected from manipulative and disruptive conduct than

pre-Dodd Frank OTC markets.

Rules prohibiting abusive trade practices such as wash trades and

front-running are intended to deter such disruptive practices, and will

protect market participants transacting on the SEF, as well as the

general public, who may rely on prices derived from the market and who

may be customers or shareholders of market participants.

The requirement that a SEF have the capacity to detect and

investigate rule violations, including adequate compliance staff and

resources to conduct automated trade surveillance

[[Page 33573]]

and real-time monitoring (or contract with a regulatory service

provider that has the capacity to perform these functions on its behalf

while maintaining ultimate responsibility), will improve a SEF's

ability to discover, sanction, and prevent violations and trading

practices that could harm market participants and, indirectly, the

public.

SEF-initiated investigations are a chief tool in protecting market

participants and the public because they provide the first opportunity

to respond to rule violations. Rules allowing the SEF to obtain

information and inspect books and records will not only deter potential

abusive trading practices, but will also enable the SEF to detect any

manipulative or fraudulent activity quickly and efficiently. Prompt and

thorough investigations are essential to detecting and remedying

violations and ensuring that the violations do not harm market

participants, result in price distortions, or contribute to systemic

risks that can harm the economy.

In the event of demonstrated customer harm, restitution damages are

generally required to make that customer whole again. Meaningful

sanctions will serve as a general deterrent by discouraging others from

engaging in violative conduct.

Impartial access requirements protect market participants from

discriminatory treatment by prohibiting similarly situated market

participants from receiving different access terms and fee structures.

The requirement that SEFs establish and enforce rules for its

employees will protect market participants and the public by helping to

ensure that employees operate in conformance with the Act and the rules

of the Commission.

(ii) Efficiency, Competitiveness, and Financial Integrity of the

Markets

The requirement that a SEF have the capacity to detect and mitigate

rule and trade practice violations, including the ability to collect

relevant information and examine books and records, and the requirement

to establish and enforce rules for its employees will increase

confidence in the financial integrity of the market by confirming to

market participants that their orders and trades are handled pursuant

to the posted rules of the SEF.

In addition, impartial access requirements will eliminate a

potential impediment to participation, resulting in a more competitive

market. At a minimum, as required by section 2(e) of the Act, market

participants must meet the definition of an ECP, which ensures that

only those participants with a sufficient level of sophistication and

financial resources are able to participate. Similarly, requiring a SEF

to maintain minimum level of enforcement resources will promote

financial integrity by ensuring that a SEF has sufficient resources to

investigate wrongdoing and make aggrieved market participants whole

again. Moreover, markets where wrongdoing is detected and deterred will

operate more efficiently.

(iii) Price Discovery

Many of the same rule provisions previously discussed that serve to

increase efficiency, liquidity, and competitiveness will, by extension,

improve price discovery, because the combination of increases in

liquidity and competition will help create a marketplace in which the

forces of supply and demand reflect more accurate pricing.

Timely investigations will increase the likelihood that

manipulation is detected early-on and quickly remedied so that price

discovery is not impaired. Additionally, a system of meaningful

sanctions will deter disruptive and manipulative trade practices,

providing a stable and competitive trading environment more likely to

foster price discovery.

(iv) Sound Risk Management Practices

The requirement that SEF participants confirm to the SEF that they

meet the definition of an ECP helps assure the market that participants

in SEF-traded markets have the skill, knowledge, and/or financial

resources necessary to enter into financially-sound transactions and

understand sound risk management practices.

(v) Other Public Interest Considerations

The Commission has not identified any effects that these rules will

have on other public interest considerations other than those

enumerated above.

(b) Chief Compliance Officer

Section 37.1501 implements Core Principle 15 and requires each SEF

to designate an individual to serve as Chief Compliance Officer

(``CCO'') and to provide its CCO with the authority and resources to

develop and enforce such policies and procedures as are necessary for

the CCO to fulfill its statutory and regulatory duties.\1111\ While the

proposed rule prohibited the CCO from serving as a member of the SEF's

legal department or as the SEF's general counsel, the Commission has

eliminated this restriction from the final rule.

---------------------------------------------------------------------------

\1111\ There are no costs associated with Sec. 37.1501(a),

which simply defines ``board of directors.''

---------------------------------------------------------------------------

The final rule also outlines the procedures for oversight authority

over the CCO and for appointing and removing the CCO. The CCO must meet

with the board of directors at least annually and the Regulatory

Oversight Committee (``ROC'') at least quarterly. The CCO must also

prepare an annual compliance report containing a detailed account of

the SEF's compliance with the CEA and Commission regulations, as well

as a detailed account of the SEF's self-regulatory program, and submit

it to the SEF's board of directors for review and to the Commission.

SEFs must maintain records pertaining to, among other things, code of

ethics and conflict of interest policies, copies of all materials

created in furtherance of the CCO's duties, and any records relevant to

the SEF's annual compliance report.

(1) Costs

Several commenters stated that the proposed requirement that the

CCO may not be a member of the SEF's legal department and may not serve

as its general counsel is prescriptive and unnecessary.\1112\ In

response to these comments, the Commission has eliminated the proposed

prohibition on who may serve as CCO. Accordingly, a SEF may use its

general counsel or a member of its legal department to serve as CCO.

This change to the final rule should significantly reduce the expense

imposed by the proposed rule, which would have necessitated the hiring

of an individual specifically to serve as CCO at an estimated annual

cost of $181,394.\1113\ The cost of assigning the role of CCO to an

existing employee will be significantly less.

---------------------------------------------------------------------------

\1112\ ICE Comment Letter at 6-7 (Mar. 8, 2011); WMBAA Comment

Letter at 6-7 (Mar. 8, 2011); MarketAxess Comment Letter at 27 (Mar.

8, 2011); CME Comment Letter at 12-13 (Mar. 8, 2011).

\1113\ This estimate is derived from the 2010 edition of SIFMA's

annual report on Management and Professional Earnings in the

Securities Industry (hereinafter ``SIFMA Report''). This figure

reflects the median total annual compensation (including base salary

and bonus) for a CCO in the securities industry. The Commission

notes that this estimate only includes the cost of hiring a CCO.

Although not required by statute or rule, SEFs may also choose to

hire additional staff at additional cost in order to support the

CCO.

---------------------------------------------------------------------------

Several commenters requested that the Commission grant SEFs more

flexibility in determining how a CCO is appointed, compensated,

supervised, and removed.\1114\ In response to these comments, the

Commission has removed the requirement in proposed

[[Page 33574]]

Sec. 37.1501(c)(1) that a CCO's appointment and compensation requires

a majority vote of directors, as well as the requirements in proposed

Sec. 37.1501(c)(3) that the SEF explain to the Commission the reason

for the CCO's removal upon departure and that the SEF immediately

appoint an interim CCO and permanent CCO as soon as reasonably

practicable thereafter. The Commission notes that these revisions will

provide the board of directors or senior officer of the SEF with a

degree of flexibility to appoint, compensate, and remove the CCO in the

manner that the SEF deems most appropriate.

---------------------------------------------------------------------------

\1114\ Tradeweb Comment Letter at 12 (Mar. 8, 2011); WMBAA

Comment Letter II at 7 (Mar. 8, 2011); MarketAxess Comment Letter at

26 (Mar. 8, 2011).

---------------------------------------------------------------------------

Several commenters also stated that the proposed requirement that

CCOs ensure ``compliance with the Act and Commission regulations'' is

impracticable and overly burdensome, as one individual cannot ensure

compliance of an entire organization.\1115\ In response, the Commission

is modifying Sec. 37.1501(d)(4) to state that one of the CCO's duties

shall include ``taking reasonable steps to ensure compliance with the

Act and Commission regulations.'' This modification should also reduce

potential costs resulting from this rule without diminishing its

benefits.

---------------------------------------------------------------------------

\1115\ Tradeweb Comment Letter at 6-7 (Jun. 3, 2011); WMBAA

Comment Letter II at 5-6 (Mar. 8, 2011); MarketAxess Comment Letter

at 26 (Mar. 8, 2011); Tradeweb Comment Letter at 12 (Mar. 8, 2011);

CME Comment Letter at 4 (Feb. 7, 2011).

---------------------------------------------------------------------------

(2) Benefits

The rule ensures that each SEF has a central figure responsible for

overseeing major areas of compliance with the CEA and Commission

regulations. The annual compliance report will enable a SEF and the

Commission to evaluate the effectiveness of the SEF's self-regulatory

programs and compliance with core principles, and to take remedial

actions and make recommendations to improve the SEF's self-regulatory

programs in order to ensure that the SEF remains in compliance with the

core principles.

(3) Consideration of Alternatives

With respect to the annual compliance report requirement in

proposed Sec. 37.1501(e), FXall stated that compiling the required

information and preparing the report in a timely manner annually will

consume considerable resources.\1116\ FXall proposed an alternative

report that would request fewer pieces of information.\1117\ Similarly,

CME stated that the Commission should specify key areas that should be

discussed in the annual report, rather than requiring the report to

describe in detail the registrant's compliance with respect to each of

the numerous components of the CEA and Commission regulations.\1118\

---------------------------------------------------------------------------

\1116\ FXall Comment Letter at 16 (Mar. 8, 2011).

\1117\ Id. at 17.

\1118\ CME Comment Letter at 7 (Feb. 7, 2011).

---------------------------------------------------------------------------

After weighing the comments and alternative proposals from FXall

and CME, the Commission has determined to adopt the rules as proposed,

subject to certain revisions detailed in the preamble.\1119\ The

Commission declines to adopt commenters' proposed alternatives because

without the detailed information required by statute in the annual

compliance report (including a self-assessment of policies and

procedures designed to ensure compliance with each core principle, a

discussion of areas for improvement, and a description of the SEF's

self-regulatory program's staffing, structure, and cataloguing of

disciplinary actions), the Commission would not have access to the

information it needs to ensure that each SEF is in compliance with the

CEA and Commission regulations.

---------------------------------------------------------------------------

\1119\ See discussion above under Sec. 37.1501(e)--Annual

Compliance Report Prepared by Chief Compliance Officer in the

preamble.

---------------------------------------------------------------------------

(4) Section 15(a) Factors (Chief Compliance Officer)

(i) Protection of Market Participants and the Public

The requirements that a CCO oversee the SEF's compliance with the

Act and Commission regulations and supervise the SEF's self-regulatory

program will ensure that the SEF monitors compliance with key

provisions of the CEA designed to protect market participants and the

public (including provisions governing trade practice and market

surveillance, real-time market monitoring, and financial reporting). To

the extent that the Commission's regulations impose more specific or

supplemental requirements when compared to those requirements

explicitly imposed by section 5h(f)(15) of the CEA, those incremental

costs are not likely to be significant. While it is possible that those

incremental costs will be passed along to market participants, the size

of those costs is likely to be negligible.

The Commission believes the CCO rules will protect market

participants and the public by promoting compliance with the core

principles and Commission regulations through the designation and

effective functioning of the CCO, and the establishment of a framework

for preparation of a meaningful annual review of a SEF's compliance

program. The annual compliance report will allow the SEF and the

Commission to periodically assess, and evaluate where necessary, the

SEF's ability to comply with the core principles. Upon review of the

compliance report, the SEF and the Commission will be better able to

determine whether the SEF has appropriate programs in place to protect

market participants and the public from market abuses.

Maintaining records as required under Sec. 37.1501 regarding a

CCO's efforts toward ensuring that the SEF complies with core

principles provides a check against what is reported in the annual

compliance report. Access to these records will assist the Commission

in its determination of whether a SEF's self-regulatory program

complies with the core principles and the Commission's regulations. If

the Commission determines the self-regulatory program is not

sufficient, the Commission will be able to use information required by

the rule to take steps to remedy the shortcomings and to prevent

disruptions that could harm market participants and the public.

(ii) Efficiency, Competitiveness, and Financial Integrity of the

Markets

An effective CCO will implement measures that enhance the stability

and efficiency of SEFs. Reliable and financially-sound SEFs are

essential for the stability of the derivatives markets they serve. The

CCO's oversight of self-regulatory programs and the annual compliance

report will provide both the SEF and the Commission with an opportunity

to assess the effectiveness of the SEF's self-regulatory programs and

will help to detect and deter rule violations, increasing participation

and competition in the markets.

Likewise, compliance reports will allow the Commission to review

the effectiveness of and order changes to self-regulatory programs,

thus enabling the market to function more efficiently while promoting

confidence and attracting competition. A board that makes proactive

changes to a SEF's self-regulatory programs based on the CCO's

compliance report will build confidence in the market and increase

competition.

(iii) Price Discovery

The Commission has not identified any effects that this rule will

have on price discovery.

(iv) Sound Risk Management Policies

The CCO rules and the required annual compliance report will

enhance a SEF's risk management policies by enhancing the standards for

a SEF's compliance program. This in turn will emphasize risk management

compliance

[[Page 33575]]

because of its significance to the overall purpose and functioning of

the SEF. Compliance with the SEF core principles and related

regulations encompasses, among other things, procedures for ensuring

the financial integrity of swaps entered on or through the facilities

of the SEF, including the clearance and settlement of swaps,

determination of resource adequacy, and system safeguards to establish

and maintain a program of risk analysis and oversight. It is the

responsibility of the CCO to ensure that the SEF is compliant with the

core principles and the regulations thereunder, and is otherwise

engaged in appropriate risk management activities in accordance with

the SEF's own rules, policies, and procedures.

(v) Other Public Interest Considerations

The Commission has not identified any effects that these rules will

have on other public interest considerations other than those

enumerated above.

6. Monitoring and Surveillance

Core Principle 2 requires, among other things, that each SEF

establish and enforce trading, trade processing, and participation

rules that will deter abuses, and have the capacity to detect,

investigate, and enforce those rules, including means to provide market

participants with impartial access to the market and to capture

information that may be used in establishing whether rule violations

have occurred. Additionally, Core Principle 4, in part, requires each

SEF to monitor trading in swaps to prevent manipulation and price

distortion through surveillance, including methods of conducting real-

time monitoring of trading and comprehensive and accurate trade

reconstructions.

(a) Monitoring of Trading

The rules that implement Core Principles 2 and 4 will require a SEF

to, among other things: (1) Maintain an automated trade surveillance

system (Sec. 37.203(d)); (2) conduct real-time market monitoring of

all trading activity on its platform and have the authority to cancel

trades and adjust trade prices when necessary (Sec. 37.203(e)); (3)

maintain an acceptable audit trail program that enables the SEF to

identify entities that are routinely non-compliant and to levy

meaningful sanctions (Sec. 37.205); \1120\ (4) monitor trading in

real-time and accurately reconstruct trading activity in order to

detect manipulation, price distortions, and other disruptions (Sec.

37.401); (5) and establish risk control mechanisms (including pauses

and halts) to prevent and reduce the potential risk of market

disruptions (Sec. 37.405).

---------------------------------------------------------------------------

\1120\ The Commission received no comments discussing the

specific costs or benefits of Sec. 37.406, which requires SEFs to

make audit trail data available to the Commission and is an explicit

requirement of the statute.

---------------------------------------------------------------------------

(1) Costs

As discussed above, potential SEFs are likely to outsource these

obligations to a regulatory service provider at significantly less cost

than performing them in-house.\1121\ Accordingly, the ongoing costs

associated with these rules would already be included in the total

annual cost of contracting with a regulatory service provider (plus the

cost of overseeing the service provider's compliance).

---------------------------------------------------------------------------

\1121\ The Commission notes, as described in the preamble, that

a SEF that elects to use the services of a regulatory service

provider must retain certain decision-making authority and cannot

outsource this authority to the regulatory service provider. See,

e.g., Sec. 37.204(c)--Regulatory Decisions Required from the Swap

Execution Facility in the preamble.

---------------------------------------------------------------------------

Should a potential SEF that is a new entity choose to develop its

own automated trade surveillance, real-time market monitoring, and

audit trail systems, it is likely to incur the costs of developing and

maintaining these systems, as well as the cost of hiring and

maintaining adequate staff to administer them. The staff necessary to

carry out a SEF's obligations under these rules would likely include

analysts, investigators, and systems and/or IT specialists. However,

existing entities may already receive the requisite data, and may also

have some infrastructure in place to perform automated trade

surveillance and real-time market monitoring. Accordingly, the

incremental cost for existing entities would be limited to investing in

enhancements to existing electronic systems to ensure that data is

captured in compliance with the rules and that the systems themselves

comply with the rules.\1122\ The Commission notes that a SEF may use a

unified monitoring system to jointly satisfy the requirements of Sec.

37.401 (monitoring of trading and trade processing) and Sec. 37.205

(audit trail).

---------------------------------------------------------------------------

\1122\ For example, SEFs are required to comply with a unified

set of audit trail requirements for all methods of execution. The

Commission notes that a SEF, for example, that utilizes the

telephone as a means of interstate commerce in providing the

execution methods in Sec. 37.9(a)(2)(i)(A) or (B) may comply with

certain of the audit trail requirements by recording all such

communications that relate to or result in swap transactions. Such

recordings must allow for reconstruction of all relevant

communications between the SEF and its customers or involving SEF

employees. While it is common industry practice to make and retain

electronic time-stamped recordings of conversations, SEFs may incur

costs to upgrade their recording systems to ensure that they comply

with all of the audit trail requirements.

---------------------------------------------------------------------------

Additionally, in response to comments that the standards set forth

in the proposed requirements for real-time market monitoring are

unreasonably high,\1123\ the Commission is modifying the final rule to

require a SEF to conduct real-time market monitoring designed to

``identify'' disorderly trading, instead of to ``ensure'' orderly

trading. The Commission believes that requiring SEFs to identify

disorderly trading when it occurs, rather than to ensure orderly

trading at all times, will likely mitigate the overall burden of the

rule. Furthermore, in response to CME's comment,\1124\ the Commission

is deleting the word ``investigating'' from proposed Sec. 37.203(d),

thus clarifying that a SEF's automated trade surveillance system will

not be expected to conduct the actual investigation of potential trade

practice violations. This deletion should further reduce costs for

SEFs.

---------------------------------------------------------------------------

\1123\ CME Comment Letter at 20 (Feb. 22, 2011).

\1124\ Id. at 19-20.

---------------------------------------------------------------------------

Tradeweb and MarketAxess commented that annual audits for member

and market participant compliance with the audit trail requirements

pursuant to Sec. 37.205(c)(1) are burdensome and unwarranted.\1125\ In

the Commission staff's follow-up conversation regarding costs, one

commenter asserted that this requirement will cost SEFs at least

$300,000 annually.

---------------------------------------------------------------------------

\1125\ Tradeweb Comment Letter at 6 (Jun. 3, 2011); MarketAxess

Comment Letter at 22 (Mar. 8, 2011).

---------------------------------------------------------------------------

To mitigate the costs associated with this provision, the

Commission is modifying the language in final Sec. 37.205(c) so that

it applies only to members and persons and firms subject to the SEF's

recordkeeping rules, rather than to members and ``market

participants.'' With this change, the Commission limits the number of

entities that a SEF must audit, which should reduce the cost noted

above without any meaningful reduction in benefits because auditing

those market participants subject to recordkeeping rules will ensure

complete coverage of all activity pertinent to transactions on any

given SEF.

Finally, SEFs may also incur the one-time cost of programming risk

controls such as pauses and halts, as well as on-going costs to

maintain and adjust such controls. For some SEFs, the costs of adding

pause and halt functionality to swap contracts should be reduced since

much of that technology is already commercially available and would not

necessarily have to be developed in-

[[Page 33576]]

house.\1126\ As noted in the Pre-Trade Functionality Subcommittee of

the CFTC Technology Advisory Committee report, the costs would largely

be borne by the exchanges and would center around intellectual

property, as many exchanges develop, own, and manage their own

technology.\1127\ However, the costs associated with implementing risk

controls were not described in detail in the Pre-Trade Functionality

Subcommittee report and will likely vary greatly from one SEF to

another depending on the type of risk controls that will be implemented

and the nature of the SEF's trading platform. The Commission received

no comments stating that risk controls cannot be implemented in a cost-

effective manner using commercially available technology. As further

noted in the Pre-Trade Functionality Subcommittee report, ``[s]ome

measure of standardization of pre-trade risk controls at the exchange

level is the cheapest, most effective and most robust path to

addressing the Commission's concern [for preserving market

integrity].'' \1128\

---------------------------------------------------------------------------

\1126\ In a separate Dodd-Frank rulemaking, DCMs are now

required to have the same types of risk controls. See Core

Principles and Other Requirements for Designated Contract Markets,

77 FR 36612 (Jun. 19, 2012).

\1127\ See ``Recommendations on Pre-Trade Practices for Trading

Firms, Clearing Firms and Exchanges involved in Direct Market

Access,'' Pre-Trade Functionality Subcommittee of the CFTC

Technology Advisory Committee (``TAC Subcommittee

Recommendations''), at 4 (Mar. 1, 2011), available at http://www.cftc.gov/idc/groups/public/@swaps/documents/dfsubmission/tacpresentation030111_ptfs2.pdf. The Commission notes that the

subcommittee report was submitted to the Technology Advisory

Committee and made available for public comment, but no final action

has been taken by the full committee.

\1128\ See TAC Subcommittee Recommendations at 4 (Mar. 1, 2011).

---------------------------------------------------------------------------

The Commission notes that while it is requiring pauses and halts in

the rule, it is also enumerating in guidance other types of automated

risk controls that may be implemented by SEFs in order to give SEFs

greater discretion to select among the enumerated risk controls or to

create new risk controls. The Commission believes that this combination

of rules and guidance will facilitate orderly markets while maintaining

a flexible environment that facilitates cost-effective innovation and

development.

(2) Benefits

The automated trade surveillance system, real-time monitoring,

audit-trail, and trade reconstruction requirements will promote orderly

trading and will ensure that SEFs have the capability to promptly

identify and correct market or system anomalies that could harm market

participants and the public. These tools will improve SEF compliance

staff's ability to record, recover, sort, and query voluminous amounts

of data in order to better detect potential rule violations and abusive

trading practices that harm market participants and market integrity.

By having the tools and data to identify these potential rule

violations, a SEF can quickly respond, mitigating their effects and

helping to prevent them from generating systemic risk or other severe

problems. SEFs will also have the tools and information needed to

prosecute rule violations supported by evidence from audit trail data

and order and trade information. These tools will not only allow SEFs

to more effectively respond to rule violations and trading abuses, but

will also deter market participants from engaging in such conduct in

the first place since market participants will be aware that rule

violations are likely to be detected.

While the provisions described above will increase the likelihood

that SEFs will promptly identify market or system anomalies, SEFs must

also have systems in place to respond to such anomalies after they

occur. Risk controls such as automated trading pauses and halts can,

among other things, allow time for market participants to analyze the

market impact of new information that may have caused a sudden market

move, allow new orders to come into a market that has moved

dramatically, and allow traders to assess and secure their capital

needs in the face of potential margin calls. Pauses and halts are

intended to apply in the event of extraordinary price movements that

may trigger or propagate systemic disruptions. Accordingly, a SEF's

ability to pause or halt trading in certain circumstances and,

importantly, to re-start trading through the appropriate re-opening

procedures, will allow SEFs to mitigate the propagation of shocks that

are of a systemic nature.

(3) Consideration of Alternatives

While commenters requested additional flexibility to determine the

risk controls that should be implemented within their market,\1129\ the

Commission views pauses and halts as effective risk management tools

that must be implemented to facilitate orderly markets. Moreover, in

recognition that such risk controls should be adapted to the unique

characteristics of the markets to which they apply, and that any

controls should consider the balance between avoiding a market

disruption while facilitating a market's price discovery function, the

Commission enumerated the other types of risk controls in guidance.

Accordingly, a SEF will have discretion to select and create risk

controls to meet the unique characteristics of its market and cost

structure.

---------------------------------------------------------------------------

\1129\ See, e.g., ICE Comment Letter at 5 (Mar. 8, 2011);

Tradeweb Comment Letter at 11 (Mar. 8, 2011); CME Comment Letter at

27 (Feb. 22, 2011).

---------------------------------------------------------------------------

Finally, in response to concerns about a lack of flexibility in the

proposed requirement to coordinate risk controls among other markets or

exchanges,\1130\ the Commission is moving the language in proposed

Sec. 37.405 to guidance.\1131\ The combination of rules and guidance

pertaining to risk controls will ensure that, at a minimum, SEFs

implement pauses and halts, while also granting SEFs the discretion to

coordinate and adopt additional risk controls in a manner they find

most cost effective and appropriate for their markets.

---------------------------------------------------------------------------

\1130\ CME Comment Letter at 26 (Feb. 22, 2011).

\1131\ The guidance provides that a SEF with a swap that is

linked to, or a substitute for, other products, either on its market

or on other trading venues, must, to the extent practicable,

coordinate its risk controls with any similar controls placed on

those other products. If a SEF's swap is based on the level of an

equity index, such risk controls must, to the extent practicable, be

coordinated with any similar controls placed on national security

exchanges. See guidance to Core Principle 4 in appendix B to part

37.

---------------------------------------------------------------------------

(4) Section 15(a) Factors (Monitoring of Trading)

(i) Protection of Market Participants and the Public

These rules will help ensure fair and equitable markets that are

protected from abusive trading practices or manipulative conditions,

and will ensure that rule violations and market disruptions that could

harm market participants and the public may be prevented or detected,

reconstructed, investigated, and prosecuted. The absence of these

regulations would result in an increased potential for violations to go

undetected and for market disruptions to create distorted prices or

systemic risks that could harm the economy and the public. These

requirements will strengthen SEFs' oversight of their trading

platforms, increase the likelihood of early detection and prompt

responses to rule violations and market disruptions, and result in

stronger protection of market participants and the general public from

rule violations, trading abuses, and other market disruptions that

could harm market participants and, directly or indirectly, the public

and the economy as a whole.

[[Page 33577]]

(ii) Efficiency, Competitiveness, and Financial Integrity of the

Markets

These rules ensure that violations and market anomalies are

detected and promptly addressed and do not generate systemic risk or

other problems that could interfere with efficient and competitive

markets. The requirements also help ensure that market prices are not

distorted by prohibited activities. The rules strengthen market

confidence and enable the market to operate more efficiently by

deterring rule violations and by establishing conditions under which

trading will be paused or halted, thereby promoting efficient pricing

and competitive trading.

(iii) Price Discovery

Requiring SEFs to conduct effective monitoring and surveillance of

their markets and to have the capacity to detect rule violations will

help ensure that legitimate trades and fundamental supply and demand

information are accurately reflected in market prices. The mitigation

of rule violations, which detract from the price discovery process in

SEF markets, will promote confidence in the prices market participants

use to hedge risk and provide confidence in the price discovery

process.

(iv) Sound Risk Management Practices

The rules are designed to allow SEFs to better deter, detect, and

address operational risks posed by trading practices or trading

activities. To the extent they deter overly risky actions by market

participants, the rules will lower potential losses and costs to SEFs

and market participants and promote sound risk management practices.

(v) Other Public Interest Considerations

The Commission has not identified any effects that these rules will

have on other public interest considerations other than those

enumerated above.

(b) Monitoring of Contracts

The Commission is adopting rules that will require a SEF to: (1)

Submit new swap contracts to the Commission in advance of listing and

trading and demonstrate that the contracts are not readily susceptible

to manipulation (Sec. 37.301); \1132\ (2) monitor physical delivery

swaps' terms and conditions and availability of the deliverable

commodity (Sec. 37.402); (3) monitor the reference price of cash-

settled swaps used to determine cash flow or settlement, the continued

appropriateness of the methodology for the reference price for SEFs

that derive that price, and the continued appropriateness of the third-

party index or instrument for reference prices that rely on such index

or instrument (Sec. 37.403); and (4) adopt position limitation or

position accountability in accordance with Commission regulations

(Sec. 37.601).\1133\

---------------------------------------------------------------------------

\1132\ SEFs must make this demonstration by providing the

information set forth in appendix C to part 38. See Core Principles

and Other Requirements for Designated Contract Markets, 77 FR at

36722.

\1133\ Core Principle 6 requires that SEFs, for each contract

and as necessary and appropriate, adopt position limitation or

position accountability, and that, for any contract that is subject

to a position limitation established by the Commission pursuant to

CEA section 4a(a), SEFs must set the position limit at a level not

higher than the position limitation established by the Commission.

See Position Limits for Derivatives, 76 FR 4752 (proposed Jan. 26,

2011).

---------------------------------------------------------------------------

(1) Swaps Not Readily Susceptible to Manipulation

(i) Costs

Compliance with these regulations will impose costs equally on

startups and entities with existing trading platforms seeking SEF

registration because all SEFs must monitor their contracts in

accordance with the rules on an ongoing basis. However, SEFs have

incentives to review their contracts to ensure they are not susceptible

to manipulation even in the absence of the core principle or these

rules. For example, SEFs have a business need to develop products that

provide market participants with reliable instruments that can be used

for hedging and risk management. In order to do so, new and existing

entities will need staff to research the underlying markets (at times

using data from private sources) and to certify that the contract rules

comply with Core Principle 3. SEFs likely will already have staff to

ensure compliance with the applicable core principles and should plan

on legal staff devoting approximately four hours per contract at a cost

of approximately $400 to review a swap's compliance with Core Principle

3 as part of a sound business practice. The scale of these costs

largely depends on how novel or complex a contract is, how many

contracts the SEF plans to list at any given time, and whether listed

swaps are similar to each other.

The Commission notes that this guidance will likely reduce the time

and costs that regulated markets will incur in providing the

appropriate information and will likely reduce the amount of time it

takes the Commission staff to analyze whether a new product or rule

amendment is in compliance with the CEA.

(ii) Benefits

When SEFs list contracts that are not readily susceptible to

manipulation, they contribute to the integrity and stability of the

marketplace by giving traders confidence that the prices associated

with swaps reflect the true supply of and demand for the underlying

commodities or financial instruments. Section 37.301, which implements

the Core Principle 3 requirement that SEFs permit trading only in swaps

that are not readily susceptible to manipulation, will promote an

environment where swap prices are less likely to be subject to

distortion and extreme volatility, allowing market participants to buy

and sell physical and financial products at fair prices and to hedge

price risk appropriately.

The guidance outlined in appendix C to part 38 provides a reference

for existing and new regulated markets for information that should be

provided to the Commission for new products and rule amendments based

on best practices developed over the past three decades by the

Commission and other regulators. This guidance will likely reduce the

time and costs that regulated markets will incur in providing the

appropriate information and should mitigate the need for extensive

follow-up discussions with the Commission. The guidance also reduces

the amount of time it takes the Commission staff to analyze whether a

new product or rule amendment is in compliance with the CEA.

(2) Monitoring of Physical-Delivery Swaps

(i) Costs

While the Commission did not receive comments discussing the costs

of this provision, the Commission is revising the requirement in

proposed Sec. 37.402(a)(2) \1134\ so that SEFs only have to monitor

the availability of the commodity supply, instead of monitoring whether

the supply is adequate. This reduced monitoring obligation should lower

ongoing costs for SEFs since they will not have to make determinations

regarding adequacy of deliverable supply as frequently as under the

proposed rule, while achieving comparable benefit for market

participants and the public. Costs will be further reduced by the

Commission's decision to remove from proposed Sec. 37.402 the

requirements that SEFs monitor specific details of the supply,

marketing, and ownership of the

[[Page 33578]]

commodity to be physically delivered. Instead, final appendix B to part

37 lists guidance for monitoring conditions that may cause a physical-

delivery swap to become susceptible to price manipulation or

distortion. Listing these details in guidance will provide SEFs with

flexibility in meeting their monitoring obligations associated with

physical-delivery swaps, which will likely further mitigate any burden

associated with compliance. The Commission notes that a SEF may

contract with a regulatory service provider to perform these duties at

potentially a lower cost.

---------------------------------------------------------------------------

\1134\ Proposed Sec. 37.402(a)(2) is now final Sec. 37.402(b).

---------------------------------------------------------------------------

(ii) Benefits

Section 37.402 requires that SEFs monitor physical-delivery swaps'

terms and conditions as they relate to the underlying commodity market

and monitor the availability of the supply of the commodity specified

by the delivery requirements of the swap. Such monitoring will allow

SEFs to take appropriate steps to relieve the potential for market

congestion or manipulation in situations where participants' ability to

make good on their delivery obligations is threatened due to supply

shortages, disruptions or shortages of transportation, or disruptions

due to weather or labor strikes. Any interference with the physical-

delivery process will likely lead to disruptions in fair and orderly

trading and participants' ability to properly manage commercial risk.

Moreover, close monitoring of physical-delivery contracts helps prevent

the manipulation of prices, and the public benefits from prices that

reflect actual market conditions.

(3) Monitoring of Cash-Settled Swaps

(i) Costs

Argus commented that monitoring of trading in underlying price

indexes will be costly, and that if SEFs are required to monitor the

availability and pricing of the commodity that forms the basis of a

price index (particularly where an index price is published based upon

transactions that are executed off the DCM or SEF), the SEF may choose

not to list the contract and thus traders will lose a hedging

instrument.\1135\

---------------------------------------------------------------------------

\1135\ Argus Comment Letter at 6-7 (Feb. 22, 2011).

---------------------------------------------------------------------------

In response to this comment, the Commission is amending the

requirement in proposed Sec. 37.403(a)(1) that a SEF monitor the

availability and pricing of the commodity making up the index to which

the swap will be settled, to only require the SEF to monitor the

pricing. The Commission is also moving the other requirements for

monitoring and obtaining information on traders' activities in proposed

Sec. 37.403(a) and (b) to guidance. The combination of rules and

guidance implementing Core Principle 4 will help ensure that the cash

settlement process is not susceptible to manipulation by providing

rules and guidance on how to meet the requirements of the core

principle, while providing SEFs with the flexibility to adopt the most

appropriate method of compliance in light of the nature of their

contracts and market structure.

As discussed above, the Commission notes that compliance with these

provisions can likely be outsourced to a regulatory service provider at

lower cost, and that on-going monitoring of pricing could be handled by

the regulatory service provider.

(ii) Benefits

The Sec. 37.403 requirement that a SEF monitor cash-settled swaps

as they relate to the reference price, instrument, or index to which

the swap is settled will reduce the potential for market disruptions or

manipulations and ensure that they are discovered and promptly

addressed. The interconnected nature of swap and underlying cash

markets may create incentives for traders to disrupt or manipulate

prices in the cash market in order to influence the prices in the swap

market (potentially to benefit the trader's position in the swap).

Detecting and preventing this sort of manipulation requires information

on traders' activities in the cash-settled contract and in, or related

to, the underlying instrument or index to which it is settled. This

rule ensures that SEFs have the information and tools they need to

accomplish their statutory duty to prevent manipulation and disruptions

to the cash-settlement process.

(4) Section 15(a) Factors (Monitoring of Contracts)

(i) Protection of Market Participants and the Public

The demonstration required by Sec. 37.301 and the monitoring

requirements in Sec. Sec. 37.402 and 37.403 allow for a timely review

by the Commission staff of the SEF's supporting analysis and data to

determine whether a contract is not readily susceptible to

manipulation, and to ensure that SEFs are able to adequately collect

information on market activity, including special considerations for

physical-delivery contracts and cash-settled contracts. As a group,

these rules protect market participants by helping to prevent price

manipulation and protect the public by creating an environment that

fosters prices that reflect actual market conditions.

(ii) Efficiency, Competitiveness, and Financial Integrity of the

Markets

By providing guidance based on best practices regarding what a SEF

should consider when developing a swap or amending the terms and

conditions of an existing swap, the contracts listed by SEFs, as a

whole, should be more reflective of the underlying cash market, thus

providing for efficient hedging of commercial risk. Sections 37.402 and

37.403 protect against disruptions and market manipulation, promote

competition, and promote the efficiency and financial integrity of

transactions in SEF markets because market mispricing that is due to

disruptions or manipulation interferes with a market's efficiency by

limiting its ability to reflect the value of the underlying product.

Markets that are prone to disruption or manipulation have a severe

competitive disadvantage to those without such problems. These rules

are designed to address and mitigate such problems for swap

transactions.

(iii) Price Discovery

Manipulation or other market disruptions interfere with the price

discovery process by artificially distorting prices and preventing

those prices from properly reflecting the fundamental forces of supply

and demand. These rules are designed to detect and, where possible,

prevent such market mispricing, and to detect disconnects between swaps

and their related market prices (e.g., between cash market prices and

the prices of related futures and swaps).

(iv) Sound Risk Management Practices

By following the best practices outlined in the guidance in

appendix C to part 38 and the requirements of Sec. Sec. 37.402 and

37.403, a SEF should minimize the susceptibility of a swap to

manipulation or price distortion at the time it is developing the

contract's terms and conditions. By performing this work early-on, a

SEF should minimize risks to its clearing house and to market

participants. Sound risk management practices rely upon execution of

hedge strategies at market prices that are free of manipulation or

other disruptions. These rules are designed to facilitate hedging at

prices free of distortions that may be preventable by adequate

controls.

[[Page 33579]]

(v) Other Public Interest Considerations

The Commission has not identified any effects that these rules will

have on other public interest considerations other than those

enumerated above.

7. Financial Resources and Integrity

(a) Background

Section 37.1301 codifies the Core Principle 13 requirement that a

SEF must maintain sufficient financial resources to cover operating

costs for at least one year, calculated on a rolling basis. The rules

implementing Core Principle 13 also clarify the types of financial

resources available to SEFs to satisfy the financial resources

requirements (Sec. 37.1302) and require that each SEF, no less

frequently than each fiscal quarter, calculate the financial resources

it needs to meet the financial resource requirements, as well as the

current market value of each financial resource (Sec. Sec. 37.1303,

37.1304). The rules also require SEFs to maintain unencumbered liquid

financial assets, such as cash or highly liquid securities, equal to at

least six months' operating costs, or a committed line of credit or

similar facility (Sec. 37.1305), and to report certain information

regarding their financial resources to the Commission quarterly or upon

request (Sec. 37.1306).

Sections 37.701, 37.702, and 37.703 implement Core Principle 7

regarding the financial integrity of transactions. Section 37.701

requires transactions executed on or through a SEF that are mandatorily

or voluntarily cleared to be cleared through a Commission-registered

DCO, or a DCO that the Commission has determined is exempt from

registration. Section 37.702 requires a SEF to establish minimum

financial standards for its members, which at a minimum, requires that

members qualify as ECPs. Section 37.703 requires a SEF to monitor its

members to ensure that they continue to qualify as ECPs.

(b) Costs

ISDA estimated that it would cost each SEF $1.4 million per year to

comply with the financial resource requirement.\1136\ The Commission

notes that the requirement that a SEF maintain sufficient financial

resources to cover its operating expenses for one year appears in the

statute itself, and that the Commission does not have the discretion to

lower the financial resource requirement. Accordingly, Sec. 37.1301

imposes no additional costs on SEFs or market participants beyond those

imposed by statute.

---------------------------------------------------------------------------

\1136\ ISDA Discussion Paper at 32 (Nov. 2011). The Commission

notes that the components of this cost estimate are unclear.

---------------------------------------------------------------------------

With respect to the reporting requirements in Sec. 37.1306,

MarketAxess stated that the proposed requirements are unnecessary and

burdensome.\1137\ The Commission expects that most, if not all, SEFs

would calculate and prepare financial statements regularly.

Accordingly, the Commission does not believe that requiring SEFs to

meet the quarterly reporting requirements imposes a significant burden

on SEFs. Extrapolation from the prepared financial statements should be

relatively straightforward, but will require staff and technology

resources to calculate, monitor, and report financial resources. In

follow-up conversations with the Commission staff, one commenter

indicated that the reporting requirements would costs SEFs about

$100,000 per year. Given the staffing and operational differences among

SEFs, this cost will vary, perhaps significantly.

---------------------------------------------------------------------------

\1137\ MarketAxess Comment Letter at 40 (Mar. 8, 2011).

---------------------------------------------------------------------------

(c) Benefits

The financial resources provisions ensure the financial stability

of SEFs, which promotes the integrity of the markets and confidence of

market participants trading on SEFs. The requirement that SEFs maintain

six months' worth of unencumbered liquid financial assets (i.e., cash

and/or highly liquid securities) will also promote market integrity by

ensuring that SEFs will have sufficient financial resources to continue

to operate and wind-down in an orderly fashion, if necessary. In

addition, the reporting requirements will ensure that the Commission

can monitor the SEF's compliance with Core Principle 13.

Sections 37.702 and 37.703 promote financial integrity by requiring