2010-31130

Federal Register, Volume 75 Issue 244 (Tuesday, December 21, 2010)[Federal Register Volume 75, Number 244 (Tuesday, December 21, 2010)]

[Proposed Rules]

[Pages 80174-80218]

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

[FR Doc No: 2010-31130]

[[Page 80173]]

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

Part III

Commodity Futures Trading Commission

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

17 CFR Part 1

Securities and Exchange Commission

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

17 CFR Part 240

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

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

and ``Eligible Contract Participant''; Proposed Rule

Federal Register / Vol. 75 , No. 244 / Tuesday, December 21, 2010 /

Proposed Rules

[[Page 80174]]

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

COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 1

RIN 3038-AD06

SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 240

[Release No. 34-63452; File No. S7-39-10]

RIN 3235-AK65

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

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

Participant'' and ``Eligible Contract Participant''

AGENCY: Commodity Futures Trading Commission; Securities and Exchange

Commission.

ACTION: Joint proposed rule; proposed interpretations.

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

SUMMARY: In accordance with Section 712(d)(1) of Title VII of the Dodd-

Frank Wall Street Reform and Consumer Protection Act of 2010 (``Dodd-

Frank Act''), the Commodity Futures Trading Commission (``CFTC'') and

the Securities and Exchange Commission (``SEC'') (collectively, the

``Commissions''), in consultation with the Board of Governors of the

Federal Reserve System, are proposing rules and interpretative guidance

under the Commodity Exchange Act (``CEA''), 7 U.S.C. 1 et seq., and the

Securities Exchange Act of 1934 (``Exchange Act''), 15 U.S.C. 78a et

seq., to further define the terms ``swap dealer,'' ``security-based

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

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

DATES: Submit comments on or before February 22, 2011.

ADDRESSES: Comments may be submitted by any of the following methods:

CFTC:

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

through the Web site.

Mail: David A. Stawick, Secretary, Commodity Futures

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

Washington, DC 20581.

Hand Delivery/Courier: Same as mail above.

Federal eRulemaking Portal: Comments also may be submitted

at http://www.regulations.gov. Follow the instructions for submitting

comments. ``Definitions'' must be in the subject field of responses

submitted via e-mail, and clearly indicated on written submissions. All

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

English translation. All comments provided in any electronic form or on

paper will be published on the CFTC Web site, without review and

without removal of personally identifying information. All comments are

subject to the CFTC Privacy Policy.

SEC

Electronic Comments

Use the Commission's Internet comment form (http://www.sec.gov/rules/proposed.shtml);

Send an e-mail to [email protected] Please include

File Number S7-39-10 on the subject line; or

Use the Federal eRulemaking Portal (http://www.regulations.gov). Follow the instructions for submitting comments.

Paper Comments

Send paper comments in triplicate to Elizabeth M. Murphy,

Secretary, Securities and Exchange Commission, 100 F Street, NE.,

Washington, DC 20549-1090.

All submissions should refer to File Number S7-39-10. This file number

should be included on the subject line if e-mail is used. To help us

process and review your comments more efficiently, please use only one

method. The Commission will post all comments on the Commission's

Internet Web site (http://www.sec.gov/rules/proposed.shtml). Comments

are also available for Web site viewing and printing in the

Commission's Public Reference Room, 100 F Street, NE., Washington, DC

20549, on official business days between the hours of 10 a.m. and 3

p.m. All comments received will be posted without change; we do not

edit personal identifying information from submissions. You should

submit only information that you wish to make available publicly.

FOR FURTHER INFORMATION CONTACT: CFTC: Mark Fajfar, Assistant General

Counsel, at 202-418-6636, [email protected], Julian E. Hammar, Assistant

General Counsel, at 202-418-5118, [email protected], or David E. Aron,

Counsel, at 202-418-6621, [email protected], Office of General Counsel,

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

Street, NW., Washington, DC 20581; SEC: Joshua Kans, Senior Special

Counsel, Jeffrey Dinwoodie, Attorney Advisor, or Richard Grant,

Attorney Advisor, at 202-551-5550, Division of Trading and Markets,

Securities and Exchange Commission, 100 F Street, NE., Washington, DC

20549-7010.

SUPPLEMENTARY INFORMATION:

I. Background

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

law.\1\ Title VII of the Dodd-Frank Act \2\ established a comprehensive

new regulatory framework for swaps and security-based swaps. The

legislation was enacted, among other reasons, to reduce risk, increase

transparency, and promote market integrity within the financial system,

including by: (1) Providing for the registration and comprehensive

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

participants and major security-based swap participants; (2) imposing

clearing and trade execution requirements on swaps and security-based

swaps, subject to certain exceptions; (3) creating rigorous

recordkeeping and real-time reporting regimes; and (4) enhancing the

rulemaking and enforcement authorities of the Commissions with respect

to, among others, all registered entities and intermediaries subject to

the Commissions' oversight.

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

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

Act, Public Law 111-203, 124 Stat. 1376 (2010). The text of the

Dodd-Frank Act may be accessed at http://www.cftc.gov./

LawRegulation/OTCDERIVATIVES/index.htm.

\2\ Pursuant to Section 701 of the Dodd-Frank Act, Title VII may

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

2010.''

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

More specifically, the Dodd-Frank Act provides that the CFTC will

regulate ``swaps,'' and the SEC will regulate ``security-based swaps.''

The Dodd-Frank Act also adds to the CEA and Exchange Act definitions of

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

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

``eligible contract participant.'' These terms are defined in Sections

721 and 761 of the Dodd-Frank Act and, with respect to the term

``eligible contract participant,'' in Section 1a(18) of the CEA,\3\ as

re-designated and amended by Section 721 of the Dodd-Frank Act.

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

\3\ See 7 U.S.C. 1a(18).

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

Section 712(d)(1) of the Dodd-Frank Act provides that the CFTC and

the SEC, in consultation with the Board of Governors of the Federal

Reserve System, shall jointly further define the terms ``swap,''

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

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

participant,'' ``eligible contract participant,'' and ``security-based

swap agreement.''

[[Page 80175]]

Further, Section 721(c) of the Dodd-Frank Act requires the CFTC to

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

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

Section 761(b) of the Dodd-Frank Act permits the SEC to adopt a rule to

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

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

contract participant,'' with regard to security-based swaps, for the

purpose of including transactions and entities that have been

structured to evade Title VII of the Dodd-Frank Act.\4\

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

\4\ The definitions of the terms ``swap,'' ``security-based

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

regarding mixed swaps are the subject of a separate rulemaking by

the Commissions.

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

In light of the requirements in the Dodd-Frank Act noted above, the

CFTC and the SEC issued a joint Advance Notice of Proposed Rulemaking

(``ANPRM'') on August 13, 2010, requesting public comment regarding the

definitions of ``swap,'' ``security-based swap,'' ``security-based swap

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

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

``eligible contract participant'' in Title VII of the Dodd-Frank

Act.\5\ The Commissions reviewed more than 80 comments in response to

the ANPRM. The Commissions also informally solicited comments on the

definitions on their respective Web sites.\6\ In addition, the staffs

of the CFTC and the SEC have met with many market participants and

other interested parties to discuss the definitions.\7\

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

\5\ See Definitions Contained in Title VII of Dodd-Frank Wall

Street Reform and Consumer Protection Act, Exchange Act Rel. No. 34-

62717, 75 FR 51429 (Aug. 20, 2010). The comment period for the ANPRM

closed on September 20, 2010.

\6\ Comments were solicited by the CFTC at http://www.cftc.gov/LawRegulation/DoddFrankAct/OTC_2_Definitions.html and the SEC at

http://www.sec.gov/spotlight/regreformcomments.shtml/.

\7\ The views expressed in the comments in response to the

ANPRM, in response to the Commissions' informal solicitation, and at

such meetings are collectively referred to as the views of

``commenters.''

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

In this release, the Commissions propose to further define ``swap

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

``major security-based swap participant'' and ``eligible contract

participant,'' and propose related rules, and also discuss certain

factors that are relevant to market participants when determining their

status with respect to the defined terms. In developing these

proposals, the Commissions have been mindful that the markets for swaps

and security-based swaps are evolving, and that the rules that we adopt

will, as intended by the Dodd-Frank Act, significantly affect those

markets. The rules not only will help determine which entities will be

subject to comprehensive regulation of their swap and security-based

swap activities, but may also cause certain entities to modify their

activities to avoid being subject to the regulations. As a result, we

are aware of the importance of crafting these rules carefully to

maximize the benefits of the regulation imposed by the Dodd-Frank Act,

and to do so in a way that is flexible enough to respond to market

developments. While we preliminarily believe that these proposals, if

adopted, would appropriately effect the intent of the Dodd-Frank Act,

we are very interested in commenters' views as to whether we have

achieved this purpose, and, if not, how to improve these proposals.\8\

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

\8\ In addition, we recognize that the appropriateness of these

proposals also should be considered in light of the substantive

requirements that will be applicable to dealers and major

participants, including capital, margin and business conduct

requirements, which are the subject of separate rulemakings. For

example, whether the definition of a major participant is too broad

or too narrow may well depend in part on the substantive

requirements applicable to such entities, and whether those

substantive requirements are themselves appropriate may in turn

depend in part on the scope of the major participant definition. We

therefore encourage comments that take into account the interplay

between the proposed definitions and these substantive requirements.

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

II. Definitions of ``Swap Dealer'' and ``Security-Based Swap Dealer''

The Dodd-Frank Act defines the terms ``swap dealer'' and

``security-based swap dealer'' in terms of whether a person engages in

certain types of activities involving swaps or security-based swaps.\9\

Persons that meet either of those definitions are subject to statutory

requirements related to, among other things, registration, margin,

capital and business conduct.\10\

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

\9\ See Section 721 of the Dodd-Frank Act (defining ``swap

dealer'' in new Section 1a(49) of the CEA, 7 U.S.C. 1a(49)) and

Section 761 of the Dodd-Frank Act (defining ``security-based swap

dealer'' in new Section 3(a)(71) of the Exchange Act, 15 U.S.C.

78c(a)(71)).

\10\ The Dodd-Frank Act excludes from the Exchange Act

definition of ``dealer'' persons who engage in security-based swap

transactions with eligible contract participants. See Section

3(a)(5) of the Exchange Act, 15 U.S.C. 78c(a)(5), as amended by

Section 761(a)(1) of the Dodd-Frank Act.

The Dodd-Frank Act does not include comparable amendments for

persons who act as brokers in swaps and security-based swaps.

Because security-based swaps are a type of security, persons who act

as brokers in connection with security-based swaps must, absent an

exemption, register with the SEC as a broker pursuant to Exchange

Act section 15(a), and comply with the Exchange Act's requirements

applicable to brokers.

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

The two definitions in general encompass persons that engage in any

of the following types of activity:

(i) Holding oneself out as a dealer in swaps or security-based

swaps,

(ii) Making a market in swaps or security-based swaps,

(iii) Regularly entering into swaps or security-based swaps with

counterparties as an ordinary course of business for one's own account,

or

(iv) Engaging in activity causing oneself to be commonly known in

the trade as a dealer or market maker in swaps or security-based

swaps.\11\

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

\11\ See CEA section 1a(49)(A); Exchange Act section

3(a)(71)(A).

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

The definitions are disjunctive, in that a person that engages in

any of the enumerated dealing activities is a swap dealer or security-

based swap dealer even if the person does not engage in any of the

other enumerated activities.

The definitions, in contrast, do not include a person that enters

into swaps or security-based swaps ``for such person's own account,

either individually or in a fiduciary capacity, but not as a part of a

regular business.'' \12\ The Dodd-Frank Act also instructs the

Commissions to exempt from designation as a dealer an entity that

``engages in a de minimis quantity of [swap or security-based swap]

dealing in connection with transactions with or on behalf of its

customers.'' \13\ Moreover, the definition of ``swap dealer'' (but not

the definition of ``security-based swap dealer'') provides that an

insured depository institution is not to be considered a swap dealer

``to the extent it offers to enter into a swap with a customer in

connection with originating a loan with that customer.'' \14\

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

\12\ See CEA section 1a(49)(C); Exchange Act section

3(a)(71)(C).

\13\ See CEA section 1a(49)(D); Exchange Act section

3(a)(71)(D).

\14\ CEA section 1a(49)(A).

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

The definitions also provide that a person may be designated as a

dealer for one or more types, classes or categories of swaps, security-

based swaps, or activities without being designated a dealer for other

types, classes or categories or activities.\15\

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

\15\ See CEA section 1a(49)(B); Exchange Act section

3(a)(71)(B).

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

The Commissions are proposing rules to further define certain

aspects of the meaning of ``swap dealer'' and ``security-based swap

dealer,'' and are providing guidance on how the Commissions propose to

interpret these terms. This release specifically addresses: (A) The

types of activities that would cause a person to be a swap dealer or

security-based swap dealer, including differences in how those two

definitions should be applied; (B) the statutory provisions requiring

the Commissions to exempt persons from the dealer

[[Page 80176]]

definitions in connection with de minimis activity; (C) the exception

from the ``swap dealer'' definition in connection with loans by insured

depository institutions; (D) the possibility that a person may be

considered a dealer for some types, classes or categories of swaps,

security-based swaps, or activities but not others; and (E) certain

interpretative issues that arise in particular situations. The

Commissions request comment on all aspects of the proposals, including

the particular points noted in the discussion below.

A. Swap and Security-Based Swap Dealing Activity

1. Comments Regarding Dealing Activities

Commenters provided numerous examples of conduct they viewed as

dealing activities--as well as conduct they did not view as dealing

activities. For example, many of the commenters stated that dealers

provide ``bid/ask'' or ``two-way'' prices for swaps on a regular basis,

or regularly participate in both sides of the swap market. Some

commenters indicated that dealers perform an intermediary function.

Other commenters stated that a person holds itself out as a dealer if

it consistently and systematically markets itself as a swap dealer to

third parties. Some commenters described market makers in the swap

markets as persons that stand ready to buy or sell swaps at all times,

are open to doing swaps business on both sides of a market, or make

bids to buy and offers to sell swaps or a type of swap at all times.

Commenters stated that a person should be included in the definition of

dealer if its sole or dominant line of business is swaps activity. One

commenter urged the Commissions to adopt a swap association's

definition of a primary member as the definition of dealer.

Some commenters stated that the definition of dealer should be read

narrowly. For example, some commenters suggested that the market maker

concept should not encompass persons that provide occasional quotes or

that do not make bids or offers consistently or at all times. Another

commenter stated that a willingness to buy or sell a swap or security-

based swap at a particular time does not constitute market making

absent the creating of a two-way market. One commenter suggested that

solely acting as a market maker should not cause a person to be a

dealer, since firms may have commercial purposes for offering two-way

trades. Another commenter stated that an entity that ``holds itself

out'' as a dealer should qualify as a swap dealer only if it

``consistently and systematically markets itself as a dealer to third-

parties.'' \16\

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

\16\ See letter from Eric Dennison, Sr. Vice President and

General Counsel, Stephanie Miller, Assistant General Counsel--

Commodities, and Bill Hellinghausen, Director of Regulatory Affairs,

EDF Trading, dated September 20, 2010 (distinguishing transactions

that the commenter enters into as part of energy management

services).

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

Many commenters called for the exclusion of particular types of

persons from the definition of swap dealer or security-based swap

dealer. Several commenters maintained that commercial end-users of

swaps or security-based swaps that enter into swaps or security-based

swaps to hedge or mitigate commercial risk should be excluded from the

definitions. Another commenter stated the definitions should exclude

persons who use swaps or security-based swaps for bona fide hedging.

Other commenters indicated that cooperatives that enter into swaps in

connection with the business of their members should be excluded.

Commenters also stated that if all of a person's swaps are cleared on

an exchange or derivatives clearing organization, the person should not

be deemed to be a dealer. One commenter stated competitive power

suppliers should be excluded, and another stated that the dealer

definition should not apply to futures commission merchants that act

economically like brokers.

Commenters, particularly those in the securities industry, urged

the Commissions to interpret the definitions of swap dealer and

security-based swap dealer consistently with precedent that

distinguishes between dealers in securities and traders in securities.

However, one commenter also noted that some concepts from the

securities and commodities laws may not easily be applied to these

markets.

2. Application of the Core Tests to ``Swap Dealers'' and ``Security-

Based Swap Dealers''

The Dodd-Frank Act defines the terms ``swap dealer'' and

``security-based swap dealer'' in a functional manner, encompassing how

a person holds itself out in the market, the nature of the conduct

engaged in by the person, and how the market perceives the person's

activities. This suggests that the definitions should not be

interpreted in a constrained or overly technical manner. Rigid

standards would not provide the necessary flexibility to respond to

evolution in the ways that dealers enter into swaps and security-based

swaps. The different types of swap and security-based swap markets are

diverse, and there does not appear to be a single set of criteria that

can be determinative in all markets.

At the same time, we note that there may be certain distinguishing

characteristics of swap dealers and security-based swap dealers,

including that:

Dealers tend to accommodate demand for swaps and security-

based swaps from other parties;

Dealers are generally available to enter into swaps or

security-based swaps to facilitate other parties' interest in entering

into those instruments;

Dealers tend not to request that other parties propose the

terms of swaps or security-based swaps; rather, dealers tend to enter

into those instruments on their own standard terms or on terms they

arrange in response to other parties' interest; and

Dealers tend to be able to arrange customized terms for

swaps or security-based swaps upon request, or to create new types of

swaps or security-based swaps at the dealer's own initiative.

We also recognize that the principles relevant to identifying

dealing activity involving swaps can differ from comparable principles

associated with security-based swaps. These differences are due, in

part, to differences in how those instruments are used. For example,

because security-based swaps may be used to hedge or gain economic

exposure to underlying securities (while recognizing distinctions

between securities-based swaps and other types of securities, as

discussed below), there is a basis to build upon the same principles

that are presently used to identify dealers for other types of

securities. Accordingly, we separately address how the core tests would

apply to swap dealers and to security-based swap dealers.

a. Application to Swap Dealers

The definition of swap dealer should be informed by the differences

between swaps, on the one hand, and securities and commodities, on the

other. Transactions in cash market securities and commodities generally

involve purchases and sales of tangible or intangible property. Swaps,

in contrast, are notional contracts requiring the performance of agreed

terms by each party.\17\ Thus, many of the concepts cited by

commenters, such as whether a person buys and sells swaps or makes a

two-sided market in swaps or trades within a bid/offer spread, cannot

[[Page 80177]]

necessarily be applied to all types of swaps to determine if the person

is a swap dealer. We understand that market participants do use this

terminology colloquially to describe the process of entering into a

swap. For example, a person seeking a fixed/floating interest rate swap

may inquire as to the fixed rates, spread above the floating rate and

other payments that another person would require in order to enter into

a swap. But, while these persons may discuss bids, offers, prices and

so forth, the parties are negotiating the terms of a contract, they are

not negotiating the price at which they will transfer ownership of

tangible or intangible property. Accordingly, these concepts are not

determinative of whether a person is a ``swap dealer.''

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

\17\ As discussed below, however (see note 42, infra), the Dodd-

Frank Act amended the Exchange Act definitions of ``buy,''

``purchase,'' ``sale'' and ``sell'' to apply to particular actions

involving security-based swaps.

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

Instead, persons who are swap dealers may be identified by the

functional role they fulfill in the swap markets. As noted above, swap

dealers tend to accommodate demand and to be available to enter into

swaps to facilitate other parties' interest in swaps (although swap

dealers may also advance their own investment and liquidity objectives

by entering into such swaps). In addition, swap dealers can often be

identified by their relationships with counterparties. Swap dealers

tend to enter into swaps with more counterparties than do non-dealers,

and in some markets, non-dealers tend to constitute a large portion of

swap dealers' counterparties. In contrast, non-dealers tend to enter

into swaps with swap dealers more often than with other non-

dealers.\18\ The Commissions can most efficiently achieve the purposes

underlying Title VII of the Dodd-Frank Act--to reduce risk and to

enhance operational standards and fair dealing in the swap markets--by

focusing their attention on those persons whose function is to serve as

the points of connection in those markets. The definition of swap

dealer, construed functionally in the manner set forth above, will help

to identify those persons.

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

\18\ Some of the commenters appeared to suggest that significant

parts of the swap markets operate without the involvement of swap

dealers. We believe that this analysis is likely incorrect, and that

the parties that fulfill the function of dealers should be

identified and are likely to be swap dealers.

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

Clause (A)(iii) of the statutory definition of swap dealer, which

includes any person that ``regularly enters into swaps with

counterparties as an ordinary course of business for its own account,''

\19\ has been the subject of significant uncertainty among commenters.

The commenters point out that its literal terms could encompass many

parties who regularly enter into swaps without engaging in any form of

swap dealing activity. In this regard, clause (A)(iii) of the

definition should be read in combination with the express exception in

subparagraph (C) of the swap dealer definition, which excludes ``a

person that enters into swaps for such person's own account, either

individually or in a fiduciary capacity, but not as a part of a regular

business.'' Thus, the difference between the inclusion in clause

(A)(iii) and the exclusion in subparagraph (C) is whether or not the

person enters into swaps as a part of, or as an ordinary course of, a

``regular business.'' \20\ We believe that persons who enter into swaps

as a part of a ``regular business'' are those persons whose function is

to accommodate demand for swaps from other parties and enter into swaps

in response to interest expressed by other parties. Conversely, persons

who do not fulfill this function should not be deemed to enter into

swaps as part of a ``regular business'' and are not likely to be swap

dealers.

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

\19\ We interpret this reference to a person entering into swaps

``with counterparties * * * for its own account'' to refer to a

person entering into a swap as a principal, and not as an agent. A

person who entered into swaps as an agent for customers (i.e., for

the customers' accounts) would be required to register as either a

Futures Commission Merchant, Introducing Broker, Commodity Pool

Operator or Commodity Trading Advisor, depending on the nature of

the person's activity.

\20\ The definition of ``security-based swap dealer'' is

structured similarly, and should be interpreted similarly.

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

In sum, to determine if a person is a swap dealer, we would

consider that person's activities in relation to the other parties with

which it interacts in the swap markets. If the person is available to

accommodate demand for swaps from other parties, tends to propose

terms, or tends to engage in the other activities discussed above, then

the person is likely to be a swap dealer. Persons that rarely engage in

such activities are less likely to be deemed swap dealers.

We request comment on this interpretive approach for identifying

whether a person is a swap dealer.

b. Application to Security-Based Swap Dealers

The definition of ``security-based swap dealer'' has parallels to

the definition of ``dealer'' under the Exchange Act.\21\ In addition,

security-based swaps may be used to hedge risks associated with the

ownership of certain other types of securities,\22\ and security-based

swaps may be used to gain economic exposure akin to ownership of

certain other types of securities.\23\ As a result, the SEC would

consider the same factors that are relevant to determining whether a

person is a ``dealer'' under the Exchange Act as also generally

relevant to the analysis of whether a person is a security-based swap

dealer.

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

\21\ The Exchange Act in relevant part defines ``dealer'' to

mean ``any person engaged in the business of buying and selling

securities (not including security-based swaps, other than security-

based swaps with or for persons that are not eligible contract

participants) for such person's own account through a broker or

otherwise,'' but with an exception for ``a person that buys or sells

securities (not including security-based swaps, other than security-

based swaps with or for persons that are not eligible contract

participants) for such person's own account, either individually or

in a fiduciary capacity, but not as a part of a regular business.''

Exchange Act sections 3(a)(5)(A) and (B), 15 U.S.C. 78c(a)(5)(A) and

(B), as amended by Section 761(a)(1) of the Dodd-Frank Act.

\22\ For example, an entity that owns a particular security may

use a security-based swap to hedge the risks of that security.

Conversely, an entity may seek to offset exposure involving a

security-based swap by using another security as a hedge.

\23\ For example, an entity may enter into a security-based swap

to gain economic exposure akin to a long or short position in a

stock or bond, without having to engage in a cash market transaction

for that instrument.

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

The Exchange Act has been interpreted to distinguish between

``dealers'' and ``traders.'' In this context, the SEC previously has

noted that the dealer-trader distinction:

Recognizes that dealers normally have a regular clientele, hold

themselves out as buying or selling securities at a regular place of

business, have a regular turnover of inventory (or participate in

the sale or distribution of new issues, such as by acting as an

underwriter), and generally provide liquidity services in

transactions with investors (or, in the case of dealers who are

market makers, for other professionals).\24\

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

\24\ Securities Exchange Act Release No. 47364 (Feb. 13, 2003)

(footnotes omitted).

Other non-exclusive factors that are relevant for distinguishing

between dealers and non-dealers can include the receipt of customer

property and the furnishing of incidental advice in connection with

transactions.

The markets involving security-based swaps are distinguishable in

certain respects from markets involving cash market securities--

particularly with regard to the concepts of ``inventory'' (which

generally appears inapplicable in this context) \25\ and ``regular

place of business.'' For example, the suggestion that dealers are more

likely to operate at a ``regular place of business'' than traders

should not be construed in a way that ignores the reality of how the

security-based swap markets operate (or that

[[Page 80178]]

ignores evolution in dealing practices involving other types of

securities). Dealers may use a variety of methods to communicate their

availability to enter into security-based swaps with other market

participants. The dealer-trader distinction should not be applied to

the security-based swap markets without taking those distinctions into

account.\26\ Even in light of those differences, however, we believe

that the dealer-trader distinction provides an important analytical

tool to assist in determining whether a person is a ``security-based

swap dealer.''

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

\25\ In particular, an analysis that considers dealers to differ

from traders in part because dealers have regular turnover in

``inventory'' appears not to apply in the context of security-based

swaps, given that those instruments are created by contract between

two market counterparties, rather than reflecting financial rights

issued by third-parties.

\26\ The definition of ``security-based swap dealer,'' unlike

the Exchange Act's definition of ``dealer,'' does not specifically

refer to ``buying'' and ``selling.'' We do not believe that this

language difference is significant, however, as the Dodd-Frank Act

amended the Exchange Act definitions of ``buy'' and ``purchase,''

and the Exchange Act definitions of ``sale'' and ``sell,'' to

encompass the execution, termination (prior to its scheduled

maturity date), assignment, exchange or similar transfer or

conveyance of, or extinguishing of rights or obligations under, a

security-based swap. See Dodd-Frank Act sections 761(a)(3), (4)

(amending Exchange Act sections 3(a)(13), (14)).

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

Commenters have raised concerns that the ambit of the security-

based swap dealer definition could encompass end-users that use

security-based swaps for hedging their business risks. Deeming those

entities to be security-based swap dealers due to their hedging

activities could discourage their use of hedging transactions or

subject them to a regulatory framework that was not intended to address

their businesses and could subject them to unnecessary costs. Under the

dealer-trader distinction, however, we would expect entities that use

security-based swaps to hedge their business risks, absent other

activity, likely would not be dealers.\27\ Also, as discussed below,

both the ``security-based swap dealer'' definition and the dealer-

trader distinction in part turn on whether a person holds itself out as

a dealer.

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

\27\ Of course, if a person's other activities satisfy the

definition of security-based swap dealer, it must comply with the

applicable requirements with regard to all of its security-based

swap activities, absent an order to the contrary, as discussed

below. Also, as discussed below, we would expect end-users to use

security-based swaps for hedging purposes less commonly than they

use swaps for hedging purposes.

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

We request comment on the application of the dealer-trader

distinction as part of the analysis of whether a person is a security-

based swap dealer.

c. Issues Common to Both Definitions

i. Holding Oneself Out as, and Being Commonly Known in the Trade as, a

Swap Dealer or Security-Based Swap Dealer

As noted above, the application of these definitions to persons

that ``hold themselves out'' as dealers or that are ``commonly known in

the trade'' as dealers highlights the need for a functional

interpretation of the dealer definitions. We believe that factors that

may reasonably indicate that a person is holding itself out as a dealer

or is commonly known in the trade as a dealer may include (but are not

limited to) the following:

Contacting potential counterparties to solicit interest in

swaps or security-based swaps,

Developing new types of swaps or security-based swaps

(which may include financial products that contain swaps or security-

based swaps) and informing potential counterparties of the availability

of such swaps or security-based swaps and a willingness to enter into

such swaps or security-based swaps with the potential counterparties,

Membership in a swap association in a category reserved

for dealers,

Providing marketing materials (such as a Web site) that

describe the types of swaps or security-based swaps that one is willing

to enter into with other parties, or

Generally expressing a willingness to offer or provide a

range of financial products that would include swaps or security-based

swaps.

Notably, holding oneself out as a security-based swap dealer would

likely encompass a situation in which a person that is a ``dealer'' in

another type of security enters into a security-based swap with a

customer.\28\ Another example of holding oneself out as a security-

based swap dealer would likely be an entity expressing its availability

to provide liquidity to counterparties that seek to enter into

security-based swaps, regardless of the ``direction'' of the

transaction or across a broad spectrum of risks (e.g., credit default

swaps related to a variety of issuers).

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

\28\ For example, if a person that is a dealer in securities

that are not security-based swaps enters into a security-based swap

transaction with one of its cash market customers, the person would

appear to be engaged in security-based swap dealing activity with

that customer. In that circumstance, the customer reasonably would

be expected to view the person as a dealer for purposes of the

security-based swap, making the applicable business conduct

requirements particularly important.

The determination of who is commonly known in the trade as a swap

dealer or security-based swap dealer may appropriately reflect, among

other factors, the perspective of persons with substantial experience

with and knowledge of the swap and security-based swap markets,

regardless of whether an entity is known as a dealer by persons without

that experience and knowledge.

ii. Making a Market in Swaps or Security-Based Swaps

A number of commenters suggested that the market making component

of the definitions should apply only to persons that quote a two-sided

market consistently or at all times. Some commenters also suggested

that a person's willingness to buy or to sell a swap or security-based

swap at any particular time should not be deemed to be market making

activity. While continuous two-sided quotations and a willingness to

stand ready to buy and sell a security are important indicators of

market making in the equities markets,\29\ these indicia may not be

appropriate in the context of the swap or security-based swap markets,

given that parties do not enter into many types of swaps or security-

based swaps on a continuous basis, and that parties may use a variety

of methods for communicating their willingness to enter into swaps or

security-based swaps. Any analysis that would impute to the definitions

a ``continuous'' activity requirement may cause certain persons that

engage in non-continuous dealing activities not to be regulated as swap

dealers or security-based swap dealers. We have not identified anything

in the statutory text or legislative history of the Dodd-Frank Act to

suggest that Congress intended such a result.

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

\29\ See Exchange Act Release No. 58875 (Oct. 14, 2008), 73 FR

61690 (Oct. 17, 2008) (``Although determining whether or not a

market maker is engaged in bona-fide market making would depend on

the facts and circumstances of the particular activity, factors that

indicate a market maker is engaged in bona-fide market making

activities may include, for example, whether the market maker incurs

any economic or market risk with respect to the securities (e.g., by

putting their own capital at risk to provide continuous two-sided

quotes in markets).'').

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

iii. No Predominance Test

Although some commenters suggested that a person should be a swap

dealer or security-based swap dealer only if such activity is the

person's sole or predominant business, the statutory definition does

not contain a predominance test or otherwise depend upon the level of

the person's dealing activity, other than the de minimis exception

discussed below. A predominance standard would not

[[Page 80179]]

provide a workable test of dealer status because many of the parties

that are commonly acknowledged as swap or security-based swap dealers

also engage in other businesses that often outweigh their swap or

security-based swap dealing business in terms of transaction volume or

other measures. Based on the plain meaning of the statutory definition,

so long as a person engages in dealing activity that is not de minimis,

as discussed below, the person is a swap dealer or security-based swap

dealer.\30\

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

\30\ As one example, a non-financial company that engages in

both swap dealing and other commercial activities would fall within

the definition of swap dealer because of its swap dealing

activities, notwithstanding that it also engages in other commercial

activities.

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

iv. Application of the Definition to New Types of Swaps and New

Activities

The Commissions intend to apply the definitions of swap dealer and

security-based swap dealer flexibly when the development of innovative

business models is accompanied by new types of dealer activity. As

discussed above, the Commissions generally intend to follow a ``facts-

and-circumstances'' approach with respect to identifying dealing

activities. The dealer definitions must be flexible enough to cover

appropriate persons as the swap markets evolve.

v. Request for Comment

The Commissions request comment on these interpretations of holding

oneself out as a dealer and being commonly known in the trade as a

dealer, as well as the lack of a predominance test, and the application

of the definitions to new types of swaps and new activities. Commenters

particularly are requested to address the relevance, to the dealer

analysis, of activities such as an entity's membership in a swap

execution facility (``SEF'') or a security-based SEF, or use of

facilities that may not be SEFs or security-based SEFs. Are there

factors that would lead entities to become members of SEFs that would

not make membership relevant to the dealer analysis? Commenters also

are requested to generally address how the dealer analysis should

appropriately apply the requirements applicable to dealers (e.g.,

capital, margin and business conduct requirements) to the entities that

should be subject to those requirements. In addition, commenters are

requested to address how the dealer definitions should be applied to

entities such as, for example, Federal home loan banks subject to

restrictions limiting their dealing activities to particular types of

counterparties. Finally, commenters are requested to address whether

additional guidance is advisable to help identify dealer activity and

to promote effective enforcement of the requirements applicable to swap

dealers and security-based swap dealers.

3. Designation of a Person as a Swap Dealer

The Dodd-Frank Act has amended the CEA and the Exchange Act to

require a person that meets either of the definitions to register as a

swap dealer and/or security-based swap dealer,\31\ and the Commissions

are proposing separate rules regarding this registration requirement.

In connection with the registration requirement, market participants

are in a position to assess their activities to determine whether they

function in the manner described in the definitions. In addition, the

Commissions have the authority to take enforcement actions in response

to a dealer's failure to register. In determining whether a person

meets the applicable definitions, the Commissions may use information

from other regulators, swap data repositories, registered clearing

agencies, derivatives clearing organizations and other sources.

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

\31\ See CEA section 4s(a)-(b); Exchange Act section 15F(a)-(b).

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

4. Application of the Swap Dealer Definition to Agricultural

Commodities

Section 723(c)(3)(B) of the Dodd-Frank Act provides that swaps in

agricultural commodities shall be subject to such terms and conditions

as the CFTC may prescribe. In a separate rulemaking, the CFTC has

proposed a definition of the term ``agricultural commodity.'' \32\

Acting under the authority in Section 723(c)(3)(B), the CFTC may

develop particular terms and conditions for the interpretation of the

swap dealer definition when it is applied to dealing in swaps in

agricultural commodities. Any such terms and conditions would not be

applicable to the definition of security-based swap dealer. The CFTC

requests comment on the application of the swap dealer definition to

dealers, including potentially agricultural cooperatives, that limit

their dealing activity primarily to swaps in agricultural commodities.

The CFTC may consider any comments on this topic for both the

definition of swap dealer and also for any rulemaking regarding swaps

in agricultural commodities.

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

\32\ See 75 FR 65586 (Oct. 26, 2010).

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

B. De Minimis Exemption to the Definitions

The Dodd-Frank Act requires that the Commissions exempt, from

designation as a ``swap dealer'' or ``security-based swap dealer,'' a

person who ``engages in a de minimis quantity of [swap or security-

based swap] dealing in connection with transactions with or on behalf

of its customers.'' \33\ The statutory definitions do not require that

the Commissions fix a specific level of swap activity that will be

considered de minimis, but instead require that the Commissions

``promulgate regulations to establish factors with respect to the

making of this determination to exempt.''

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

\33\ See CEA section 1a(49)(D); Exchange Act section

3(a)(71)(D).

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

1. Comments Regarding the De Minimis Exemption

Some commenters asserted that the de minimis exemption should be

linked to systemic risk concerns, stating that persons engaged in

dealing activities that do not pose systemic risk should be able to

take advantage of the exemption. Other commenters suggested that a

person's dealing activities should be considered de minimis if they do

not pose undue risks to the person. Commenters also expressed the view

that the application of the exemption should be based on quantitative

criteria.

2. Proposed Rule Regarding the De Minimis Exemption

The Commissions preliminarily believe that the ``de minimis''

exemption should be interpreted to address amounts of dealing activity

that are sufficiently small that they do not warrant registration to

address concerns implicated by the regulations governing swap dealers

and security-based swap dealers.\34\ In other words, the exemption

should apply only when an entity's dealing activity is so minimal that

applying dealer regulations to the entity would not be warranted.

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

\34\ The Title VII requirements applicable to swap and security-

based swap dealers include, for example: requirements that dealers

conform to regulatory standards relating to the confirmation,

processing, netting, documentation and valuation of swaps and

security-based swaps (CEA section 4s(i), Exchange Act section

15F(i)); requirements that dealers disclose, to regulators,

information concerning terms and conditions of swaps or security-

based swaps, as well as information concerning trading practices,

financial integrity protections and other trading information (CEA

section 4s(j)(3), Exchange Act section 15F(j)(3)); conflicts of

interest provisions (CEA section 4s(j)(5), Exchange Act section

15F(j)(5)); and chief compliance officer requirements (CEA section

4s(k), Exchange Act section 15F(k)).

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

We thus preliminarily do not agree with those commenters that

argued that

[[Page 80180]]

a de minimis quantity of dealing should be measured in relation to the

level of the person's other activities (or other swap or security-based

swap activities). Aside from the fact that the statute does not

explicitly call for a relative test, such an approach would lead to the

result that larger and more active companies, which presumably would be

more able to influence the swap markets, would be more likely to

qualify for the exemption than smaller and less active companies. Also,

a relative test not only would require a means of measuring the

person's dealing activities, but also would require a means of

measuring the larger scope of activities to which its swap dealing or

security-based swap dealing activities are to be compared, thus

introducing unnecessary complexity to the exemption's application.

Our proposed factors for the de minimis exemption seek to focus the

availability of the exemption toward entities for which registration

would not be warranted from a regulatory point of view in light of the

limited nature of their dealing activities. At the same time, we

recognize that this focus does not appear to readily translate into

objective criteria. Thus, while the proposed factors discussed below

reflect our attempt to delimit the de minimis exemption appropriately,

we recognize that a range of alternative approaches may be reasonable,

and we are particularly interested in commenters' suggestions as to the

appropriate factors.

The first proposed factor is that the aggregate effective notional

amount, measured on a gross basis, of swaps or security-based swaps

that an entity enters into over the prior 12 months in connection with

its dealing activities \35\ could not exceed $100 million.\36\ We

understand that in general the notional size of a small swap or

security-based swap is $5 million or less, and this proposed threshold

would reflect 20 instruments of that size. Given the customer

protection issues raised by swaps and security-based swaps--including

the risks that counterparties may not fully appreciate when entering

into swaps or security-based swaps--we believe that this notional

amount reflects a reasonable limit for identifying those entities that

engage in a de minimis level of dealing activity.\37\ This standard

would measure an entity's quantity of dealing on a gross basis (without

consideration of the market risk offsets associated with combining long

and short positions) to reflect the entity's overall amount of dealing

activity. Similarly, the proposed notional threshold would not account

for the amount of collateral held by or provided by the entity, nor

other risk mitigating factors, in determining whether it engages in a

de minimis quantity of dealing, given that dealer status focuses on an

entity's absolute level of activity, and is not directly based on the

risks that an entity poses or faces.\38\

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

\35\ The de minimis exemption specifically places limits on a

person's dealing activity involving swaps or security-based swaps.

Thus, these limits would not apply to swap or security-based swap

activity that does not itself constitute dealing activity, such as

activity in which a person hedges or mitigates a commercial risk of

its business that is unrelated to a dealing business (i.e., as

discussed above, when the person did not accommodate demand from the

other party, respond to the other party's interest in swaps or

security-based swaps, solicit the other party, propose economic

terms, intermediate between parties, provide liquidity, or engage in

other dealing activities). See part II.A.2, supra.

\36\ See proposed CEA rule 1.3(ppp)(4)(ii); proposed Exchange

Act rule 3a71-2(a). To the extent that the stated notional amount of

a swap or security-based swap is leveraged or enhanced by its

structure, the calculation shall be based on the effective notional

amount of the swap or security-based swap rather than on its stated

notional amount.

\37\ We preliminarily believe that activity above this amount

would be sufficient to warrant dealer registration to bring about

the benefits of such registration.

\38\ Also, allowing offsets for collateral would result in a de

minimis standard that could encompass positions of virtually

unlimited size.

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

In addition, the aggregate effective notional amount of such swaps

or security-based swaps, in which the person's counterparty is a

``special entity'' (as that term is defined in CEA Section 4s(h)(2)(C)

and Exchange Act Section 15F(h)(2)(C)),\39\ that an entity enters into

over the prior 12 months could not exceed $25 million.\40\ The Dodd-

Frank Act provided special protections to special entities in

connection with swaps and security-based swaps, and we preliminarily

believe that this lower proposed threshold reasonably reflects the

special protections afforded to those entities.

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

\39\ The term ``special entity'' encompasses: Federal agencies;

States, State agencies and political subdivisions (including cities,

counties and municipalities); ``employee benefit plans'' as defined

under the Employee Retirement Income Security Act of 1974

(``ERISA''); ``governmental plans'' as defined under ERISA; and

endowments.

\40\ See proposed CEA rule 1.3(ppp)(4)(ii); proposed Exchange

Act rule 3a71-2(b).

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

In addition, to take advantage of the de minimis exemption, the

proposed rule would provide that the entity could not have entered into

swaps or security-based swaps (as applicable) as a dealer with more

than 15 counterparties, other than security-based swap dealers, over

the prior 12 months.\41\ The Commissions preliminarily believe that an

entity that enters into swaps or security-based swaps, in a dealer

capacity, with a larger number of counterparties should be registered

to help achieve Title VII's orderly market goals, and thus cannot be

said to engage in a de minimis quantity of dealing (even if the

aggregate effective notional amount of the swaps or security-based

swaps is less than the thresholds noted above).\42\ For purposes of

determining the number of counterparties, we preliminarily believe that

counterparties who are members of an affiliated group would generally

count as one counterparty, given that the purpose of the limit is to

measure the scope of dealer's interaction with separate

counterparties.\43\

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

\41\ See proposed CEA rule 1.3(ppp)(4)(iii); proposed Exchange

Act rule 3a71-2(c). That these tests measure the entity's activities

over the prior 12 months provides certainty. As of the end of each

month, the entity will know whether it may qualify for the exemption

during the following month.

\42\ Similarly, because all the de minimis factors must be

satisfied, a person who enters into only a single swap or security-

based swap, as a swap dealer, with a single counterparty could not

qualify for the de minimis exemption if that swap or security-based

swap exceeds the effective notional amount threshold.

\43\ For this purpose, an affiliated group would be defined as

any group of entities that is under common control and that reports

information or prepares its financial statements on a consolidated

basis.

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

Finally, the proposed rule would provide that, to take advantage of

the de minimis exemption, the entity could not have entered into more

than 20 swaps or security-based swaps (as applicable) as a dealer

during the prior 12 months.\44\ As is the case for the limitation on

the number of counterparties, the Commissions preliminarily believe

that an entity that enters into a larger number of swaps or security-

based swaps, in a dealer capacity, would, if registered, help achieve

Title VII's orderly market goals, and thus cannot be said to engage in

a de minimis quantity of dealing. For these purposes, we would expect

that each separate transaction the entity enters into under a swap or

security-based swap master agreement in general would count as entering

into a swap or security-based swap, but that an amendment of an

existing swap or security-based swap in which the counterparty remained

the same and the underlying item remained substantially the same would

not count as a new swap or security based swap.\45\

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

\44\ See proposed CEA rule 1.3(ppp)(4)(iv); proposed Exchange

Act rule 3a71-2(d).

\45\ For these purposes only, an amendment to an existing swap

or security-based swap would not need to be counted as a new swap or

security-based swap if the underlying item is substantially the same

as the original item. This may occur, for example, to reflect the

effect of a corporate action such as a merger. An amendment would be

counted as a new swap or security-based swap, however, to the extent

that the change in the underlying item modifies the economic risk

reflected by the swap or security-based swap.

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

[[Page 80181]]

The proposed rule would not distinguish between different types of

swaps or security-based swaps into which entities may enter (e.g., rate

swaps versus other commodity swaps, or credit default swaps versus

equity swaps). The Commissions preliminarily do not believe that the

ceiling for distinguishing de minimis dealing activities from other

dealing activities appropriately turns upon the particular type of swap

or security-based swap.\46\

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

\46\ The Exchange Act's definition of ``dealer'' does not

include a de minimis exemption. Thus, an entity that engages in

dealing activity involving securities (other than security-based

swaps with eligible contract participants) would be required to

register as a ``dealer'' under the Exchange Act, and comply with the

Exchange Act's requirements applicable to dealers, absent some other

exception or exemption from registration.

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

The Commissions request comment on the proposed rule regarding the

de minimis exemption. Commenters particularly are requested to address

whether certain of the proposed factors should be modified or

eliminated; for example, should the proposed $100 million limit on

annual notional swaps or security-based swaps entered into in a dealer

capacity be raised or lowered to better implement the intended scope of

the de minimis exemption--i.e., to exclude entities for which dealer

regulation would not be warranted? Should we adopt different thresholds

that would appropriately limit the exemption so it encompasses only

those entities whose dealing activities are such that dealer regulation

is not warranted? To what extent would certain entities be expected to

reduce or otherwise adjust their dealing activity to fall within the

scope of the de minimis exemption? Would there be any adverse

implications for market participants if this happens? To what extent

could the proposed factors potentially reduce dealing activity, and in

doing so reduce the liquidity available in the swap or security-based

swap market?

Commenters also are requested to address whether the rule should

seek to identify only certain types of counterparties with which a

person could engage in dealing activities under the exemption. We also

particularly request comment on the proposed $25 million notional

threshold for dealer transactions with ``special entities,'' including

whether that proposed threshold should be raised or lowered, and

whether an entity that enters into dealing transactions with ``special

entities'' should be able to take advantage of the exemption at all. In

addition, we request comment on whether the proposed threshold for

transactions with ``special entities'' would provide a disincentive to

dealers entering into transactions with such entities.

Commenters further are requested to address whether the factors may

appropriately account for the size of the swap or security-based swap

activities compared to the size of the entity; how an entity's swaps or

security-based swaps with affiliated counterparties should be treated

for purposes of the test; and whether the exemption's factors should

vary depending on the type of swap or security-based swap at issue.

In addition, commenters are requested to address the significance

of the fact that the statutory de minimis exemption specifically

references transactions with or on behalf of a customer. Does that mean

the exemption was intended to specifically address dealing activity as

an accommodation to an entity's customers? If so, should the exemption

be conditioned on the presence of an existing relationship between the

entity and the counterparty that does not entail swap or security-based

swap dealing activity, and if so, which types of relationships should

be treated as creating a ``customer'' relationship?

Commenters also are requested to address whether the de minimis

exemption should excuse an entity from having to comply with certain

regulatory requirements imposed on swap dealers or security-based swap

dealers, while also mandating compliance with other dealer

requirements. In addition, commenters are requested to address whether,

in lieu of the self-executing approach proposed here, the Commissions

instead should require that entities which seek relief under this de

minimis exemption must submit exemptive requests to the relevant agency

for the agency's consideration and action. Commenters further are

requested to address whether the proposed notional threshold for the de

minimis exception should be subject to a formula that permits automatic

periodic adjustments to the threshold, such as to reflect changes in

market size or in the size of typical contracts.

C. Statutory Exclusion for Swaps in Connection With Originating a Loan

The ``swap dealer'' definition excludes an insured depository

institution (``IDI'') ``to the extent it offers to enter into a swap

with a customer in connection with originating a loan with that

customer.'' \47\ This exclusion does not appear in the definition of

``security-based swap dealer.''

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

\47\ See CEA section 1a(49)(A).

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

1. Comments Regarding the Exclusion for Swaps in Connection With Loans

Three IDIs commented on this aspect of the definition, stating that

the exclusion should encompass any swap entered into contemporaneously

with a loan that is related to any of the borrower's activities that

affect the ability to repay the loan and can be hedged. Thus, in their

view, the exclusion should cover exchange rate and physical commodity

swaps in addition to interest rate swaps. The IDIs also said the

exclusion should apply to amendments, restructurings and workouts of

loans, and to lenders that act through a syndicate.

Another commenter expressed similar views, and also asked for

clarification whether the exclusion applies to all aspects of the

definition, or if it applies only to whether a person is commonly known

in the trade as a swap dealer. The CFTC preliminarily believes the

exclusion applies to all aspects of the swap dealer definition.

2. Proposed Rule Regarding the Exclusion for Swaps in Connection With

Loans

The CFTC preliminarily interprets the word ``offer'' in this

exclusion to include scenarios where the IDI requires the customer to

enter into a swap, or the customer asks the IDI to enter into a swap,

specifically in connection with a loan made by that IDI. Also, the

proposed rule provides that, in order to prevent evasion, the statutory

exclusion does not apply where (i) The purpose of the swap is not

linked to the financial terms of the loan; (ii) the IDI enters into a

``sham'' loan; or (iii) the purported ``loan'' is actually a synthetic

loan such as a loan credit default swap or loan total return swap.

The proposed rule would apply the statutory exclusion only to swaps

that are connected to the financial terms of the loan, such as, for

example, its duration, interest rate, currency or principal amount.

Although commenters urged that this exclusion be extended to other

aspects of the lending relationship, we preliminarily believe that it

would not be appropriate that this exclusion from the swap dealer

definition encompass swaps that are connected to the borrower's other

business activities, even if the loan agreement requires that the

borrower enter into such swaps or otherwise refers to them. We

preliminarily believe that a broader reading of the exclusion could

encompass all swap activity

[[Page 80182]]

between an IDI and its borrowers, which we do not think is intended.

The origination of commercial loans is a complex process, and the

CFTC preliminarily believes that this exclusion should be available to

all IDIs that are a source of funds to a borrower. For example, all

IDIs that are part of a loan syndicate providing a loan to a borrower

could claim this exclusion with respect to swaps entered into with the

borrower that are connected to the financial terms of the loan.

Similarly, the proposed exclusion could be claimed with respect to such

swaps entered into by any IDI that participates in or obtains a

participation in such loan by means of a transfer or otherwise.\48\

Also, an IDI that is a source of funds for the refinancing of a loan

(whether directly or through a syndicate, participation or otherwise)

could claim the exclusion if it enters into a swap with the refinancing

borrower.

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

\48\ The CFTC preliminarily believes that the proposed exclusion

could be claimed by any IDI that participates in a loan through any

means that involves a payment to a lender to take the place of that

lender, including an ``English style'' participation.

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

We emphasize that this proposed exclusion, by its statutory terms,

is available only to IDIs. If an IDI were to transfer its participation

in a loan to a non-IDI, then the non-IDI would not be able to claim

this exclusion, regardless of the terms of the loan or the manner of

the transfer. Similarly, a non-IDI that is part of a loan syndicate

with IDIs would not be able to claim the exclusion.

In sum, the proposed exclusion may be claimed by a person that

meets the following three conditions: (i) The person is an IDI; (ii)

the person is the source of funds to a borrower in connection with a

loan (either directly or through syndication, participation,

refinancing or otherwise); and (iii) the person enters into a swap with

the borrower that is connected to the financial terms of the loan (so

long as the loan is not a sham or a synthetic loan).

The CFTC requests comment on the proposed rule relating to the

statutory exclusion for swaps in connection with originating a loan,

and in particular on whether this statutory exclusion should be

extended beyond swaps that are connected to the financial terms of the

loan, and if so, why. The CFTC also requests comment on whether this

exclusion should apply only to swaps that are entered into

contemporaneously with the IDI's origination of the loan (and if so,

how ``contemporaneously'' should be defined for this purpose), or

whether this exclusion should also apply to swaps entered into during

part or all of the duration of the loan.

D. Designation as a Dealer for Certain Types, Classes, or Categories of

Swaps, Security-Based Swaps, or Activities

The statutory definitions include a provision stating that a person

may be designated as a dealer for one or more types, classes or

categories of swaps, security-based swaps, or activities without being

considered a swap dealer or security-based swap dealer for other types,

classes or categories of swaps, security-based swaps, or activities.

This provision is permissive and does not require the Commissions to

designate persons as dealers for only a limited set of types, classes

or categories of swaps, security-based swaps, or activities.

1. Comments Regarding Limited Designation as a Swap Dealer or Security-

Based Swap Dealer

One commenter stated that the Commissions should allow a person to

register as a swap dealer or security-based swap dealer for only a

limited set of types, classes or categories of swaps or security-based

swaps. Another commenter expressed the view that a person designated as

a swap dealer or security-based swap dealer should be designated as

such for all types of swaps or security-based swaps, respectively.

2. Proposed Rule Regarding Limited Designation as a Swap Dealer or

Security-Based Swap Dealer

In general, the Commissions propose that a person that satisfies

the definition of swap dealer or security-based swap dealer would be a

dealer for all types, classes or categories of swaps or security-based

swaps, or activities involving swaps or security-based swaps, in which

the person engages.\49\ Thus, the person would be subject to all

regulatory requirements applicable to dealers for all swaps or

security-based swaps into which it enters. We propose this approach

because it may be difficult for swap dealers and security-based swap

dealers to separate their dealing activities from their other

activities involving swaps or security-based swaps.\50\

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

\49\ See proposed CEA rule 1.3(ppp)(3); proposed Exchange Act

rule 3a71-1(c).

\50\ For example, in order to efficiently impose the dealer

requirements on only the person's dealing activities, it may be

necessary for the person to have separate books and records and a

separate compliance regime for its dealing activities.

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

The proposed rule also states, however, that the Commissions may

provide for a person to be designated as a swap dealer or security-

based swap dealer for only specified categories of swaps, security-

based swaps, or activities, without being classified as a dealer for

all categories.\51\ This proposed rule would afford persons an

opportunity to seek, on an appropriate showing, a limited designation

based on facts and circumstances applicable to their particular

activities. The Commissions anticipate that a swap dealer could seek a

limited designation at the same time as, or at a later time subsequent

to, the person's initial registration as a swap dealer.

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

\51\ CEA section 1a(49)(B); Exchange Act section 3(a)(71)(B). As

discussed below, the Commissions preliminarily believe that there

are four major categories of swaps and two major categories of

security-based swaps. See part IV.A, infra. The designation as a

swap dealer or security-based swap dealer may, for example, be

limited in terms of these categories or in terms of particular

activities of the person.

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

The CFTC understands that there may potentially be non-financial

entities, such as physical commodity firms, that conduct swap dealing

activity through a division of the entity, and not a separately-

incorporated subsidiary. In these instances, the entity's swap dealing

activity would not be a core component of the entity's overall

business. If this type of entity registered as a swap dealer, the CFTC

anticipates that certain swap dealer requirements would apply to the

swap dealing activities of the division, but not necessarily to the

swap activities of other parts of the entity.

The Commissions request comment on the proposed rules regarding

limited designation as a swap dealer or security-based swap dealer.

Commenters particularly are requested to address the circumstances in

which such limited purpose designations would be appropriate, the

factors that the Commissions should consider when addressing such

requests, and the type of information requestors should provide in

support of their request. For example, would it be appropriate to grant

such limited purpose designations only to entities that do not

otherwise fall within the definition of a financial entity, and whose

dealing activity is below a defined threshold of the entity's overall

activity? At what level should the Commissions set such a threshold?

Which of the requirements applicable to dealers should or should not

apply to such entity's non-dealing activities in swaps and security-

based swaps?

In addition, commenters are requested to address whether the

Commissions should provide for limited purpose designations of swap

dealers or security-based swap dealers through some other mechanism as

an alternative to, or in

[[Page 80183]]

addition to, case-by-case evaluations of individual applications. If

so, what criteria and procedures would be appropriate for making

limited purpose designations through this type of approach? Also,

should the limited purpose designation apply on a provisional basis

starting at the time that the entity makes an application for a limited

purpose designation?

Finally, commenters also are asked to address whether such limited

purpose designations should be conditioned in any way, such as by the

provision of information of the type that would be required with

respect to an entity's swaps or security-based swaps involving the

particular category or activity for which they are not designated as a

dealer.

E. Certain Interpretative Issues

1. Affiliate Issues

We preliminarily believe that the word ``person'' in the swap

dealer and security-based swap dealer definitions should be interpreted

to mean that the designation applies with respect to a particular legal

person. That is, for example, we would not view a trading desk or other

discrete business unit that is not a separately organized legal person

as a swap dealer; rather, the legal person of which it is a part would

be the swap dealer. Also, an affiliated group of legal persons under

common control could include more than one dealer. Within such a group,

any legal person that engages in swap or security-based swap dealing

activities would be a swap dealer or security-based swap dealer, as

applicable.

In determining whether a particular legal person is a swap dealer

or security-based swap dealer, we preliminarily believe it would be

appropriate for the person to consider the economic reality of any

swaps and security-based swaps it enters into with affiliates (i.e.,

legal persons under common control with the person at issue), including

whether those swaps and security-based swaps simply represent an

allocation of risk within a corporate group.\52\ Swaps and security-

based swaps between persons under common control may not involve the

interaction with unaffiliated persons that we believe is a hallmark of

the elements of the definitions that refer to holding oneself out as a

dealer or being commonly known as a dealer. To the extent, however,

that an entity seeks to use transactions between persons under common

control to avoid one of the dealer definitions, the Commissions have

the authority to prohibit practices designed to evade the requirements

applicable to swap dealers and security-based swap dealers.\53\

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

\52\ Such swaps and security-based swaps should be considered in

this way only for purposes of determining whether a particular

person is a swap dealer or security-based swap dealer and does not

necessarily apply in the context of the Exchange Act's general

definition of ``dealer.'' The swaps and security-based swaps,

moreover, would continue to be subject to all laws and requirements

applicable to such swaps and security-based swaps.

\53\ See Dodd-Frank Act sections 721(b)(2), 761(b)(3). For

example, it would not be permissible for an entity that provides

liquidity on one side of the market to use affiliated entities to

provide liquidity on the other side in an attempt to avoid having to

register as a swap or security-based swap dealer.

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

The Commissions invite comment as to how the swap dealer and

security-based swap dealer definitions should be applied to members of

an affiliated group. Commenters particularly are invited to address how

the Commissions should interpret common control for these purposes, and

whether this interpretation should be limited to wholly-owned

affiliates.

2. Application to Particular Swap Markets

The swap markets are diverse and encompass a variety of situations

in which parties enter into swaps with each other. We believe it is

helpful to the understanding of the rule to discuss some of these

situations, particularly those that have been raised by commenters,

here. The situations discussed below include persons who enter into

swaps as aggregators, as part of their participation in physical

markets, or in connection with the generation and transmission of

electricity. We invite comment as to what aspects of the parties'

conduct in these situations should, or should not, be considered swap

dealing activities, and whether the parties involved in these

situations are swap dealers.

a. Aggregators

Commenters explained that some persons enter into swaps with other

parties in order to aggregate the swap positions of the other parties

into a size that would be more amenable to entering into swaps in the

larger swap market, or otherwise to make entering into such swaps more

efficient. For example, certain cooperatives enter into swaps with

smaller cooperatives, smaller businesses or their members in order to

establish a position in a commodity that is large enough to be traded

on a swap or futures market. Similarly, one smaller financial

institution explained that it enters into swaps with counterparties

whose swap positions would not be large enough to be of interest to

larger financial institutions. This institution stated that it enters

into offsetting swaps with larger financial institutions so that it is

in a neutral position between the counterparties and the larger

financial institutions.

The result of these arrangements is that such persons engage in

activities that are similar in many respects to those of a swap dealer

as set out in the definition--the person enters into swaps to

accommodate demand from other parties, it enters into swaps with a

relatively large number of non-dealers, and it holds itself out as

willing to enter into swaps. It may be that the swap dealing activities

of these aggregators would not exceed the de minimis threshold, and

therefore they would not be swap dealers. The CFTC, in particular,

requests comment as to how the de minimis threshold would apply to such

persons. If their activity would exceed the de minimis threshold set

forth in the proposed rule, the Commissions request comment on the

application of the swap dealer definition to their activity.

b. Physical Market Participants

The markets in physical commodities such as oil, natural gas,

chemicals and metals are complex and varied. They involve a large

number of market participants that, over time, have developed highly

customized transactions and market practices that facilitate

efficiencies in their market in unique ways. Some of these transactions

would be encompassed by the statutory definition of ``swap,'' and some

participants in these markets engage in swap dealing activities that

are above the proposed de minimis threshold. The Commissions invite

comment as to any different or additional factors that should be

considered in applying the swap dealer definition to participants in

these markets.

c. Electricity Generation and Transmission

The use of swaps in the generation and transmission of electricity

is highly complex because electricity cannot be stored and therefore is

generated, transmitted and used on a continuous, real-time basis. Also,

the number and variety of participants in the electricity market is

very large and some electricity services are provided as a public good

rather than for profit. Nevertheless, some participants engage in swap

dealing activities as described above that are above the de minimis

threshold set forth in the proposed rule. The Commissions invite

comment as to any different or additional factors that should be

considered in applying the

[[Page 80184]]

swap dealer definition to participants in the generation and

transmission of electricity. Specifically, the Commissions invite

comment on whether there are special considerations, including without

limitation special considerations arising from section 201(f) of the

Federal Power Act, related to non-profit, public power systems such as

rural electric cooperatives and entities operating as political

subdivisions of a State, and the applicability of the exemptive

authority in section 722(f) of the Dodd-Frank Act to address those

considerations.

III. Amendments to Definition of Eligible Contract Participant

A. Overview

The Commodity Futures Modernization Act of 2000 (``CFMA'') \54\

generally excluded or exempted transactions between eligible contract

participants (``ECPs'') from most provisions of the CEA.\55\ Section

723(a)(1)(A) of the Dodd-Frank Act repeals those exclusions and

exemptions. ECP status remains important, however, because Section

723(a)(2) of the Dodd-Frank Act renders it unlawful for a non-ECP to

enter into a swap other than on, or subject to the rules of, a

designated contract market (``DCM'').\56\ Section 763(e) of the Dodd-

Frank Act also renders it unlawful for a non-ECP to enter into a

security-based swap unless such transaction is effected on a national

securities exchange registered pursuant to Section 6(b) of the Exchange

Act.\57\ In addition, Section 768(b) of the Dodd-Frank Act makes it

unlawful for a non-ECP to enter into a security-based swap unless a

registration statement is in effect. While this means that non-ECPs

cannot enter into swaps on SEFs or on a bilateral, off-exchange basis,

it also opens swaps to non-ECPs, so long as the swaps are entered into

on, or subject to the rules of, a DCM. Similarly, while non-ECPs cannot

enter into security-based swaps unless the transaction is effected on a

national securities exchange and the security-based swap has an

effective registration statement, it also opens security-based swaps to

non-ECPs.

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

\54\ Public Law 106-554, 114 Stat. 2763 (Dec. 21, 2000).

\55\ See CEA sections 2(d) (Excluded Derivative Transactions),

2(e) (Excluded Electronic Trading Facilities), 2(g) (Excluded Swap

Transactions) and 2(h) (Legal Certainty for Certain Transactions in

Exempt Commodities) (7 U.S.C. 2(d), (e), (g), (h)). The CFMA also

excluded swap agreements from the definitions of ``security'' in

Section 3(a)(10) of the Exchange Act and Section 2(a)(1) of the

Securities Act. See Section 3A of the Exchange Act, 15 U.S.C. 78c-1,

and Section 2A of the Securities Act, 15 U.S.C. 77b-1 (both of which

have been modified by the Dodd-Frank Act). The CFMA, however,

provided that the SEC had antifraud authority over security-based

swap agreements.

\56\ Section 723(a)(2) of the Dodd-Frank Act adds new subsection

(e) to CEA section 2 (7 U.S.C. 2(e)). New CEA section 2(e) provides

that ``[i]t shall be unlawful for any person, other than an eligible

contract participant, to enter into a swap unless the swap is

entered into on, or subject to the rules of, a board of trade

designated as a contract market under section 5.''

\57\ Section 763(e) of the Dodd-Frank Act adds paragraph (l) to

Exchange Act section 6. New Exchange section 6(l) provides that

``[i]t shall be unlawful for any person to effect a transaction in a

security-based swap with or for a person that is not an eligible

contract participant, unless such transaction is effected on a

national securities exchange registered pursuant to subsection

(b).''

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

Congress also amended \58\ the ECP definition in Section 721(a)(9)

of the Dodd-Frank Act by: (1) Raising a threshold that governmental

entities may use to qualify as ECPs, in certain situations, from $25

million in discretionary investments to $50 million in such

investments; and (2) replacing the ``total asset'' standard for

individuals to qualify as ECPs with a discretionary investment

standard.\59\

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

\58\ The changes to the ECP definition made by the Dodd-Frank

Act originated in the Administration's ``White Paper'' on financial

regulatory reform. See Financial Regulatory Reform, A New

Foundation: Rebuilding Financial Supervision and Regulation,

available at http://www.financialstability.gov/docs/regs/FinalReprot_web.pdf, at 48-49 (June 17, 2009) (``Current law seeks

to protect unsophisticated parties from entering into inappropriate

derivatives transactions by limiting the types of counterparties

that could participate in those markets. But the limits are not

sufficiently stringent.'').

\59\ The monetary component of ECP status for individuals

remains the same under the amended ECP definition: More than $10

million (but now in discretionary investments, not in total assets),

or $5 million if the transactions for which ECP status is necessary

are for risk management of an asset or liability the individual owns

or incurs, or is reasonably likely to own or incur.

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

B. Commenters' Views

The ECP definition elicited comment from nine commenters. The

comments ranged from requests not to increase the monetary thresholds

for governmental employee benefit plans in certain instances to

suggestions to dramatically raise them across the board, and from

requests not to change the definition in a way that would limit the

commenter's access to swaps to specific proposals to address such

otherwise limited access.

In the Dodd-Frank Act, Congress addressed aspects of the ECP

definition that it found to be of particular concern regarding

governmental entities and individuals. Otherwise, though, persons who

qualified for exclusions or exemptions to enter into bilateral, off-

exchange swaps prior to the Dodd-Frank Act will still qualify to do so

with respect to non-standardized swaps under the Dodd-Frank Act, with

the exceptions discussed below. We have not identified any legislative

history suggesting that Congress intended the Commissions to undertake

a wholesale revision of the ECP definition. Accordingly, the

Commissions are limiting the further definition of the term ECP to the

discrete issues discussed below.

C. New ECP categories

The CEA definition of ECP generally is comprised of regulated

persons; \60\ entities defined as ECPs based on a total asset test

(e.g., a corporation, partnership, proprietorship, organization, trust,

or other entity with total assets exceeding $10 million) \61\ or an

alternative monetary test coupled with a non-monetary component (e.g.,

an entity with a net worth in excess of $1 million and engaging in

business-related hedging; \62\ or certain employee benefit plans, the

investment decisions of which are made by one of four enumerated types

of regulated entities \63\); and certain governmental entities and

individuals that meet defined thresholds.\64\

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

\60\ CEA section 1a(18)(A)(i), (ii), (iii), (iv), (viii), (ix),

(x) (7 U.S.C. 1a(18)(A)(i), (ii), (iii), (iv), (viii), (ix), (x)),

as redesignated by Section 721(a)(9) of the Dodd-Frank Act.

\61\ CEA section 1a(18)(A)(v)(I) (7 U.S.C. 1a(18)(A)(v)(I)), as

redesignated by Section 721(a)(9) of the Dodd-Frank Act.

\62\ CEA section 1a(18)(A)(v)(III) (7 U.S.C. 1a(18)(A)(v)(III)),

as redesignated by Section 721(a)(9) of the Dodd-Frank Act.

\63\ CEA section 1a(18)(A)(vi) (7 U.S.C. 1a(18)(A)(vi)), as

redesignated by Section 721(a)(9) of the Dodd-Frank Act.

\64\ CEA sections 1a(18)(A)(vii) and (xi) (7 U.S.C.

1a(18)(A)(vii) and (xi), as redesignated by Section 721(a)(9) of the

Dodd-Frank Act.

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

Persons in the new major swap participant, major security-based

swap participant, swap dealer and security-based swap dealer categories

are likely to be among the most active and largest users of swaps and

security-based swaps. Accordingly, the Commissions propose to further

define the term ECP to include these new categories, which will permit

such persons to enter into swaps and security-based swaps on SEFs and

on a bilateral basis (where otherwise permitted under the Dodd-Frank

Act and regulations thereunder).

We seek comment on this proposed expansion of the ECP definition.

D. Relationship Between Retail Foreign Currency and ECP Status in the

Context of a Commodity Pool

Prior to the Dodd-Frank Act, clause (A)(iv) of the ECP definition

provided that a commodity pool was an ECP if the pool and its operator

met certain requirements (i.e., the commodity pool has $5 million in

total assets and is operated by a commodity pool operator regulated

under the CEA or subject to

[[Page 80185]]

foreign regulation), regardless of whether each pool participant was

itself an ECP.\65\ Section 741(b)(10) of the Dodd-Frank Act amended

clause (A)(iv) of the ECP definition to provide that a commodity pool

engaging in retail foreign currency transactions of the type described

in CEA sections 2(c)(2)(B) or 2(c)(2)(C) ; \66\ (``retail forex'' and

such pools, ``Retail Forex Pools'') no longer qualifies as an ECP for

those purposes if any participant in the pool is not independently an

ECP. The Commissions believe that in some cases commodity pools unable

to satisfy the conditions of clause (A)(iv) of the ECP definition may

rely on clause (A)(v) to qualify as ECPs instead for purposes of retail

forex. Clause (A)(v) of the ECP definition applies to business entities

irrespective of their form of organization (i.e., corporations,

partnerships, proprietorships, organizations, trusts and other

entities), and contains a $1 million net worth test where such an

entity ``enters into an agreement, contract, or transaction in

connection with the conduct of the entity's business or to manage the

risk associated with an asset or liability owned or incurred or

reasonably likely to be owned or incurred by the entity in the conduct

of the entity's business.'' \67\

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

\65\ CEA section 1a(12)(A)(iv) (7 U.S.C. 1a(12)(A)(iv)).

\66\ 7 U.S.C. 2(c)(2)(B) and (C). See generally ``Regulation of

Off-Exchange Retail Foreign Exchange Transactions and

Intermediaries,'' 75 FR 55410 (Final Rule; Sept. 10, 2010)

(discussing the new CFTC retail forex regulatory regime);

``Regulation of Off-Exchange Retail Foreign Exchange Transactions

and Intermediaries,'' 75 FR 3282 (Proposed Rule; Jan. 20, 2010)

(providing historical background on the regulation of retail forex

transactions).

\67\ CEA section 1a(18)(A)(v) (7 U.S.C. 1a(18)(A)(v), as

redesignated by Section 721(a)(9) of the Dodd-Frank Act.

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

The Commissions believe that permitting Retail Forex Pools with one

or more non-ECP participants to achieve ECP status by relying on clause

(A)(v) of the ECP definition would frustrate the intent of Congress in

denying ECP status to Retail Forex Pools under clause (A)(iv).

Consequently, the Commissions propose to further define the term ECP to

preclude a Retail Forex Pool with one or more non-ECP participants from

qualifying as an ECP by relying on clause (A)(v) of the ECP definition

if such Retail Forex Pool is not an ECP due to the language added to

clause (A)(iv) of the ECP definition by section 741(b)(10) of the Dodd-

Frank Act (i.e., because the pool contains one or more non-ECP

participants). Because commodity pools can be structured in various

ways and can have one or more feeder funds and/or pools, many with

their own participants, the Commissions propose to preclude a Retail

Forex Pool from being an ECP pursuant to clause (A)(iv) of the ECP

definition if there is a non-ECP participant at any investment level

(e.g., a participant in the pool itself (a direct participant), an

investor or participant in a fund or pool that invests in the pool in

question (an indirect participant), an investor or participant in a

fund or pool that invests in that investor fund or pool (also an

indirect participant), etc.).

Similarly, the Commissions believe that some commodity pools unable

to satisfy the total asset or regulated status components of clause

(A)(iv) of the ECP definition may rely on clause (A)(v) to qualify as

ECPs instead. The Commissions are of the view that a commodity pool

that cannot satisfy the monetary and regulatory status conditions

prescribed in clause (A)(iv) should not qualify as an ECP in reliance

on clause (A)(v) of the ECP definition. Therefore, the Commissions

propose to further define the term ECP to prevent such an entity from

qualifying as an ECP pursuant to clause (A)(v) of the ECP definition.

E. Request for comment

The Commissions request comment on all aspects of the proposed

amendments to the definition of ``eligible contract participant.'' Are

the proposed interpretations with respect to Retail Forex Pools and

other commodity pools appropriate? Do entities described in the various

enumerated ECP categories (other than commodity pools) rely on clause

(A)(v) to qualify as ECPs? If so, should an entity that would be

described in one of the clauses of paragraph (A) of the ECP definition,

but cannot satisfy the conditions prescribed in that clause, be

prohibited from relying on clause (A)(v) of the ECP definition?

In addition, should the Commissions further narrow any or all of

the ECP categories? Why or why not? If so, what additional conditions

would be appropriate? Should the Commissions define the term

``discretionary basis,'' as requested by one commenter, either solely

for purposes of clause (A)(vii) or clause (A)(xi), or for both clauses?

Alternatively, should the Commissions add any additional categories of

ECPs, such as the following categories suggested by commenters:

Commercial real estate developers; energy or agricultural cooperatives

or their members; or firms using swaps as hedges pursuant to the terms

of the CFTC's Swap Policy Statement? If so, which ones and why?

IV. Definitions of ``Major Swap Participant'' and ``Major Security-

Based Swap Participant''

The definitions of ``major swap participant'' and ``major security-

based swap participant'' (also jointly referred to as the ``major

participant'' definitions) respectively focus on the market impacts and

risks associated with an entity's swap and security-based swap

positions. In this respect, the major participant definitions differ

from the definitions of ``swap dealer'' and ``security-based swap

dealer,'' which focus on an entity's activities and account for the

amount or significance of those activities only in the context of the

de minimis exception.

Despite those differences in focus, persons that meet the major

participant definitions in large part must follow the same statutory

requirements that apply to swap dealers and security-based swap

dealers.\68\ In this way, the statute applies comprehensive regulation

to entities whose swap or security-based swap activities do not cause

them to be dealers, but nonetheless could pose a high degree of risk to

the U.S. financial system generally.\69\

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

\68\ In particular, under CEA section 4s and Exchange Act

section 15F, dealers and major participants in swaps or security-

based swaps generally are subject to the same types of margin,

capital, business conduct and certain other requirements, unless an

exclusion applies. See CEA section 4s(h)(4), (5); Exchange Act

section 15F(h)(4), (5).

\69\ As discussed below, the tests of the major participant

definitions use terms--particularly ``systemically important,''

``significantly impact the financial system'' or ``create

substantial counterparty exposure''--that denote a focus on entities

that pose a high degree of risk through their swap and security-

based swap activities. In addition, the link between the major

participant definition and risk was highlighted during the

Congressional debate on the statute. See 156 Cong. Rec. S5907 (daily

ed. July 15, 2010) (dialogue between Senators Hagen and Lincoln,

discussing how the goal of the major participant definition was to

``focus on risk factors that contributed to the recent financial

crisis, such as excessive leverage, under-collateralization of swap

positions, and a lack of information about the aggregate size of

positions'').

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

The major participant definitions are similar in their key

provisions, although one exception, as discussed below, is available

only in connection with the ``major swap participant'' definition. Both

major participant definitions encompass persons that satisfy any of

three alternative tests: \70\

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

\70\ Also, neither major participant definition encompasses an

entity that meets the respective swap dealer or security-based swap

dealer definition. See CEA section 1a(33)(A); Exchange Act section

3(a)(67)(A)(i).

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

The first test encompasses persons that maintain a

``substantial position'' in any of the ``major'' categories of swaps or

security-based swaps, as those categories are determined by the CFTC

[[Page 80186]]

or SEC as applicable. This test excludes both ``positions held for

hedging or mitigating commercial risk,'' and positions maintained by or

contracts held by any employee benefit plan (as defined in paragraphs

(3) and (32) of section 3 of ERISA (29 U.S.C. 1002)) for the primary

purpose of hedging or mitigating risks directly associated with the

operation of the plan.\71\

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

\71\ See CEA section 1a(33)(A)(i); Exchange Act section

3(a)(67)(A)(ii)(I).

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

The second test encompasses persons whose outstanding

swaps or security-based swaps create ``substantial counterparty

exposure that could have serious adverse effects on the financial

stability of the United States banking system or financial markets.''

\72\

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

\72\ See CEA section 1a(33)(A)(ii); Exchange Act section

3(a)(67)(A)(ii)(II).

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

The third test encompasses any ``financial entity'' that

is ``highly leveraged relative to the amount of capital such entity

holds and that is not subject to capital requirements established by an

appropriate Federal banking agency'' and that maintains a ``substantial

position'' in swaps or security-based swaps for any of the ``major''

categories of swaps or security-based swaps.\73\

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

\73\ See CEA section 1a(33)(A)(iii); Exchange Act section

3(a)(67)(A)(ii)(III).

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

The statute directs the CFTC or the SEC to define ``substantial

position'' for the respective definition at the threshold that it

determines to be ``prudent for the effective monitoring, management,

and oversight of entities that are systemically important or can

significantly impact the financial system of the United States.'' The

definitions further provide that when defining ``substantial

position,'' the CFTC or SEC ``shall consider the person's relative

position in uncleared as opposed to cleared [swaps or security-based

swaps] and may take into consideration the value and quality of

collateral held against counterparty exposures.'' \74\

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

\74\ See CEA Section 1a(33)(B); Exchange Act section

3(a)(67)(B).

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

Both major participant definitions provide that a person may be

designated as a major participant for one or more categories of swaps

or security-based swaps without being classified as a major participant

for all classes of swaps or security-based swaps.\75\

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

\75\ See CEA section 1a(33)(C); Exchange Act section

3(a)(67)(C).

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

Finally, the definition of ``major swap participant''--but not the

definition of ``major security-based swap participant''--includes an

exception for any ``entity whose primary business is providing

financing, and uses derivatives for the purpose of hedging underlying

commercial risks related to interest rate and foreign currency

exposures, 90 percent or more of which arise from financing that

facilitates the purchase or lease of products, 90 percent or more of

which are manufactured by the parent company or another subsidiary of

the parent company.'' \76\

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

\76\ See CEA section 1a(33)(D).

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

Although the two major participant definitions are similar, they

address instruments that reflect different types of risks and that can

be used by end-users and other market participants for different

purposes. Interpretation of the definitions must appropriately account

for those differences.

The Commissions are proposing rules to further define the ``major

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

definitions, by specifically addressing: (a) The ``major'' categories

of swaps or securities-based swaps; (b) the meaning of ``substantial

position''; (c) the meaning of ``hedging or mitigating commercial

risk''; (d) the meaning of ``substantial counterparty exposure that

could have serious adverse effects on the financial stability of the

United States banking system or financial markets''; and (e) the

meanings of ``financial entity'' and ``highly leveraged.'' We also are

proposing rules to specify the use of a daily average methodology for

identifying whether a person meets one of the major participant

definitions, provide for a reevaluation period for certain entities

that exceed the relevant daily average by a small amount, and provide

for a minimum length of time before a person may no longer be deemed a

major participant.

We further propose that the CFTC or SEC may limit an entity's

designation as a major participant to only certain types, classes or

categories of swaps or security-based swaps. We also address certain

additional interpretive issues that commenters have raised. Finally,

while the Commissions also are not proposing any exclusions from the

major participant definitions, we are soliciting comment as to whether

certain types of entities should be excluded from the definitions'

application.\77\

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

\77\ In light of the significant and novel issues raised by the

major participant definitions, the Commissions recognize the

importance of monitoring the swap and security-based swap markets

following adoption of major participant rules. This will help us

evaluate whether the rules appropriately reflect how market

participants use these instruments, and will help us consider the

impact of market evolution and the ways in which market participants

may change their practices in response to the rules, so we may

identify potential improvements to the rules or other actions to

enhance enforcement of major participant regulation.

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

A. ``Major'' Categories of Swaps and Securities-Based Swaps

The first and third tests of the statutory major participant

definitions encompass entities that have a substantial position in a

``major'' category of swaps or security-based swaps. The Commissions

are responsible for designating these ``major'' categories.\78\

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

\78\ See CEA section 1a(33)(A)(i), (iii); Exchange Act section

3(a)(67)(a)(2)(i), (iii). One commenter suggested that we determine

these categories by reference to the types of instruments

specifically listed in the statutory definition of ``swap.'' See

Northwestern Mutual letter (suggesting that, for regulatory

consistency, each type of swap listed in the definition and options

on each of those swaps should be considered to be an individual

major category). The statutory definition of ``swap'' lists 22

different types of swaps.

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

The Commissions propose to designate ``major'' categories of swaps

and security-based swaps in a manner that reflects the risk profiles of

these various instruments and the different purposes for which end-

users make use of the various instruments. We preliminarily believe

that it is important not to parse these ``major'' categories so finely

as to base the ``substantial position'' thresholds on unduly narrow

risks that would reduce those thresholds' effectiveness as risk

measures. The ``major'' categories will apply only for purposes of the

major participant definitions and are not necessarily determinative

with respect to any other provision of the Dodd-Frank Act or the

regulations adopted thereunder.

1. Major Categories of Swaps

We propose to designate four ``major'' categories of swaps for

purposes of the ``major swap participant'' definition. The four

categories are rate swaps, credit swaps, equity swaps and other

commodity swaps.\79\ The first category would encompass any swap which

is primarily based on one or more reference rates, such as swaps of

payments determined by fixed and floating interest rates, currency

exchange rates, inflation rates or other monetary rates. The second

category would encompass any swap that is primarily based on

instruments of indebtedness, including but not limited to any swap

primarily based on one or more indices related to debt instruments, or

any swap that is an index credit default swap or total return

[[Page 80187]]

swap on one or more indices of debt instruments. The third category

would encompass any swap that is primarily based on equity securities,

such as any swap primarily based on one or more indices of equity

securities, or any total return swap on one or more equity indices. The

fourth category would encompass any swap not included in any of the

first three categories. This fourth category would generally include,

for example and not by way of limitation, any swap for which the

primary underlying item is a physical commodity or the price or any

other aspect of a physical commodity.\80\

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

\79\ See proposed CEA rule 1.3(rrr). For the avoidance of doubt,

the term ``swap'' as it is used in the definitions of the major swap

categories in rule 1.3(rrr) has the meaning set forth in section

1a(47) of the CEA and the rules promulgated thereunder.

\80\ The term ``commodity'' as defined in Section 1a(9) of the

CEA, 7 U.S.C. 1a(9), and CFTC Rule Sec. 1.3(e), 17 CFR 1.3(e)

includes interest rates, foreign exchange rates, and equity and debt

indices as well as physical commodities. Thus, the fourth category

of swaps is entitled ``other commodity swaps'' because it includes

any swap not included in the other three categories.

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

The four major categories of swaps are intended to cover all swaps.

Each swap would be in the category that most closely describes the

primary item underlying the swap. If a swap is based on more than one

underlying item of different types, the swap would be in the category

that describes the underlying item that is likely to have the most

significant effect on the economic return of the swap. The proposed

categories are consistent with market statistics that distinguish

between these general types of swaps, as well as market infrastructures

that have been established for these types of swaps.

We request comment on this proposed method of allocating swaps

among ``major'' categories. Commenters particularly are asked to

address whether there are any types of swaps that would have unclear

status under this proposal, as well as whether all swaps instead should

be placed into a single ``major'' category for purposes of the ``major

swap participant'' definition, or whether there should be additional

``major'' categories of swaps. Commenters are also asked to address

whether the rate swap category should be divided into two separate

categories--one for swaps based on rates of exchange between different

currencies, and another for swaps based on interest rates, inflation

rates and other monetary rates--and if so, in which category cross-

currency rate swaps should be included. Also, should the major swap

category for other commodity swaps be divided into two separate

categories--one for swaps based on agricultural commodities, and

another for swaps based on all other commodities not included in the

other categories?

2. Major Categories of Security-Based Swaps

We propose to designate two ``major'' categories of security-based

swaps for purposes of the ``major security-based swap definition.'' The

first category would encompass any security-based swap that is based,

in whole or in part, on one or more instruments of indebtedness

(including loans), or a credit event relating to one or more issuers or

securities, including but not limited to any security-based swap that

is a credit default swap, total return swap on one or more debt

instruments, debt swap, debt index swap, or credit spread.\81\ The

second category would encompass any other security-based swaps not

included in the first category; this category would include, for

example, equity swaps.\82\

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

\81\ This category does not encompass a security-based swap that

is based on an instrument of indebtedness solely in connection with

the swap's financing leg.

\82\ See proposed Exchange Act rule 3a67-2.

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

The proposed categories reflect the fact that entities that

transact in security-based swaps for non-speculative purposes would be

expected to use the respective instruments for different purposes. For

example, swaps based on instruments of indebtedness, such as credit

derivatives, can be used to hedge the risks associated with the default

of a counterparty or debt obligation. Equity swaps can be used, among

other ways, to hedge the risks associated with equity ownership or gain

synthetic exposure to equities.\83\ The proposed categories also are

consistent with market statistics that currently distinguish between

those general types of security-based swaps, as well as market

infrastructures, including separate trade warehouses, that have been

established for credit default swaps and equity swaps.

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

\83\ At the same time, we note that the distinctions between

these proposed ``major'' categories of ``security-based swaps''

arguably are less significant than the distinctions among the

proposed major categories of ``swaps'' (such as, for example, the

distinction between other commodity swaps and rate swaps).

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

We request comment on this proposed method of allocating security-

based swaps between two ``major'' categories. In particular, we request

comment on whether there are any types of security-based swaps that

would have unclear status under this proposal, as well as whether all

security-based swaps instead should be placed into a single ``major''

category for purposes of the ``major security-based swap participant''

definition, or whether there should be additional ``major'' categories

of security-based swaps.

B. ``Substantial Position''

As noted above, the Commissions are required to define the term

``substantial position'' as a threshold that is ``prudent for the

effective monitoring, management, and oversight of entities that are

systemically important or can significantly impact the financial system

of the United States.'' \84\ This raises two fundamental issues: (i)

What types of measures should be used to identify the risks posed by an

entity's swap or security-based swap positions; and (ii) for each of

those measures, how much risk should be required to evidence a

``substantial position''?

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

\84\ See CEA section 1a(33)(B); Exchange Act section

3(a)(67)(B).

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

1. Commenters' Views

Commenters have expressed diverse views as to what should

constitute a substantial position. A number of commenters suggested the

use of a test based on the current uncollateralized mark-to-market

exposure posed by an entity's swap or security-based swap positions,

after taking bilateral netting agreements into account. Two commenters

suggested specific dollar amounts of uncollateralized exposure to use

as the substantial position threshold.\85\ Several commenters expressed

the view that positions subject to central clearing should be entirely

excluded from the analysis, or at least should be discounted for

purposes of the analysis.\86\

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

\85\ See letter from Timothy W. Cameron, Esq., Managing

Director, SIFMA Asset Management Group, dated September 20, 2010

(``SIFMA AMG letter'') (suggesting a standard of $2.5 billion

average exposure in any calendar quarter based on the entity's

entire portfolio of swaps and security-based swaps, other than

foreign exchange swaps and forwards); letter from Gus Sauter, Chief

Investment Officer, Vanguard, dated September 20, 2010 (``Vanguard

letter'') (suggesting that the applicable threshold be $500 million

in uncollateralized exposure for any single major swap category or

$1 billion aggregate exposure across all major categories).

\86\ See letter from Jennifer J. Kalb, Associate General

Counsel, Metropolitan Life Insurance Company, dated September 20,

2010 (``MetLife letter'') (suggesting that cleared trades be subject

to a lesser ``charge'' for purposes of the substantial position

calculation, or be excluded entirely).

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

Some commenters opposed using the notional amount of swap or

security-based swap positions to set the threshold, stating that the

notional amount is not indicative of the risks associated with a

position. Some commenters similarly opposed using measures of swap or

security-based swap volume to set the threshold,

[[Page 80188]]

contending that the number of trades does not reflect risk.\87\

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

\87\ But see letter from Christopher A. Klem, Ropes & Gray,

dated September 2, 2010 (test should account for frequency of

trading and frequency of trading with non-dealers).

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

A few commenters addressed the possibility that the threshold could

take into account the potential future risks associated with a

position, in addition to the risks associated with uncollateralized

current exposure.\88\ Some commenters suggested that the threshold take

into account the potential riskiness of the particular type of

instrument at issue. Some commenters maintained that the threshold

should take into account the number of counterparties an entity has,

the size of an entity's positions compared to the size of the market,

the size of an entity's swap or security-based swap positions compared

to the entity's ability to absorb losses of that magnitude, or the

financial strength of an entity's counterparties. Several commenters

stated that the threshold should be based on an average measure over

time, so that short-term spikes in measures such as exposure would not

by themselves cause an entity to meet the major participant

definitions. Some commenters suggested that the substantial position

threshold should reflect an amount of ``systemic risk.'' \89\

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

\88\ See letter from Andrew Baker, Chief Executive Officer,

Alternative Investment Management Association, dated September 24,

2010 (``AIMA letter'') (discussing possible methods of estimating

the maximum risk of loss related to positions); letter from Warren

Davis, Of Counsel, Sutherland Asbill & Brennan LLP on behalf of the

Federal Home Loan Banks, dated September 20, 2010 (in addressing

``substantial counterparty exposure'' test, noting the possibility

of accounting for the potential exposure of a portfolio).

\89\ See letter from Edward J. Rosen, Cleary Gottlieb Steen &

Hamilton LLP, dated September 21, 2010 (``Cleary letter'')

(suggesting that the threshold should be akin to the amount that is

required for a non-financial entity to be designated as systemically

important under Title I of the Dodd-Frank Act).

Section 113 of the Dodd-Frank Act provides that the Financial

Stability Oversight Council (``FSOC'') may determine that a non-bank

financial company shall be supervised by the Federal Reserve Board,

subject to prudential standards, if the FSOC ``determines that

material financial distress at the U.S. nonbank financial company,

or the nature, scope, size, scale, concentration,

interconnectedness, or mix of the activities of the U.S. nonbank

financial company, could pose a threat to the financial stability of

the United States.'' In making that determination, the FSOC is to

consider: Leverage; off-balance sheet exposures; transactions and

relationships with other significant non-bank financial companies

and bank holding companies; importance as a source of credit and

liquidity; extent to which assets are managed rather than owned; the

nature, scope, size, scale, concentration, interconnectedness and

mix of activities; presence of a primary financial regulator; assets

and liabilities; and any other appropriate risk-related factors.

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

2. Proposed Substantial Position Thresholds

The Commissions recognize that it is important for the substantial

position thresholds to be set using objective numerical criteria.

Objective criteria should permit regulators, market participants and

entities that may be subject to the regulations to readily evaluate

whether swap or security-based swap positions meet the thresholds, and

should promote the predictable application and enforcement of the

requirements governing major participants.

In determining the substantial position thresholds--in light of

what is ``prudent for the effective monitoring, management, and

oversight'' of entities that are systemically important or can

significantly impact the U.S. financial system--the Commissions are

mindful that tests based on current uncollateralized exposure and tests

based on potential future exposure both have respective advantages and

disadvantages. We thus are proposing tests that would account for both

types of exposure.

A test that focuses solely on the current uncollateralized exposure

associated with an entity's swap and security-based swap positions

should provide a reasonable measure of the theoretical amount of

potential risk that an entity would pose to its counterparties if the

entity currently were to default.\90\ Such a test also should be

relatively clear-cut for market entities to implement, and would be

based on calculations that we expect that market entities would perform

as a matter of course.

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

\90\ In practice, however, this measure may underestimate the

amount of risk that an entity poses to its counterparties, given

that it may take multiple days to liquidate a defaulting entity's

swap or security-based swap positions, during which time prices may

move against the defaulting entity.

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

At the same time, a focus solely on current uncollateralized

exposure could be overly narrow by failing to identify risky entities

until some time after they begin to pose the level of risk that should

subject them to regulation as major participants. Because exposure can

change significantly over short periods of time, and a swap or

security-based swap position that may pose large potential exposures

nonetheless would often have a mark-to-market exposure of zero at

inception, an entity's positions may already pose significant risk to

counterparties and to the market even before its uncollateralized mark-

to-market exposure increases up to the applicable threshold. A test

that focuses solely on current uncollateralized exposure thus would not

appear to be sufficient to satisfy the systemic importance standard

required by the statute.

Tests based on measures of potential future exposure--which would

address an estimate of how much the value of a swap or security-based

swap might change against an entity over the remaining life of the

contract--could address the gap left by a current uncollateralized

exposure test. Potential future exposure tests, however, would reflect

only an estimate of that type of risk, and would only be as effective

as the factors used by the test.

While we have considered several other types of tests that could be

used to determine the substantial position threshold, we preliminarily

do not believe that the advantages of those tests justify their

disadvantages. For example, while a threshold based on the number of an

entity's counterparties could help identify highly interconnected

entities (a factor that some have argued is important for identifying

an entity's systemic risk), it also has been argued that a large number

of counterparties could mean that the losses associated with that

entity's default would be divided and absorbed by many counterparties

without broader market effects.\91\ While a threshold that is based on

an entity's financial strength would help account for the possibility

of an entity's default as well as the effects of such a default, it

would not address swap-related risks to the market that are not

directly linked to the entity's default. In other words, an entity that

has large out-of-the-money swap or security-based swap positions and

faces a margin call may cause significant price movements in the swaps

or security-based swaps and in the related reference entities or assets

if the entity chooses to unwind its positions, even if the entity

itself does not appear to present a large threat of default. These

movements may be exacerbated if other entities have similar positions.

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

\91\ See AIMA letter (``An entity that has only a small number

of counterparties may only affect a small number of entities

directly, should it fail, but the impact could be significant if the

position is large and the counterparty is a systemically important

entity. A diversified exposure to multiple entities could affect

more entities but is likely to be smaller and thus shares the losses

in the industry and having less systemic impact.'').

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

Moreover, although substantial position thresholds based on the

financial strength of an entity's counterparties would help measure the

potential that an entity's default would have a broader impact, such

thresholds could result in disparate results between two entities with

identical positions,

[[Page 80189]]

and also could encourage concentration of exposure or potential future

exposure within a few counterparties. While tests that are based on the

volume of an entity's swaps or security-based swaps may be helpful in

identifying significant swap or security-based swap activity, such

tests would not directly be germane to the current or potential future

exposure posed by an entity's swap and security-based swap positions.

Finally, while we have considered the feasibility of tests that take

specific contract features into account (e.g., triggers that require

the payment of mark-to-market margin if an entity's credit rating is

lowered), we preliminarily believe that simpler tests of exposure can

more efficiently identify the risks associated with particular swap or

security-based swap positions.

After considering these alternatives, the Commissions are proposing

two tests to define ``substantial position.'' One test would focus

exclusively on an entity's current uncollateralized exposure; the other

would supplement a current uncollateralized exposure measure with an

additional measure that estimates potential future exposure. A position

that satisfies either test would be a ``substantial position.''

The Commissions, however, request comment on whether it would be

appropriate to use other types of approaches for determining whether an

entity has a substantial position--as an alternative to, or in addition

to, the two proposed tests.

a. Proposed Current Exposure Test

The proposed first substantial position test, which would focus

solely on current uncollateralized exposure, in general would set the

substantial position threshold by reference to the sum of the

uncollateralized current exposure, obtained by marking-to-market using

industry standard practices, arising from each of the person's

positions with negative value in each of the applicable ``major''

category of swaps or security-based swaps (other than positions

excluded from consideration, such as positions for the purpose of

``hedging or mitigating commercial risk'').\92\

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

\92\ See proposed CEA rule 1.3(sss)(2); proposed Exchange Act

rule 3a67-3(b)(1). In other words, the test would measure the

portion of the exposure that is not offset by the posting of

collateral. If a position was collateralized only partially, the

value of the collateral posted would be offset against the total

exposure, and the test would measure the residual part of the

exposure. We recognize that there may be operational delays between

changes in exposure and the resulting exchanges of collateral, and

in general we would not expect that operational delays associated

with the daily exchange of collateral would be considered to lead to

uncollateralized exposure for these purposes.

As noted above, the statutory definitions require us to consider

the presence of central clearing in setting the substantial position

threshold. This test would account for the risk-mitigating effects

of central clearing in that centrally cleared swaps and security-

based swaps are subject to mark-to-market margining that would

largely eliminate the uncollateralized exposure associated with a

position, effectively resulting in cleared positions being excluded

from the analysis.

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

A person would apply this proposed substantial position test on a

major category-by-major category basis, examining its positions with

each counterparty with which the person has swaps or security-based

swaps in the particular category. For each counterparty, the person

would determine the dollar value of the aggregate current exposure

arising from each of its swap or security-based swap positions with

negative value (subject to the netting provisions described below) in

that major category by marking-to-market using industry standard

practices, and deduct from that amount the aggregate value of the

collateral the person has posted with respect to the swap or security-

based swap positions. The aggregate uncollateralized outward exposure

would be the sum of those uncollateralized amounts over all

counterparties with which the person has entered into swaps or

security-based swaps in the applicable major category.\93\

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

\93\ See proposed CEA rule 1.3(sss)(2); proposed Exchange Act

rule 3a67-3(b)(2).

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

The proposed test would not prescribe any particular methodology

for measuring current exposure or the value of collateral posted,\94\

and instead would provide that the method should be consistent with

counterparty practices and industry practices generally.\95\

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

\94\ Depending on the particular circumstances of the swap or

security-based swap, such collateral may be posted to a third-party

custodian, directly to the counterparty, or in accordance with the

rules of a derivatives clearing organization or clearing agency.

\95\ Consistent with industry practices, we would expect that

entities may value exposure based on measures that take into account

the amounts that would be payable if the transaction were

terminated. Also, to the extent the valuation of collateral posted

in connection with swaps or security-based swaps is subject to other

rules or regulations, we would expect that the valuation of

collateral for purposes of the major participant calculations would

be consistent with those applicable rules.

At the same time, we recognize that there can be disputes or

uncertainty as to an entity's exposure in connection with swap and

security-based swap positions, and as to the valuation of the

collateral it has posted in connection with those positions. In some

circumstances this could lead to uncertainty as to whether the

entity is a major participant. As addressed below, we are requesting

comment as to the potential significance of these issues, and as to

whether we should set forth additional guidance or mandate the use

of specific standards with respect to these valuations.

Also, it is important to recognize that while we expect that

other regulatory requirements applicable to the valuation of swap or

security-based swap positions and collateral would be relevant to

certain calculations relating to major participant status, our

proposed rules would not be relevant for other purposes, such as in

the context of capital and margin requirements.

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

This proposed test would account for the risk mitigating effects of

netting agreements \96\ by permitting an entity to calculate its

exposure on a net basis, by applying the terms of master netting

agreements entered into between the entity and a single

counterparty.\97\ When calculating the net exposure the entity may take

into account offsetting positions with that particular counterparty

involving swaps, security-based swaps and securities financing

transactions (consisting of securities lending and borrowing,

securities margin lending and repurchase and reverse repurchase

agreements) to the extent that is consistent with the offsets provided

by the master netting agreement.\98\

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

\96\ Section 362(b)(17) of the United States Bankruptcy Code

generally provides derivatives contracts with a safe harbor from the

Bankruptcy Code's automatic stay, thus allowing parties to these

contracts to enforce their contractual rights, including those

associated with netting and offsets, even after a counterparty has

filed for bankruptcy.

In addition, Section 210(c)(8)(A) of the Dodd-Frank Act

reaffirms the enforceability of netting and offset provisions in

certain derivatives contracts with insolvent counterparties that

have been placed under the receivership of the Federal Deposit

Insurance Corporation (``FDIC''). However, the Dodd-Frank Act also

places certain limitations on the timing by which netting rights may

be exercised when the FDIC has been appointed as the receiver of an

insolvent counterparty. See Dodd-Frank Act section 210(c)(10)(B).

\97\ To the extent that the two counterparties maintain multiple

netting agreements (e.g., separate agreements for dollar-denominated

and euro-denominated instruments), the calculation would account

only for the netting permitted under the netting agreement that is

relevant to the swap or security-based swap at issue.

\98\ See proposed CEA rule 1.3(sss)(2)(iii)(A); proposed

Exchange Act rule 3a67-3(b)(3)(A). As is the case for the proposed

rules on valuation, the proposed rules regarding possible offsets of

various positions are for purposes of determining major participant

status only. Other rules proposed by the Commissions may address the

extent to which, if any, persons such as dealers and major

participants may offset positions for other purposes.

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

The Commissions preliminarily believe that this approach is

appropriate because it avoids identifying a position's exposure as

being ``uncollateralized'' when there is no current counterparty risk

associated with it due to offsets under a netting agreement with the

counterparty.\99\ In

[[Page 80190]]

calculating current uncollateralized exposure, however, the entity may

not take into account the market risk offsets associated with holding

positions with multiple counterparties.\100\ Also, the entity may not

``double count'' any offset or collateral--once any item of collateral

or any position with positive value has been applied against current

exposure, the same item cannot be applied for purposes of this test

against any other exposure.

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

\99\ If, for example, an entity was $X out of the money in

connection with a security-based swap, but was $X in the money with

the same counterparty in connection with a swap, there would be no

economic need for the entities to exchange collateral in connection

with those offsetting positions. A test that fails to account for

this netting of exposure could lead the entities to engage in

needless offsetting exchanges of collateral.

\100\ See proposed CEA rule 1.3(sss)(2)(iii)(C); proposed

Exchange Act rule 3a67-3(b)(2)(iii). While recognizing that

offsetting positions of that type would reduce the market risk

facing the entity, the offsets would not be expected to directly

mitigate the risks that the entity's counterparties would face if

the entity were to default.

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

The proposal to permit this type of netting, however, raises

questions as to how an entity's net out-of-the-money exposure with a

counterparty, and the collateral posted with respect to its positions

with the counterparty, should be allocated among swap positions,

security-based swap positions and other positions specified in the

rule.\101\ In particular, when an entity has not fully collateralized

its net current exposure to a particular counterparty with which it has

a netting agreement, there may be questions regarding how to attribute

the net out-of-the-money positions and associated collateral to its

swap or security-based swap positions. We preliminarily believe that an

entity that has net uncollateralized exposure to a counterparty should,

for purposes of the test, allocate that net uncollateralized exposure

pro rata in a manner that reflects the exposure associated with each of

its out-of-the-money swap positions, security-based swap positions and

non-swap positions.\102\ This allocation would be intended to cause the

measure of uncollateralized exposure connected with swaps or security-

based swaps for purposes of the test to reasonably reflect the relative

contribution of those instruments to an entity's total overall

uncollateralized exposure.

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

\101\ This issue does not arise to the extent that an entity's

net positions with a counterparty are fully collateralized.

\102\ In other words, if an entity's out-of-the-money rate swap

positions have $W exposure, its out-of-the-money other commodity

swap positions have $X exposure, its out-of-the-money security-based

swap positions have $Y exposure, and its other out-of-the money

positions covered by that netting agreement have $Z exposure,

fractions of the collateral equal to W/(W+X+Y+Z) should be allocated

to the rate swap positions, X/(W+X+Y+Z) to the other commodity swap

positions and Y/(W+X+Y+Z) to the security-based swap positions. A

similar process should be used for allocating net out-of-the-money

exposure across the categories of swaps and security-based swaps

that have out-of-the-money exposure when one or more categories are

in-the-money.

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

For purposes of the definition of ``major swap participant,'' the

Commissions are proposing to set the current uncollateralized exposure

threshold at a daily average of $1 billion in the applicable major

category of swaps, except that the threshold for the rate swap category

would be a daily average of $3 billion. For purposes of the definition

of ``major security-based swap participant,'' this threshold would be

based on a daily average of $1 billion in the applicable major category

of security-based swaps.\103\ We preliminarily believe that these

proposed thresholds are appropriate for identifying entities that,

through their swap and security-based swap activities, have a

significant potential to pose the systemic importance or risks to the

U.S. financial system that the major participant definition and

associated statutory requirements were intended to address, but we also

recognize that it is possible that the appropriate threshold should be

higher or lower. In proposing these specific thresholds, we have sought

to take into account several factors: (i) The ability of the financial

system to absorb losses of a particular size; \104\ (ii) the

appropriateness of setting ``prudent'' thresholds that are materially

below the level that could cause significant losses to the financial

system as it would not be appropriate for the substantial position test

to encompass entities only after they pose significant risks to the

market through their swap or security-based swap activity; \105\ and

(iii) the need to account for the possibility that multiple market

participants may fail close in time, rather than focusing narrowly on

the potential impact of a single participant's default.\106\ Based on

these factors, we preliminarily believe that the proposed substantial

position thresholds would reasonably be expected to apply to entities

that have the potential of satisfying the statutory criteria of

systemic importance or significant impact to the U.S. financial system.

As discussed below, however, we welcome comments on the appropriateness

of the proposed threshold.

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

\103\ See proposed CEA rule 1.3(sss)(1); proposed Exchange Act

rule 3a67-3(a)(1).

\104\ In this regard, the Commissions preliminarily believe that

the ``Tier 1'' capital of major dealer banks provides relevant

information about the ability of the financial system to absorb

losses of a particular size. We note that, among U.S. banks that are

dealers in credit derivatives, the six largest banks account for the

vast majority of dealing activities. We understand that the most

liquid ``Tier 1'' regulatory capital for those six banks ranges from

$14 billion to $113 billion.

\105\ In other words, the proposed thresholds are intended to be

low enough to provide for the appropriately early regulation of an

entity whose swap or security-based swap positions have a reasonable

potential of posing significant counterparty risks and risks to the

market that stress the financial system, while being high enough

that it would not unduly burden entities that are materially less

likely to pose these types of risks.

\106\ For example, the proposed $1 billion threshold for swaps

and security-based swaps would reflect a potential loss of $3

billion if three large swap or security-based swap entities were to

fail close in time. That $3 billion could represent a significant

impairment of the ability of some major dealers to absorb losses, as

reflected by their Tier 1 capital.

We also are mindful of the views expressed by the two commenters

that suggested particular dollar values for the threshold. See note

85, supra.

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

These proposed thresholds would be evaluated by reference to a

calculation of the mean of an entity's uncollateralized exposure

measured at the close of each business day, beginning on the first

business day of each calendar quarter and continuing through the last

business day of that quarter.\107\ In this regard, the Commissions have

taken into account commenters' concerns that an entity's exposure

should not be evaluated based on a single point in time, as short-term

market fluctuations may not fairly reflect the risks of the entity's

positions. The use of a daily average approach should help address

commenters' concerns about the impact of short-term price fluctuations,

and also help preclude the possibility that an entity may seek to use

short-term transactions to distort the measure of exposure.

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

\107\ See proposed CEA rule 1.3(sss)(4); proposed Exchange Act

rule 3a67-3(d).

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

The Commissions request comment on the proposed current

uncollateralized exposure test. Commenters particularly are requested

to address whether the proposed threshold amounts of current

uncollateralized exposure are appropriate, and, if not, what

alternative higher or lower threshold amounts would appropriately

identify entities that pose the types of risks that the definition was

intended to address. In this regard, commenters specifically are

requested to address whether bank Tier 1 capital provides a good

indicative reference of the ability of major dealers to absorb losses

of a particular size, or whether alternative reference points for the

analysis (e.g., the size of the swap market or security-based swap

market) would also be applied. Commenters are requested to address

whether uncollateralized mark-to-market exposure is the appropriate way

to measure current exposure, and if not, what alternative approach is

more appropriate, and why. Commenters also are requested to address

whether the

[[Page 80191]]

proposed thresholds reasonably address the need to set the threshold at

a prudent level so as to avoid the possibility that the substantial

position test would encompass entities only after they pose significant

risks to the market, whether the proposed thresholds reasonably address

the possibility that multiple market entities could fail close in time,

and whether the proposed thresholds reasonably address the fact that

swap or security-based swap activities would comprise only part of the

risks to the market posed by an entity. To what extent would this

proposed definition of ``substantial position'' have an effect on the

activities of entities that potentially may be deemed to be major

participants? What impact could these types of effects have on

liquidity, on risk-taking or risk-reducing activities, or on other

aspects of the relevant markets?

Also, more fundamentally, we request comment on whether the

substantial position analysis also should encompass a test that does

not account for the collateral posted in connection with an entity's

exposure, given that tests that account for the posting of collateral

would not encompass entities that have very large swap or security-

based swap positions that are fully collateralized (either by the

posting of bilateral collateral or by virtue of central clearing). In

that light, should the analysis seek to capture entities that have very

large positions in light of potential market disruptions such entities

could cause, regardless of whether the positions are collateralized?

Commenters further are requested to address whether such thresholds

should also account for entities that have large in-the-money positions

that may indicate their potential significance to the market. In this

regard, commenters also are asked to address whether the thresholds

should specifically address entities with large in-the-money positions

that lead them to receive large amounts of collateral posted by their

counterparties, particularly to the extent that such collateralized in-

the-money positions could later turn and lead the entity to incur

losses.

In addition, commenters are requested to address whether and how it

would be appropriate to adjust the threshold amounts over time,

including whether these proposed current uncollateralized exposure

thresholds should periodically be adjusted by formula to reflect

changes in the ability of the market to absorb losses over time, or

changes in other criteria over time. Commenters further are requested

to address whether the test will be practical for potential major

participants to use. Moreover, commenters are requested to address

whether the proposed current exposure test should be modified to

account for the risks associated with the expected time lag between an

entity's default and the liquidation of its swap or security-based swap

positions.

Commenters also are requested to address whether we should set

forth additional guidance or mandate the use of specific standards with

respect to the measure of exposure or valuing collateral posted, or

should specify particular procedures in the event of valuation

disputes. What particular industry standard documentation and other

methodologies could be used to measure exposure and value collateral?

Also, how could regulatory requirements applicable to the valuation of

collateral be relevant to the valuation of collateral for purposes of

the major participant definitions?

Commenters are invited to address whether the rule should provide

that, in measuring their current uncollateralized exposure, entities

must value collateral in a way that is at least as conservative as such

collateral would be valued according to applicable haircuts or other

adjustments dictated by applicable regulations. Commenters further are

requested to address whether the test should exclude certain types of

collateral that cannot readily be valued. Also, commenters are

requested to address whether the proposed method of evaluation--the

mean of an entity's uncollateralized exposure measures at the close of

each business day, beginning on the first business day of each calendar

quarter and continuing through the last business day of that quarter--

would be unduly burdensome or potentially subject to gaming or evasion.

Should the proposed approach for measuring uncollateralized current

exposure be amended or supplemented, such as by establishing

requirements for how exposure should be measured or collateral should

be valued in certain circumstances (e.g., requiring the valuation of

certain types of collateral to be conservative during times of rapid

price changes in the relevant asset class)? Should current exposure and

collateral be required to be valued in accordance with US generally

accepted accounting principles? Would measurement according to such

principles differ in any respects from measurement under the proposal,

and, if so, how?

In addition, commenters are requested to address the proposed

netting provisions of this test, including: whether the proposed test

would reasonably permit the measure of uncollateralized exposure to

account for bilateral netting agreements; whether additional types of

positions should be included within the netting provisions; whether the

proposal appropriately takes into account the netting of exposures and

collateral involving positions in financial instruments other than

swaps, security-based swaps and securities financing transactions and

if so, whether any limitations to such offsetting would be necessary or

appropriate; whether the netting provisions should accommodate

offsetting positions involving the net equity balance in an entity's

securities account (e.g., free credit balances, other credit balances,

and fully paid securities), and if so, whether any limitations to such

offsetting would be necessary or appropriate; whether the netting

provisions should accommodate offsets for exposures, or collateral

connected with the positions that an entity has with the affiliate of a

counterparty; and whether the proposed method of allocating the

uncollateralized portion of exposures among the different types of

financial instruments that are all subject to a single netting

agreement is appropriate.

Commenters also are requested to address whether the proposed

current uncollateralized exposure test would pose significant

monitoring burdens upon entities that have swap or security-based swap

positions that are significant enough to potentially meet the current

uncollateralized exposure threshold. Should we provide guidance as to

policies and procedures that such an entity should be able to follow to

demonstrate that it does not meet the applicable thresholds?

b. Proposed Current Exposure Plus Potential Future Exposure test

The second proposed test would account both for current

uncollateralized exposure (as discussed above) and for the potential

future exposure associated with swap or security-based swap positions

in the applicable ``major'' category of swaps or security-based swaps.

This additional test would allow the major participant analysis to take

into account estimates of how the value of an entity's swap or

security-based swap positions may move against the entity over time.

The potential future exposure portion of this proposed test would

be based on an entity's ``aggregate potential outward exposure,'' which

would reflect the potential exposure of the entity's swap or security-

based swap positions in the applicable ``major'' category of swap or

security-based swaps, subject to certain adjustments. Bank capital

standards also

[[Page 80192]]

make use of this type of test,\108\ and this proposal builds upon those

standards but modifies them to focus on the risk that an entity poses

to its counterparties (rather than on the risk that counterparties pose

to an entity). In doing so, this proposal seeks to use a test that can

be implemented by a range of market participants, and that can be

expected to lead to reproducible results across market participants

with identical swap or security-based swap portfolios, rather than

relying on alternative tests (e.g., value at risk measures or stress

testing methodologies) that may be costly for market participants to

implement and that would not be expected to lead to reproducible

results across participants.

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

\108\ See 12 CFR part 3, app. C, section 32 (Office of the

Comptroller of the Currency bank capital standards).

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

The exposure measures in general would be based on the total

notional principal amount of those positions, adjusted by certain risk

factors that reflect the type of swap or security-based swap at issue

and the duration of the position.\109\ For positions in which the

stated notional amount is leveraged or enhanced by the particular

structure, this calculation would be based on the position's effective

notional amount.\110\

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

\109\ For example, consistent with the bank standards, the

multiplier for equity swaps would range from 0.06 for equity swaps

of one year or less to 0.10 for equity swaps with a maturity of more

than five years. See proposed Exchange Act rule 3a67-3(c)(2)(i)(A).

For security-based swaps based on the credit of a reference entity,

the multiplier would be 0.1.

The current bank capital standards contain a distinction based

on whether the credit derivative is on ``investment grade'' or

``non-investment grade'' reference entities, providing a 0.1

multiplier for the former and a lower 0.05 multiplier for the

latter. We preliminarily do not believe that a test that

distinguishes among reference entities by reference to their credit

ratings would be appropriate for purposes of these definitions,

particularly in light of the fact that the Dodd-Frank Act mandates

the substitution of credit ratings with other standards of

creditworthiness in U.S. regulations. See Dodd-Frank Act section

939A.

The multipliers in part will be a function of the remaining

maturity of the swap or security-based swap. If the swap or

security-based swap, however, is structured such that on specified

dates the outstanding exposure is settled and the terms are reset so

the market value is zero, the remaining maturity would equal the

time until the next reset date.

Although we recognize that these risk multipliers may suggest a

lower than expected volatility of credit or equity derivatives of

that duration, this may be offset by the fact that the proposed

calculations of potential future exposure do not directly account

for portfolio netting or collateral updates that could mitigate

future exposure. We preliminarily believe that the use of these

thresholds (and proposed related calculations) for purposes of

identifying major participants are consistent with similar bank

capital standards and are therefore suitable for use as an estimate

of potential future exposure. We are also cognizant that requiring a

more complete calculation of potential future exposure may be costly

and burdensome for participants, especially those who would

otherwise not meet the thresholds for major swap or security-based

swap participant and would not have systems in place to perform a

more complete calculation.

\110\ See proposed CEA rule 1.3(sss)(3)(ii); proposed Exchange

Act rule 3a67-3(c)(2)(i)(B). For purposes of this rule, in the case

of positions that represent the sale of an option on a swap or

security-based swap (other than the sale of an option permitting the

person exercising the option to purchase a credit default swap), we

would view the effective notional amount of the option as being

equal to the effective notional amount of the underlying swap or

security-based swap, and we would view the duration used for

purposes of the formula as being equal to the sum of the duration of

the option and the duration of the underlying swap or security-based

swap.

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

At the same time, the proposed measures would contain adjustments

for certain types of positions that pose relatively lower potential

risks.\111\ In addition, the general risk-adjusted notional measures of

potential future exposure would be reduced to reflect the risk

mitigation effects of master netting agreements, in a manner consistent

with bank capital standards.\112\

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

\111\ The analysis would exclude swap or security-based swap

positions that constitute the purchase of an option, such that the

person has no additional payment obligations under the position, as

well as other positions on which the person has prepaid or otherwise

satisfied all of its payment obligations. See proposed Exchange Act

rule 3a67-3(c)(2)(i)(C).

For similar reasons, the potential outward exposure associated

with a position by which a person buys credit protection using a

credit default swap would be capped at the net present value of the

unpaid premiums. See proposed CEA rule 1.3(sss)(3)(ii)(A)(4);

proposed Exchange Act rule 3a67-3(c)(2)(i)(D).

\112\ In particular, for swaps or security-based swaps subject

to master netting agreements the potential exposure associated with

the person's swap or security-based swaps with each counterparty

would equal a weighted average of the potential exposure in the

applicable ``major'' category of swaps or security-based swaps with

a particular counterparty as calculated without reference to

netting, and that amount reduced by the ratio of net current

replacement cost to gross current replacement cost of all swap and

security-based swap positions with that counterparty, consistent

with the following equation: PNet = 0.4 x PGross + 0.6 x NGR x

PGross.

Under this formula, PNet is the potential exposure in the

applicable ``major'' category of swaps or security-based swaps

adjusted for bilateral netting; PGross is the potential exposure in

that category without adjustment for bilateral netting; and NGR is

the ratio of net current replacement cost to gross current

replacement cost. See proposed CEA rule 1.3(sss)(3)(ii)(B); proposed

Exchange Act rule 3a67-3(c)(2)(ii).

The ``NGR'' ratio is intended to serve as a type of proxy for

the impact of netting on potential future exposure, but does not

serve as a precise indicator of future changes in net exposure

relative to gross exposure, as the ratio and potential exposure can

be influenced by many idiosyncratic properties of individual

portfolios. See Basle Committee on Banking Supervision, ``The

Treatment of the Credit Risk Associated with Certain Off-Balance-

Sheet Items'' (July 1994).

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

The proposed measures of potential future exposure would contain

further downward adjustments to account for the risk mitigation effects

of central clearing and mark-to-market margining. In particular, if the

swap or security-based swap positions are cleared by a registered

clearing agency or subject to daily mark-to-market margining,\113\ the

measures of potential future exposure would further be adjusted to

equal twenty percent of the potential future exposure calculated using

the methodology described above.\114\ The Commissions preliminarily

believe that a significant downward adjustment would be appropriate

because clearing and daily mark-to-market margining would be expected

to reduce the potential future risks posed by an entity's swap or

security-based swap positions. Also, it is appropriate to incentivize

the use of central clearing and daily mark-to-market margining as

practices for helping to control risks. We are not proposing to

entirely eliminate such cleared and margined positions from the

analysis of potential future exposure, however, because clearing may

not entirely eliminate the risks posed by an entity's potential

default,\115\ and daily mark-to-market margining would not eliminate

the risks associated with large intra-day price movements. While the

proposed amount of the adjustment seeks to balance these

[[Page 80193]]

competing factors, we recognize that alternative higher or lower

downward adjustments may also be appropriate.

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

\113\ For these purposes, a swap or security-based swap would be

considered to be subject to daily mark-to-market margining if, and

for as long as, the counterparties follow the daily practice of

exchanging collateral to reflect changes in exposure (after taking

into account any other positions addressed by a netting agreement

between the parties). If a person is permitted to maintain an

uncollateralized ``threshold'' amount under the agreement, that

amount (regardless of actual exposure) would be considered current

uncollateralized exposure for purposes of the test. Also, if the

agreement provides for a minimum transfer amount in excess of $1

million, the entirety of that amount would be considered current

uncollateralized exposure. See proposed CEA rule

1.3(sss)(3)(iii)(B); proposed Exchange Act rule 3a67-3(c)(3)(ii).

In this way, the measure of potential future exposure would

reflect for the risk mitigating benefits of daily margining, while

specifically accounting for industry practices that limit those

benefits. Of course, to take advantage of this adjustment it is not

enough to the agreement to provide for daily mark-to-market

margining--the parties must actually follow that practice.

\114\ See proposed CEA rule 1.3(sss)(3)(iii)(A); proposed

Exchange Act rule 3a67-3(c)(3).

\115\ For example, the central counterparties that clear credit

default swaps do not necessarily become the counterparties of their

members' customers (although even absent direct privity those

central counterparties benefit customers by providing for protection

of collateral they post as margin, and by providing procedures for

the portability of the customer's positions in the event of a

dealer's default). As a result, central clearing may not eliminate

the counterparty risk that the customer poses to the dealer. Even

then, however, required mark-to-market margining should help control

that risk, and central clearing thus would be expected to reduce the

likelihood that an entity's default would lead to broader market

impacts.

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

For purposes of the ``major swap participant'' definition, the

substantial position threshold would be $2 billion in daily average

current uncollateralized exposure plus aggregate potential outward

exposure in the applicable major swap category, except that the

threshold for the rate swap category would be a daily average of $6

billion. For purposes of the ``major security-based swap participant''

definition, the substantial position threshold would be $2 billion in

daily average current uncollateralized exposure plus aggregate

potential outward exposure in any major security-based swap

category.\116\ These proposed amounts reflect the same factors

discussed above in the context of the current uncollateralized exposure

test,\117\ but are raised to reflect the fact that potential future

exposure is a measure of potential risk over time, and hence is less

likely to pose a direct, immediate impact on the markets than current

measures of uncollateralized exposure. We recognize that alternative

risk thresholds may also be appropriate, and we welcome comment on

potential alternatives.

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

\116\ See proposed Exchange Act rule 3a67-3(a)(2).

\117\ See notes 103 to 106, supra, and accompanying text.

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

In light of the amount of this threshold and the underlying risk

adjustments, we preliminarily do not believe that an entity would need

to calculate its potential future exposure for purposes of the test

unless the entity has large notional positions. For example, in light

of the proposed risk adjustment of 0.10 for credit derivatives, an

entity that does not have any uncollateralized current exposure would

have to have notional positions of at least $20 billion to potentially

meet the $2 billion threshold, even before accounting for the discounts

associated with netting agreements. If those swaps or security-based

swaps are cleared or subject to mark-to-market margining, the

additional 20 percent risk adjustment would mean that the entity

without current uncollateralized exposure would have to have cleared

notional positions of at least $100 billion to possibly meet that

threshold.\118\

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

\118\ Based on these thresholds, we preliminarily believe that

only relatively few entities would regularly have to perform these

potential future exposure calculations with regard to their

security-based swaps. See notes 181 and 182, infra, and accompanying

text.

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

The Commissions request comment on this proposed use of a current

exposure plus potential future exposure test to determine the

substantial position threshold. Commenters particularly are requested

to address the appropriateness of using potential exposure risk

adjustments derived from bank capital rules; and the appropriateness of

using bank capital methodologies for addressing positions subject to

netting agreements. Also, should this test be supplemented by a test

that accounts for the notional amount of an entity's swap or security-

based swap positions without risk-adjustments, to focus on entities

that have very large swap or security-based swap positions?

Commenters are requested to address whether the proposed threshold

amounts for the proposed current exposure plus potential future

exposure test are appropriate, and if not, what alternative threshold

amounts would be more appropriate, and why. In addition, commenters are

requested to address the proposed method of discounting the potential

future exposure associated with cleared positions or positions subject

to daily mark-to-market margining to equal 20 percent of what the

measure of potential future exposure would be otherwise. Would a larger

or smaller discount be appropriate? Is there data available that may

assist with reaching the appropriate discount factor? Also, in that

regard, should both sets of discounts be equal, or should cleared

positions be subject to more of a discount than uncleared positions

subject to daily mark-to-market margining? Commenters also are invited

to address whether the proposed discounts for cleared positions or

positions that are marked-to-market would make it unnecessary or

duplicative for this test separately to account for netting agreements.

Also, if an entity currently has posted excess collateral in connection

with a position, should the amount of that current

overcollateralization be deducted from its measure of potential future

exposure?

Commenters also are requested to address whether the proposed test

in connection with purchases of credit protection--which would cap the

measure of exposure at the net present value of unpaid premiums--would

raise problems in implementation, and whether we should propose any

particular discount rate to be used in conducting the calculation (and,

if so, what discount rate should be appropriate). Also, should the

measure of potential future exposure in connection with purchases of

credit protection and options also account for collateral that a

counterparty has posted in connection with an entity's in-the-money

positions, given that such collateralized in-the-money positions could

later turn and cause losses to an entity? In addition, for positions

that represent the sale of options on swaps or security-based swaps,

would the effective notional amount of the option for purposes of the

calculation properly be deemed to be the notional amount of the

underlying instrument (or should the notional amount of the option vary

based on the link between the changes in the value of the option and

changes in the value of the underlying), and would the duration of the

option properly be deemed to be the sum of the duration of the option

and the duration of the underlying swap or security-based swap?

Commenters also are requested to address whether the risk

adjustment for credit derivatives should reflect the riskiness of the

underlying reference entity, and, if so, how should that be

accomplished in a way that does not rely on the use of credit ratings.

The proposed test of potential future exposure is based in part on

the application of fixed multipliers to the notional amounts, or

effective notional amounts, of swaps and security-based swaps. In this

regard, commenters are invited to discuss whether there are alternative

tests that would be more effective to determine potential future

exposure or otherwise to supplement an uncollateralized current

exposure test, and whether such alternative tests may be more

effectively developed in the near future, when additional data

regarding swap and security-based swap positions are likely to be

available. In particular, commenters are requested to identify any

tests based on non-proprietary risk models that could be uniformly

applied by all potential major participants to measure potential future

exposure. Commenters who propose alternative tests are asked to address

how the tests would provide consistent results across different types

of swaps and security-based swaps, including customized instruments, in

the different major categories. Commenters are also invited to address,

on the other hand, whether a single test based on uncollateralized

current exposure (i.e., without any test of potential future exposure)

would be adequate for identifying entities whose swap or security-based

swap positions pose a relatively high degree of risk to counterparties

and to the markets. In addition, commenters are invited to identify any

tests or thresholds below which a party would be deemed not to be a

major swap participant, without needing to calculate the exposure tests

set forth in the proposed rule.

[[Page 80194]]

Commenters further are requested to address whether and how it

would be appropriate to adjust the threshold amounts over time,

including whether these proposed thresholds should periodically be

adjusted by formula to reflect changes in the ability of the market to

absorb losses over time, or changes in other criteria over time. In

addition, commenters are requested to address whether the proposed use

of a daily average measure for purposes of this test would be

burdensome for potential major participants to implement, and, if so,

how often should potential participants have to measure these amounts.

Commenters also are requested to address whether any such tests should

seek to reflect the maximum level of exposure associated with a

position, rather than risk-adjusted estimates of exposure proposed

here.

In addition, commenters are requested to address whether this

proposed test would pose significant monitoring burdens upon entities

that have swap or security-based swap positions that are significant

enough to potentially meet the combined current uncollateralized

exposure and potential future exposure test. Should we provide guidance

as to policies and procedures that such an entity should be able to

follow to be able to demonstrate that it does not meet the applicable

thresholds?

C. ``Hedging or Mitigating Commercial Risk''

The first test of the major participant definitions excludes

positions held for ``hedging or mitigating commercial risk'' from the

substantial position analysis.\119\

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

\119\ See CEA section 1a(33)(A)(i)(I); Exchange Act section

3(a)(67)(A)(i)(I).

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

Commenters took the position that this exclusion from the major

participant definitions should encompass a variety of uses of swaps and

security-based swaps to hedge risks faced by non-financial

entities.\120\ Some commenters also suggested that the exclusion should

be interpreted to address risks such as ``balance sheet risk,'' the

``risk of under-diversification,'' and hedges undertaken on a portfolio

basis. Some commenters favored interpreting this exclusion to permit

its use by insurers and banks. One commenter emphasized the need to

avoid taking interpretations that would encourage commercial entities

not to manage risks that they otherwise would manage.\121\ Commenters

also took the position that the addition of the word ``mitigating'' was

intended to expand the exclusion beyond what would have been

encompassed had only the term ``hedging'' been used.\122\

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

\120\ See, e.g., letter from Coalition for Derivatives End-

Users, dated September 20, 2010 (discussing, inter alia, a

supplier's use of credit derivatives in connection with a cash

receivable, and a company's use of equity derivatives in connection

with a stock repurchase program).

\121\ See Cleary letter (also urging inclusion of ``all risks''

arising in connection with a company's business activities,

including risks incidental to a company's ordinary course of

business).

\122\ See MetLife letter (addition of mitigation ``plainly

indicates that this exclusion intends an expansive definition of

hedging and can also encompass non-speculative derivatives positions

used to manage economic risk, including potentially diversification

and synthetic asset strategies, such as the conservative

`replication' strategy permitted under State insurance laws'');

letter from Joanne R. Medero, Managing Director, BlackRock, dated

September 20, 2010 (addressing the parallel context of the exclusion

for ERISA plan positions).

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

1. Proposed Interpretation

In interpreting the meaning of ``hedging or mitigating commercial

risk'' for purposes of the first test of the major participant

definitions, the Commissions first note that virtually identical

language is found in the Dodd-Frank provisions granting an exception

from the mandatory clearing requirement to non-financial entities that

are using swaps or security-based swaps to hedge or mitigate commercial

risk.\123\ Because Congress used virtually identical language in both

instances, the Commissions intend to interpret the phrase ``hedging or

mitigating commercial risk'' with respect to the participant

definitions in the same manner as the phrase ``hedge or mitigate

commercial risk'' in the exception from the mandatory clearing

requirement.\124\ The Commissions also note that although only non-

financial entities that are using swaps or security-based swaps to

hedge or mitigate commercial risk generally may qualify for the

clearing exemption, no such statutory restriction applies with respect

to the exclusion for hedging positions in the first major participant

test. Accordingly, with respect to the first major participant test, it

appears that positions established to hedge or mitigate commercial risk

may qualify for the exclusion, regardless of the nature of the entity--

i.e., whether a financial entity (including a bank) or a non-financial

entity.\125\

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

\123\ See CEA section 2(h)(7)(A); Exchange Act section

3C(g)(1)(B) (exception from mandatory clearing requirements when one

or more counterparties are not ``financial entities'' and are using

swaps or security-based swaps ``to hedge or mitigate commercial

risk''). The definition of commercial risk here is for purposes of

only the major participant definitions and, to the extent the

interpretation is similar, for purposes of the end-user exception

from the mandatory clearing requirement. The concept of commercial

risk may be interpreted differently for other purposes under the CEA

and the Exchange Act.

\124\ There is a technical difference in the way those

provisions use the concept of hedging and mitigating commercial

risk--in that the major participant definitions specifically refer

to ``positions held for hedging and mitigating commercial risk''

while the end-user exception refers to a counterparty that ``is

using [swaps or security-based swaps] to hedge or mitigate

commercial risk.'' That difference is consistent with the different

language used in the two places (particularly the use of

``substantial position'' in the major participant definitions) and

we do not see a reason why the use of the term in the context of the

major participant definitions should be construed differently than

its use in the comparable clearing exception.

\125\ The presence of the third major participant test suggests

that financial entities generally may not be precluded from taking

advantage of the hedging exclusion in the first test. The third

test, which does not account for hedging, specifically applies to

non-bank financial entities that are highly leveraged and have a

substantial position in a major category of swaps or security-based

swaps. That test would be redundant if the hedging exclusion in the

first major participant test were entirely unavailable to financial

entities.

Also, had the statute intended the phrase ``hedge or mitigate

commercial risk'' to apply only to activities of or positions held

by non-financial entities, it would not have been necessary to

include an additional provision in the statute generally restricting

the availability of the clearing exception to non-financial

entities.

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

In general, we are premising the proposed exclusion on the

principle that swaps or security-based swaps necessary to the conduct

or management of a person's commercial activities should not be

included in the calculation of a person's substantial position.\126\ In

this regard, the Commissions preliminarily believe that whether an

activity is commercial should not be determined solely by the person's

organizational status as a for-profit company, a non-profit

organization or a governmental entity. Rather, the determinative factor

should be whether the underlying activity to which the swap relates is

commercial in nature.\127\

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

\126\ The scope of the proposed exclusion is based on our

understanding that when a swap or security-based swap is used to

hedge an entity's commercial activities, the gains or losses

associated with the swap or security-based swap itself will be

offset by losses or gains in the entity's commercial activities, and

hence the risks posed by the swap or security-based swap to

counterparties or the industry generally will be mitigated.

\127\ We do not concur with the suggestion that the use of the

word ``mitigating'' within the major participant definitions was

intended to mean something significantly more than hedging. Other

provisions of the Dodd-Frank Act appear to use the terms ``hedging''

and ``mitigating'' interchangeably; for example, certain provisions

of the Dodd-Frank Act refer to ``risk-mitigating hedging

activities.'' See Dodd-Frank Act section 619 (adding Section 13 to

the Bank Holding Company Act of 1956); Dodd-Frank Act section 619

(adding Section 27B to the Securities Act of 1933). Title VII also

refers to ``[h]edging and other similar risk mitigating

activities.'' Dodd-Frank Act section 716(d)(1).

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

[[Page 80195]]

a. Proposed Exclusion in the ``Major Swap Participant'' Definition

As a general matter, the CFTC preliminarily believes that whether a

position hedges or mitigates commercial risk should be determined by

the facts and circumstances at the time the swap is entered into, and

should take into account the person's overall hedging and risk

mitigation strategies. At the same time, the swap position could not be

held for a purpose that is in the nature of speculation, investing or

trading. Although the line between speculation, investing or trading,

on the one hand, and hedging, on the other, can at times be difficult

to discern, the statute nonetheless requires such determinations.\128\

The CFTC expects that a person's overall hedging and risk management

strategies will help inform whether or not a particular position is

properly considered to hedge or mitigate commercial risk. Although the

definition includes swaps that are recognized as hedges for accounting

purposes or as bona fide hedging for purposes of an exemption from

position limits under the CEA, the swaps included within the proposed

exclusion are not limited to those categories. Rather, the proposal

covers swaps hedging or mitigating any of a person's business risks,

regardless of their status under accounting guidelines or the bona fide

hedging exemption.

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

\128\ We preliminarily believe that swap positions that are held

for the purpose of speculation or trading are, for example, those

positions that are held primarily to take an outright view on the

direction of the market, including positions held for short term

resale, or to obtain arbitrage profits. Swap positions that hedge

other positions that themselves are held for the purpose of

speculation or trading are also speculative or trading positions.

We preliminarily believe that swap positions that are held for

the purpose of investing are, for example, those positions that are

held primarily to obtain an appreciation in value of the swap

position itself, without regard to using the swap to hedge an

underlying risk. In contrast, a swap position related to a non-swap

investment (such as the purchase of an asset that a commercial

enterprise will use to produce income or otherwise advance its

commercial interests) may be a hedging position if it otherwise

qualifies for the definition of hedging or mitigating commercial

risk.

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

The CFTC invites comment on whether swaps qualifying for the

hedging or risk mitigation exclusion should be limited to swaps where

the underlying hedged item is a non-financial commodity. Commenters may

also address whether swaps subject to this exception should hedge or

mitigate commercial risk on a single risk or an aggregate risk basis,

and on a single entity or a consolidated basis. The CFTC also invites

comment on whether risks such as the foreign exchange, currency, or

interest rate risk relating to offshore affiliates, should be covered;

whether industry-specific rules on hedging, or rules that apply only to

certain categories of commodity or asset classes are appropriate at

this time; whether swaps facilitating asset optimization or dynamic

hedging should be included; and whether hedge effectiveness should be

addressed. Commenters are requested to discuss both the policy and

legal bases underlying their comments.

b. Proposed Exclusion in the ``Major Security-Based Swap Participant''

Definition

The proposed meaning of ``hedging or mitigating commercial risk''

for purposes of the ``major security-based swap participant''

definition would require that a security-based swap position be

economically appropriate to the reduction of risks in the conduct and

management of a commercial enterprise, where they arise from the

potential change in the value of assets, liabilities and services

connected with the ordinary course of business of the enterprise.\129\

This standard is intended to exclude from the first major participant

test security-based swaps that pose limited risk to the market and to

counterparties because the positions would be substantially related to

offsetting risks from an entity's commercial operations.\130\ The

security-based swaps included within the proposed rule would not be

limited to those recognized as hedges for accounting purposes; rather,

the proposal has been drafted to cover security-based swaps used in the

broader range of transactions commonly referred to as economic hedges,

regardless of their status under accounting guidelines.

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

\129\ See proposed Exchange Act rule 3a67-4(a). The concept of

``economically appropriate'' already is found in rules under the CEA

pertaining to the definition of ``bona fide hedging'' for purposes

of an exemption from position limits. See CEA rule 1.3(z). In the

context of the definition of ``major security-based swap

participant,'' we may take into account existing interpretations of

that term under the CEA, but only to the extent that such

interpretations would appropriately be applied to the use of

security-based swaps for hedging.

The SEC preliminarily plans to interpret the concept of

``economically appropriate'' based on whether a reasonably prudent

person would consider the security-based swap to be appropriate for

managing the identified commercial risk. The SEC also preliminarily

believes that for a security-based swap to be deemed ``economically

appropriate'' in this context, it should not introduce any new

material quantum of risks (i.e., it cannot reflect over-hedging that

could reasonably have a speculative effect) and it should not

introduce any basis risk or other new types of risk (other than the

counterparty risk that is attendant to all security-based swaps)

more than reasonably necessary to manage the identified risk.

\130\ These hedging positions would include activities, such as

the management of receivables, that arise out of the ordinary course

of an entity's commercial operations, including activities that are

incidental to those operations.

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

At the same time, the security-based swap position could not be

held for a purpose that is in the nature of speculation or

trading.\131\ In addition, the security-based swap position could not

be held to hedge or mitigate the risk of another security-based swap

position or swap position unless that other position itself is held for

the purpose of hedging or mitigating commercial risk as defined by the

rule or CEA rule 1.3(ttt).\132\

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

\131\ See proposed Exchange Act rule 3a67-4(b)(1). For these

purposes, we preliminarily believe that security-based swap

positions that are held for the purpose of speculation or trading

are those positions that are held intentionally for short-term

resale and/or with the intent of benefiting from actual or expected

short-term price movements or to lock in arbitrage profits, as well

as security-based swap positions that hedge other positions that

themselves are held for the purpose of speculation or trading. Thus,

for example, positions that would be part of a ``trading book'' of

an entity such as a bank would not constitute hedging positions that

may be excluded for purposes of the first major participant test.

\132\ See proposed Exchange Act rule 3a67-4(b)(2).

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

We look forward to commenters' views on whether the proposed

standard strikes an appropriate balance in determining which positions

may be excluded for purposes of the first major participant test. We

recognize that there are other reasonable views as to what positions

may appropriately be considered to be for the purposes of hedging or

mitigating commercial risk. We also recognize the importance of

providing as clear guidance as possible as to what is or is not a

hedging position for these purposes.

The proposal also would condition the entity's ability to exclude

these security-based swap positions on the entity engaging in certain

specified activities related to documenting the underlying risks and

assessing the effectiveness of the hedge in connection with the

positions.\133\ These activities are intended to help ensure that

positions excluded for purposes of the

[[Page 80196]]

first major participant test would not extend to positions that are not

entered into to reduce or hedge commercial risks, or that at a later

time no longer substantially serve to reduce or mitigate such

risks.\134\

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

\133\ See proposed Exchange Act rule 3a67-4(a)(3). The proposal

particularly would require the person to: Identify and document the

risks that are being reduced by the security-based swap position;

establish and document a method of assessing the effectiveness of

the security-based swap as a hedge; and regularly assess the

effectiveness of the security-based swap as a hedge.

We expect that market participants that have security-based swap

activities significant enough that they may be major participants

would already engage in risk assessment activities for their hedging

positions, either formally or informally, and thus we do not believe

that the proposed requirements would disrupt existing business

practices. Instead, the proposal is intended to create standards

that will allow market participants to confirm their compliance with

the rule by formalizing risk assessment activities that should

already be part of an effective hedging program.

\134\ This condition does not mandate that an entity follow a

particular set of procedures to take advantage of the exclusion. We

would expect that an entity that already engages in these types of

risk assessment procedures in connection with its existing business

activities to be able to rely on those procedures to satisfy the

condition. These conditions also could be satisfied by the entity's

use of a third-party to assist with these risk assessment

activities.

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

We preliminarily believe that this proposed approach would

facilitate the following types of security-based swap positions:

Positions established to manage the risk posed by a

customer's, supplier's or counterparty's potential default in

connection with: financing provided to a customer in connection with

the sale of real property or a good, product or service; a customer's

lease of real property or a good, product or service; a customer's

agreement to purchase real property or a good, product or service in

the future; or a supplier's commitment to provide or sell a good,

product or service in the future; \135\

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

\135\ The references here to customers and counterparties do not

include swap or security-based swap counterparties.

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

Positions established to manage the risk posed by a

financial counterparty (different from the counterparty to the hedging

position at issue) in connection with a separate transaction (including

a position involving a credit derivative, equity swap, other security-

based swap, interest rate swap, commodity swap, foreign exchange swap

or other swap, option, or future that itself is for the purpose of

hedging or mitigating commercial risk pursuant to the rule or CEA rule

1.3(ttt));

Positions established to manage equity or market risk

associated with certain employee compensation plans, including the risk

associated with market price variations in connection with stock-based

compensation plans, such as deferred compensation plans and stock

appreciation rights;

Positions established to manage equity market price risks

connected with certain business combinations, such as a corporate

merger or consolidation or similar plan or acquisition in which

securities of a person are exchanged for securities of any other person

(unless the sole purpose of the transaction is to change an issuer's

domicile solely within the United States), or a transfer of assets of a

person to another person in consideration of the issuance of securities

of such other person or any of its affiliates;

Positions established by a bank to manage counterparty

risks in connection with loans the bank has made; and

Positions to close out or reduce any of those positions.

2. Request for Comments

We request comment on the proposed definition of ``hedging or

mitigating commercial risk'' for purposes of both the ``major swap

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

definitions. Commenters particularly are requested to address whether

the proposed definitions would adequately limit the types of swaps or

security-based swaps that are encompassed by the definition, such that

the definitions do not encompass positions that serve speculative,

trading or other non-hedging purposes. In this regard, do the proposed

definitions appropriately exclude from the scope of the definition

swaps and security-based swaps that would be less likely to pose risks

to counterparties and the market, by virtue of gains or losses on those

swaps being offset by losses or gains associated with an entity's

commercial operations? Commenters further are requested to address

whether the proposed ``economically appropriate'' standard would

effectively limit the positions encompassed by the definition. If not,

what alternative standards (e.g., standards derived from accounting

principles) would more effectively identify hedging positions and

distinguish those from positions held for other purposes? In that

regard, is the concept of ``economically appropriate'' well-understood,

and, if not, is there another concept that would more effectively

delimit the nature of the relationship between the swap or security-

based swap position and the risk being hedged or mitigated? Also, in

the context of the definition of this term for purposes of security-

based swaps, should existing interpretive guidance pertaining to the

concept of ``economically appropriate'' with respect to the CEA's bona

fide hedging exemption for position limits be considered, and, if so,

to what extent? We further request comment on possible alternative

approaches to the test identifying positions entered into for the

purpose of hedging or mitigating commercial risk. For example, should

the test require the entity excluding a position to have a reasonable

basis to believe, and to actually believe, that the excluded swap would

be a ``highly effective,'' ``reasonably effective'' or ``economically

appropriate'' hedge of a specified commercial risk? Should the test be

generally identical to the proposed test, but with the substitution of

the phrase ``highly effective'' or ``reasonably effective'' (or another

standard) for ``economically appropriate''? Should the test be based on

accounting principles for hedging treatment (i.e., a quantitative test

requiring the hedge to be within a certain band of effectiveness)?

Commenters also are requested to address the proposed restrictions

on positions in the nature of speculation or trading. Is it appropriate

not to permit any speculative or trading positions from being deemed

for the purpose of hedging or mitigating commercial risk? What would be

the impact of such an interpretation on an entity's risk mitigation

practices? Also, is the dividing line between speculative and trading

positions on the one hand, and positions eligible to be considered to

be hedging positions on the other hand, sufficiently clear? Is such a

line appropriately based on whether the position is intended to be held

for the short-term versus long-term intent? Would some alternative

criteria be preferable in terms of setting forth objective standards

for identifying risk reducing hedging positions and distinguishing them

from other positions? Also, would additional standards or other

guidance be appropriate to help ensure that positions used in

connection with speculative or trading purposes do not fall within the

definition?

We further request comment on the proposal that a swap or security-

based swap would not fall within the definition of ``hedging or

mitigating commercial risk'' if it is held to hedge or mitigate the

risk of another swap or security-based swap, unless that other position

itself is held for the purpose of hedging or mitigating commercial

risk. One consequence of this approach might be that a particular swap

or security-based swap hedging a particular type of risk would be

included or excluded based solely on whether that risk arises from

another swap or security-based swap or from a different type of

transaction.\136\ Is this the appropriate approach? What would be the

consequences of this approach for

[[Page 80197]]

different types of entities? How would the proposed approach affect the

risk management practices of entities that are close to the proposed

threshold? Is it appropriate to include both positions within the major

participant calculations? If this general approach in the proposed rule

were adopted, should there be any exceptions to the approach? What

alternative approaches might be considered? For example, would it be

appropriate to exclude a swap or security-based swap that hedges

another swap or security-based swap from the calculation? What would be

the advantages and disadvantages of this approach?

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

\136\ For example, under this proposal an entity may exclude

from the first major participant test a security-based swap used to

manage the credit risk posed by a customer's default in connection

with financing that an entity provides to that customer. The entity

may not exclude an identical security-based swap, however, if that

security-based swap is used to hedge the credit risk associated with

a second swap or security-based swap that itself is not for the

purpose of hedging or mitigating commercial risk.

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

Moreover, commenters are requested to address whether the

definition should encompass a quantitative test that would limit the

total value of swaps and security-based swaps that an entity may

include under this rule to be no more than the total value of

underlying risk identified by such entity. If so, what measurement

should be used for determining an entity's total value of swaps and

security-based swaps and total value of underlying risk, and what

methods or procedures should entities be required to follow when

calculating and comparing the two values?

In addition, commenters are requested to address whether the

proposed procedural requirements, in the context of this definition for

purposes of the ``major security-based swap participant'' analysis, are

appropriate. In this regard, commenters are requested to discuss

whether there are any advantages or disadvantages to providing more

specific procedural requirements; whether the proposed procedural

requirements will alter business practices to the extent that a

transition period is necessary before they are implemented; and whether

specific guidance is required to address how the proposed procedural

requirements will affect existing positions. In addition, commenters

are requested to address whether the proposed procedural requirements

should include a requirement to quantify the underlying risk and the

effectiveness of the hedge, and whether such quantitative assessments

would impose significant systems costs or other costs. Also, should an

assessment of hedging effectiveness be required at all, in light of the

costs that may be associated with such a requirement?

More generally, would the proposed standards for identifying

positions for the purpose of hedging or mitigating commercial risk

suffice to allow a person holding a security-based swap position to

identify and document the commercial risks that are being hedged or

mitigated by that position, and if not, what additional requirements

are needed? Should additional guidance be provided regarding whether

components of risks (in assets, liabilities or services) or whether

risks in portfolios (of assets, liabilities or services) may be

identified as the commercial risks that are being hedged or mitigated

by the position, and, if so, which components? Also, should additional

guidance be provided with respect to the form of documentation or the

elements of the hedging relationship that should be documented, and, if

so, which elements? Moreover, if a swap or security-based swap that was

hedging at inception were no longer to serve a hedging purpose over

time, should it no longer fall within the definition of hedging or

mitigating commercial risk?

In addition, should the rule specify the frequency with which an

entity should assess the effectiveness of the hedge? Also, should we

provide additional guidance on the acceptable methods of assessing

effectiveness? Is a qualitative assessment adequate to assess

effectiveness or should a quantitative assessment also be required?

Should the rule establish a level of offset between the position and

the hedged risk, below which the position would not be considered to be

effective at reducing risk, and, if so, what is the level of offset (or

range of levels) below which the position should not be considered to

be effective? Are there methods for assessing effectiveness that should

not be permitted for these purposes?

Commenters also are requested to address whether the proposal also

should encompass certain activities in which an entity hedges an

affiliate's risks.

We further request comment on how the definition should apply to

hedging activities by financial entities. Commenters particularly are

invited to address whether financial entities should be able to rely on

this exclusion, or whether financial entities should face special

limits in the context of this exclusion. Commenters further are

requested to address how the proposed provisions excluding positions in

the nature of speculation or trading from the definition would apply to

activities by banks, including permissible trading activities by banks,

and, in particular, whether it is appropriate to exclude positions that

are part of an entity's ``trading book.''

Commenters also are requested to address the application of the

proposal to registered investment companies, including whether

additional guidance would be appropriate with respect to which uses of

security-based swaps by registered investment companies would fall

within the exclusion.

D. ``Substantial Counterparty Exposure''

The second test of the major participant definitions addresses

entities whose swaps and security-based swaps ``create substantial

counterparty exposure that could have serious adverse effects on the

financial stability of the United States banking system or financial

markets.'' \137\ Unlike the first test of the major participant

definitions, this test does not focus on positions in a ``major''

category of swaps or security-based swaps. Also, unlike the first test,

this test does not explicitly exclude hedging positions or certain

ERISA plan positions from the analysis.

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

\137\ See CEA section 1a(33)(A)(ii); Exchange Act section

3(a)(67)(A)(ii)(II).

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

Some commenters suggested that the second major participant

definition test should be interpreted in a manner similar to the first

test. Many commenters stated that the analysis should also reflect

netting agreements and the posting of collateral. Some commenters

stated that the test should exclude hedging positions, and cleared

positions.

We preliminarily believe that the second major participant

definition test's focus on the counterparty risk associated with an

entity's swap or security-based swap positions is similar enough to the

``substantial position'' risks embedded in the first test that the

second test appropriately takes into account the same measures of

current uncollateralized exposure and potential future exposure that

are used in our proposal for the first test. For the second test,

however, the thresholds must focus on the entirety of an entity's swap

positions or security-based swap positions, rather than on positions in

any specific ``major'' category. In addition, this second test does not

explicitly account for positions for hedging commercial risk or ERISA

positions.

Accordingly, these proposed calculations of substantial

counterparty exposure would be performed in largely the same way as the

calculation of substantial position in the first major participant

definition tests, except that the amounts would be calculated by

reference to all of the person's swap or security-based swap positions,

rather than by reference to a specific ``major'' category of such

positions.\138\

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

\138\ See proposed CEA rule 1.3(uuu)(2); proposed Exchange Act

rule 3a67-5(b)(1).

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

For purposes of the ``major swap participant'' definition, the CFTC

[[Page 80198]]

proposes that the second major participant definition test be satisfied

by a current uncollateralized exposure of $5 billion, or a combined

current uncollateralized exposure and potential future exposure of $8

billion, across the entirety of an entity's swap positions.\139\ For

purposes of the ``major security-based swap participant'' definition,

the SEC proposes that the second test be satisfied by a current

uncollateralized exposure of $2 billion, or a combined current

uncollateralized exposure and potential future exposure of $4 billion,

across the entirety of an entity's security-based swap positions.\140\

We look forward to commenters' views as to whether alternative

thresholds would be more appropriate to achieve the statutory goals.

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

\139\ See proposed CEA rule 1.3(uuu)(1).

\140\ See proposed Exchange Act rule 3a67-5(a).

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

These proposed thresholds in part are based on the same factors

that underpin the proposed ``substantial position'' thresholds.\141\

The proposed thresholds, however, also reflect the fact that this test

must account for an entity's positions across four major swap

categories or two major security-based swap categories.\142\ These

proposed thresholds, moreover, have further been raised to reflect the

fact that this second test (unlike the first major participant test)

encompasses certain hedging positions that, in general, we would expect

to pose fewer risks to counterparties and to the markets as a whole

than positions that are not for purposes of hedging.

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

\141\ See notes 103 to 106 and 117, supra, and accompanying

text.

\142\ Thus, these proposed thresholds in part would account for

an entity that has large positions in more than one major category

of swaps or security-based swaps, but that does not meet the

substantial position threshold for either.

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

We request comment on this proposal. Commenters particularly are

requested to address whether the proposed use of current

uncollateralized exposure and potential future exposure tests

(including the parts of those tests that account for positions that are

cleared or subject to mark-to-market margining) are appropriate, and

whether the proposed thresholds are set at an appropriate level. Should

the thresholds be higher or lower? If so, what alternative threshold

amounts would be more appropriate, and why? Commenters also are

requested to address whether the test should exclude commercial risk

and ERISA hedging positions, on the grounds that those hedging

positions may not raise the same degree of risk to counterparties as

other swap or security-based swap positions. Comments are also

requested on whether the test of substantial counterparty exposure,

given its focus on the systemic risks arising from the entirety of a

person's portfolio, should include a measure to take into account the

person's combined swap positions and security-based swap positions.

E. ``Financial Entity'' and ``Highly Leveraged''

The third test of the major participant definitions addresses any

``financial entity,'' other than one subject to capital requirements

established by an appropriate Federal banking agency,\143\ that is

``highly leveraged relative to the amount of capital'' the entity

holds, and that maintains a substantial position in a ``major''

category of swaps or security-based swaps. This test does not permit an

exclusion for positions held for hedging.

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

\143\ Sections 721 and 761 of the Dodd-Frank Act add a

definition of the term ``appropriate Federal banking agency'' in

sections 1a and 3(a) of the CEA and the Exchange Act, respectively,

7 U.S.C. 1a(2), 15 U.S.C. 78c(a)(72). The Commissions propose to

refer to those statutory definitions for purposes of the rules.

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

As discussed below, we are proposing specific definitions of the

terms ``financial entity'' and ``highly leveraged.'' In addition, we

request comment on whether we should include additional regulators

within the proposed interpretation of what is an appropriate Federal

banking agency.

1. Meaning of ``financial entity''

While the third major participant definition test does not

explicitly define ``financial entity,'' Title VII of the Dodd-Frank Act

defines ``financial entity'' in the context of the end-user exception

from mandatory clearing (an exception that generally is not available

to those entities).\144\ Some commenters have pointed out that using

that definition here would produce circular results.\145\

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

\144\ See CEA section 2(h)(7)(C)(i); Exchange Act section

3C(g)(3)(A).

\145\ See Cleary letter (also addressing status of broker-

dealers and futures commission merchants as part of the analysis).

The circularity would result because, for purposes of the end-

user clearing exception, ``financial entity'' is defined to include

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

and major security-based swap participants.

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

We preliminarily do not believe there is a basis to define

``financial entity'' for purposes of the major participant definitions

in a way that materially differs from the definition used in the end-

user exception from mandatory clearing. Using the same basic definition

also would appear to be consistent with the statute's intent to treat

non-financial end-users differently than financial entities.

Accordingly, other than technical changes to avoid circularity, we

propose to use the same definition in the major participant

definitions.\146\

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

\146\ See proposed CEA rule 1.3(vvv)(1); proposed Exchange Act

rule 3a67-6(a). To avoid circularity, the meaning of ``financial

entity'' for purposes of the ``major swap participant'' definition

would not encompass any ``swap dealer'' or ``major swap

participant'' (but would encompass ``security-based swaps dealers''

and ``major security-based swap participants''). The meaning of

``financial entity'' for purposes of the ``major security-based swap

participant'' definition would not encompass any ``security-based

swap dealer'' or ``major security-based swap participant (but would

encompass ``swap dealers'' and ``major swap participants''). For

both definitions, ``financial entity'' would include any: commodity

pool (as defined in section 1a(10) of the CEA); private fund (as

defined in section 202(a) of the Investment Advisers Act of 1940);

employee benefit plan as defined in paragraphs (3) and (32) of

section 3 of the Employee Retirement Income Security Act of 1974;

and person predominantly engaged in activities that are in the

business of banking or financial in nature (as defined in section

4(k) of the Bank Holding Company Act of 1956).

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

Commenters are requested to address our proposed definition of

``financial entity.''

2. Meaning of ``Highly Leveraged''

Some commenters have stated that the term ``highly leveraged''

should be interpreted by looking at the leverage associated with other

firms in an entity's line of business, rather than by applying an

across-the-board measure of leverage.\147\ One commenter suggested that

higher leverage may be warranted for entities with a smaller capital

base, and another commenter suggested that we look at analogous banking

regulations rather than creating a new regime for measuring leverage.

Some commenters suggested ways of addressing specific items for

purposes of determining leverage.\148\

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

\147\ See letter from Robert Pickel, Executive Vice Chairman,

International Swaps and Derivatives Association, Inc., dated

September 20, 2010 (suggesting that ``leverage ratio limits to which

banks and other regulated entities are subject would be unsuitably

low for other enterprises''); letter from Steve Martinie, Assistant

General Counsel and Assistant Secretary, The Northwestern Mutual

Life Insurance Company, dated September 20, 2010 (``Northwestern

Mutual letter'') (suggesting that financial firms require less

cushion than other entities because financial firms are able to

match their assets and liabilities more closely).

\148\ See Northwestern Mutual letter (suggesting that the

Commissions recognize that liabilities such as bank deposits and

insurance policy reserves are not leverage); Vanguard letter

(suggesting that leverage should relate to debt financing and should

not encompass potential leveraging effects posed by derivatives);

SIFMA AMG letter (suggesting that the Commissions take into account

the difference between non-recourse and recourse obligations, the

difference between notional amounts payable and actual payable

obligations, and the difference between actual financial obligations

and leverage embedded in a derivative that affects returns but does

not result in a payment obligation).

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

The Commissions recognize that traditional balance sheet measures

of leverage have limitations as tools for

[[Page 80199]]

evaluating an entity's ability to meet its obligations. In part this is

because such measures of leverage do not directly account for the

potential risks posed by specific instruments on the balance sheet, or

financial instruments that are held off of an entity's balance sheet

(as may be the case with an entity's swap and security-based swap

positions). At the same time, we preliminarily do not believe that it

is necessary to use more complex measures of risk-adjusted leverage

here, particularly given that the third test in the major participant

definitions already addresses those types of risks by considering

whether an entity has a substantial position in a major category of

swaps or security-based swaps. We are also mindful of the costs that

entities would face if forced to undertake a complex risk-adjusted

leverage calculation, especially for entities that would not already be

performing this type of analysis.\149\ Additionally, we preliminarily

do not believe that it is necessary for the leverage standard to

account for the degree of leverage associated with different types of

financial entities.

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

\149\ The Basel Committee on Banking Supervision recently

proposed one method for calculating risk-adjusted leverage in its

Consultative Document entitled: ``Strengthening the resilience of

the banking sector'' (Dec. 2009). This proposal would create a new

leverage ratio based on a comparison of capital to total exposure.

Total exposure for these purposes would be measured by, among other

things, including the notional value of all written credit

protection, severely limiting the recognition given to netting, and

calculating the risks associated with off-balance sheet derivatives

transactions, as measured by the current exposure method for

calculating future risks outlined in Basel II. The Consultative

Document drew over 150 comments from the international financial

community, which included both those in support of, and those that

questioned the inclusion of a risk-adjusted leverage ratio within

the Basel framework. The Basel Committee on Banking Supervision

expects to deliver a full package of reforms by the end of 2010,

based on the Consultative Document released in December 2009 and

comments received thereon.

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

Although the third test of the major participant definitions does

not define ``highly leveraged,'' we note that Congress addressed the

issue of leverage in Title I of the Dodd-Frank Act. There, Congress

provided that the Board of Governors of the Federal Reserve System must

require a bank holding company with total consolidated assets equal to

or greater than $50 billion, or a nonbank financial company supervised

by the Board of Governors, to maintain a debt to equity ratio of no

more than 15 to 1 if the FSOC determines ``that such company poses a

grave threat to the financial stability of the United States and that

the imposition of such requirement is necessary to mitigate the risk

that such company poses to the financial stability of the United

States.'' \150\

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

\150\ See Dodd-Frank Act section 165(j)(1).

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

This requirement in Title I suggests potential alternative

approaches to the definition of ``highly leveraged'' for purposes of

the major participant definitions. On the one hand, the 15 to 1 limit

may represent an upper limit of acceptable leverage, indicating that

the limit for the major participant definitions should be lower so as

to create a buffer between entities at that upper limit and entities

that are not highly leveraged. On the other hand, the Title 1

requirement, which applies only when the entity in question poses a

``grave threat'' to financial stability, may indicate that the 15 to 1

leverage ratio is also the appropriate test of whether an entity poses

the systemic risk concerns implicated by the major participant

definitions.

For these reasons, we propose two possible definitions of the point

at which an entity would be ``highly leveraged''--either an entity

would be ``highly leveraged'' if the ratio of its total liabilities to

equity is in excess of 8 to 1, or an entity would be ``highly

leveraged'' if the ratio of its total liabilities to equity is in

excess of 15 to 1. In either case, the determination would be measured

at the close of business on the last business day of the applicable

fiscal quarter. To promote consistent application of this leverage

test, entities that file quarterly reports on Form 10-Q and annual

reports on Form 10-K with the SEC would determine their total

liabilities and equity based on the financial statements included with

such filings.\151\ All other entities would calculate the value of

total liabilities and equity consistent with the proper application of

U.S. generally accepted accounting principles.

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

\151\ These entities would include those that submit periodic

reports on a voluntary basis to the SEC, as well as those that are

required to file periodic reports with the SEC.

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

We believe that the 15 to 1 ratio could be consistent with the use

of that ratio in Title I, which, as noted above, provides that the 15

to 1 leverage ratio would be applied to a bank holding company or

nonbank financial company subject to Title I as a maximum only if it is

determined that the company poses a ``grave threat'' to financial

stability. Commenters are requested to address whether the proposed 15

to 1 standard used in Title I suggests that a standard higher than 15

to 1 should be used here, given that the Title I standard is applicable

only to large entities that also pose a ``grave threat'' to financial

stability and thus may suggest that a higher standard is appropriate

for entities that do not pose the same degree of threat. Alternatively,

the 8 to 1 ratio could be consistent with the exemption in the third

test of the major participant definitions for financial institutions

that are subject to capital requirements set by the Federal banking

agencies, as it is possible that financial institutions were

specifically excluded from the third test based on the presumption that

they generally are highly leveraged, and hence would have been covered

by the third test if they were not expressly exempted. Based on our

analysis of financial statements it appears that those institutions

generally have leverage ratios of approximately 10 to 1, which may

suggest that the ``highly leveraged'' threshold would have to be lower

for those institutions to be potentially subject to the third test.

Such an approach would help to ensure that the third test of the major

participant definition applies to financial entities that are not

subject to capital requirements set by the Federal banking agencies,

but that have leverage ratios similar to institutions that are subject

to those requirements.

The Commissions request comment on the proposed alternative

definitions of ``highly leveraged.'' Commenters particularly are

requested to specifically address the relative merits of the proposed

alternative 8 to 1 and 15 to 1 standards, as well as other standards

that they believe would be appropriate for these purposes.\152\

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

\152\ In this regard, we recognize that under Exchange Act rule

15c3-1, a broker-dealer may determine its required minimum net

capital, among other ways, by applying a financial ratio that

provides that its aggregate indebtedness shall not exceed 1500% of

its net capital (i.e., a 15 to 1 aggregate indebtedness to net

capital ratio). Exchange Act Rule 17a-11 further requires that

broker-dealers that use such method to establish their required

minimum net capital must provide notice to regulators if their

aggregate indebtedness exceeds 1200% of their net capital (i.e., a

12 to 1 aggregate indebtedness to net capital ratio). We recognize

that these measures, however, reflect a different ratio of total

liabilities to equity; for example, the calculation of aggregate

indebtedness in rule 15c3-1 excludes certain liabilities, and the

calculation of net capital includes certain subordinated debt--

meaning that these measures would respectively be equivalent to

ratios higher than 15:1 or 12:1 when converted to a balance sheet

ratio of liabilities to equity such as that used under the proposed

rule.

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

Commenters further are requested to address whether a risk-adjusted

leverage ratio should be used, and, if so, how the ratio should be

calculated (including whether particular items should be included or

excluded when making this calculation), and whether a risk-adjusted

leverage ratio could be developed relying on measures already

[[Page 80200]]

calculated by entities as a matter of course.\153\ Commenters further

are requested to address whether the leverage ratio should be revised

to require that the amount of potential future exposure (as outlined in

the ``substantial position'' discussion above) be combined with total

liabilities before such number is compared to equity for purposes of

calculating the ratio, and, if so, whether the proposed ratios would

still be appropriate; whether the rule should more specifically address

issues as to how certain types of positions or liabilities should be

accounted for when calculating leverage; whether the proposed timing of

the measurement--the close of business on the last business day of the

applicable fiscal quarter--would be potentially subject to gaming or

evasion; and whether the rule text should particularly prescribe how

separate categories of entities calculate leverage.

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

\153\ For example, would adjustments akin to those discussed

above in the context of broker-dealer net capital provide a more

useful measure of leverage for these purposes?

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

F. Implementation Standard, Reevaluation Period and Minimum Duration of

Status

While the analysis of whether an entity is a major participant is

backward looking, an entity that meets the criteria for being a major

participant is required to register with the CFTC and/or the SEC, and

comply with the requirements applicable to major participants. We

recognize that these entities will need time to complete their

applications for registration and to come into compliance with the

applicable requirements. We thus propose that an unregistered entity

that meets the major participant criteria as a result of its swap or

security-based swap activities in a fiscal quarter would not be deemed

to be a major participant until the earlier of the date on which it

submits a complete application for registration pursuant to CEA Section

4s(b) or Exchange Act Section 15F(b), or two months after the end of

that quarter.\154\ We preliminarily believe that this would provide

entities with an appropriate amount of time to apply for registration

and, with the time between the submission of an application and the

effectiveness of the registration, to comply with the requirements

applicable to major participants, without permitting undue delay.

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

\154\ See proposed CEA rule 1.3(qqq)(4)(i); proposed Exchange

Act rule 3a67-7(a). The Commissions are proposing separate rules

regarding the registration requirements and processes for major

participants.

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

We also propose to provide a reevaluation for entities that meet

one or more of the applicable major participant thresholds, but only by

a modest amount.\155\ In particular, an unregistered entity that has

met these criteria as a result of its swap or security-based swap

activities in a fiscal quarter, but without exceeding any applicable

threshold by more than twenty percent, would not immediately be subject

to the timing requirements discussed above. Instead, that entity would

become subject to those requirements if the entity exceeded any of the

applicable daily average thresholds in the next fiscal quarter.\156\ We

preliminarily believe this type of reevaluation period would avoid

applying the major participant requirements to entities that meet the

major participant criteria for only a short time due to unusual

activity.

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

\155\ Commenters raised concerns over an entity qualifying as a

major participant due to an unusual event. See, e.g., letter from

American Benefits Council and Committee on the Investment of

Employee Benefit Assets, dated September 20, 2010 (stating that

quirky volatility may affect the determinations).

\156\ See proposed CEA rule 1.3(qqq)(4)(ii); proposed Exchange

Act rules 3a67-7(b).

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

In addition, we propose that any entity that is deemed to be a

major participant would retain that status until such time that it does

not exceed any of the applicable thresholds for four consecutive

quarters after the entity becomes registered.\157\ Commentators raised

concerns about the possibility of entities moving in and out of the

status on a rapid basis,\158\ and we believe that this proposal

appropriately addresses that concern in a way that would help promote

the predictable application and enforcement of the requirements

governing major participants.

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

\157\ See proposed CEA rule 1.3(qqq)(5); proposed Exchange Act

rules 3a67-7(c)(1).

\158\ See Vanguard letter (suggesting that entities should

remain in the status after qualification for an extended defined

period such as one calendar year); AIMA letter (noting that

recategorization of entities could be disruptive for entities'

business models and could be administratively burdensome for the

Commissions).

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

The Commissions request comment on these proposals. Commenters

particularly are requested to address: Whether two months is an

adequate amount of time for entities that have met the criteria to

submit an application for registration; whether there is an adequate

amount of time to make the necessary internal changes to come into

compliance with the requirements applicable to major participants

before being subject to those requirements as a result of a

registration becoming effective; whether twenty percent is the

appropriate threshold for applicability of the reevaluation period;

whether there would be any risks arising from delaying registration as

a major participant for an entity that exceeds the thresholds, but

qualifies for the reevaluation period; and whether four consecutive

quarters of not meeting the criteria for major participant status after

registration is granted is the appropriate amount of time that a major

participant should be required to stay in the status.

In addition, we request comment on the appropriateness of the

proposed reevaluation period. Commenters particularly are requested to

address whether it is likely that unusual market conditions could cause

an entity to exceed the proposed thresholds over the course of a

quarter (based on a daily average) without generally raising the types

of risks that the thresholds were intended to identify. Also, should

the use of the reevaluation period be conditioned on requiring any

entity relying on the reevaluation period to make a representation, or

otherwise demonstrate, that it exceeded the threshold due to a one-time

extraordinary event, and that it will be below the threshold at the

next time of measurement?

G. Limited Purpose Designations

In general, a person that meets the definition of major participant

will be considered to be a major participant with respect to all

categories of swaps or security-based swaps, as applicable, and with

regard to all activities involving those instruments.\159\ As discussed

above, however, the statutory definitions provide that a person may be

designated as a major participant for one or more categories of swaps

or security-based swaps without being classified as a major participant

for all categories.\160\ Thus, as with the definitions of ``swap

dealer'' and ``security-based swap dealer,'' we propose to provide that

major participants who engage in significant activity with respect to

only certain types, classes or categories of swaps or security-based

swaps may apply for relief with respect to other types of swaps or

security-based swaps from certain of the requirements that are

applicable to major participants. The Commissions anticipate that a

major participant could seek a limited designation at the same time as,

or at a later time subsequent to, the person's initial registration as

a major participant. Because of the variety of situations in which

major participants

[[Page 80201]]

may enter into swaps or security-based swaps, it is difficult to set

out at this time the conditions, if any, which would allow a person to

be designated as a major participant with respect to only certain

types, classes or categories of swaps or security-based swaps.

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

\159\ See proposed CEA rule 1.3(qqq)(2); proposed Exchange Act

rule 3a67-1(c).

\160\ CEA section 1a(33)(C); Exchange Act section 3(a)(67)(C).

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

The Commissions request comment on the proposed rules regarding

limited designation as a major participant. Commenters particularly are

requested to address the circumstances in which such limited purpose

designations would be appropriate, and to address the factors that the

Commissions should consider when addressing such requests, and the type

of information requestors should provide in support of their request.

Commenters also are asked to address whether such limited purpose

designations should be conditioned in any way, such as by the provision

of information of the type that would be required with respect to an

entity's swaps or security-based swaps involving the particular

category or activity for which they are not designated as a major

participant.

H. Additional Interpretive Issues

Commenters have raised additional issues related to the major

participant definitions.

1. Exclusion for ERISA Plan Positions

As discussed above, the first test of the major participant

definitions excludes from the analysis ``positions maintained by any

employee benefit plan (or any contract held by such a plan) as defined

in paragraphs (3) and (32) of section 3 of ERISA (29 U.S.C. 1002) for

the primary purpose of hedging or mitigating any risk directly

associated with the operation of the plan.'' Some commenters suggested

that the exclusion should encompass activities such as portfolio

rebalancing and diversification, and gaining exposure to alternative

asset classes, and that this type of exclusion also should apply to

certain other types of entities.\161\

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

\161\ See Cleary letter (addressing welfare plans or entities

holding assets of such plans, such as voluntary employee beneficiary

associations, employer group trusts or bank-maintained collective

trusts); see also letter from Jane Hamblen, State of Wisconsin

Investment Board, dated September 20, 2010.

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

We preliminarily do not believe that it is necessary to propose a

rule to further define the scope of this exclusion. In this regard, we

note that this ERISA plan exclusion, unlike the other exclusion in the

first major participant test, is not limited to ``commercial'' risk,

which may be construed to mean that hedging by ERISA plans should be

broadly excluded.

While the Commissions are not proposing to make this type of

exclusion available to additional types of entities, we request comment

on whether we should do so. If so, what type of entities should receive

this type of exclusion, and why do the concerns that led to the

enactment of the major participant requirements in the Dodd-Frank Act

not apply to such entities?

2. Application of Major Participant Definitions to Managed Accounts

Some commenters have stated that asset managers and investment

advisers should not be deemed to be major participants by virtue of the

swap and security-based swap positions held by the accounts they

manage. These commenters have emphasized that asset managers and

investment advisers are separate legal entities from the accounts that

they administer, the accounts themselves are the counterparties to the

swaps and security-based swaps, and managers and advisers do not

maintain capital to support the trades of their clients. One commenter

also expressed the view that the positions of individual accounts under

the advisement of a single asset manager should not be aggregated for

the purpose of the major participant definitions because different

accounts managed by an asset manager may use the same positions for

different purposes.\162\

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

\162\ In addition, a colloquy on the Senate floor addressed the

status of managed accounts for purposes of the major participant

definitions, particularly focusing on whether the analysis should

``look at the aggregate positions of funds managed by asset managers

or at the individual fund level?'' In response, it was stated that,

``[a]s a general rule, the CFTC and the SEC should look at each

entity on an individual basis when determining its status as a major

swap participant.'' See 156 Cong. Rec. S5907 (daily ed. July 15,

2010) (colloquy between Senators Hagan and Lincoln).

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

Preliminarily, we do not believe that the major participant

definitions should be construed to aggregate the accounts managed by

asset managers or investment advisers to determine if the asset manager

or investment adviser itself is a major participant. The major

participant definitions apply to the entities that actually

``maintain'' substantial positions in swaps and security-based swaps or

that have swaps or security-based swaps that create substantial

counterparty exposure. The Commissions have the authority to adopt

anti-evasion rules to address the possibility that persons who enter

into swaps and security-based swaps may attempt to allocate the swaps

and security-based swaps among different accounts (thereby attempting

to treat such other accounts as the entity that has entered into the

swaps or security-based swaps) for the purpose of evading the

regulations applicable to major participants.\163\ In addition, we note

that since the major participant definitions focus on the entity that

enters into swaps or security-based swaps, all of the managed positions

of which a person is the beneficial owner are to be aggregated (along

with such beneficial owner's other positions) for purposes of

determining whether such beneficial owner is a major participant.\164\

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

\163\ See Dodd-Frank Act sections 721(b)(2), 761(b)(3).

\164\ This guidance relates only to the application of the major

participant definitions to managed accounts. It is not intended to

apply to the treatment of managed accounts with respect to any other

rules promulgated by the CFTC or SEC to implement Title VII of the

Dodd-Frank Act or to any other applicable rules or requirements.

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

The Commissions request comment on the application of the major

participant definitions to managed accounts. Commenters particularly

are requested to address: whether additional guidance is necessary to

address issues relating to the application of the major participant

definition to managed accounts; whether there are areas of potential

abuse, and if so, what they may be. Commenters further are requested to

address whether the Commissions should adopt anti-evasion rules to

address areas of potential abuse, and if so, how such rules should be

crafted.

In addition, commenters are requested to discuss any implementation

concerns that may arise if the beneficial owner of a managed account

meets one of the major participant definitions; for example, would the

beneficial owner face any impediments in terms of identifying whether

it falls within the major participant definitions? Also, what

implementation issues would arise with respect to applying the major

participant definitions to managed accounts and/or their beneficial

owners if the accounts' advisers or managers are not subject to

regulation as major participants?

3. Application of Major Participant Definitions to Positions of

Affiliated Entities

The issues discussed above with regard to managed accounts also are

related to the separate issue of whether the major participant tests

should, in some circumstances, aggregate the swap and security-based

swap positions of entities that are affiliated. Absent that type of

aggregation, an entity could seek to evade major participant status by

allocating swap or security-based swap

[[Page 80202]]

positions among a number of affiliated entities.

In situations in which a parent is the majority owner of a

subsidiary entity, we preliminarily believe that the major participant

tests may appropriately aggregate the subsidiary's swaps or security-

based swaps at the parent for purposes of the substantial position

analyses.\165\ Attributing those positions to a parent appears

consistent with the concepts of ``substantial position'' and

``substantial counterparty exposure,'' given that the parent would

effectively be the beneficiary of the transaction. In those

circumstances, however, there still may be questions as to whether the

requirements applicable to major participants--e.g., capital, margin

and business conduct--should be placed upon the parent or the

subsidiary. We recognize that it may be appropriate at times to apply

such requirements upon the subsidiary to the extent that the subsidiary

is acting on behalf of the parent.\166\

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

\165\ Arguably, the basis for this type of attribution would be

even stronger if the parent wholly owns the subsidiary. An

attribution rule that only addresses 100 percent ownership

situations, however, may readily be susceptible to gaming if the

parent were to sell a very small interest in the subsidiary to

another party.

\166\ It may also be appropriate to address these issues in

connection with the rule proposals addressing the substantive

requirements applicable to major participants.

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

Commenters particularly are invited to discuss when it would be

appropriate to apply the major participant definitions to entities that

are the majority owner of subsidiaries that enter into swaps or

security-based swaps, or whether attribution of a subsidiary's

security-based swap positions is generally inappropriate. Also, to the

extent this type of attribution is appropriate, to what extent should

the subsidiary retain responsibilities for complying with the capital,

margin, business conduct and other requirements applicable to major

participants?

Commenters further are requested to address whether the swaps or

security-based swaps of corporate subsidiaries in some circumstances

should be attributed to an entity that itself is not the majority owner

of the direct counterparty to a swap or security-based swap. Moreover,

should this type of attribution apply when one entity controls another

entity, and, if so, how should the concept of control be defined for

these purposes? In addition, commenters are requested to address

whether, as an alternative approach, this type of attribution would be

appropriate specifically when a parent provides guarantees on behalf of

its subsidiaries, or third parties provide guarantees on behalf of

unaffiliated entities.

Commenters further are requested to address any issues that would

arise with regard to the effective implementation of the requirements

applicable to major participants in the context of this type of

attributions.

4. Application of Major Participant Definitions to Inter-Affiliate

Swaps and Security-Based Swaps

Several commenters have suggested that swaps and security-based

swaps between affiliated counterparties should not be considered within

the analysis of whether an entity's swap or security-based swap

positions cause it to be a major participant. Such inter-affiliate

swaps and security-based swaps may be used to achieve various

operational and internal efficiency objectives.

The Commissions preliminarily believe that when a person analyzes

its swap or security-based swap positions under the major participant

definitions, it would be appropriate for the person to consider the

economic reality of any swaps or security-based swaps it enters into

with wholly owned affiliates, including whether the swaps and security-

based swaps simply represent an allocation of risk within a corporate

group.\167\ Such swaps and security-based swaps among wholly-owned

affiliates may not pose the exceptional risks to the U.S. financial

system that are the basis for the major participant definitions. As

discussed above in the context of managed accounts, however, an entity

would not be able to evade the requirements applicable to major

participants by allocating among multiple affiliates swap or security-

based swap positions of which it is the beneficial owner.

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

\167\ Such swaps and security-based swaps should be considered

in this way only for purposes of determining whether a particular

person is a major participant. The swaps and security-based swaps

would continue to be subject to all laws and requirements applicable

to such swaps and security-based swaps.

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

The Commissions request comment on the treatment of inter-affiliate

swaps and security-based swaps between wholly-owned affiliates of the

same corporate parent in connection with the major participant

definitions. Commenters also are requested to address whether similar

interpretations should apply to swaps and security-based swaps between

entities within a consolidated group as determined in accordance with

U.S. generally accepted accounting principles. Commenters further are

requested to discuss whether the major participant definition should be

interpreted to encompass an entity (including an affiliate of the named

counterparty to the swap or security-based swap) that provides a

guarantee of the named counterparty's obligations, either in the form

of a guarantee or through some other form of credit support whereby the

guarantor agrees to satisfy margin obligations of the named

counterparty and/or periodic payment obligations of the named

counterparty.

5. Legacy Portfolios

Some commenters have stated that certain entities that maintain

legacy portfolios of credit default swaps that previously had been

entered into in connection with the activities of monoline insurers and

``credit derivative product companies'' should not be considered major

participants. The commenters argued that these entities would be unable

to comply with the capital and margin requirements applicable to major

participants, and that regulation as major participants is unnecessary

given that the entities are not writing any additional swaps or

security-based swaps.

We request comment on whether the rules further defining major swap

participant and major security-based swap participant should exclude

such entities from the major participant definition if their swap and

security-based swap positions are limited to those types of legacy

positions. The exclusion from the definition could be conditional, and

any such excluded entity would be required to provide the Commissions

with position information of the type that registered major

participants would be required to provide. We invite comment on any

other conditions that might be appropriate to an exclusion of such

legacy portfolios from the major participant definitions.

6. Potential Exclusions

Some commenters stated that the major participant definitions

should not be interpreted to apply to entities such as investment

companies,\168\ ERISA plans, registered broker-dealers and/or

registered futures commission

[[Page 80203]]

merchants,\169\ and long-term investors such as sovereign wealth

funds.\170\

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

\168\ See letter from Karrie McMillan, General Counsel,

Investment Company Institute, dated September 20, 2010 (registered

investment companies should be excluded from the major participant

(and dealer) definitions, or else the terms of the definitions

should be interpreted to clarify that mutual funds generally will

not be major participants).

\169\ See letter from The Swaps & Derivatives Marketing Ass'n,

dated September 20, 2010 (certain hedged positions of broker-dealers

and futures commission merchants with customers should not be

considered as part of the substantial position analysis); Cleary

letter (registered and well-capitalized broker-dealers and futures

commission merchants should not fall within the scope of the third

major participant test).

\170\ See letter from Lee Ming Chua, General Counsel, Government

of Singapore Investment Corp., dated September 20, 2010 (stating

that the major participant definitions were not intended to apply to

long-term financial investors); see also letter from Richard M.

Whiting, The Financial Services Roundtable, dated September 20, 2010

(major participant definitions should exclude firms that solely act

as investors).

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

These comments, and the rationale behind the comments, raise the

issue of whether we should exclude, conditionally or unconditionally,

certain types of entities from the major participant definitions, on

the grounds that such entities do not present the risks that underpin

the major participant definitions and/or to avoid duplication of

existing regulation. While we are not proposing any such exclusions, we

request comment as to whether we should exclude certain types of

entities, including those noted above, as well as to entities subject

to bank capital rules, State-regulated insurers, private and State

pension plans, and registered derivatives clearing organizations or

clearing agencies.

Commenters particularly are requested to address whether such

exclusions are necessary and appropriate in light of the proposed rules

that would be applicable to major participants, whether any conditions

would be appropriate for such exclusions, and whether modifying those

proposed rules would more effectively address these issues than

granting specific exclusions from the major participant definitions for

specific types of entities. Commenters also are particularly requested

to discuss whether banks should be excluded from the major participant

definitions because of the regulation to which they already are

subject. Commenters also are requested to discuss whether registered

investment companies should be excluded from the major participant

definitions because of the regulations to which they already are

subject, and whether registered investment companies would be able to

comply with capital and margin requirements applicable to major

participants.

Commenters also particularly are requested to address whether

sovereign wealth funds or other entities linked to foreign governments

should be excluded from the major participant definitions, particularly

in light of the provisions of the Dodd-Frank Act governing its

territorial reach, and whether the answer in part should be determined

based on whether the entity's obligations are backed by the full faith

and credit of the foreign government.

V. Administrative Law Matters--CEA Revisions (Definitions of ``Swap

Dealer'' and ``Major Swap Participant,'' and Amendments to Definition

of ``Eligible Contract Participant'')

A. Regulatory Flexibility Act

The Regulatory Flexibility Act requires that agencies consider

whether the rules they propose will have a significant economic impact

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

regulatory flexibility analysis respecting the impact.\171\ The rules

proposed by the CFTC provide definitions that will largely be used in

future rulemakings and which, by themselves, impose no significant new

regulatory requirements. Accordingly, the Chairman, on behalf of the

CFTC, hereby certifies pursuant to 5 U.S.C. 605(b) that the proposed

rules will not have a significant economic impact on a substantial

number of small entities.

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

\171\ 5 U.S.C. 601 et seq.

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

B. Paperwork Reduction Act

The proposed rule will not impose any new recordkeeping or

information collection requirements, or other collections of

information that require approval of the Office of Management and

Budget under the Paperwork Reduction Act.\172\ The CFTC invites public

comment on the accuracy of its estimate that no additional

recordkeeping or information collection requirements or changes to

existing collection requirements would result from the rules proposed

herein.

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

\172\ 44 U.S.C. 3501 et seq.

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

C. Cost-Benefit Analysis

Section 15(a) of the CEA \173\ requires the CFTC to consider the

costs and benefits of its actions before issuing a rulemaking under the

CEA. By its terms, Section 15(a) does not require the CFTC to quantify

the costs and benefits of a rule or to determine whether the benefits

of the rulemaking outweigh its costs; rather, it requires that the CFTC

``consider'' the costs and benefits of its actions. Section 15(a)

further specifies that the costs and benefits shall be evaluated in

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

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

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

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

considerations. The CFTC may in its discretion give greater weight to

any one of the five enumerated areas and could in its discretion

determine that, notwithstanding its costs, a particular rule is

necessary or appropriate to protect the public interest or to

effectuate any of the provisions or accomplish any of the purposes of

the CEA.

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

\173\ 7 U.S.C. 19(a).

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

1. Summary of Proposed Requirements

The proposed regulations would further define the terms ``swap

dealer,'' ``eligible contract participant,'' ``major swap

participant,'' and related terms, including ``substantial position''

and ``substantial counterparty exposure.'' The proposed regulations

regarding eligible contract participants are clarifying changes that

are not expected to have substantive effects on market participants.

The proposed regulations further defining swap dealer and major swap

participant are significant because any entity determined to be a swap

dealer or major swap participant would be subject to registration,

margin, capital, and business conduct requirements set forth in the

Dodd-Frank Act, as those requirements are implemented in rules proposed

or to be proposed by the CFTC. Those requirements will likely lead to

compliance costs, capital holding costs, and margin posting costs,

which have been or will be addressed in the CFTC's proposals to

implement those requirements. On the other hand, those requirements

will likely lead to benefits in the form of increased market

transparency, reduced counterparty risk and a lower incidence of

systemic crises and other market failures. This discussion concerns the

costs and benefits arising from the proposed definitional tests

themselves, in terms of the burden on market participants to determine

how the proposed definitions apply, and the benefits arising from the

specificity of the proposals.

2. Proposed Regulations Regarding ``Eligible Contract Participant''

The proposal regarding ``eligible contract participant'' would

provide that swap dealers and major swap participants would qualify as

eligible contract participants. The CFTC believes this proposal is in

line with the expectations of market participants and would impose

virtually no costs while providing the benefit of greater certainty.

The proposal would also

[[Page 80204]]

provide that certain commodity pools could not qualify as eligible

contract participants under certain provisions specified in the

proposal. The CFTC believes that this proposal clarifies the

interpretation of this aspect of the eligible contract participant

definition and would prevent the commodity pools from using a provision

of the definition that was not intended to apply to the commodity

pools. Thus, while the proposal would potentially impose some costs on

the commodity pools that could no longer rely on certain provisions of

the definition, benefits would arise from preventing the

misinterpretation of the definition.

3. Proposed Regulations Regarding ``Swap Dealer''

The proposal regarding ``swap dealer'' would further define the

term by providing that any person that engages in specified activities

is a swap dealer. The proposal describes these activities qualitatively

and in relatively general terms that apply in the same way to all parts

of the swap markets. With regard to the de minimis exemption from the

definition, the proposal sets out bright-line quantitative tests to

determine if a person's swap dealing activity is de minimis. For the

exclusion of swaps in connection with originating a loan by an insured

depository institution, the proposal describes the scope of the

exclusion qualitatively in terms that depend primarily on the terms of

the swaps that would be eligible for the exclusion and the identity of

the parties to the swap. Also, the proposal includes a voluntary

process by which a swap dealer may request that the CFTC limit the swap

dealer designation to certain aspects of the person's activity.

a. Costs

The costs to a market participant from the proposed regulations

further defining ``swap dealer'' would arise primarily from its need to

review its activities and determine, as a qualitative matter, whether

its activities are of the type described in the proposal. As its

activities change from time to time, it would be necessary to repeat

this review, and ongoing compliance costs may arise if the market

participant determines that it should adapt its activities so as to not

be encompassed by the definition. Because the proposed regulations are

qualitative and on relatively general terms, there may be multiple

interpretations of the general criteria by market participants. A

market participant whose activities fall within the realm of those

described in the proposal may have to incur the costs of a more focused

review to determine whether or not it is encompassed by the definition.

The proposal regarding the de minimis exemption, on the other hand,

would impose lower costs because of the precise, quantitative nature of

the proposed exemption. A market participant would incur only the cost

of determining the applicable quantities, such as notional value,

number of swaps, number of counterparties, and so forth set out in the

proposal. The CFTC believes that relatively few market participants

would have to determine whether the de minimis exemption applies to

their activities, and there would be only a low number of instances

where application of the quantitative tests would be uncertain.

Similarly, the CFTC believes that insured depository institutions would

incur relatively low costs to apply the proposed exclusion of swaps in

connection with originating loans because the proposed criteria relate

to matters in which the institution is directly involved.

Last, the costs of the voluntary process for a request for a

limited designation as a swap dealer are difficult to predict because

they would depend on the complexity of the person making the request

and the particular factors that are relevant to the limited

designation. The CFTC believes that the person making the request would

have broad discretion in determining how to do so and thereby could

control the costs of the request to some extent.

b. Benefits

The benefits of the proposed regulations further defining ``swap

dealer'' include that they set out a single set of criteria to be

applied by all market participants. Thus, the proposed regulations

create a level playing field that permits all market participants to

determine, on an equal basis, which activities would potentially lead

to designation as a swap dealer. The proposed regulations are set out

in plain language terms that may be understood and applied by all

market participants without relying on the technical expertise that may

be required to implement more elaborate tests. The CFTC believes that

the proposal can be fairly applied by substantially all market

participants who could potentially be swap dealers.

Regarding the proposals regarding the de minimis exemption and the

exclusion of swaps in connection with the origination of loans,

benefits arise from the relatively specific, quantitative nature of the

proposals. Since these proposals are expected to be applied by

relatively few market participants in limited situations, more detailed

regulations are appropriate. The CFTC believes that these detailed

criteria will permit market participants to make a relatively quick and

low-cost determination of whether the exemption or exclusion apply. The

proposal for requests for a limited swap dealer designation provides

the benefit of flexibility to allow each market participant making this

request to determine how to do so.

4. Proposed Regulations Regarding ``Major Swap Participant''

The proposal regarding ``major swap participant'' would further

define the term by setting out quantitative thresholds against which a

market participant would compare its swap activities to determine

whether it is encompassed by the definition. The proposal would require

that potential major swap participants analyze their swaps in detail to

determine, for example, which of their swaps are subject to netting

agreements or mark-to-market collateralization and the amount of

collateral posted with respect to the swaps. The proposal includes a

general, qualitative definition of the swaps that may be excluded from

the comparison because they are used to ``hedge or mitigate commercial

risk.'' Like the swap dealer proposal, there is a voluntary process by

which a major swap participant may request that the CFTC limit the

major swap participant designation to certain aspects of the person's

activity.

a. Costs

The costs to a market participant from the proposed regulations

further defining ``major swap participant'' would arise primarily from

its need to analyze its swaps and determine whether it has a

``substantial position'' or ``substantial counterparty exposure'' as

defined in the proposal. The proposed rule defines potential future

exposure by a factor of the dollar notational value of the swap. The

Commission also considered market-based tests of potential future

exposure such as margin requirements or other valuations of the

outstanding position. The Commission decided in favor of a more easily

implementable test rather than market-based criteria for potential

future exposure, given that daily variation in market prices is

captured by the current exposure calculation. The CFTC believes that

because the proposed quantitative thresholds are high, only very few

market participants would have to conduct a detailed analysis to

determine whether they are encompassed by the proposed

[[Page 80205]]

definition. The cost of the detailed analysis would vary for each

market participant, depending on the particular characteristics of its

swaps. Similarly, the costs to a market participant of determining

whether it uses swaps to hedge or mitigate commercial risk would depend

on how the market participant uses swaps. It is possible that for some

market participants with complex positions in swaps, the costs of the

analysis could be relatively high.

As is the case for the similar proposal regarding swap dealers, the

costs of the voluntary process for a request for a limited designation

as a major swap participant are difficult to predict because they would

depend on the complexity of the particular case. The CFTC believes that

the person making the request would have broad discretion in

determining how to do so and thereby could control the costs of the

request to some extent.

b. Benefits

The benefits of the proposed regulations further defining ``major

swap participant'' include that they set out a quantitative, bright-

line test that can be applied at a relatively low cost. Also, the

definition of ``hedging or mitigating commercial risk'' is stated in

general terms that may be flexibly applied by potential major swap

participants. In preparing this proposal, the CFTC considered other

methods of defining ``major swap participant,'' including multi-factor

analyses, stress tests and adversary processes. The CFTC believes that

these other methods would impose significantly higher costs for both

the market participants that would have to apply them and for the CFTC

(and, indirectly, the taxpayer), without providing additional benefits.

The costs would result primarily from the need to retain qualified

experts who would devote significant time and other resources to a

detailed analysis of multiple aspects of the potential major swap

participant's swap positions. The benefits that could justify more

costly proposals include reductions in arbitrary differences in results

and greater consistency and predictability. However, other potential

methods of further defining ``major swap participant'' do not appear

likely to provide such benefits to an extent that would justify the

higher costs.

5. Request for Comment

The CFTC invites public comment on its cost-benefit considerations.

Commenters are also invited to submit any data or other information

that they may have quantifying or qualifying the costs and benefits of

the proposed rules with their comments.

D. Consideration of Impact on the Economy

For purposes of the Small Business Regulatory Enforcement Fairness

Act of 1996 (``SBREFA'') \174\ the CFTC must advise the Office of

Management and Budget as to whether the proposed rules constitute a

``major'' rule. Under SBREFA, a rule is considered ``major'' where, if

adopted, it results or is likely to result in: (1) An annual effect on

the economy of $100 million or more (either in the form of an increase

or a decrease); (2) a major increase in costs or prices for consumers

or individual industries; or (3) significant adverse effect on

competition, investment or innovation. If a rule is ``major,'' its

effectiveness will generally be delayed for 60 days pending

Congressional review. We do not believe that any of the proposed rules,

in their current form, would constitute a major rule.

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

\174\ Public Law 104-121, Title II, 110 Stat. 857 (1996)

(codified in various sections of 5 U.S.C., 15 U.S.C. and as a note

to 5 U.S.C. 601).

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

We request comment on the potential impact of the proposed rules on

the economy on an annual basis, on the costs or prices for consumers or

individual industries, and on competition, investment or innovation.

Commenters are requested to provide empirical data and other factual

support for their views to the extent possible.

VI. Administrative Law Matters--Exchange Act Rules (Definitions of

``Security-Based Swap Dealer'' and ``Major Security-Based Swap

Participant'')

A. Paperwork Reduction Act Analysis

Certain provisions of the proposed rules may impose new

``collection of information'' requirements within the meaning of the

Paperwork Reduction Act of 1995 (``PRA'').\175\ The SEC has submitted

them to the Office of Management and Budget (``OMB'') for review in

accordance with 44 U.S.C. 3507 and 5 CFR 1320.11. The title of the new

collection of information is ``Procedural Requirements Associated with

the Definition of `Hedging or Mitigating Commercial Risk.''' An agency

may not conduct or sponsor, and a person is not required to respond to,

a collection of information unless it displays a currently valid OMB

control number. OMB has not yet assigned a control number to the new

collection of information.

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

\175\ 44 U.S.C. 3501 et seq.

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

1. Summary of Collection of Information

Proposed Exchange Act rule 3a67-4 would define the term ``hedging

or mitigating commercial risk.'' \176\ Security-based swap positions

that meet this proposed definition would be excluded from the

``substantial position'' analysis under the first test of the proposed

definition of major security-based swap participant.

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

\176\ As noted previously, the concept of ``hedging or

mitigating commercial risk'' also is found in the statutory

provisions granting an exception to end-users from the mandatory

clearing requirement in connection with swaps and security-based

swaps. See CEA section 2(h)(7)(A); Exchange Act section 3C(g)(1)(B)

(exception from mandatory clearing requirements when one or more

counterparties are not ``financial entities'' and are using swaps or

security-based swaps ``to hedge or mitigate commercial risk''). If

the proposed rule 3a67-4 definition of ``hedging or mitigating

commercial risk'' is used any future SEC rulemakings, including

rulemaking with respect to the end-user exception, any necessary

discussion of administrative law matters relating to the use of

proposed rule 3a67-4 will be provided at that time.

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

For a security-based swap position to be held for the purpose of

hedging or mitigating commercial risk under proposed rule 3a67-4, the

person holding the position must satisfy several conditions, including

the following:

(i) The person must identify and document the risks that are being

reduced by the security-based swap position;

(ii) The person must establish and document a method of assessing

the effectiveness of the security-based swaps as a hedge; and

(iii) The person must regularly assess the effectiveness of the

security-based swap as a hedge.

2. Proposed Use of Information

The collections of information in proposed rule 3a67-4 are designed

to help prevent abuse of the exclusion and to help ensure that the

exclusion is only available to those entities that are engaged in

legitimate hedging or risk mitigating activities.

3. Respondents

The collections of information in proposed rule 3a67-4 would apply

to those entities seeking to exclude the security-based swap positions

held for hedging or mitigating commercial risk from the substantial

position calculation. As discussed below in Section VI.B.4., based on

the current market, we estimate that approximately 10 entities have

security-based swap positions of a magnitude that they could

potentially reach the major security-based swap participant thresholds.

Accordingly, we estimate that approximately 10 entities would seek to

avail themselves of the exclusion from

[[Page 80206]]

the substantial position calculation for security-based swap positions

held for hedging or mitigating commercial risk.

4. Total Annual Reporting and Recordkeeping Burden

We do not anticipate that the proposed collection of information in

proposed rule 3a67-4 would cause the estimated 10 entities to incur any

new costs. We believe that only highly sophisticated market

participants would potentially meet the proposed thresholds for the

major security-based swap participant designation and thus have a need

to take advantage of the exclusion for positions held for hedging or

mitigating commercial risk (and be required to meet the attendant

collection requirements). We understand from our staff's discussions

with industry participants that the entities that have security-based

swap positions and exposures of this magnitude currently create and

maintain the documentation proposed to be required in rule 3a67-4, as

part of their ordinary course business and risk management

practices.\177\ Thus, we do not believe that any new burdens or costs

will be imposed on the approximately 10 entities that may seek to use

the exclusion. We therefore estimate the total annual reporting and

recordkeeping burden associated with proposed rule 3a67-4 to be

minimal.

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

\177\ Some entities follow these types of procedures so that

their hedging transactions will qualify for hedge accounting

treatment under generally accepted accounting principles, which

requires procedures similar to those in proposed rule 3a67-4.

Hedging relationships involving security-based swaps that qualify

for the hedging or mitigating commercial risk exception in the

proposed rule are not limited to those recognized as hedges for

accounting purposes. We believe that all of the estimated 10

entities that have security-based swap positions of a magnitude that

they could potentially be deemed to be major security-based swap

participants already identify and document their risk management

activities (including their security-based swap positions used to

hedge or mitigate commercial risks) and assess the effectiveness of

those activities as a matter of their ordinary business practice--

even if they are not seeking hedge accounting treatment.

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

5. Collection of Information is Mandatory

The collections of information in proposed rule 3a67-4 would be

mandatory for those entities seeking to exclude positions they hold for

hedging or mitigating commercial risk from the substantial position

calculation.

6. Confidentiality

There is no proposed requirement that the collections of

information in proposed rule 3a67-4 be provided to the SEC or a third

party on a regular, ordinary course basis. In a situation where the SEC

has obtained the information, the SEC would consider requests for

confidential treatment on a case-by-case basis.

7. Record Retention Period

Proposed rule 3a67-4 does not contain a specific record retention

requirement. Nonetheless, we would expect the approximately 10 entities

that may seek to use the exclusion for positions held for hedging or

mitigating commercial risk to maintain the records they create in

connection with the exclusion. Because we understand from our staff's

discussions with industry participants that the entities that have

security-based swap positions and exposures of this magnitude currently

create and maintain the documentation proposed to be required in rule

3a67-4, as part of their ordinary course business and risk management

practices, we do not expect any new burdens or costs will be imposed to

maintain the records.

8. Request for Comments

The SEC invites comments on these estimates. Pursuant to 44 U.S.C.

3506(c)(2)(B), the SEC requests comments in order to: (a) Evaluate

whether the collection of information is necessary for the proper

performance of our functions, including whether the information will

have practical utility; (b) evaluate the accuracy of our estimate of

the burden of the collection of information; (c) determine whether

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

information to be collected; and (d) evaluate whether there are ways to

minimize the burden of the collection of information on those who

respond, including through the use of automated collection techniques

or other forms of information technology.

Persons submitting comments on the collection of information

requirements should direct them to the Office of Management and Budget,

Attention: Desk Officer for the Securities and Exchange Commission,

Office of Information and Regulatory Affairs, Washington, DC 20503, and

should also send a copy of their comments to Elizabeth M. Murphy,

Secretary, Securities and Exchange Commission, 100 F Street, NE.,

Washington, DC 20549-1090, with reference to File No. S7-39-10.

Requests for materials submitted to OMB by the SEC with regard to this

collection of information should be in writing, with reference to File

No. S7-39-10, and be submitted to the Securities and Exchange

Commission, Records Management, Office of Filings and Information

Services, 100 F Street, NE., Washington, DC 20549-1090. As OMB is

required to make a decision concerning the collections of information

between 30 and 60 days after publication, a comment to OMB is best

assured of having its full effect if OMB receives it within 30 days of

publication.

B. Consideration of Benefits and Costs

1. Introduction

The Dodd-Frank Act added definitions of ``security-based swap

dealer'' and ``major security-based swap participant'' to the Exchange

Act in conjunction with other provisions that require entities meeting

either of those definitions to register with the SEC and to be subject

to capital, margin, business conduct and certain other requirements.

Consistent with the direction of the Dodd-Frank Act, the SEC is

proposing rules to further define ``major security-based swap

participant'' along with additional terms used in that definition. The

SEC also is proposing rules to further define ``security-based swap

dealer'' and to set forth factors for determining the availability of

the de minimis exception from that definition. We believe that these

proposed rules are consistent with the purposes of the Dodd-Frank Act,

and, as appropriate, set forth objective standards to facilitate market

participants' compliance with the amendments that the Dodd-Frank Act

made to the Exchange Act. Market participants, however, may incur costs

associated with certain of these proposed rules.

The SEC believes that there would be two categories of potential

costs. First, there would be costs associated with the regulatory

requirements that would apply to a ``security-based swap dealer'' or a

``major security-based swap participant'' (e.g., the registration,

margin, capital, and business conduct requirements that would be

imposed on security-based swap dealers and major security-based swap

participants). While the specific costs and benefits associated with

these regulatory requirements are being addressed in the SEC's

proposals to implement those requirements, we recognize that the costs

and benefits of these proposed definitions are directly linked to the

costs and benefits of the requirements applicable to dealers and major

participants. We welcome comment on the costs and benefits of these

proposed definitions in that broader context.

Second, there may be costs that entities incur in determining

whether they qualify as a ``security-based swap dealer'' or a ``major

security-based swap participant'' under the proposed definitional

rules. These costs, along

[[Page 80207]]

with the benefits associated with the proposed rules, are discussed

below.

2. Proposed Exchange Act rule 3a67-1--Definition of ``Major Security-

Based Swap Participant''

Proposed Exchange Act rule 3a67-1 would largely restate the

statutory definition of ``major security-based swap participant,'' to

consolidate the definition and related interpretations for ease of

reference.

A person that meets the definition of major security-based swap

participant generally will be subject to the requirements applicable to

major security-based swap participants without regard to the purpose

for which it enters into a security-based swap, and without regard to

the particular category of security-based swap.\178\ However, the

statutory definitions provide that a person may be designated as a

major security-based swap participant for one or more categories of

security-based swaps or for particular activities without being

classified as a major security-based swap participant for all

categories or activities.\179\ Proposed rule 3a67-1 would provide that

a major security-based swap participant that engages in significant

activity with respect to only certain types, classes or categories of

security-based swaps or only in connection with specified activities,

could obtain relief with respect to other types of security-based swaps

from certain of the requirements that are applicable to major security-

based swap participants. The rule would have the benefit of

implementing the statutory provision and providing that major security-

based swap participants may obtain relief from the SEC. A person that

seeks to be considered to be a major security-based swap participant

only with respect to one category of security-based swaps, or only with

respect to certain activities, would be expected to incur costs in

connection with requesting an order from the SEC. However, any such

costs would be voluntarily incurred by any person seeking to take

advantage of that limited designation, and thus we preliminarily do

believe that those costs would be attributable to the statute and not

to this rule.

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

\178\ The specific costs associated with these regulatory

requirements will be addressed in the SEC's proposals to implement

those requirements.

\179\ See Exchange Act section 3(a)(67)(C).

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

3. Proposed Exchange Act Rule 3a67-2--``Major'' Categories of Security-

Based Swaps

Proposed Exchange Act rule 3a67-2 would fulfill Congress's mandate

that the SEC designate ``major'' categories of security-based swaps by

setting forth two such ``major'' categories--one consisting of credit

derivatives and the other consisting of equity-swaps and other

security-based swaps. We believe that these proposed categories would

have the benefit of being consistent with the different ways in which

those products are used, as well as market statistics and current

market infrastructures (particularly the separate trade warehouses for

credit default swaps and equity swaps). Although, as discussed below,

this categorization is relevant to the ``substantial position'' tests

of the ``major security-based swap participant'' definition, we believe

that the categorization itself would not impose any costs on market

participants. While the categorization may affect the costs that market

participants will incur from particular statutory and regulatory

requirements applicable to major security-based swap participants,\180\

those costs are being addressed in our proposals to implement those

requirements.

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

\180\ For example, distinguishing between categories of

security-based swaps may cause some entities to incur additional

costs to calculate their major security-based swap participant

status with respect to each category. Similarly, categorization may

affect whether an entity ultimately qualifies as a major security-

based swap participant.

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

4. Proposed Exchange Act Rule 3a76-3--Definition of ``Substantial

Position''

Proposed Exchange Act rule 3a67-3 would define the term

``substantial position,'' which is used in the first and third tests of

the definition of ``major security-based swap participant.'' The Dodd-

Frank Act requires the SEC to define this term. We have proposed two

tests for identifying the presence of a substantial position--one test

based on a daily average measure of uncollateralized mark-to-market

exposure, and one based on a daily average measure of combined

uncollateralized mark-to-market exposure and potential future exposure.

Both of these daily measures would be calculated and averaged over a

calendar quarter.

We believe that this proposed definition would have the benefit of

providing objective criteria that reasonably would measure the risks

associated with security-based swap positions, and reflect the

counterparty risk and risk to the market factors that are embedded

within the ``major security-based swap participant'' definition. We

also believe that the proposed use of objective numerical criteria for

the substantial position thresholds would promote the predictable

application and enforcement of the requirements governing major

security-based swap participants by permitting market participants to

readily evaluate whether their security-based swap positions meet the

thresholds.

The first ``substantial position'' test would encompass entities

that have a daily average uncollateralized mark-to-market exposure of

$1 billion in a major category of security-based swaps. The second

``substantial position'' test would encompass entities that have a

daily average combined uncollateralized mark-to-market exposure and

potential future exposure of $2 billion. Potential future exposure

would be measured, consistent with bank capital rules, largely by

multiplying notional positions by risk factors. Additional adjustments

would reflect netting agreements, the presence of central clearing and

the presence of daily mark-to-market margining practices.

As previously noted, there will be costs associated with the

registration, margin, capital, business conduct, and other requirements

that will be imposed on major security-based swap participants. Those

costs are being addressed in the SEC's rule proposals to implement

those requirements. We also believe that there will be costs incurred

by entities in determining whether they meet the definition of major

security-based swap participant. These costs are discussed below.

Based on the current over-the-counter derivatives market, we

estimate that no more than 10 entities that are not otherwise security-

based swap dealers would have either uncollateralized mark-to-market

positions \181\ or

[[Page 80208]]

combined uncollateralized current exposure and potential future

exposure of a magnitude \182\ that may rise close enough to the levels

of our proposed thresholds to necessitate monitoring to determine

whether they meet those thresholds. Additionally, we preliminarily

believe that all of these approximately 10 entities currently maintain

highly sophisticated financial operations in order to achieve the large

security-based swap positions necessitating their use of the tests.

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

\181\ We believe that an estimate of an entity's mark-to-market

exposure associated with its security-based swap positions can be

derived from the level of an entity's notional positions. We

recognize that the ratio of exposure to notional amount will vary by

market participant and by position. We understand that mark-to-

market exposures associated with credit derivative positions on

average are equal to approximately three percent of an entity's

level of notional positions in credit derivatives. This estimate is

based on second quarter 2010 U.S. bank market statistics involving

credit derivatives, given that banks have credit derivative

positions with gross positive fair value (which would equate to

negative fair value for the banks' counterparties) of $403 billion,

compared to total notional credit derivative positions of $13.9

trillion. See Office of the Comptroller of the Currency, ``OCC's

Quarterly Report on Bank Trading and Derivatives Activities''

(Second Quarter 2010) at 4 & Table 12. This data suggests that, on

average, an entity would need to have notional credit derivative

positions of roughly $33 billion to meet our proposed threshold for

the first substantial position test, $1 billion in mark-to-market

exposure.

We understand, based on our staff's discussions with industry,

that approximately 39 entities have credit default swap notional

positions of roughly $33 billion or above. We understand that the

large majority of those entities are banks or hedge funds (which we

would expect to fully collateralize their positions with dealers as

a matter of course). We further understand that banks, securities

firms, and hedge funds typically collateralize most or all of their

mark-to-market exposure to U.S. banks as a matter of practice. See

OCC's Quarterly Report on Bank Trading and Derivatives Activities

(second quarter 2010) at 6. Therefore, it is not clear if any

entities would have uncollateralized credit default swap positions

near the proposed first substantial position threshold of $1 billion

uncollateralized outward exposure.

\182\ The proposed risk multiplier of 0.1 for credit derivatives

would require an entity to have a notional position of $20 billion

in credit derivatives to reach the proposed $2 billion potential

future exposure threshold (even before accounting for netting

adjustments). The proposed additional multiplier of 0.2 for

security-based swaps cleared by a registered clearing agency or

subject to daily mark-to-market margining would mean that an entity

with credit derivative positions that are cleared or subject to

daily mark-to-market margining would need a notional position in

credit derivatives of at least $100 billion to potentially reach the

proposed $2 billion potential future exposure threshold. In this

example, we are assuming an uncollateralized outward exposure of

zero.

We understand, based on our staff's discussions with industry,

that there are approximately 10 non-dealer entities that have a

notional position in credit derivatives of over $50 billion.

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

We expect the costs associated with the proposed substantial

position tests to be modest for these entities. We understand that the

entities that have this magnitude of security-based swap positions

already monitor and collect all of the data necessary for the proposed

substantial position tests. Preliminarily, we understand that these

entities already use automated systems to gauge their positions and

exposures and assist in their risk management. Accordingly, we estimate

that each of the entities would incur a one-time programming cost,\183\

as well as ongoing costs associated with the continuing use and

monitoring of the testing.\184\ We estimate that the one-time

programming cost would be approximately $13,444 per entity, and

$134,440 for all entities.\185\ We estimate that the annual ongoing

costs would be approximately $7,260 per entity, and $72,600 for all

entities.\186\

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

\183\ For each of the entities, we estimate that the initial

programming would require the following levels of work from a

Compliance Attorney, Compliance Manager, Programmer Analyst, Senior

Internal Auditor, and Chief Financial Officer. The estimated

contributions are as follows: approximately 2 hours of work from a

Compliance Attorney to advise the entity's compliance department on

the legal requirements associated with the proposed tests;

approximately 8 hours of work from a Compliance Manager to assist a

Programmer Analyst in making the necessary changes to the entity's

existing automated system and to oversee and manage the entire

programming process; approximately 40 hours of work from a

Programmer Analyst to make the necessary programming changes to the

existing automated system and to test the system; approximately 8

hours of work from a Senior Internal Auditor to perform quality

assurance to ensure that the automated system is properly performing

the proposed tests; and approximately 3 hours of work from the

entity's Chief Financial Officer to monitor the process. We estimate

that the hourly wage of a Compliance Attorney, Compliance Manager,

Programmer Analyst, Senior Internal Auditor, and Chief Financial

Officer would be approximately $291, $294, $190, $195, and $450,

respectively. The $291/hour figure for a Compliance Attorney, the

$294/hour figure for a Compliance Manager, the $190/hour figure for

a Programmer Analyst, and the $195/hour figure for a Senior Internal

Auditor are from SIFMA's Management & Professional Earnings in the

Securities Industry 2009, modified by SEC staff to account for an

1800-hour work-year and multiplied by 5.35 to account for bonuses,

firm size, employee benefits, and overhead. The $450/hour figure for

a Chief Financial Officer is from http://www.payscale.com, modified

by SEC staff to account for an 1800-hour work-year and multiplied by

5.35 to account for bonuses, firm size, employee benefits, and

overhead. See http://www.payscale.com (last visited Nov. 1, 2010).

\184\ We anticipate that each entity would incur ongoing

monitoring costs to evaluate their test results and to ensure that

the tests are properly run. We estimate that each entity would have

a Senior Internal Auditor spend approximately 4 hours each quarter

(or a total of 16 hours annually) to perform this quality assurance.

We also estimate that each entity would need a Compliance Attorney,

a Compliance Manager, and its Chief Financial Officer to each spend

approximately 1 hour each quarter (or a total of 4 hours annually)

to monitor the entity's test results and the entity's status under

the proposed rule.

\185\ The estimated one-time programming cost of approximately

$13,444 per entity and $134,440 for all entities was calculated as

follows: (Compliance Attorney at $291 per hour for 2 hours) +

(Compliance Manager at $294 per hour for 8 hours) + (Programmer

Analyst at $190 per hour for 40 hours) + (Senior Internal Auditor at

$195 per hour for 8 hours) + (Chief Financial Officer at $450 per

hour for 3 hours) x (10 entities) = $134,440.

\186\ The estimated ongoing monitoring cost of approximately

$7,260 per year per entity and $72,600 per year for all entities was

calculated as follows: (Senior Internal Auditor at $195 per hour for

16 hours) (Compliance Attorney at $291 per hour for 4 hours) +

(Compliance Manager at $294 per hour for 4 hours) + (Chief Financial

Officer at $450 per hour for 4 hours) x (10 entities) = $72,600.

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

5. Proposed Exchange Act Rule 3a67-4--Definition of ``Hedging or

Mitigating Commercial Risk''

Proposed Exchange Act rule 3a67-4 would define the term ``hedging

or mitigating commercial risk.'' Security-based swap positions that

meet that definition are excluded from the ``substantial position''

analysis under the first test of the major participant definition. The

proposed rule is intended to be objective and promote the predictable

application and enforcement of the requirements governing major

security-based swap participants.

For a security-based swap position to be held for the purpose of

hedging or mitigating commercial risk under proposed Exchange Act rule

3a67-4, the person holding the position must satisfy certain

conditions:

(i) The person must identify and document the risks that are being

reduced by the security-based swap position;

(ii) The person must establish and document a method of assessing

the effectiveness of the security-based swap as a hedge; and

(iii) The person must regularly assess the effectiveness of the

security-based swap as a hedge.

Proposed rule 3a67-4 would affect whether an entity will meet the

definition of major security-based swap participant. The specific costs

associated with these regulatory requirements are being addressed in

the SEC's proposals to implement those requirements.

While we expect that there could be some potential costs associated

with the procedural requirements of proposed rule 3a67-4, as described

in Section VI.B.4., supra, we expect only highly sophisticated entities

to hold security-based swap positions of a magnitude that would require

use of the proposed tests. Thus, we do not anticipate that these

proposed procedural requirements would cause market participants to

incur costs that they do not incur already as a matter of their

ordinary business and risk management practices. Accordingly, we do not

expect that the proposed definition of ``hedging or mitigating

commercial risk'' would impose any costs on the potentially affected

entities beyond those already regularly incurred by these entities as a

matter of course.

6. Proposed Exchange Act Rule 3a67-5--Definition of ``Substantial

Counterparty Exposure That Could Have Serious Adverse Effects on The

Financial Stability of The United States Banking System or Financial

Markets''

Proposed Exchange Act rule 3a67-5 would define ``substantial

counterparty exposure that could have serious adverse effects on the

financial stability of the United States banking system or financial

markets,'' a term that comprises part of the second test of the ``major

security-based swap participant'' definition. This proposed rule would

[[Page 80209]]

parallel the ``substantial position'' analysis discussed above, but

would examine an entity's security-based swap positions as a whole

(rather than focusing on a particular ``major'' category), and would

not exclude certain hedging positions. Consistent with this broader

scope, and the proposal that there be two ``major'' categories of

security-based swaps, the thresholds used in this test would be two

times the comparable ``substantial position'' thresholds. We believe

that this approach reasonably would measure the counterparty exposure

associated with the entirety of an entity's security-based swap

positions, consistent with the risk factors in the ``major security-

based swap participant'' definition. Additionally, we believe that the

proposed definition would provide objective criteria and promote the

predictable application and enforcement of the requirements governing

major security-based swap participants by permitting market

participants to readily evaluate whether their security-based swap

positions meet the proposed thresholds.

We believe that the same approximately 10 entities would calculate

their substantial counterparty exposure under this rule as would

undertake the substantial position calculation under proposed rule

3a67-3. Given that the threshold for this proposed rule is derived from

the calculations of substantial position that would be mandated by

proposed rule 3a67-3, we do not anticipate that it would create any

costs outside of those already covered in the discussion of the

estimated costs associated with the proposed definition of substantial

position.

7. Proposed Exchange Act Rule 3a67-6--Definitions of ``Financial

Entity'' and ``Highly Leveraged''

Proposed Exchange Act rule 3a67-6 would define the terms

``financial entity'' and ``highly leveraged,'' both of which are used

in the third test of the ``major security-based swap participant''

definition. The proposed definition of ``financial entity'' would be

consistent with the use of that term in the Title VII exception from

mandatory clearing for end-users of security-based swaps (subject to

limited technical changes). One of the two alternative proposed

definitions of ``highly leveraged'' would be consistent with a standard

used in Title I of the Dodd-Frank Act, while the other alternative is

based on an understanding of typical leverage ratios for certain

financial entities. We believe that these proposed alternative

standards would apply reasonable objective criteria to implement and

further define the third test. Additionally, we believe that the

proposed use of these objective definitions and numerical criteria

would promote the predictable application and enforcement of the

requirements governing major security-based swap participants by

permitting market participants to readily evaluate whether they meet

the threshold for major security-based swap participant status.

We do not believe that the proposed definition of ``financial

entity'' would impose any significant costs on market entities, given

the objective nature of the definition. We also do not believe that the

proposed definition of ``highly leveraged''--a balance sheet test that

would be based on the ratio of an entity's liabilities and equity, and

that, in the case of entities subject to public reporting requirements,

could be derived from financial statements filed with the SEC--would

impose any significant costs on entities that have security-based swap

positions large enough to potentially meet the ``substantial position''

requirement that is part of the third test.

8. Proposed Exchange Act Rule 3a67-7--Timing Requirements, Reevaluation

Period and Termination of Status

Proposed Exchange Act rule 3a67-7 would set forth methods for

specifying when an entity that satisfies the tests specified within the

definition of ``major security-based swap participant'' would be deemed

to meet that definition. The proposed rule also would address the

termination of an entity's status as a major security-based swap

participant. We believe that the proposed rule would set forth

pragmatic standards for permitting entities that have security-based

swap positions that require registration to go through the registration

process, and to terminate their status when appropriate. We believe

that this proposed rule would impose no direct costs on market

entities.\187\

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

\187\ As noted above, we recognize that major security-based

swap participants will incur costs associated with the registration

and termination of registration processes. These costs will be

addressed in the SEC rule's proposals to implement those

requirements.

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

9. Proposed Exchange Act Rule 3a71-1--Definition of ``Security-Based

Swap Dealer''

Proposed Exchange Act rule 3a71-1 largely would restate the

statutory definition of ``security-based swap dealer,'' to consolidate

the definition and related interpretations for market participants'

ease of reference. We are not proposing to further define the four

specific tests set forth in the ``security-based swap dealer''

definition. However, our release contains interpretive language that

would have the benefit of providing additional legal certainty to

market participants. While market participants would incur certain

costs to analyze whether their security-based swap activities cause

them to be on the ``dealer'' side of the dealer-trader distinction

(which would require them to register with the SEC and comply with the

other requirements applicable to security-based swap dealers unless

they can take advantage of the de minimis exception), these costs would

be incurred because of the statutory change, rather than due to

proposed rule 3a71-1. The Dodd-Frank Act determined that persons that

engage in dealing activities involving security-based swaps should be

subject to comprehensive regulation, and any such analytic costs arise

from Congress's determination to amend the Exchange Act.\188\

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

\188\ Based on our staff's discussions with industry, we

estimate that approximately 50 entities may be required to register

as security-based swap dealers following implementation of these

proposed rules. The specific costs associated with these regulatory

requirements will be addressed in the SEC's proposals to implement

those requirements.

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

10. Proposed Exchange Act Rule 3a71-2--de Minimis Exception

Proposed Exchange Act rule 3a71-2 would set forth factors for

determining whether a person that otherwise would be a security-based

swap dealer can take advantage of the de minimis exception. The Dodd-

Frank Act directed the SEC to promulgate these factors.\189\ The

proposed factors would account for an entity's annual notional

security-based swap positions in a dealing capacity, its total notional

security-based swap positions in a dealing capacity when the

counterparty is a ``special entity,'' \190\ and its total number of

counterparties and security-based swaps as a dealer. We believe that

these factors appropriately would focus on dealing activities that do

not warrant an entity's regulation as a security-based swap dealer. We

also believe that these objective numerical criteria for the de minimis

exception would promote the predictable application and enforcement of

the de minimis exception from security-based swap dealer status.

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

\189\ See Section 761(a)(6) of the Dodd-Frank Act.

\190\ See Section 15F(h)(2)(C) of the Exchange Act.

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

In general, we would expect a person that enters into security-

based swaps in a dealing capacity would, as a matter of course, be

aware of the notional amount

[[Page 80210]]

of those positions, whether a particular counterparty is a ``special

entity,'' and the total number of counterparties and security-based

swaps it has in a dealer capacity. As a result, we believe that there

would be no new costs incurred by entities in assessing the

availability of the de minimis exception. Moreover, any costs

associated with ensuring that a person can take advantage of the de

minimis exception would be voluntarily incurred by entities that engage

in dealing activities that seek to take advantage of the exception.

11. Request for Comments

The SEC requests comment on these estimated benefits and costs.

Commenters particularly are requested to address: the accuracy of our

estimate that there would be approximately 10 entities in the market

(that would not otherwise be security-based swap dealers) that would

have security-based swap positions of a magnitude that may rise close

enough to the levels of our proposed thresholds to necessitate

monitoring to determine whether they meet those thresholds; the

accuracy of our estimate that there would be approximately 50 entities

in the market that may be required to register as security-based swap

dealers following implementation of the proposed rules; the accuracy of

our estimates of the costs associated with entities performing the

proposed substantial position tests; whether the entities that have

security-based swap positions that are significant enough to

potentially meet one or more of the tests in the ``major security-based

swap participant'' definition would, as a matter of course, already

have the data necessary to perform the two proposed substantial

position tests, and if not, what additional data would they need and

how much time and expense would gathering that data require; whether

these same entities would, as a matter of course, already comply with

the proposed procedural requirements associated with the exclusion for

positions that are for the purpose of ``hedging or mitigating

commercial risk;'' and whether entities would change their behavior to

avoid meeting the proposed definitions of ``security-based swap

dealer'' or ``major security-based swap participant,'' and if so, what,

if any, economic costs would be associated with such behavioral

changes.

In addition, and more generally, we request comment on the costs

and benefits of these proposed definitions in the broader context of

the substantive rules, including capital, margin and business conduct

rules, applicable to dealers and major participants. Commenters

particularly are requested to address whether the proposed scope of the

dealer and major participant definitions are appropriate in light of

the costs and benefits associated with those substantive rules.

C. Consideration of Burden on Competition, and Promotion of Efficiency,

Competition, and Capital Formation

Section 3(f) of the Exchange Act requires the SEC, whenever it

engages in rulemaking and is required to consider or determine whether

an action is necessary or appropriate in the public interest, to

consider whether the action would promote efficiency, competition, and

capital formation.\191\ In addition, Section 23(a)(2) of the Exchange

Act \192\ requires the SEC, when adopting rules under the Exchange Act,

to consider the impact such rules would have on competition. Section

23(a)(2) of the Exchange Act also prohibits the SEC from adopting any

rule that would impose a burden on competition not necessary or

appropriate in furtherance of the purposes of the Exchange Act.

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

\191\ 15 U.S.C. 78c(f).

\192\ 15 U.S.C. 78w(a)(2).

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

We preliminarily do not believe that the proposed rules would

result in any burden on competition that is not necessary or

appropriate in furtherance of the purposes of the Exchange Act. We are

proposing rules to further define ``major security-based swap

participant,'' along with several terms used in that definition. We are

also proposing rules to further define ``security-based swap dealer''

and to set forth factors for determining the availability of the de

minimis exception from that definition. We believe that the proposed

rules are consistent with the purposes of Title VII of the Dodd-Frank

Act, and, as appropriate, set forth objective standards to facilitate

market participants' compliance with the amendments that Title VII of

the Dodd-Frank Act made to the Exchange Act. These amendments mandate

that the SEC regulate major security-based swap participants and

security-based swap dealers, which include some, but not all, entities

that enter into security-based swaps. Although regulation of certain

security-based swap market participants may result in competitive

burdens to these entities when compared to unregulated security-based

swap market participants, these burdens stem directly from Congress's

decision to impose regulation on a specified set of security-based swap

market participants through the Dodd-Frank Act.

While our decisions on how to further define the terms may have

some effect on competition (e.g., our determinations regarding the

proposed definition of substantial position will affect whether

entities qualify as major security-based swap participants), we

preliminarily do not believe that our decisions would impose additional

competitive burdens on entities outside of those that Congress

previously imposed through its decision in Title VII of the Dodd-Frank

Act to regulate and differentiate security-based swap market

participants. Moreover, we believe that defining substantial position

will help provide market participants with legal certainty regarding

their need to register as major security-based swap participants and is

necessary and appropriate to implement the purposes of regulating

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

We also preliminarily believe that the proposed rules would promote

efficiency. We believe that the proposed rules would set forth clear

objective standards to facilitate market participants' compliance with

the amendments that the Dodd-Frank Act made to the Exchange Act.

Moreover, we believe that the proposed rules would promote the

predictable application and enforcement of the Exchange Act. We also

have considered what effect, if any, our proposed rules would have on

capital formation. We preliminarily do not believe that our proposed

rules would have a negative effect on capital formation.

The SEC requests comment on the effect of the proposed rules on

efficiency, competition, and capital formation. Commenters are

particularly requested to address whether entities would change their

behavior to avoid meeting the proposed definitions of ``security-based

swap dealer'' or ``major security-based swap participant,'' and if so,

how. Commenters are also requested to address the effect, if any, that

the proposed definitions of ``substantial position,'' ``hedging or

mitigating commercial risk,'' ``substantial counterparty exposure,''

``financial entity,'' or ``highly leveraged,'' or the proposed

categories of security-based swaps would have on business decisions,

trading behavior, transaction costs, or capital allocation. We also

request comment on the effect, if any that the proposed de minimis

exception to the definition of security-based swap dealer would have on

business decisions, trading behavior, transaction costs, or capital

allocation, and if so, how. Commenters are particularly

[[Page 80211]]

encouraged to provide quantitative information to support their views.

D. Consideration of Impact on the Economy

For purposes of SBREFA, the SEC must advise the Office of

Management and Budget as to whether the proposed rules constitute a

``major'' rule. Under SBREFA, a rule is considered ``major'' where, if

adopted, it results or is likely to result in: (1) An annual effect on

the economy of $100 million or more (either in the form of an increase

or a decrease); (2) a major increase in costs or prices for consumers

or individual industries; or (3) significant adverse effect on

competition, investment or innovation. If a rule is ``major,'' its

effectiveness will generally be delayed for 60 days pending

Congressional review. We do not believe that any of the proposed rules,

in their current form, would constitute a major rule.

We request comment on the potential impact of the proposed rules on

the economy on an annual basis, on the costs or prices for consumers or

individual industries, and on competition, investment or innovation.

Commenters are requested to provide empirical data and other factual

support for their views to the extent possible.

E. Regulatory Flexibility Act Certification

The Regulatory Flexibility Act (``RFA'') \193\ requires Federal

agencies, in promulgating rules, to consider the impact of those rules

on small entities. Section 603(a) \194\ of the Administrative Procedure

Act,\195\ as amended by the RFA, generally requires the SEC to

undertake a regulatory flexibility analysis of all proposed rules, or

proposed rule amendments, to determine the impact of such rulemaking on

``small entities.'' \196\ Section 605(b) of the RFA provides that this

requirement shall not apply to any proposed rule or proposed rule

amendment, which if adopted, would not have a significant economic

impact on a substantial number of small entities.\197\

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

\193\ 5 U.S.C. 601 et seq.

\194\ 5 U.S.C. 603(a).

\195\ 5 U.S.C. 551 et seq.

\196\ Although Section 601(b) of the RFA defines the term

``small entity,'' the statute permits the Commissions to formulate

their own definitions. The SEC has adopted definitions for the term

small entity for the purposes of SEC rulemaking in accordance with

the RFA. Those definitions, as relevant to this proposed rulemaking,

are set forth in Rule 0-10, 17 CFR 240.0-10. See Securities Exchange

Act Release No. 18451 (Jan. 28, 1982), 47 FR 5215 (Feb. 4, 1982)

(File No. AS-305).

\197\ See 5 U.S.C. 605(b).

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

For purposes of SEC rulemaking in connection with the RFA, a small

entity includes: (i) When used with reference to an ``issuer'' or a

``person,'' other than an investment company, an ``issuer'' or

``person'' that, on the last day of its most recent fiscal year, had

total assets of $5 million or less,\198\ or (ii) a broker-dealer with

total capital (net worth plus subordinated liabilities) of less than

$500,000 on the date in the prior fiscal year as of which its audited

financial statements were prepared pursuant to Rule 17a-5(d) under the

Exchange Act,\199\ or, if not required to file such statements, a

broker-dealer with total capital (net worth plus subordinated

liabilities) of less than $500,000 on the last day of the preceding

fiscal year (or in the time that it has been in business, if shorter);

and is not affiliated with any person (other than a natural person)

that is not a small business or small organization.\200\ Under the

standards adopted by the Small Business Administration, small entities

in the finance and insurance industry include the following: (i) For

entities engaged in credit intermediation and related activities,

entities with $175 million or less in assets; \201\ (ii) for entities

engaged in non-depository credit intermediation and certain other

activities, entities with $7 million or less in annual receipts; \202\

(iii) for entities engaged in financial investments and related

activities, entities with $7 million or less in annual receipts; \203\

(iv) for insurance carriers and entities engaged in related activities,

entities with $7 million or less in annual receipts; \204\ and (v) for

funds, trusts, and other financial vehicles, entities with $7 million

or less in annual receipts.\205\

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

\198\ See 17 CFR 240.0-10(a).

\199\ See 17 CFR 240.17a-5(d).

\200\ See 17 CFR 240.0-10(c).

\201\ See 13 CFR 121.201 (Subsector 522).

\202\ See id. at Subsector 522.

\203\ See id. at Subsector 523.

\204\ See id. at Subsector 524.

\205\ See id. at Subsector 525.

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

Based on feedback from industry participants about the security-

based swap markets, the SEC preliminarily believes that entities that

would qualify as security-based swap dealers and major security-based

swap market participants, whether registered broker-dealers or not,

exceed the thresholds defining ``small entities'' set out above. Thus,

the SEC believes it is unlikely that the proposed rules would have a

significant economic impact any small entity.

For the foregoing reasons, the SEC certifies that the proposed

rules would not have a significant economic impact on a substantial

number of small entities for purposes of the RFA.

The SEC encourages written comments regarding this certification.

The SEC requests that commenters describe the nature of any impact on

small entities and provide empirical data to illustrate the extent of

the impact.

VII. Statutory Basis and Rule Text

List of Subjects

17 CFR Part 1

Definitions.

17 CFR Part 240

Reporting and recordkeeping requirements, Securities.

Commodity Futures Trading Commission

Text of Proposed Rules

For the reasons stated in this release, the CFTC is proposing to

amend 17 CFR part 1 as follows:

PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT

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

Authority: 7 U.S.C. 1a, 2, 5, 6, 6a, 6b, 6c, 6d, 6e, 6f, 6g, 6h,

6i, 6j, 6k, 6l, 6m, 6n, 6o, 6p, 7, 7a, 7b, 8, 9, 12, 12a, 12c, 13a,

13a-1, 16, 16a, 19, 21, 23, and 24, as amended by Title VII of the

Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L.

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

2. Amend Sec. 1.3 by:

a. Adding paragraph (m); and

b. As proposed to be amended at 75 FR 63762, October 18, 2010, and

75 FR 77576, December 13, 2010, adding (ppp) through (vvv) to read as

follows:

Sec. 1.3 Definitions

* * * * *

(m) Eligible contract participant. This term has the meaning set

forth in Section 1a(18) of the Commodity Exchange Act, except that:

(1) A major swap participant, as defined in Section 1a(33) of the

Commodity Exchange Act and Sec. 1.3(qqq), is an eligible contract

participant;

(2) A swap dealer, as defined in Section 1a(49) of the Commodity

Exchange Act and Sec. 1.3(ppp), is an eligible contract participant;

(3) A major security-based swap participant, as defined in Section

3(a)(67) of the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(67))

and Sec. 240.3a67-1 of this title, is an eligible contract

participant;

(4) A security-based swap dealer, as defined in Section 3(a)(71) of

the

[[Page 80212]]

Securities and Exchange Act of 1934 (15 U.S.C. 78c(a)(71)) and Sec.

240.3a71-1 of this title, is an eligible contract participant;

(5) A commodity pool with one or more direct or indirect

participants that is not an eligible contract participant is not an

eligible contract participant for purposes of Sections 2(c)(2)(B)(vi)

and 2(c)(2)(C)(vii) of the Commodity Exchange Act; and

(6) A commodity pool that does not have total assets exceeding

$5,000,000 or that is not operated by a person described in clause

(A)(iv)(II) of Section 1a(18) of the Commodity Exchange Act is not an

eligible contract participant pursuant to clause (A)(v) of such

Section.

* * * * *

(ppp) Swap Dealer. (1) In general. The term ``swap dealer'' means

any person who:

(i) Holds itself out as a dealer in swaps;

(ii) Makes a market in swaps;

(iii) Regularly enters into swaps with counterparties as an

ordinary course of business for its own account; or

(iv) Engages in any activity causing it to be commonly known in the

trade as a dealer or market maker in swaps.

(2) Exception. The term ``swap dealer'' does not include a person

that enters into swaps for such person's own account, either

individually or in a fiduciary capacity, but not as a part of regular

business.

(3) Scope. A person who is a swap dealer shall be deemed to be a

swap dealer with respect to each swap it enters into, regardless of the

category of the swap or the person's activities in connection with the

swap. However, if a person makes an application to limit its

designation as a swap dealer to specified categories of swaps or

specified activities of the person in connection with swaps, the

Commission shall determine whether the person's designation as a swap

dealer shall be so limited. A person may make such application to limit

its designation at the same time as, or at a later time subsequent to,

the person's initial registration as a swap dealer.

(4) De minimis exception. A person shall not be deemed to be a swap

dealer as a result of swap dealing activity involving counterparties

that meets each of the following conditions:

(i) The swap positions connected with those activities into which

the person enters over the course of the immediately preceding 12

months have an aggregate gross notional amount of no more than $100

million, and have an aggregate gross notional amount of no more than

$25 million with regard to swaps in which the counterparty is a

``special entity'' (as that term is defined in Section 4s(h)(2)(C) of

the Commodity Exchange Act). For purposes of this paragraph, if the

stated notional amount of a swap is leveraged or enhanced by the

structure of the swap, the calculation shall be based on the effective

notional amount of the swap rather than on the stated notional amount.

(ii) The person has not entered into swaps in connection with those

activities with more than 15 counterparties, other than swap dealers,

over the course of the immediately preceding 12 months. In determining

the number of counterparties, all counterparties that are members of a

single group of persons under common control shall be considered to be

a single counterparty.

(iii) The person has not entered into more than 20 swaps in

connection with those activities over the course of the immediately

preceding 12 months. For purposes of this paragraph, each transaction

entered into under a master agreement for swaps shall constitute a

distinct swap, but entering into an amendment of an existing swap in

which the counterparty to such swap remains the same and the item

underlying such swap remains substantially the same shall not

constitute entering into a swap.

(5) Insured depository institution swaps in connection with

originating loans to customers. Swaps entered into by an insured

depository institution with a customer in connection with originating a

loan with that customer shall not be considered in determining whether

such person is a swap dealer.

(i) A swap shall be considered to have been entered into in

connection with originating a loan only if the rate, asset, liability

or other notional item underlying such swap is, or is directly related

to, a financial term of such loan. The financial terms of a loan

include, without limitation, the loan's duration, rate of interest, the

currency or currencies in which it is made and its principal amount.

(ii) An insured depository institution shall be considered to have

originated a loan with a customer if the insured depository

institution:

(A) Directly transfers the loan amount to the customer;

(B) Is a part of a syndicate of lenders that is the source of the

loan amount that is transferred to the customer;

(C) Purchases or receives a participation in the loan; or

(D) Otherwise is the source of funds that are transferred to the

customer pursuant to the loan or any refinancing of the loan.

(iii) The term loan shall not include:

(A) Any transaction that is a sham, whether or not intended to

qualify for the exclusion from the definition of the term swap dealer

in this rule; or

(B) Any synthetic loan, including without limitation a loan credit

default swap or loan total return swap.

(qqq) Major Swap Participant. (1) In general. The term major swap

participant means any person:

(i) That is not a swap dealer; and

(ii)(A) That maintains a substantial position in swaps for any of

the major swap categories, excluding both positions held for hedging or

mitigating commercial risk, and positions maintained by any employee

benefit plan (or any contract held by such a plan) as defined in

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

Security Act of 1974 (29 U.S.C. 1002) for the primary purpose of

hedging or mitigating any risk directly associated with the operation

of the plan;

(B) Whose outstanding swaps create substantial counterparty

exposure that could have serious adverse effects on the financial

stability of the United States banking system or financial markets; or

(C) That is a financial entity that:

(1) Is highly leveraged relative to the amount of capital such

entity holds and that is not subject to capital requirements

established by an appropriate Federal banking agency (as defined in

Section 1a(2) of the Commodity Exchange Act); and

(2) Maintains a substantial position in outstanding swaps in any

major swap category.

(2) Scope of designation. A person that is a major swap participant

shall be deemed to be a major swap participant with respect to each

swap it enters into, regardless of the category of the swap or the

person's activities in connection with the swap. However, if a person

makes an application to limit its designation as a major swap

participant to specified categories of swaps or specified activities of

the person in connection with swaps, the Commission shall determine

whether the person's designation as a major swap participant shall be

so limited. A person may make such application to limit its designation

at the same time as, or at a later time subsequent to, the person's

initial registration as a major swap participant.

(3) Timing requirements. A person that is not registered as a major

swap participant, but that meets the criteria in this rule to be a

major swap participant as a result of its swap activities in a

[[Page 80213]]

fiscal quarter, will not be deemed to be a major swap participant until

the earlier of the date on which it submits a complete application for

registration as a major swap participant or two months after the end of

that quarter.

(4) Reevaluation period. Notwithstanding paragraph (qqq)(3) of this

section, if a person that is not registered as a major swap participant

meets the criteria in this rule to be a major swap participant in a

fiscal quarter, but does not exceed any applicable threshold by more

than twenty percent in that quarter:

(i) That person will not immediately be subject to the timing

requirements specified in paragraph (qqq)(3) of this section; but

(ii) That person will become subject to the timing requirements

specified in paragraph (3) at the end of the next fiscal quarter if the

person exceeds any of the applicable daily average thresholds in that

next fiscal quarter.

(5) Termination of status. A person that is deemed to be a major

swap participant shall continue to be deemed a major swap participant

until such time that its swap activities do not exceed any of the daily

average thresholds set forth within this rule for four consecutive

fiscal quarters after the date on which the person becomes registered

as a major swap participant.

(rrr) Category of swaps; major swap category. For purposes of

Sections 1a(33) and 1a(49) of the Commodity Exchange Act and Sec. Sec.

1.3(ppp) and 1.3(qqq), the terms major swap category, category of swaps

and any similar terms mean any of the categories of swaps listed below.

For the avoidance of doubt, the term swap as it is used in this Sec.

1.3(rrr) has the meaning set forth in Section 1a(47) of the Commodity

Exchange Act and the rules thereunder.

(1) Rate swaps. Any swap which is primarily based on one or more

reference rates, including but not limited to any swap of payments

determined by fixed and floating interest rates, currency exchange

rates, inflation rates or other monetary rates, any foreign exchange

swap, as defined in Section 1a(25) of the Commodity Exchange Act, and

any foreign exchange option.

(2) Credit swaps. Any swap that is primarily based on instruments

of indebtedness, including but not limited to any swap primarily based

on one or more broad-based indices related to debt instruments, and any

swap that is an index credit default swap or total return swap on one

or more indices of debt instruments.

(3) Equity swaps. Any swap that is primarily based on equity

securities, including but not limited to any swap based on one or more

broad-based indices of equity securities and any total return swap on

one or more equity indices.

(4) Other commodity swaps. Any swap that is not included in the

rate swap, credit swap or equity swap categories.

(sss) Substantial position. (1) In general. For purposes of Section

1a(33) of the Commodity Exchange Act and Sec. 1.3(qqq), the term

substantial position means swap positions, other than positions that

are excluded from consideration, that equal or exceed any of the

following thresholds in the specified major category of swaps:

(i) For rate swaps:

(A) $3 billion in daily average aggregate uncollateralized outward

exposure; or

(B) $6 billion in:

(1) Daily average aggregate uncollateralized outward exposure plus

(2) Daily average aggregate potential outward exposure.

(ii) For credit swaps:

(A) $1 billion in daily average aggregate uncollateralized outward

exposure; or

(B) $2 billion in:

(1) Daily average aggregate uncollateralized outward exposure plus

(2) Daily average aggregate potential outward exposure.

(iii) For equity swaps:

(A) $1 billion in daily average aggregate uncollateralized outward

exposure; or

(B) $2 billion in:

(1) Daily average aggregate uncollateralized outward exposure plus

(2) Daily average aggregate potential outward exposure.

(iv) For other commodity swaps:

(A) $1 billion in daily average aggregate uncollateralized outward

exposure; or

(B) $2 billion in:

(1) Daily average aggregate uncollateralized outward exposure plus

(2) Daily average aggregate potential outward exposure.

(2) Aggregate uncollateralized outward exposure. (i) In general.

Aggregate uncollateralized outward exposure in general means the sum of

the current exposure, obtained by marking-to-market using industry

standard practices, of each of the person's swap positions with

negative value in a major swap category, less the value of the

collateral the person has posted in connection with those positions.

(ii) Calculation of aggregate uncollateralized outward exposure. In

calculating this amount the person shall, with respect to each of its

swap counterparties in a given major swap category:

(A) Determine the dollar value of the aggregate current exposure

arising from each of its swap positions with negative value (subject to

the netting provisions described below) in that major category by

marking-to-market using industry standard practices; and

(B) Deduct from that dollar amount the aggregate value of the

collateral the person has posted with respect to the swap positions.

The aggregate uncollateralized outward exposure shall be the sum of

those uncollateralized amounts across all of the person's swap

counterparties in the applicable major category.

(iii) Relevance of netting agreements. (A) If the person has a

master netting agreement in effect with a particular counterparty, the

person may measure the current exposure arising from its swaps in any

major category on a net basis, applying the terms of the agreement.

Calculation of net exposure may take into account offsetting positions

entered into with that particular counterparty involving swaps (in any

swap category) as well as security-based swaps and securities financing

transactions (consisting of securities lending and borrowing,

securities margin lending and repurchase and reverse repurchase

agreements), to the extent these are consistent with the offsets

permitted by the master netting agreement.

(B) Such adjustments may not take into account any offset

associated with positions that the person has with separate

counterparties.

(3) Aggregate potential outward exposure. (i) In general. Aggregate

potential outward exposure in any major swap category means the sum of:

(A) The aggregate potential outward exposure for each of the

person's swap positions in a major swap category that are not subject

to daily mark-to-market margining and are not cleared by a registered

clearing agency or derivatives clearing organization, as calculated in

accordance with paragraph (sss)(3)(ii); and

(B) The aggregate potential outward exposure for each of the

person's swap positions in such major swap category that are subject to

daily mark-to-market margining or are cleared by a registered clearing

agency or derivatives clearing organization, as calculated in

accordance with paragraph (sss)(3)(iii) of this section.

(ii) Calculation of potential outward exposure for swaps that are

not subject to daily mark-to-market margining and are not cleared by a

registered clearing

[[Page 80214]]

agency or derivatives clearing organization. (A) In general. (1) For

positions in swaps that are not subject to daily mark-to-market

margining and are not cleared by a registered clearing agency or a

derivatives clearing organization, potential outward exposure equals

the total notional principal amount of those positions, adjusted by the

following multipliers on a position-by-position basis reflecting the

type of swap. For any swap that does not appropriately fall within any

of the specified categories, the ``other commodities'' conversion

factors are to be used. If a swap is structured such that on specified

dates any outstanding exposure is settled and the terms are reset so

that the market value of the swap is zero, the remaining maturity

equals the time until the next reset date.

Table to Sec. 1.3 (sss)--Conversion Factor Matrix for Swaps

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

Foreign exchange Precious metals

Residual maturity Interest rate rate and gold (except gold) Other commodities

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

One year or less............ 0.00 0.01 0.07 0.10

Over one to five years...... 0.005 0.05 0.07 0.12

Over five years............. 0.015 0.075 0.08 0.15

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

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

Residual maturity Credit Equity

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

One year or less.............. 0.10 0.06

Over one to five years........ 0.10 0.08

Over five years............... 0.10 0.10

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

(2) Use of effective notional amounts. If the stated notional

amount on a position is leveraged or enhanced by the structure of the

position, the calculation in paragraph (sss)(3)(ii)(A)(1) of this

section shall be based on the effective notional amount of the position

rather than on the stated notional amount.

(3) Exclusion of certain positions. The calculation in paragraph

(sss)(3)(ii)(A)(1) of this section shall exclude:

(i) Positions that constitute the purchase of an option, such that

the person has no additional payment obligations under the position;

and

(ii) Other positions for which the person has prepaid or otherwise

satisfied all of its payment obligations.

(4) Adjustment for certain positions. Notwithstanding paragraph

(sss)(3)(ii)(A)(1) of this section, the potential outward exposure

associated with a position by which a person buys credit protection

using a credit default swap or index credit default swap is capped at

the net present value of the unpaid premiums.

(B) Adjustment for netting agreements. Notwithstanding paragraph

(sss)(3)(ii)(A) of this section, for positions subject to master

netting agreements the potential outward exposure associated with the

person's swaps with each counterparty equals a weighted average of the

potential outward exposure for the person's swaps with that

counterparty as calculated under paragraph (sss)(3)(ii)(A), and that

amount reduced by the ratio of net current exposure to gross current

exposure, consistent with the following equation as calculated on a

counterparty-by-counterparty basis:

PNet = 0.4 * PGross + 0.6 * NGR * PGross

Note to paragraph (sss)(3)(ii)(B): PNet is the potential outward

exposure, adjusted for bilateral netting, of the person's swaps with

a particular counterparty; PGross is that potential outward exposure

without adjustment for bilateral netting; and NGR is the ratio of

net current exposure to gross current exposure.

(iii) Calculation of potential outward exposure for swaps that are

subject to daily mark-to-market margining or are cleared by a

registered clearing agency or derivatives clearing organization. For

positions in swaps that are subject to daily mark-to-market margining

or cleared by a registered clearing agency or derivatives clearing

organization:

(A) Potential outward exposure equals the potential exposure that

would be attributed to such positions using the procedures in paragraph

(sss)(3)(ii) of this section multiplied by 0.2.

(B) For purposes of this calculation, a swap shall be considered to

be subject to daily mark-to-market margining if, and for so long as,

the counterparties follow the daily practice of exchanging collateral

to reflect changes in the current exposure arising from the swap (after

taking into account any other financial positions addressed by a

netting agreement between the counterparties. If the person is

permitted by agreement to maintain a threshold for which it is not

required to post collateral, the total amount of that threshold

(regardless of the actual exposure at any time) shall be added to the

person's aggregate uncollateralized outward exposure for purposes of

paragraph (sss)(1)(i)(B), (ii)(B), (iii)(B) or (iv)(B) of this section,

as applicable. If the minimum transfer amount under the agreement is in

excess of $1 million, the entirety of the minimum transfer amount shall

be added to the person's aggregate uncollateralized outward exposure

for purposes of paragraph (sss)(1)(i)(B), (ii)(B), (iii)(B) or (iv)(B),

as applicable.

(4) Calculation of daily average. Measures of daily average

aggregate uncollateralized outward exposure and daily average aggregate

potential outward exposure shall equal the arithmetic mean of the

applicable measure of exposure at the close of each business day,

beginning the first business day of each calendar quarter and

continuing through the last business day of that quarter.

(ttt) Hedging or mitigating commercial risk. For purposes of

Section 1a(33) of the Commodity Exchange Act and Sec. 1.3(qqq), a swap

position shall be deemed to be held for the purpose of hedging or

mitigating commercial risk when:

(1) Such position:

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

conduct and management of a commercial enterprise, where the risks

arise from:

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

produces, manufactures, processes, or merchandises or reasonably

anticipates owning, producing, manufacturing, processing, or

merchandising in the ordinary course of business of the enterprise;

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

has incurred or reasonably anticipates incurring in the ordinary course

of business of the enterprise; or

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

provides, purchases, or reasonably anticipates

[[Page 80215]]

providing or purchasing in the ordinary course of business of the

enterprise;

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

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

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

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

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

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

arising from foreign exchange rate movements associated with such

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

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

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

liabilities; or

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

from position limits under the Commodity Exchange Act; or

(iii) Qualifies for hedging treatment under Financial Accounting

Standards Board Accounting Standards Codification Topic 815,

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

(2) Such position is:

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

investing or trading;

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

securities-based swap position, unless that other position itself is

held for the purpose of hedging or mitigating commercial risk as

defined by this rule or Sec. 240.3a67-4 of this title.

(uuu) Substantial counterparty exposure. (1) In general. For

purposes of Section 1a(33) of the Act and Sec. 1.3(qqq), the phrase

substantial counterparty exposure that could have serious adverse

effects on the financial stability of the United States banking system

or financial markets means a swap position that satisfies either of the

following thresholds:

(i) $5 billion in daily average aggregate uncollateralized outward

exposure; or

(ii) $8 billion in:

(A) Daily average aggregate uncollateralized outward exposure plus

(B) Daily average aggregate potential outward exposure.

(2) Calculation methodology. For these purposes, the terms ``daily

average aggregate uncollateralized outward exposure'' and ``daily

average aggregate potential outward exposure'' have the same meaning as

in Sec. 1.3(sss), except that these amounts shall be calculated by

reference to all of the person's swap positions, rather than by

reference to a specific major swap category.

(vvv) Financial entity; highly leveraged. (1) For purposes of

Section 1a(33) of the Commodity Exchange Act and Sec. 1.3(qqq), the

term ``financial entity'' means:

(i) A security-based swap dealer;

(ii) A major security-based swap participant;

(iii) A commodity pool as defined in Section 1a(10) of the

Commodity Exchange Act;

(iv) A private fund as defined in Section 202(a) of the Investment

Advisers Act of 1940 (15 U.S.C. 80b-2(a));

(v) An employee benefit plan as defined in paragraphs (3) and (32)

of Section 3 of the Employee Retirement Income Security Act of 1974 (29

U.S.C. 1002); and

(vi) A person predominantly engaged in activities that are in the

business of banking or financial in nature, as defined in Section 4(k)

of the Bank Holding Company Act of 1956.

(2) For purposes of Section 1a(33) of the Commodity Exchange Act

and Sec. 1.3(qqq), the term ``highly leveraged'' means the existence

of a ratio of an entity's total liabilities to equity in excess of [8

to 1 or 15 to 1] as measured at the close of business on the last

business day of the applicable fiscal quarter. For this purpose,

liabilities and equity should each be determined in accordance with

U.S. generally accepted accounting principles.

Securities and Exchange Commission

Pursuant to the Exchange Act, 15 U.S.C. 78a et seq., and

particularly, Sections 3 and 23 thereof, and Sections 712 and 761(b) of

the Dodd-Frank Act, the SEC is proposing to adopt Rules 3a67-1, 3a67-2,

3a67-3, 3a67-4, 3a67-5, 3a67-6, 3a67-7, 3a71-1, and 3a71-2 under the

Exchange Act.

Text of Proposed Rules

For the reasons stated in the preamble, the SEC is proposing to

amend Title 17, Chapter II of the Code of the Federal Regulations as

follows:

PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF

1934

1. The authority citation for part 240 is amended by adding the

following citation in numerical order:

Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3,

77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78d, 78e, 78f, 78g, 78i,

78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78o, 78o-4, 78p, 78q, 78s,

78u-5, 78w, 78x, 78ll, 78mm, 80a-20, 80a-23, 80a-29, 80a-37, 80b-3,

80b-4, 80b-11, and 7201 et seq., 18 U.S.C. 1350; and 12 U.S.C.

5221(e)(3), unless otherwise noted.

* * * * *

Sections 3a67-1 through 3a67-7 and sections 3a71-1 and 3a71-2

are also issued under Pub. L. 111-203, Sec. Sec. 712, 761(b), 124

Stat. 1841 (2010).

* * * * *

2. Add Sec. Sec. 240.3a67-1 through 240.3a67-7 and Sec. Sec.

240.3a71-1, 240.3a71-2 to read as follows:

* * * * *

Sec.

240.3a67 1--Definition of ``Major Security-based Swap Participant.''

240.3a67 2--Categories of Security-based Swaps.

240.3a67 3--Definition of ``Substantial Position.''

240.3a67 4--Definition of ``Hedging or Mitigating Commercial Risk.''

240.3a67 5--Definition of ``Substantial Counterparty Exposure.''

240.3a67 6--Definitions of ``Financial Entity'' and ``Highly

Leveraged.''

240.3a67 7--Timing Requirements, Reevaluation Period, and

Termination of Status.

240.3a71 1--Definition of ``Security-based Swap Dealer.

240.3a71 2--De minimis Exception.

* * * * *

Sec. 240.3a67-1 Definition of ``Major Security-based Swap

Participant.''

(a) General. Major security-based swap participant means any

person:

(1) That is not a security-based swap dealer; and

(2)(i) That maintains a substantial position in security-based

swaps for any of the major security-based swap categories, excluding

both positions held for hedging or mitigating commercial risk, and

positions maintained by any employee benefit plan (or any contract held

by such a plan) as defined in paragraphs (3) and (32) of section 3 of

the Employee Retirement Income Security Act of 1974 (29 U.S.C. 1002)

for the primary purpose of hedging or mitigating any risk directly

associated with the operation of the plan;

(ii) Whose outstanding security-based swaps create substantial

counterparty exposure that could have serious adverse effects on the

financial stability of the United States banking system or financial

markets; or

(iii) That is a financial entity that:

(A) Is highly leveraged relative to the amount of capital such

entity holds and that is not subject to capital requirements

established by an appropriate Federal banking agency (as defined in 15

U.S.C. 78c(a)(72)); and

(B) Maintains a substantial position in outstanding security-based

swaps in any major security-based swap category.

[[Page 80216]]

(b) Scope of designation. A person that is a major security-based

swap participant in general shall be deemed to be a major security-

based swap participant with respect to each security-based swap it

enters into, regardless of the category of the security-based swap or

the person's activities in connection with the security-based swap,

unless the Commission limits the person's designation as a major

security-based swap participant to specified categories of security-

based swaps or specified activities of the person in connection with

security-based swaps.

Sec. 240.3a67-2 Categories of Security-based Swaps.

For purposes of sections 3(a)(67) and 3(a)(71) of the Act, 15

U.S.C. 78c(a)(67) and 78c(a)(71), and the rules thereunder, the terms

major security-based swap category, category of security-based swaps

and any similar terms mean either of the following categories of

security-based swaps:

(a) Security-based credit derivatives. Any security-based swap that

is based, in whole or in part, on one or more instruments of

indebtedness (including loans), or on a credit event relating to one or

more issuers or securities, including but not limited to any security-

based swap that is a credit default swap, total return swap on one or

more debt instruments, debt swap, debt index swap, or credit spread.

(b) Other security-based swaps. Any security-based swap not

described in paragraph (a) of this section.

Sec. 240.3a67-3 Definition of ``Substantial Position.''

(a) General. For purposes of section 3(a)(67) of the Act, 15 U.S.C.

78c(a)(67), and Sec. 240.3a67-1 of this chapter, the term substantial

position means security-based swap positions, other than positions that

are excluded from consideration, that equal or exceed either of the

following thresholds in any major category of security-based swaps:

(1) $1 billion in daily average aggregate uncollateralized outward

exposure; or

(2) $2 billion in:

(i) Daily average aggregate uncollateralized outward exposure; plus

(ii) Daily average aggregate potential outward exposure.

(b) Aggregate uncollateralized outward exposure. (1) General.

Aggregate uncollateralized outward exposure in general means the sum of

the current exposure, obtained by marking-to-market using industry

standard practices, of each of the person's security-based swap

positions with negative value in a major security-based swap category,

less the value of the collateral the person has posted in connection

with those positions.

(2) Calculation of aggregate uncollateralized outward exposure. In

calculating this amount the person shall, with respect to each of its

security-based swap counterparties in a given major security-based swap

category:

(i) Determine the dollar value of the aggregate current exposure

arising from each of its security-based swap positions with negative

value (subject to the netting provisions described below) in that major

category by marking-to-market using industry standard practices; and

(ii) Deduct from that dollar amount the aggregate value of the

collateral the person has posted with respect to the security-based

swap positions. The aggregate uncollateralized outward exposure shall

be the sum of those uncollateralized amounts across all of the person's

security-based swap counterparties in the applicable major category.

(3) Relevance of netting agreements. (i) If a person has a master

netting agreement with a counterparty, the person may measure the

current exposure arising from its security-based swaps in any major

category on a net basis, applying the terms of the agreement.

Calculation of net exposure may take into account offsetting positions

entered into with that particular counterparty involving security-based

swaps (in any swap category) as well as swaps and securities financing

transactions (consisting of securities lending and borrowing,

securities margin lending and repurchase and reverse repurchase

agreements), to the extent these are consistent with the offsets

permitted by the master netting agreement.

(ii) Such adjustments may not take into account any offset

associated with positions that the person has with separate

counterparties.

(c) Aggregate potential outward exposure. (1) General. Aggregate

potential outward exposure means the sum of:

(i) The aggregate potential outward exposure for each of the

person's security-based swap positions in a major security-based swap

category that are not cleared by a registered clearing agency or

subject to daily mark-to-market margining, as calculated in accordance

with paragraph (c)(2) of this section; and

(ii) The aggregate potential outward exposure for each of the

person's security-based swap positions in a major security-based swap

category that are cleared by a registered clearing agency or subject to

daily mark-to-market margining, as calculated in accordance with

paragraph (c)(3) of this section.

(2) Calculation of potential outward exposure for security-based

swaps that are not cleared by a registered clearing agency or subject

to daily mark-to-market margining.

(i) General. (A)(1) For positions in security-based swaps that are

not cleared by a registered clearing agency or subject to daily mark-

to-market margining, potential outward exposure equals the total

notional principal amount of those positions, multiplied by the

following factors on a position-by-position basis reflecting the type

of security-based swap. For any security-based swap that is not of the

``credit'' or ``equity'' type, the ``other'' conversion factors are to

be used:

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

Residual maturity Credit Equity Other

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

One year or less................................. 0.10 0.06 0.10

Over one to five years........................... 0.10 0.08 0.12

Over five years.................................. 0.10 0.10 0.15

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

(2) If a security-based swap is structured such that on specified

dates any outstanding exposure is settled and the terms are reset so

that the market value of the security-based swap is zero, the remaining

maturity equals the time until the next reset date.

(B) Use of effective notional amounts. If the stated notional

amount on a position is leveraged or enhanced by the structure of the

position, the calculation in paragraph (c)(2)(i)(A) of this section

shall be based on the effective notional amount of the position rather

than on the stated notional amount.

[[Page 80217]]

(C) Exclusion of certain positions. The calculation in paragraph

(c)(2)(i)(A) of this section shall exclude:

(1) Positions that constitute the purchase of an option, such that

the person has no additional payment obligations under the position;

and

(2) Other positions for which the person has prepaid or otherwise

satisfied all of its payment obligations.

(D) Adjustment for certain positions. Notwithstanding paragraph

(c)(2)(i)(A) of this section, the potential outward exposure associated

with a position by which a person buys credit protection using a credit

default swap is capped at the net present value of the unpaid premiums.

(ii) Adjustment for netting agreements. Notwithstanding paragraph

(c)(2)(i) of this section, for positions subject to master netting

agreements the potential outward exposure associated with the person's

security-based swaps with each counterparty equals a weighted average

of the potential outward exposure for the person's security-based swaps

with that counterparty as calculated under paragraph (c)(2)(i) of this

section, and that amount reduced by the ratio of net current exposure

to gross current exposure, consistent with the following equation as

calculated on a counterparty-by-counterparty basis:

PNet = 0.4 x PGross + 0.6 x NGR x PGross

Note to paragraph (c)(2)(ii). Where: PNet is the potential

outward exposure, adjusted for bilateral netting, of the person's

security-based swaps with a particular counterparty; PGross is that

potential outward exposure without adjustment for bilateral netting;

and NGR is the ratio of net current exposure to gross current

exposure.

(3) Calculation of potential outward exposure for security-based

swaps that are cleared by a registered clearing agency or subject to

daily mark-to-market margining. For positions in security-based swaps

that are cleared by a registered clearing agency or subject to daily

mark-to-market margining:

(i) Potential outward exposure equals the potential outward

exposure that would be attributed to such positions using the

procedures in paragraph (c)(2) of this section, multiplied by 0.2.

(ii) For purposes of this calculation, a security-based swap shall

be considered to be subject to daily mark-to-market margining if, and

for as long as, the counterparties follow the daily practice of

exchanging collateral to reflect changes in the current exposure

arising from the security-based swap (after taking into account any

other financial positions addressed by a netting agreement between the

counterparties). If the person is permitted by agreement to maintain a

threshold for which it is not required to post collateral, the total

amount of that threshold (regardless of the actual exposure at any

time) shall be added to the person's aggregate uncollateralized outward

exposure for purposes of paragraph (a)(2) of this section. If the

minimum transfer amount under the agreement is in excess of $1 million,

the entirety of the minimum transfer amount shall be added to the

person's aggregate uncollateralized outward exposure for purposes of

paragraph (a)(2) of this section.

(d) Calculation of daily average. Measures of daily average

aggregate uncollateralized outward exposure and daily average aggregate

potential outward exposure shall equal the arithmetic mean of the

applicable measure of exposure at the close of each business day,

beginning the first business day of each calendar quarter and

continuing through the last business day of that quarter.

Sec. 240.3a67-4 Definition of ``Hedging or Mitigating Commercial

Risk.''

For purposes of section 3(a)(67) of the Act, 15 U.S.C. 78c(a)(67),

and Sec. 240.3a67-1 of this chapter, a security-based swap position

shall be deemed to be held for the purpose of hedging or mitigating

commercial risk when:

(a) Such position is economically appropriate to the reduction of

risks that are associated with the present conduct and management of a

commercial enterprise, or are reasonably expected to arise in the

future conduct and management of the commercial enterprise, where such

risks arise from:

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

produces, manufactures, processes, or merchandises or reasonably

anticipates owning, producing, manufacturing, processing, or

merchandising in the ordinary course of business of the enterprise;

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

has incurred or reasonably anticipates incurring in the ordinary course

of business of the enterprise; or

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

provides, purchases, or reasonably anticipates providing or purchasing

in the ordinary course of business of the enterprise;

(b) Such position is:

(1) Not held for a purpose that is in the nature of speculation or

trading; and

(2) Not held to hedge or mitigate the risk of another security-

based swap position or swap position, unless that other position itself

is held for the purpose of hedging or mitigating commercial risk as

defined by this section or 17 CFR 1.3(ttt); and

(c) The person holding the position satisfies the following

additional conditions:

(1) The person identifies and documents the risks that are being

reduced by the security-based swap position;

(2) The person establishes and documents a method of assessing the

effectiveness of the security-based swap as a hedge; and

(3) The person regularly assesses the effectiveness of the

security-based swap as a hedge.

Sec. 240.3a67-5 Definition of ``Substantial Counterparty Exposure.''

(a) General. For purposes of section 3(a)(67) of the Act, 15 U.S.C.

78c(a)(67), and Sec. 240.3a67-1 of this chapter, the term substantial

counterparty exposure that could have serious adverse effects on the

financial stability of the United States banking system or financial

markets means a security-based swap position that satisfies either of

the following thresholds:

(1) $2 billion in daily average aggregate uncollateralized outward

exposure; or

(2) $4 billion in:

(i) Daily average aggregate uncollateralized outward exposure; plus

(ii) Daily average aggregate potential outward exposure.

(b) Calculation. For these purposes, daily average aggregate

uncollateralized outward exposure and daily average aggregate potential

outward exposure shall be calculated the same way as is prescribed in

Sec. 240.3a67-3 of this chapter, except that these amounts shall be

calculated by reference to all of the person's security-based swap

positions, rather than by reference to a specific major security-based

swap category.

Sec. 240.3a67-6 Definitions of ``Financial Entity'' and ``Highly

Leveraged.''

(a) For purposes of section 3(a)(67) of the Act, 15 U.S.C.

78c(a)(67), and Sec. 240.3a67-1 of this chapter, the term financial

entity means:

(1) A swap dealer;

(2) A major swap participant;

(3) A commodity pool as defined in section 1a(10) of the Commodity

Exchange Act (7 U.S.C. 1a(10));

(4) A private fund as defined in section 202(a) of the Investment

Advisers Act of 1940 (15 U.S.C. 80b-2(a));

(5) An employee benefit plan as defined in paragraphs (3) and (32)

of section 3 of the Employee Retirement Income Security Act of 1974 (29

U.S.C. 1002); and

[[Page 80218]]

(6) A person predominantly engaged in activities that are in the

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

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

(b) For purposes of section 3(a)(67) of the Act, 15 U.S.C.

78c(a)(67), and Sec. 240.3a67-1 of this chapter, the term highly

leveraged means the existence of a ratio of an entity's total

liabilities to equity in excess of [8 to 1 or 15 to 1] as measured at

the close of business on the last business day of the applicable fiscal

quarter. For this purpose, liabilities and equity should each be

determined in accordance with U.S. generally accepted accounting

principles.

Sec. 240.3a67-7 Timing Requirements, Reevaluation Period, and

Termination of Status.

(a) Timing requirements. A person that is not registered as a major

security-based swap participant, but that meets the criteria in Sec.

240.3a67-1 of this chapter to be a major security-based swap

participant as a result of its security-based swap activities in a

fiscal quarter, will not be deemed to be a major security-based swap

participant until the earlier of the date on which it submits a

complete application for registration pursuant to 15 U.S.C. 78o-8 or

two months after the end of that quarter.

(b) Reevaluation period. Notwithstanding paragraph (a) of this

section, if a person that is not registered as a major security-based

swap participant meets the criteria in Sec. 240.3a67-1 of this chapter

to be a major security-based swap participant in a fiscal quarter, but

does not exceed any applicable threshold by more than twenty percent in

that quarter:

(1) That person will not immediately be subject to the timing

requirements specified in paragraph (a) of this section; but

(2) That person will become subject to the timing requirements

specified in paragraph (a) of this section at the end of the next

fiscal quarter if the person exceeds any of the applicable daily

average thresholds in that next fiscal quarter.

(c) Termination of status. A person that is deemed to be a major

security-based swap participant shall continue to be deemed a major

security-based swap participant until such time that its security-based

swap activities do not exceed any of the daily average thresholds set

forth within Sec. 240.3a67-1 of this chapter for four consecutive

fiscal quarters after the date on which the person becomes registered

as a major security-based swap participant.

Sec. 240.3a71-1 Definition of ``Security-based Swap Dealer.''

(a) General. The term security-based swap dealer in general means

any person who:

(1) Holds itself out as a dealer in security-based swaps;

(2) Makes a market in security-based swaps;

(3) Regularly enters into security-based swaps with counterparties

as an ordinary course of business for its own account; or

(4) Engages in any activity causing it to be commonly known in the

trade as a dealer or market maker in security-based swaps.

(b) Exception. The term security-based swap dealer does not include

a person that enters into security-based swaps for such person's own

account, either individually or in a fiduciary capacity, but not as a

part of regular business.

(c) Scope of designation. A person that is a security-based swap

dealer in general shall be deemed to be a security-based swap dealer

with respect to each security-based swap it enters into, regardless of

the category of the security-based swap or the person's activities in

connection with the security-based swap, unless the Commission limits

the person's designation as a major security-based swap participant to

specified categories of security-based swaps or specified activities of

the person in connection with security-based swaps.

Sec. 240.3a71-2 De minimis Exception.

For purposes of section 3(a)(71) of the Act, 15 U.S.C. 78c(a)(71),

and Sec. 240.3a71-1 of this chapter, a person shall not be deemed to

be a security-based swap dealer as a result of security-based swap

dealing activity involving counterparties that meets each of the

following conditions:

(a) Notional amount of outstanding security-based swap positions.

The security-based swap positions connected with those activities into

which the person enters over the course of the immediately preceding 12

months have an aggregate gross notional amount of no more than $100

million and have an aggregate gross notional amount of no more than $25

million with regard to security-based swaps in which the counterparty

is a ``special entity'' (as that term is defined in 15 U.S.C. 78o-8).

For purposes of this paragraph (a), if the stated notional amount of a

security-based swap is leveraged or enhanced by the structure of the

security-based swap, the calculation shall be based on the effective

notional amount of the security-based swap rather than on the stated

notional amount.

(b) No more than 15 counterparties. The person does not enter into

security-based swaps in connection with those activities with more than

15 counterparties, other than security-based swap dealers, over the

course of the immediately preceding 12 months. In determining the

number of counterparties, all counterparties that are members of a

single affiliated group shall be considered to be a single

counterparty.

(c) No more than 20 security-based swaps. The person has not

entered into more than 20 security-based swaps in connection with those

activities over the course of the immediately preceding 12 months. For

purposes of this paragraph, each transaction entered into under a

master agreement for security-based swaps shall constitute a distinct

security-based swap, but entering into an amendment of an existing

security-based swap in which the counterparty to such swap remains the

same and the notional item underlying such security-based swap remains

substantially the same shall not constitute entering into a security-

based swap.

Dated: December 1, 2010.

By the Commodity Futures Trading Commission.

David A. Stawick,

Secretary.

Dated: December 7, 2010.

By the Securities and Exchange Commission.

Elizabeth M. Murphy,

Secretary.

Additional Statement by the Commodity Futures Trading Commission

Regarding the Joint Proposed Rule Entitled ``Further Definition of

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

`Major Security-Based Swap Participant,' and `Eligible Contract

Participant.'''

On this matter, Chairman Gensler and Commissioners Dunn and Chilton

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

the negative.

[FR Doc. 2010-31130 Filed 12-20-10; 8:45 am]

BILLING CODE 6351-01-P; 8011-01-P

Last Updated: May 3, 2011